In what scenario would market value and investment value diverge most?

• A. When the investor's required return differs from market's return expectations.
• B. When replacement cost equals sale price.
• C. When property tax assessment aligns with sale price.
• D. When there are perfect market conditions with equal risk.

Answer: (A)

The key idea is that market value and investment value move with different discount rates. Market value reflects what the market is willing to pay based on prevailing return expectations, while investment value reflects what a specific investor requires, discounted at that investor’s own rate of return.

Divergence is largest when the investor’s required return differs from the market’s return expectations. If the market implies a lower rate of return than the investor requires, the investment value will fall relative to market value; if the investor requires a higher rate, the investment value rises relative to market value. The bigger the gap between the investor’s required return and the market’s expected return, the greater the divergence.

Other scenarios describe situations where valuations would align more closely (or at least not diverge as much), such as when replacement cost equals sale price, tax assessments align with price, or conditions are perfectly matched with equal risk.