The time value of money (TVM) is an economic principle that a dollar received today has greater value than a dollar received in the future. The following questions are important to know.
Compounding is the process of determining the future value (FV) of an investment made today (PV) and/or a series of equal payments made each period (PMT). It assumes that interest that is earned is reinvested to earn additional interest over the life of the investment. Discounting is the process of determining the present value (PV) of money to be received in the future (FV or PMT) as a lump sum or payments. PV is the lump sum amount received today of all future cash flow benefits discounted back to the present at a discount rate.
CD certificate of deposit where money deposited remains in the account and interest is earned until the CD matures or investment where funds are invested and not withdrawn until the investment is sold. Investor buys land $100,000 (PV) and the property increases in value by 9% per year. What is it worth at the end of the 10th year?
Inputs PV = -100,000 PMT= 0 I/YR = 9% P/YR=1 Pay at beg of period=OFF Years=10 FV=?
Results n=10 FV = 236,736
Rent or Lease payments or recurring deposit situations - annuities. Investor deposits $10,000 (PMT) at the end of the year for the next 10 years earning 10% compounded. What is it worth at the end of the 10th year?
Inputs PV= 0 PMT =-10,000 I/YR = 10% P/YR=1 Pay at beg of period=OFF Years=10 FV=?
Results n=10 FV = 159,374
It is a stream of equal payments set aside to reach a future target amount like a college fund, a retirement account or planned savings. Rental property needs the parking lot resurfaced in three years, the estimated cost is $50,000. How much is needs to be invested each month at the end of each month for three years earning 10% is needed? Inputs PV= 0 PMT =? I/YR = 10% P/YR=12 Pay at beg of period=OFF FV=50,000 Years=3
Results n=12x3=36 PMT = -1197
Investments held for their appreciation potential such as art or land. Investor is buying a tract of land you hope will sell for $1,300,000 three years from now. What would the investor pay today with an annual of 10% yield?
Inputs PMT=0 I/YR = 10% P/YR=1 Pay at beg of period=OFF FV=1,300,000 Years=3 PV= ?
Results n=3 PV = -976,709
Investments who buy mortgages. What is the value of a series of $1,000 payments, to be received at the end of each month for three years when discounted at 10% annually?
Inputs PMT =1000 I/YR = 10% P/YR=12 Pay at beg of period=OFF FV=0 Years=3 PV= ?
Results n=12x3=36 PV = 30991
Calculate the periodic payments due on a mortgage or other installment loans. What is the monthly payment on a $250,000 loan for 25 years at 10% interest?
Inputs PV= 250,000 I/YR = 10% P/YR=12 Pay at beg of period=OFF FV=0 N=25 PMT =?
Results n=12x25=300 PMT=-2272
An investor wants to know how long it will take to accumulate a Future Value. If an investor deposits $100 per year in an investment paying 12% interest , how long will it take to reach a value of $3,239.26?
Inputs PV=0 PMT=-100 I/YR=12% P/YR=1 Pay at beg of period=OFF FV=3,239.26 n=?
Results n= 14
How much yield on an investment problem. If an investment can be purchased for $10,000 and sold ten years later for $31,058.48 , at what annual rate of interest will it earn?
Inputs PV= -10,000 PMT = 0 P/YR=1 Pay at beg of period=OFF FV=31,058.48 Years=10 I/YR = ?
Results I/YR= 12%
The internal rate of return for an investment (IRR) is the percentage earned on each dollar invested for each period it is invested. IRR is another term for interest. It is used to measure an investment’s performance.
An investor pays $10,000 for an investment today and it is anticipated to produce net sales of $28,300 at the end of year 10. What is the IRR?
Inputs Cash Flow (Cf0) = -10,000 Sale Proceeds (SP10) = 28,300
Results IRR = 10.96%
If a $10,000 investment is forecasted to produce a level of annuity of $1,650 per year for ten years, what is the IRR?
Inputs Cash Flow (Cf0) = -10,000 Cash Flow (CF0 to CF10) = 1,650 Sale Proceeds (SP10) = 0
Results IRR = 10.32%
If an investment requiring $20,000 down is forecasted to produce income of $3,000 per year for five years and will be sold at the end of year five for $20,000, what is the IRR?
Inputs Cash Flow (Cf0) = -20,000 Cash Flow (CF0 to CF10) = 2,000 Sale Proceeds (SP10) = 20,000
Results IRR = 15%
If an investment requires $60,000 down is forecasted to produce variable cash flows each year over a ten year period and will be sold at the end of the year ten for $45,000, what is the IRR?
Inputs Cash Flow (Cf0) = -60,000 Cash Flows CF1=10000, CF2=9000, CF3=8000, CF4=700, CF5=6000 Cash Flows CF6 = 5000, CF7=4000, CF8=3000, CF9=2000, CF10=1000 Sale Proceeds (SP10) = 45,000
Results IRR = 8.61%
The Net Present Value of an investment is the sum of the present values (PV’s) of all the future cash flows netted against (added to) the initial investment.
NPV = sum of all PV’s from future cash flows + (initial investment)
The initial investment is a negative number from the investor’s point of view. The future cash flows are discounted to PV’s using a discount rate.
A buyer makes an initial investment of $10,000 that produces cash flow of $0 at EOY 1, $1,000 at EOY 2, $5000 at EOY 3, and $7,931 at EOY 4. If he investor’s target yield is 7% what is the NPV?
Inputs Cash Flow (Cf0) = -10,000 Cash Flows CF1=0 CF2=1000 CF3=5000 CF4=7931 All Sale Proceeds (SP) = 0 NPV Discount Rate = 7%
Results NPV = 1005 Positive NPV this means it earns more than the target of 7%
An Investor wished to purchase an investment for $10,000 that produces cash flow of $0 at EOY 1, $1,000 at EOY 2, $5000 at EOY 3, and $7,931 at EOY 4. If he investor’s target yield is 13% what is the NPV?
Inputs Cash Flow (Cf0) = -10,000 Cash Flows CF1=0 CF2=1000 CF3=5000 CF4=7931 All Sale Proceeds (SP) = 0 NPV Discount Rate = 13%
Results NPV = -887 Positive NPV this means it does not earn the target of 13%
An Investor wishes to purchase a property that produces cash flow of $0 at EOY 1, $1,000 at EOY 2, $5000 at EOY 3, and $7,931 at EOY 4. If he investor’s target yield is 10% what price could the investor pay for the property to earn the desired return?
Inputs Cash Flow (Cf0) = 0 Cash Flows CF1=0 CF2=1000 CF3=5000 CF4=7931 All Sale Proceeds (SP) = 0 NPV Discount Rate = 10%
Results NPV = 10,000 = PV or PV of all future cash flows + (initial investment) = NPV
The objective is to determine the value one should pay for a real estate investment such as a rental property, apartments, medical building, or office building where these rental properties are generating a PGI or gross income and have expenses each year resulting in a net cash flow to you the investor and at the end of the holding period you will sell the property. So at the last year there is cash flow (NOI) and a sale price that must be netted.
The NPV will be the value of the property, which is determined from the net cash flows (NOI’s) the rental property will generate and the sale price at the end the term when you sell the property. Using the discount rate or the expected return for the investor (you) the cash flows and the sale price are discounted back the present time (year 0) and the result is the value of the property.
A subsequent statistic that is computed is the cap (which is computed as the average of the NOI’s).
Cap Rate = Average NOI / Value where Value is the NPV or that value you have computed.
NOI is the net cash flow.
(NOI = PGI - Expenses) where NOI is the net operating income and PGI is the Potential Gross Income
The program subtracts expenses from PGI and stores it into the NOI (Net operating income)
The program reads the sale price and assumes it is an input cash flow on the last year that the user has inputted a PGI
The program takes all of the NOI’s and the Price it is Sold at the last year data has been entered and determines the net present value which is the value of the property - it is the value that the investor should pay for the investment
The program also determines the average yearly NOI and with the value it determines from the evaluation, it computes an average cap rate
With the cap rate and the value of the property the investor can compare this investment to others
A 401(k) plan is a type of defined contribution plan (under the IRS’s definition). It is a salary reduction plan, where employees must choose a percentage of their salary to contribute to the plan, and the plan spells out the extent of employer matching, if any (regardless of profits). Employee taxable salaries are reduced by these contributions, the contributions are invested, and any earnings are tax-deferred, i.e., until the employee draws the money out at retirement.
You currently have $10,000 in your 401(k). Your annual salary is $50,000 and your monthly contribution is 6% of your monthly salary. The plan has been earning an average of 8% (compounded annually) per year, and you expect that to continue for 10 years.
Answer:
Inputs:
401k/IRA Balance = $10000
Monthly Contribution = $250
Expected Yearly Return Percent = 8%
Number of Years in Future = 10
Results:
Total Profit: $27,932.91
Future Value of Investment: $67,932.91
Determine the time it takes to payoff a credit card given initial dept, monthly payment, and annual interest rate. This will also calculate how much interest you paid over time.