By Alec Pacella, CCIM
Managing Partner at NAI Daus
Among the favorite memories of my youth were birthday celebrations – most notably, mine. Both of my parents had six siblings and even though all of my aunts and uncles worked hard to make ends meet, they would always remember my birthday.
The gifts were typical fare for that era – Matchbox cars, puzzles and baseball cards. But one of my uncles, Uncle Ralph, would always get me something cool. One year, it was a game program from Super Bowl IX and another year, it was a Guinness Book of World Records. But the one that really stands out was a Swiss Army Knife, a pocketknife that included not only a blade but also a screwdriver, can opener, bottle opener, wire stripper and nail file. I had never seen anything like it – one tool that could do multiple tasks. This month, we are going to discuss another such tool – time value of money (TVM). TVM has been frequently discussed in this column over the years but typically in the context of determining value or evaluating a loan. And while these two concepts are the “blades” of TVM, this tool can certainly complete many other tasks.
Example #1 – An investor is evaluating the purchase of a cell tower lease. The lease is for five years and the rent starts at $12,000 a year with 2% annual increases. If the investor has return requirement of 9%, what would the investor be willing to pay for this lease? How to solve – In this instance, we are going to discount a series of future cash flows back to a net present value. Looking at each of the five financial components, we know time (denoted as N), which is five years. We know payment (PMT), which is the rent to be receive each year. We know interest (I/YR), which is the investor’s return threshold of 9%. Finally, future value (FV) is assumed to be zero, as there will be no underlying value once the lease expires.
We will again utilize the CCIM T-bar to assist with the setup, as illustrated in Figure 1 (above). Once this is correctly constructed, solving is a snap. Simply enter each of the components into a financial calculator, solving for present value (PV) and shazam – this lease would have a value of $44,418 to this specific investor and under this set of assumptions. Click to read full article.