The Time Value of Money

Purchasing a house is a critical financial decision in one’s life. Cashflows give direction in the investment decision; hence, it is important to understand the value of cash flows and outflows. Several factors influence the value of money, such as the present consumption compared to the future comparison, inflation, and other uncertainties associated with the cash flow. John, a finance graduate, is preparing for the purchase with an overview of the amount required to make his dream of buying a house come to pass. Some of the findings by John are listed below.

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The home is estimated at a purchase price of $178,000. With an interest rate of 2.5 % per annum, the retailer’s price will be $201,390.66. The purchase price of the home is determined through the compound interest theory, calculated on a yearly basis (Peirson et al., 2014), as shown below:

FV = PV * (1+r) n

= $178,000 * (1+2.5%)5

= $201,390.66

From this calculation, $40,278.13 must be saved, which is 20% of the purchase price. Inclusive of the down payment, savings are required to meet the closing, costs, moving and furniture expenses. The savings will be $4027.81.

= (100% + 10%) * $40,278.13

= 110% * $40,278.13

= 1.1 * $40,278.13

= $44,305.94

From the given information, $10,000 were saved. It is required to save $203.12 every month to meet the set goals.

FV = PV * (1+r) n

= 10,000 * (1+5%)5

= $12,762.82

The cash need after 5 years will be $40,278.13+ $44,305.94.

= $84,583.94

The total amount they require to save monthly will be: $84,584.07 – $12,762.82.

= $71,821.25

P = FV(r)/(1+r) n – 1

= $71,821.25(5%)/ (1+5%)60 – 1

= $3,591.06/17.679

= $203.12

John uses an E-trade account, which will be helpful in case he changes the current investment plan. There will be an extra 1.5 % per annum, which he would save to reach their goals. The savings total to $200.51.

FV = PV * (1+r) n

= 10,000 * (1+6.5%)5

= $13,700.87

The amount needed in 5 years will be $ 84, 583.94.

The monthly savings will be $84,584.07 $13,700.87.

= $70.883.20

P = FV(r)/(1+r) n – 1

= $70.883.20(5%)/ (1+5%)60 – 1

= $3,544.16/17.679

= $200.51

With John’s laid out plans for his family, he is likely to find success in the future. The ownership of houses is an investment opportunity, which is associated with some risks. This understanding of the basic financial theories will help to achieve this success. For instance, the effective risk in sharing the savings may limit a downward risk, which will also help John make better choices, which are productive and beneficial to the welfare in the economy (Vernimmen et al., 2018). These considerations have encouraged the consumers to create financial instruments that help to share the risks, which are not directly exchanged in the equity markets.

 

References

Peirson, G., Brown, R., Easton, S., & Howard, P. (2014). Business finance. McGraw-Hill Education Australia.

Vernimmen, P., Le Fur, Y., Dallochio, M., Salvi, A., & Quiry, P. (2018). The time value of money and net present value. In P. Vernimmen, P. Quiry, M. Dallocchio, Y. Le Fur, & A. Salvi (Eds.), Corporate finance: Theory and practice, (5th ed.) (pp. 267-283). Wiley.