Understanding Time Value of Money
AC Associates
"A Dollar Today is Worth More Than A Dollar Tomorrow"
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This is an economic principal that needs to be clearly understood. A contract is a cash flow spread out
over several years. Its not an appreciating asset. Each monthly payment is being paid with deflating
dollars. What do we mean by deflating dollars?
We all understand the realities of inflation. Inflation means a steady increase over time of the costs of
goods and services. If the costs of goods and services are going up in the future, and a dollar is gradually
losing its purchasing power, the contract buyer has a problem keeping the cash flow even with inflation.
They say to themselves, "what are these monthly payments going to be worth 5, 10, or 15 years from now"?
By discounting the note, the contract buyer has a chance of keeping the cash flow even with inflation. How
much discount is required depends how long the contract is spread over time. A 10 year contract won't
require the same discount as that of a 20 year contract. The faster the money is paid back the more its
worth.
The time value of money is really easy to understand. Consider what inflation has done to the purchasing
power of the dollar. How much less were the property taxes on your house 10 or 12 years ago? What did
it cost for gasoline 10 years ago? If only we could buy a new car for the same price they sold for 12 years
ago. What did auto insurance cost 10 years ago? Are you paying less for food than you were 10 years
ago? How about entertainment and eating out compared to a few years ago? Medical costs have gone
out of sight compared to a number of years ago. You see, the list can go on and on.
The point is every day dollars are deflating. They will not buy in the future what they can buy today.
Let’s give you a visual example of the time value of money.
I want you to picture the two of us sitting at a table. I tell you I want to give you some money. I put a five
hundred dollar bill and a thousand dollar bill side-by-side on the table. You can either take the five
hundred or the thousand. We all would all take the thousand, right? There’s a stipulation if you take the
thousand. You have to wait ten years to receive it. Now, which bill do you want? The five hundred of
course. Having cash right now in our hand is worth more than waiting. We would say to ourselves, "how
much will the thousand be worth ten years from now?" The contract buyer thinks the same thing.
The current face value of a contract could be $60,0000.00. But what will those deflating dollars from the
monthly payments be worth in the future? The contract buyer offsets those deflating dollars with a
discount. That's what the time value of money is all about.
O.K., you say to yourself, “I understand the reason for a discount. But its still pretty hard to accept the
discount when the contract is sold. Can I come out better”? Yes, absolutely. There are several ways to
structure the sale to your advantage.
Contact me for further information and obtain your free, no obligation evaluation of your note.
over several years. Its not an appreciating asset. Each monthly payment is being paid with deflating
dollars. What do we mean by deflating dollars?
We all understand the realities of inflation. Inflation means a steady increase over time of the costs of
goods and services. If the costs of goods and services are going up in the future, and a dollar is gradually
losing its purchasing power, the contract buyer has a problem keeping the cash flow even with inflation.
They say to themselves, "what are these monthly payments going to be worth 5, 10, or 15 years from now"?
By discounting the note, the contract buyer has a chance of keeping the cash flow even with inflation. How
much discount is required depends how long the contract is spread over time. A 10 year contract won't
require the same discount as that of a 20 year contract. The faster the money is paid back the more its
worth.
The time value of money is really easy to understand. Consider what inflation has done to the purchasing
power of the dollar. How much less were the property taxes on your house 10 or 12 years ago? What did
it cost for gasoline 10 years ago? If only we could buy a new car for the same price they sold for 12 years
ago. What did auto insurance cost 10 years ago? Are you paying less for food than you were 10 years
ago? How about entertainment and eating out compared to a few years ago? Medical costs have gone
out of sight compared to a number of years ago. You see, the list can go on and on.
The point is every day dollars are deflating. They will not buy in the future what they can buy today.
Let’s give you a visual example of the time value of money.
I want you to picture the two of us sitting at a table. I tell you I want to give you some money. I put a five
hundred dollar bill and a thousand dollar bill side-by-side on the table. You can either take the five
hundred or the thousand. We all would all take the thousand, right? There’s a stipulation if you take the
thousand. You have to wait ten years to receive it. Now, which bill do you want? The five hundred of
course. Having cash right now in our hand is worth more than waiting. We would say to ourselves, "how
much will the thousand be worth ten years from now?" The contract buyer thinks the same thing.
The current face value of a contract could be $60,0000.00. But what will those deflating dollars from the
monthly payments be worth in the future? The contract buyer offsets those deflating dollars with a
discount. That's what the time value of money is all about.
O.K., you say to yourself, “I understand the reason for a discount. But its still pretty hard to accept the
discount when the contract is sold. Can I come out better”? Yes, absolutely. There are several ways to
structure the sale to your advantage.
Contact me for further information and obtain your free, no obligation evaluation of your note.
