Posted by John Behle on January 19, 2000 at 17:58:45:
The less you pay the higher your yield and vice versa.
Notes – Please Help John Behle - Posted by chill
Posted by chill on January 18, 2000 at 09:40:28:
I have a chance to buy a couple of notes and I want to see if I am figuring something correctly.
Basically I would buy a note secured by a mh and land package. I would pay off another note that is already in place as financing. The present holder of the note wants some cash to go with the deal. What would you offer to make a yield of 30%?
The difference between the note I would receive and pay would cash flow $57 for 137 months. After that it would pay $559 for 94 additional months.
When using a financial calculator and doing the Net Present Value, would I have to divide the interest into months – in other words, instead of entering 30 as the interest rate, would I enter 30/12 or 2.5?
Thanks – this stuff is tough, but you make it sound like it will be easy once I understand it.
Uneven cash flows. Download the free spreadsheet - Posted by John Behle
Posted by John Behle on January 18, 2000 at 11:11:18:
I’ll work it on the free spreadsheet at my website. That way you can follow along easily on Quattro or Excel. It’s the same steps on a financial calculator. On the ?EasyCalc? spreadsheet, the annual rate is entered as it assumes a monthly payment. For most calculators you will need to enter the periodic rate of 2.5% instead of 30%.
- 0 - (Initial Cash Flow)
57 (Cash Flow 1)
137 (#Times)
559 (Cash Flow 2)
94 (#Times)
You would then enter the yield you want on a periodic basis. Your period is monthly so you need to divide the 30% by 12 for a 2.5% periodic rate. Enter that rate and then Calculate for NPV or Net Present Value.
You’ll come up with $-2887.18
ALTERNATE METHOD OF UNEVEN CASH FLOW
The alternate way is to calculate each cash flow and then add them together. The first cash flow is a series of payments and is calculated through substituting the desired yield for the interest rate and re-calculating for PV or Present Value.
Here’s the numbers.
N = 137
PMT = 57
%I = 2.5
FV = -0-
Calculate for the PV and you come up with $-2,202.60
The second cash flow is a “Future Series” of payments and has a more complex calculation. You have to take the “wait” time into account. Calculate the value of the payments as if they began today and then factor in a discount for the wait time. There are two ways to do that. One is the “Double Discount” and the other is a “Subtraction” method.
The DOUBLE DISCOUNT METHOD - calculates the value of the cash flow as if it began today and then discounts that value again to account for the wait time.
Today’s value
94 = N
559 = PMT
2.5 = %I
-0- = FV
The Present Value is $-20,165.03 (IF it started today)
Now we treat the discounted value as a balloon payment amount and discount it over the time period we have to wait (137 months).
137 = N
2.5 = %I
-0- = PMT
20,165.03 = FV (the discounted value at that time)
If we calculate for PV we come up with $-684.59 which is the value of that cash flow TODAY. Now, add the two cash flows together and you come up with the value of the note at a 30% yield (2.5% periodic).
Which is: $-2887.18 (same answer as above)
THE SUBTRACTION METHOD
For some people the first method of discounting a ?future series? cash flow makes sense. For some this one makes more sense (and actually has a few less keystrokes). The theory here is simple. I calculate the value of the cash flow including the ?wait? time. In other words - I calculate as if the payment began today and continued through the end of all payments (dis-regarding cash flow one). Remember this is only the calculation for cash flow two. We already did cash flow one.
So the first step is to figure the value in that way. To come up with the total time period or ?N? we add the wait time of 137 months to the pay time of 94 and come up with 231.
231 = N
557 = PMT
2.5 = %I
-0- = FV
We solve for PV and come up with $-22,285.48 which is the value ?as if? we had received the first 137 payments - but we didn?t. So, our next calculation is to determine the value of what we ?didn?t? receive (the first 137 payments) and subtract that out. We?re looking at it as we should have received 231 payments, but didn?t receive the first 137, so what is the value of what we actually received - the last 94 payments.
137 = N
557 = PMT
2.5 = %I
-0- = FV
We solve for PV and come up with $-21,600.89. Now subtract that from the previous calculation of $-22,285.48 and we come up with the value of what we really did receive of $-684.59. Add that to the value of the first cash flow we calculated previously ($-2,202.60) and you come up with the value of the whole note of $-2887.18 (same answer as above).
Re: Uneven cash flows. Download the free spreadsheet - Posted by salih
Posted by salih on June 14, 2000 at 02:47:52:
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Re: Thanks & One More Question - Posted by chill
Posted by chill on January 18, 2000 at 17:43:21:
Thanks, John – that was a wonderful explanation. You are generous to take the time to do the full calculation several ways.
One last question (“last” is probably wrong): Conceptually, if the NPV is $-2887.18, does that mean if I pay the holder of this note $2887.18 cash for it now, then I will have a yield of 30%; if I pay less, I’ll have more yield. That’s how I understand it – just want to make sure.