Time Value of Money: How to Calculate It

The concept of the time value of money asserts that the value of money today is worth more in future as the money at hand has an earning capacity. This is based on the assertion that so long as money can earn interest in its present estate, it is possible that the money bears a higher worth as soon as it is received (Crundwell, 2008). As a result, this paper seeks to analyze the financial decisions that Rebecca Young has to make in light of her present predicament regarding whether to rent or buy a condominium.

Assumptions 

In the time-value analysis, several assumptions were made to cater for the progressive calculation of sums due for the property. In the case of renting the property, the assumed rate of rent inflation was set at 3 percent, while the assumed rate of after tax return was fixed at 6 percent annually. In the case of buying the property, general inflation was fixed at 2 percent as part of the simulation, while the marginal income tax rate was fixed at 30 percent. On the other hand, the annual appreciation was held at 3 percent. Furthermore, it was assumed that the condominium would not attract housing association dues. However, the owner would take insurance for it at a cost of $1500 per annum. Therefore, the values for housing association dues stood at zero. Nevertheless, substitution was done for all other provided values.

Methodology 

A buy-versus-rent excel template was obtained, for which values would be substituted and an adequate picture of the entire affair would be mapped out until the twentieth year. The template would express the figures and values given, thereby providing an adequate picture of the scenario Rebecca would have in the case of any eventualities as predicted in the case study. As a result, there was adequate room to simulate any possible outcomes as required in the instructions.

Results 

Having determined the costs, Rebecca would want to determine the monthly mortgage payments should she go with this idea. The table below provides an excerpt from the completed excel template, showing the value of payments being a little over $2500:

Considering that all factors remain constant within the initial ten years, different points of sale would be considered as follows:

At all three points of consideration to sell the house, the total cash outflow from the buying scenario outdoes the renting scenario, thereby enabling Rebecca to meet her costs of buying the house as well as have an additional income to meet monthly expenses. Nevertheless, an ever-increasing savings when renting presents itself, with the value already well over $162,000 in the first two years. Should the condominium price remain unchanged, it would be better to rent. Again, considering that the annual appreciation for the property stands at 3 percent in this simulation, setting it at 2 percent alongside the inflation rate still provides a significantly lower appreciation rate. The house would still be a better option when rented. Additionally, considering a scenario where the appreciation rate increases to 5 percent does not significantly change the outcomes. In fact, there is only slightly more savings when renting, which is a negligible value.

Conclusively, it would be better to rent this property under all scenarios as opposed to buying the house. This would stand regardless of any changes in prevailing circumstances. According to the time value of money, buying the property is simply not worth it.

References

Crundwell, F. K. (2008). Time Value of Money. Finance for Engineers: Evaluation and Funding of Capital Projects , 125-161.