Showing posts with label Calculations. Show all posts
Showing posts with label Calculations. Show all posts
Time Value of Money related to CAP Education Plan Options
In a recent post from pinoymoneytalk.com, a member of the forum holding an education plan ECU-A from CAP (College Assurance Plan) was offered the following options for her plan:
Option 1: Tuition Fee Reimbursement
These options can actually be considered as an annuity or a series of payments that you would receive in regular intervals. Computing for the present value of this annuity using the Time value of money will allow you to compare the amounts as if you have them in your hands at this very moment.
The present value of an annuity is computed using the following formulas:
where PVA = Present Value of an Annuity
PMT = The payments received
PVIFA = Present Value interest Factor for an annuity
i or K = Interest rate
n = number of periods
Using these equations to the different options, assuming a 5% interest rate, we would actually get a present value of 153,717 for Option 1 (assuming the maximum amount of 19,759 is received) and a present value of 151,550 for Option 2. In order for the present values to be equal, Option 1's payments must equal to 19,480 pesos.
What does this mean?
This means that you only have a small margin of around 279 pesos (19759 - 19480) for both options to be equal in value. Therefore, if you're not sure how much the college tuition will be, I think it would be wiser to choose Option 2. This holds true specially if the beneficiary is not scheduled to enter college in the near future.
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An interest rate of 5% per annum is quite reasonable as investors can currently avail of time deposits at this rate. The higher the interest rate, the smaller the margin becomes. Let's say you can invest your money in an instrument earning 10% per annum, the margin would be lessened to 245 pesos.
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Computation guidelines / data:
Option 1:
PMT = 19.759
i = 0.05 / 8
n = 8
PVIFA = 7.568
Option 2:
PMT = 7,778
i = 0.05 / 20
n = 20
PVIFA = 18.987
Option 1: Tuition Fee Reimbursement
- Maximum reimbursement per semester = P19,759
- Total receivable amount for 4 college years = P158,072
- Check release takes 1-2 months processing
- Check release every 3 months = P7,778
- Total of 20 payments for 5 years
- Total Receivable amount for 5 years = P155,560
These options can actually be considered as an annuity or a series of payments that you would receive in regular intervals. Computing for the present value of this annuity using the Time value of money will allow you to compare the amounts as if you have them in your hands at this very moment.
The present value of an annuity is computed using the following formulas:
where PVA = Present Value of an AnnuityPMT = The payments received
PVIFA = Present Value interest Factor for an annuity
i or K = Interest rate
n = number of periods
Using these equations to the different options, assuming a 5% interest rate, we would actually get a present value of 153,717 for Option 1 (assuming the maximum amount of 19,759 is received) and a present value of 151,550 for Option 2. In order for the present values to be equal, Option 1's payments must equal to 19,480 pesos.
What does this mean?
This means that you only have a small margin of around 279 pesos (19759 - 19480) for both options to be equal in value. Therefore, if you're not sure how much the college tuition will be, I think it would be wiser to choose Option 2. This holds true specially if the beneficiary is not scheduled to enter college in the near future.
-0-
An interest rate of 5% per annum is quite reasonable as investors can currently avail of time deposits at this rate. The higher the interest rate, the smaller the margin becomes. Let's say you can invest your money in an instrument earning 10% per annum, the margin would be lessened to 245 pesos.
-0-
Computation guidelines / data:
Option 1:
PMT = 19.759
i = 0.05 / 8
n = 8
PVIFA = 7.568
Option 2:
PMT = 7,778
i = 0.05 / 20
n = 20
PVIFA = 18.987
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Investment Principles Everyone Should Know: No. 1 Time Value of Money
This series will present fundamental principles everyone, especially the young, should know when it comes to personal finance.
The Time Value of Money
Money received and invested today is not the same value as that of money, with the same face value, received in the future.
Most would think that a hundred pesos received today is the same as that of a hundred pesos to be received next year. This assumption is wrong simply because of all the ways you can make the money grow during that gap. Just by putting the 100 pesos you received today in a savings account, you'll at least earn interest on it, thereby increasing its future value.
Here's a simple formula to determine the future value of funds compounded annually given a specific interest rate:
FV = Future Value
PV = Present Value
i = interest rate
n = number of years
Example:
If I have 69,500 pesos and I allow it to compound for 31 years at an annual interest of 9% per annum, the future value of my money would be
FV = 69,500 (1+.09)^31
FV = 1,005,092 pesos!
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Double your savings! (Rule of 72)
Do you know when your savings will double? Follow the rule of 72. Here's the formula:
years to double = 72 / interest rate
This is just an estimate by the way, but a very good one. Example: If your bank is offering 6% interest per annum then it would take exactly 12 (72/6) to double your money. You can use the formula backwards to compute for the interest rate given a particular no. of years. Like say you want your money to double in 10 years, then you would have to look for an institution offering 7.2% interest.
Want to know how this formula was derived? Read more here.
Want to know how this formula was derived? Read more here.
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