Hypothetical Situation by C48y311X

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									Hypothetical Situation...

   Suppose you win the Publisher’s
    Clearinghouse Sweepstakes and are
    given a choice of taking
     $10,000 today or
     $12,000 three years from today



   Which should you choose?
       Re-stated, what is the promise of
        $12,000 three years from now worth
        to you today?
Present Value Calculations

   Present value calculation - assessing
    what a future dollar amount is worth to
    you today.
     Present value of a future lump sum –
      PV
     Present value of future periodic
      payments – PVA
  Present value of a future
  lump sum...
       FV
PV 
     1  r n



     where
       r = interest rate per period
       n = number of periods
       FV = the future value of the
        investment
          Back to our example...
   FV = $12,000
   Use r = .08
   Get your money in 3 years

          12 ,000
    PV 
         1  .08 3
   = $9,525.99
   Implies that, based on economic considerations, you should
    take the $10,000 today
              Present Value of a lump sum

Period            1%      2%      3%      4%      5%      6%      7%      8%

          1     0.990   0.980   0.971   0.962   0.952   0.943   0.935   0.926

          2     0.980   0.961   0.943   0.925   0.907   0.890   0.873   0.857

          3     0.971   0.942   0.915   0.889   0.864   0.840   0.816   0.794

          4     0.961   0.924   0.888   0.855   0.823   0.792   0.763   0.735

          5     0.951   0.906   0.863   0.822   0.784   0.747   0.713   0.681

          6     0.942   0.888   0.837   0.790   0.746   0.705   0.666   0.630

          7     0.933   0.871   0.813   0.760   0.711   0.665   0.623   0.583

          8     0.923   0.853   0.789   0.731   0.677   0.627   0.582   0.540

          9     0.914   0.837   0.766   0.703   0.645   0.592   0.544   0.500

         10     0.905   0.820   0.744   0.676   0.614   0.558   0.508   0.463

         11     0.896   0.804   0.722   0.650   0.585   0.527   0.475   0.429

         12     0.887   0.788   0.701   0.625   0.557   0.497   0.444   0.397

         13     0.879   0.773   0.681   0.601   0.530   0.469   0.415   0.368

         14     0.870   0.758   0.661   0.577   0.505   0.442   0.388   0.340

         15     0.861   0.743   0.642   0.555   0.481   0.417   0.362   0.315

         16     0.853   0.728   0.623   0.534   0.458   0.394   0.339   0.292
        How do these calculations change if the
        payment is repeated periodically?

   Suppose you want to know how much a
    retirement annuity is worth to you today if it
    claims…
     $20,000 annual payment
     5 year time period
     r=.03
   Need to calculate the present value of future
    periodic payments (also called the present
    value of annuity payments → PVA)
  Present Value of an Annuity

         1  1  r                n
PVA  FV              
               r      
   All terms defined as previously
   Please note: That really is
        a negative n [-n]
   Previous Example:
     $20,000  annual payment
     5 year time period
     r=.03
            1  1  .03 
                          5
PVA  20,000              
                  .03     


      PVA = $91,594.14
   Present value of an annuity

Period          1%      2%      3%      4%      5%      6%      7%      8%


          1   0.990   0.980   0.971   0.962   0.952   0.943   0.935   0.926


          2   1.970   1.942   1.913   1.886   1.859   1.833   1.808   1.783


          3   2.941   2.884   2.829   2.775   2.723   2.673   2.624   2.577


          4   3.902   3.808   3.717   3.630   3.546   3.465   3.387   3.312


          5   4.853   4.713   4.580   4.452   4.329   4.212   4.100   3.993


          6   5.795   5.601   5.417   5.242   5.076   4.917   4.767   4.623


          7   6.728   6.472   6.230   6.002   5.786   5.582   5.389   5.206


          8   7.652   7.325   7.020   6.733   6.463   6.210   5.971   5.747


          9   8.566   8.162   7.786   7.435   7.108   6.802   6.515   6.247


         10   9.471   8.983   8.530   8.111   7.722   7.360   7.024   6.710
Example:

 $500 received each month for 2
  years, assuming 8% annual interest
 FV = $500 per month

 r = (.08/12) = .006667

 n = 2(12) = 24
         1  1  .00666724
                                 
PVA  500                       
                .006667         

       PVA = $11,055.27
        Let’s try it...
   Uncle Bob dies and leaves you $750,000, but
    you cannot collect it for 25 years. Assuming a
    3% inflation rate, what is the money worth to
    you today?
   PV
         750 ,000
    PV 
         1  .03 25




   PV = $358,204.18
Present Value of a Lump Sum
   Period         1%      2%      3%      4%      5%
            1    0.990   0.980   0.971   0.962   0.952

            2    0.980   0.961   0.943   0.925   0.907

            3    0.971   0.942   0.915   0.889   0.864

            4    0.961   0.924   0.888   0.855   0.823

            5    0.951   0.906   0.863   0.822   0.784

            6    0.942   0.888   0.837   0.790   0.746

            7    0.933   0.871   0.813   0.760   0.711

            8    0.923   0.853   0.789   0.731   0.677

            9    0.914   0.837   0.766   0.703   0.645

            10   0.905   0.820   0.744   0.676   0.614

            11   0.896   0.804   0.722   0.650   0.585

            12   0.887   0.788   0.701   0.625   0.557

            13   0.879   0.773   0.681   0.601   0.530

            14   0.870   0.758   0.661   0.577   0.505

            15   0.861   0.743   0.642   0.555   0.481

            16   0.853   0.728   0.623   0.534   0.458

            17   0.844   0.714   0.605   0.513   0.436

            18   0.836   0.700   0.587   0.494   0.416

            19   0.828   0.686   0.570   0.475   0.396

            20   0.820   0.673   0.554   0.456   0.377

            25   0.780   0.610   0.478   0.375   0.295

            30   0.742   0.552   0.412   0.308   0.231

            35   0.706   0.500   0.355   0.253   0.181

            40   0.672   0.453   0.307   0.208   0.142

            50   0.608   0.372   0.228   0.141   0.087
     Let’s try it some more...
   Your work is offering an incentive for you to
    retire early. Should you take $500,000 now or
    $30,000 per year for the next 20 years?
   PVA
               1  1  .0320 
    PVA  30,000                 
                       .03       
   PVA = $446,324.25
   So, take the $500,000 now
Present Value of an Annuity
Period           1%       2%       3%       4%       5%

          1    0.990    0.980    0.971    0.962    0.952

          2    1.970    1.942    1.913    1.886    1.859

          3    2.941    2.884    2.829    2.775    2.723

          4    3.902    3.808    3.717    3.630    3.546

          5    4.853    4.713    4.580    4.452    4.329

          6    5.795    5.601    5.417    5.242    5.076

          7    6.728    6.472    6.230    6.002    5.786

          8    7.652    7.325    7.020    6.733    6.463

          9    8.566    8.162    7.786    7.435    7.108
         10    9.471    8.983    8.530    8.111    7.722

         11   10.368    9.787    9.253    8.760    8.306

         12   11.255   10.575    9.954    9.385    8.863

         13   12.134   11.348   10.635    9.986    9.394

         14   13.004   12.106   11.296   10.563    9.899

         15   13.865   12.849   11.938   11.118   10.380

         16   14.718   13.578   12.561   11.652   10.838
         17   15.562   14.292   13.166   12.166   11.274

         18   16.398   14.992   13.754   12.659   11.690

         19   17.226   15.678   14.324   13.134   12.085

         20   18.046   16.351   14.877   13.590   12.462
Proverb #7: The Only Two
Certainties in Life are Death and
Taxes
   Costs and benefits of alternative
    resource allocation options should
    only be assessed net of taxes.

     Some choices of how to spend
      resources are nontaxable and
      therefore they are worth more than
      taxable options.
     Some choices reduce your amount of
      taxable income while others do not.
Example

   Finance the purchase of a car using…
     a 7% loan from your credit union, or
     a 7% home equity loan

   On the surface, the financing options
    appear to be equivalent, but interest
    paid on a home equity loan can be
    deducted from taxable income while
    interest paid on a credit union loan
    cannot.
2012 Federal Tax Rates –
Single
Income between        Marginal Tax Bracket
$0 - $8,700           10%
$8,700 - $35,350      15%
$35,350 - $85,650     25%
$85,650 - $217,470    28%
$217,470 - $178,650   33%
> $178,650            35%
2009 Federal Tax Rates –
Married Filing Jointly
Income between        Marginal Tax Bracket
$0 - $17,400          10%
$17,400 - $70,700     15%
$70,700 - $142,700    25%
$142,700 - $217,470   28%
$217,470 - $388,350   33%
> $388,350            35%
Federal Tax Brackets
Interesting note:

 Highest marginal tax bracket now is
  35%
 1952-1963 = 91%

 1964-1982 = btw 65-75%

 Then dropped to 45% for a while

 1988-1990 = bottomed out at 28%

 1992 = back up to 38%
       Tax rates for 2013 are
       scheduled to be:
        10% rate will collapse into the 15%
         rate
        25% rate will become 28%

        28% rate will become 31%

        33% rate will become 36%

        35% rate will become 39.6%

These rate changes will take effect beginning in 2013 absent further
legislation.
Proverb #8: A Bird in the Hand is
(sometimes) Better than two in the
Bush
   The future is riddled with uncertainty
     future income
     future inflation

 But, some resource allocation options
  involve more risk than others.
 All other things being equal,
  households typically like to avoid risk
  and uncertainty.

								
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