HomeTIP OF THE WEEK
November 13th, 2009
Part II - MORE ABOUT PAPER
CASE: ANALYZING A PAPER INCOME STREAM
SITUATION:
A $10,000 note is offered to you for sale for $5,800 and the seller is desperate for cash (pressure from the I.R.S.) The face interest is 8% and the payments are $121.33 per month. 90 monthly payments remain of the original 120 months. The note is two and one half years old.
PROBLEM:
Your company's pension fund will not let you invest in real estate secured paper below a 13% yield. What is the investment yield of the above situation? How do we calculate yields?
SOLUTION:
What are you really the "buying for your $5,800 cash? "90 n's of $121.33
That's right. You are about to spend your $5,800 on is the right to receive 90 monthly payments of $121.33. How did we come up with the numbers?
Look for the givens that are stated in the note. The first given was 120 months of payments (the original term of the $10,000.00 note called for 10 years of monthly payments including 8% interest.) The second given is the stated payment amount of $121.33. But the note is 2 1/1 years old and 30 months have been paid already. So all that you will be able to purchase will be the remaining 90 payments. Each of these monthly payments is for $121.33 no more or no less - that is stated (given) in the original note terms.
So to summarize the two givens: 90 n's of $121.33.
The "givens are what you "get" for your $5,800 cash investment. You get the right to receive 90 monthly payments of $121.33. That is all you get, no more no less.
So, Jay, what is the yield on this deal? How do I compute the yield on my $5,800?
Get your financial calculator. The top row of keys will be:
"n" for "number".
"i" for "interest" or "yield"
"pmt" for "payment amount"
"PV" for present value (in this case the original loan amount of $10,000
"FV" for future value (in this case put a zero in the key - not using the key)
Now key 90 into "n" (number of payments). You are buying 90 payments.
The key 121.33 into "pmt" key(the amount of each payment you will be receiving each month.
Key your investment of (minus)5800 into "PV" (the amount you are investing/spending today for the right to receive the income stream) Notice the negative sign before the 5800. Since you are spending the money, it is expressed as "negative" 5800.
Put a zero into the "FV" key to make sure the key has no numbers left in it from another calculation - that will really mess up the numbers.
NOW JUST SOLVE FOR "i" (your yield will flash up expressed in the monthly yield rate. Just multiply the "i" number by 12 (the payments are expressed in months) and you will see your yield is 18.99% (rounding to 19% here is fine).
With a 19% return on and of your initial investment of $5800, it is OK for the pension fund to purchase, if everything else checks out.
BENEFITS:
Once you have done the keying in of the numbers a few times, you will begin to see what a powerful tool your little financial calculator really is. Start making up some example of other notes you might like to buy. Plug in the givens a go for the yield, Or plug in the yield to determine what you would pay for the right to receive so many "n's" of so many dollars per month. These little annuities are everywhere in our daily life. More on this in future Tips of the Week.
Good Luck and Good Hunting. Remember: Your competition can and does use a financial calculator where or not you know how to use one.
Jay
Jay Turner -
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About the Author:
Jay Turner - http://www.OneUpRealEstate.com