Question

4.      An investor into the real estate mentioned to you that he/she wishes to purchase a property for investment upon his/her graduation in about 3 years time. The property value he/she can afford are in the range of rm300,000. Evaluate the above in the perspective of time value of money. (300 words)

Assume based rate=3%  BLR=5.85%

Answer 1

Purchase of the real estate in 3 years for RM300,000. RM 300,000 is to be spent on the property 3 years from today. RM300,000 in three years does not equal to RM300,000 now. This is because of the time value of money. It is the concept as per which the money now has more value than the equal money in the future since the money now can potentially earn income. In other words, since money can earn income through interest, the money that is obtained sooner has more worth.

In the given quesiton, Base rate is 3% and BLR is 5.85%. Assume the typical spread is 1.5%. Thus, the applicable rate will be Base Rate + Spread = 3%+1.5% = 4.5%. Assume the rate stays same for both borrowing and depositing. Thus, money deposited into a bank now will earn interest annually and in 3 years will aggregate to a higher amount.

To find the equivalent amount of RM 300,000 in 3 years now, lets find the present value of it today using the below formula:

Present Value = Future Value * Time Value Factor

Future Value = RM 300,000

Time Value Factor = Discount factor at 4.5% for 3 years = (1/(1+4.5%)^3) = 0.8763

Thus, Present Value = RM 300,000*0.8763 = RM 262,889

Thus, to buy a property in 3 years for RM 300,000, the investor has to currently hold RM 262,889. RM 262,889 once invested in an asset or investment at 4.5% interest per annum gets compounded to RM300,000 in three years as follow:

Year 1 = RM 262,889 * (1+4.5%) = RM 274,719

Year 2 = RM 274,719 * (1+4.5%) = RM 287,081

Year 3 = RM 287,081 * (1+4.5%) = RM 300,000