30 Days of 3.0 – Day 21: Net Present Value
Welcome to Day 21 in our “30 Days of 3.0” series. Yesterday we talked about a simple, straight-line way to measure your returns. Today, we’re going to talk about how to take into consideration the Time Value of Money.
If you don’t know about this concept, it’s cool… few people are trained to think about money this way. But if you learn, it takes your investing to the next level.
The Time Value of Money concept is simple: $1 in your hand right now will not be worth $1 in the future, it will likely be worth less. This is due to inflation. 60 years ago, you could get milk for a dime. Now it costs $4. That’s inflation. As Investopedia explains it, “In other words, a dollar earned in the future won’t be worth as much as one earned in the present.”
Net Present Value is the present value of future returns. It's a way of showing future cash flows in today's dollars. Other inflation adjustments, like this one from Box Office Mojo, is like standing in today and looking at what yesterday's money would be like now. NPV is like standing in today and looking at what tomorrow's money would look like now.
To find that value, you have to take the Cash Flow Before Taxes for the current reporting year, along with each prior year, and divide each year by the discount rate over time, and then subtract out the investment costs.
The result of this process shows you how much the investment will be worth at the end of that reporting year, but in today’s dollars. Here’s an example from a property in our system, forecasting returns for the year 2024 (unimportant details left out for clarity):
As you can see, the investment will make $2M in 2024 dollars, but that will only be worth $1.5M in today’s dollars.
So now that you “hopefully” understand this concept, there is one last indicator we’ve added; you can think of it as the Time Value of Money counterpart for the Return on Investment percentage. I’ll see you then, and as always, I hope you have a fantastic day! :)