W4_Rotimi_Acutual Dollar and Real Dollar Values of Investment

1.    Problem Definition

Determining the Real Dollar Amount against Actual Dollar on return on Investment.Comparing the Real Dollar (R$) with the Actual Dollar (A$) required for university education in the US, 13 years time

It was established in Blogs 2 & 3 that $49,000 will be required annually to send my child to University in the U.S.A, 13 years from now (2025).

We now want to establish the effect of inflation on our proposed investment.

2.    Development of Feasible Alternatives

a)    Use actual dollar value as basis of saving

b)    Use real dollar as basis for saving

3.    Development of Outcomes and cash flows for each alternative

Based on computations from W_3 blog, the average cost of tuition in an American University is

Cost of University = 24,685 + 18,090 + 41,310=28,028 ≈≈ $30,000

In America (2025)                   3

This tells me that I would require about $30,000.00 yearly to fund my son’s university education.

Determination of amount required a year before he starts University:

Using the equation P = A (P/A, I_r, N )

                                    =30,000 ( P/A, 6%, 4)

                                    =30,000 * 3.4651

                                    = $103,956.27

i.e I must have $103,956.27 in an investment account paying interest at 6% per annum, one year before my son begins his university education.

To begin preparing today and know how much I am to put away yearly to have saved up$103.956.27 in 8 years

Using the equation   A= F( A/F, I, N )

                                    = 103,956.27 (A/F, 6%, 8)

                                    = 103,956.27 * 0.0593

                                    = $10,500.00

I.E I am to save $10,500.00 per annum in in an investment account paying interest at 6% per annum starting 8 years before he starts his university education

                                                                                

a)    Actual Dollar

This can be defined as the amount of dollars associated with a cash flow as at the time it occurs. The purchasing powerof Actual cash flow is affected by the level of Inflation or Deflation. From my Blog 3, I have established that I would require an average of $30,000 per year to send my son to the University 13 years from now.

Using annuities, I have computed the amount that I need accumulated in an annuity account paying interest at 6% as

 Year    Addition           Opening Balance        (1+i_r)^N Actual Dollars

1          10,500.00        10,500.00                   1.0600                         11,130.00

2          10,500.00        21,630.00                   1.0600                         22,927.80

3          10,500.00        33,427.80                   1.0600                         35,433.47

4          10,500.00        45,933.47                   1.0600                         48,689.48

5          10,500.00        59,189.48                   1.0600                         62,740.84

6          10,500.00        73,240.84                   1.0600                         77,635.30

7          10,500.00        88,135.30                   1.0600                         93,423.41

8          10,500.00        103,923.41                 1.0600                         110,158.82

 

b)    Real Dollar:

The real dollar is expressed in terms of the same purchasing power relative to a time period Inflation rate in Nigeria is 10% on average

 

Year    Addition            Opening Balance        1/ (1 + f )^N      Real Dollars

1          10,500.00        10,500.00                   0.9091                         9,545.55

2          10,500.00        21,630.00                    0.8264                        17,875.03

3          10,500.00        33,427.80                   0.7513                         25,114.31

4          10,500.00        45,933.47                   0.6830                         31,372.56

5          10,500.00        59,189.48                   0.6209                         36,750.75

6          10,500.00        73,240.80                   0.5645                         41,344.46

7          10,500.00        88,135.30                   0.5132                         45,231.03

8          10,500.00        103,923.41                 0.4665                         48,480.27

 

Implication of Results

The implication of this results show that if I go ahead in investing $10,500 yearly in an account paying 6% interest per annum for 8 years, I would have saved up to $84,000.(10,500*8). My investment statement would be indicating a value of $103,956.27, but my real purchasing power would be $48,480.27.

In real terms, I would have lost  $55,476.00 to inflation.

 

4.    Analysis and comparison of alternatives

In order to maintain the purchasing power of whatever amount I will be putting away, I will have to establish my expected return on investment and using the formular:

                        (1 + I_m) = (1 + f )(1 + i_f)

                        1 + I_m = (1+0.10)(1+0.06)

                        1 + I_m= 1.166

                        I_m=16.6%

 

I would have to seek for an investment that has a rate of return of at least 16.5% per annum or investments that will respond to changes in levels of inflation.

The available investment vehicles that fit this description are:                     

a.    Investment in shares

b.    Investment in real estate

c.    Government Treasury Bills  (Yield = 13.5%)

 

Investment in shares (Capital Market)

a)            Alternative A: Investing in capital market. Though, share prices react to inflation, there is a high risk that things may not go as planned.

b)            Investment in Real Estate

c)            Government Treasury Bills

Investment in Government Treasury Bills, making a yearly investment of $10,500, and  an additional $10,500 for every other year at a minimum interest rate of 13.5%. This option carries a much lower risk and return on investment is almost 100% guaranteed

d)            Investment in Gold.

Goldhas proven to be very stable and reliable. it has provrn to react to inflation and other economic factors. it is for this reason that the country reserves are stored in Gold

 

 

5.    Selection criteria

a)         Risk

b)         Guaranteed returns

c)         Ability to raise initial Capital

 

 

6.    Selection of preferred alternative

I would invest in Gold as it is the only substance as of now that would retain the purchasing power of my investment.

 

7.    Performance Measurement and Post Evaluation Results

To track the performance of my chosen investment vehicle, I will have to compare the return on investment with the rate of inflation

 

 

References

Sullivan, W., Wicks, E., Koelling, P., Kumar, p., & Kumar, N. (2012). Engineering economy (15^th edition). England: Pearson Education Limited

Trading Economics. (2012). Nigerian Inflation Rate. Retrieved from www.tradingeconomics.com

Hari Kumar Sellappan, (November 2012). Exploring gold as Alternative Currency for Future Cost Estimation in Telecommunications Projects. Retreived from www.pmworldjornal.net