Fair Market Value of a Cash Flow Stream and Deferred Annuity

The present value of an annuity is computed using the formula: Given: R = P 35,000 = 0.014859156 n = 4 15) - 20 Solution: P = 35,000 P = P 601, 559.47 Therefore, XYZ Company's offer is preferable since its market value is larger than the other one. Example 2: Martha inherited a lot property from her grandfather. She wants to sell the lot because she will be moving to other country with her parents. She got two buyers with different offers on the lot that she wants to sell. Jhazzy's offer. Down payment of P 50,000 and a P 1 million lump sum payment, 5 years from now. Nika's offer: Down payment of P 50,000 plus P 40,000 every quarter for five years. If money can earn 5% compounded annually, compare the fair market values of the two offers. Which offer has a higher market value? Given: Jhazzy's offer Nike's offer Down payment of P 50,000 Down payment of P 50,000 P 1 000 000 after 5 years P 40,000 every quarter for five years Find: Fair Market Value of each offer a. Illustrate the cash flows of the two offers using time diagrams. Jhazzy's offer 50,000 1,000,000 2 3 20 Nika's offer 50 000 40.000 40.000 40.000 40 000 2 3 20Discover Fair Market Value of Cash Flow Steam that includes an Annuity A cash flow refers to any type of payments done. Cash inflow happens when a person receives the payment and a cash outflow are payments or deposits made by a person. Cash inflows can be represented by positive numbers and cash outflows can be represented by negative numbers. Fair market value (FMV) is the price that two parties are willing to pay for an asset or liability, given the following conditions: Both parties are well informed about the condition of the asset or liability. Neither party is under undue pressure to buy or sell the item. There is no time pressure to complete the deal. The fair market value concept is used for many purposes, including the following: Establishing the replacement value of an insured asset; Establishing the tax basis upon which property will be assigned a property tax; and . Establishing the basis for damages in a court award. The fair market value or economic value of a cash flow (payment stream) on a particular date refers to a single amount that is equivalent to the value of the payment stream at that date. This particular date is called the focal date.XYZ's Company 35.000 35,000 35,000 35.000 20 Suppose that selected focal date is the start of the term. Compute for the present value of each offer. ABCD Company's Offer: In computing for the present value of P 250,000 three years from now, the formula to be used is P, = F (1+/). Given: Solution: F - P 250,000 -=0.03 P. = 250,000 (1 + 0.03]-6 n - 2 3) - 6 P = P 209, 371.06 Given: Solution: F = P 400,000 PF(1+)) 10: - 0.03 P = 400,000 (1 + 0.03)-LE n - 215 - 10 P = P 297,637.57 In computing for the Fair Market Value (FMV), use the formula: Fair Market Value (FMV) = P, + P, = 209,371.06 + 297,637.57 = P 507, 008. 63 XYZ Company's Offer. Compute for present value of a general annuity with quarterly payments but with semi-annual compounding interest at 6%%. Solve the equivalent rate, compounded quarterly, of 6% compounded semi- annually. P(1 + (1+ 0.06 10 = 1+ 2 1+ - = (103) -= (103) -1 = 0.014889156Activity 1: Complete Me! Directions: Read and analyze the given problem below. Then, complete the table by solving the given problem. HOUSE AND LOT FOR SALE Jaz and her siblings got a house and lot inheritance for their father. They wanted to sell the property to sell the property so that they can divide the amount among themselves. The siblings got two buyers with different offers: Company A: Down payment of P 250,000.00 and P 1,000,000.00 lump sum payment, 5 years from now. Company B: Down payment of P 200,000.00 plus P 50,000.00 every quarter for 5 years. Compare the fair market values of the two offers if money can earn 5%% compounded annually. Which company has a better offer? Why? Given: Company A: Down payment of P 250,000.00 and 1,000,000.00 lump sum payment, 5 years from now. Company B: Down payment of P 200,000.00 plus P 50,000.00 every quarter for 5 years. Find: Fair market values of the two offers if money can earn 5% compounded annually Solutions: Final AnswerFair Market Value is computed by adding the Down payment and Present Value or "Fair Market Value (FMV) = Down payment + Present Value" In computing for the present value of the given problem, the formula to be used are the following: A. Simple Annuity - the payment interval is the same as the interest period P = F(1+/)- where F - is the future value j - interest rate per period and is given by the formula, / = = where ris the annual interest rate and m is the number of compounds. Note: annually (m. =1) quarterly (m =4) semi-annually (2 32) monthly =12) n - number of actual payments and is given by the formula, n = mt where m is the number of compounds and f is time express in years. B. General Annuity- the payment interval is not the same as the interest period P = R 1 - (1+1)-" where R- is the regular payment j - equivalent rate (see example 1) n - number of actual payments and is given by the formula, it = it where m is the number of compounds and tis time express in years. Example 1: ABCD Company offers P 250,000 at the end of 3 years plus P 400,000 at the end of 5 years. XYZ Company offers P 35,000 at the end of each quarter for the next 5 years. Assume that money is worth 6% compounded semi-annually. Which company offers a better market value? Given! ABCD Company XYZ Company P 250,000 at the end of 3 years P 35,000 at the end of each quarter for P100,000 at the end of 5 years the next 5 years Find: Fair Market Value of each offer Solution: a. Illustrate the cash flows of the two offers using time diagrams. ABCD's Company 250,000 400,000 2