Time Value of Money Flashcards
Interest and other charges while borrowing funds.
COST OF BORROWING
Interest can be
FLOATING OR FIXED
The rate will be Floating (ex.Prime+0.5%)
IF THE BORROWING FACILITY IS A GENERAL LINE OF CREDIT.
Typically the rate/term is Fixed and Closed
IF THE CREDIT FACILITY IS TIED TO A CERTAIN ASSET OR SUBJECT TO AN INCOME RATIO.
Other charges
BANK FEES
LOAN SET-UP FEES
STANDBY CHARGES
LOAN DISCHARGE FEE
PREMIUM
BROKERAGE FEE
Commitment fee usually around 0.5% - 1%
LOAN SET UP FEE
Fees to be paid for an unused credit facility
STANDBY CHARGES
When a loan is fully / partially repaid, a bank typically charges a fee to do so.
LOAN DISCHARGE FEE
If financing is arranged by a third-party broker, a fee is typically charged, and it can range from 0.15% - 1% of the loan amount.
BROKERAGE FEE
Premium in interest rate.
THE INTEREST, TERM, SECURITY ARE ALL FACTORS DETERMINE BY BANK CREDIT RISK APPROVAL DEPARTMENT.
THEY ARE REFERRED TO AS THE PRICING OF THE DEAL BY BANKS.
Short / long term arrangement with a set amount of limit.
Flexible withdrawals or repayments.
OPERATING REVOLVING
NONREVOLVING FACILITY
Facility is replenished by the amount repaid
OPERATING REVOLVING
Facility amount is reduced by the amount withdrawn and cannot be increased by the amount repaid.
NON-REVOLVING FACILITY
Term loan or Mortgage
FIXED AMOUNT OF BORROWING FOR A FIXED AMOUNT OF AMORTIZATION PERIODS.
LOAN IS PAID DOWN AT THE PRE-SET INTEREST RATE AND FIXED AMOUNT OF PERIODS.
LOAN AMOUNT IS CAPPED AT DSCR. DEBT-TO-SERVICE RATIO.
Calculated by income (before interest /tax) / annual interest payment.
DSCR - DEBT-TO-SERVICE RATIO
Usually subject to a ratio of 1.1 to 1.25.
COMMERCIAL AND RESIDENTIAL MORTGAGE
Ex. A residential building is generating a net income of $1.5m per year. At a mortgage of rate 5.2%, an amortization rate of 25 years, and DSCR ratio of 1.25, the max mortgage amount is $17,440,953.
Guarantee (Corporate/Personal)
A LEGAL AGREEMENT AMONG THE LENDER, THE BORROWER, AND THE GUARANTOR, WHEREBY THE CORPORATE OR PERSON TAKES RESPONSIBILITY TO PAY THE LOAN IF THE BORROWER DEFAULT ON THE LOAN. GUARANTEE (CORPORATE VS. PERSONAL)
Assets / Collateral
IT IS AN ITEM OF VALUE PLEDGED TO SECURE THE LOAN.
IF THE BORROWER DEFAULTS THE LOAN, IT GIVES THE LENDER TO SEIZE IT AND SELL TO RECOUP ITS LOSSES.
Example of collateral
REVENUE STREAM / NET ACCOUNTS RECEIVABLE
INVENTORY / EQUIPMENT
RENT / INSURANCE
BUILDING / LAND
Simple calculation of interest
INTEREST (I) = PRINCIPAL (P) X INT (INTEREST RATE)
NEW PRINCIPAL = OLD PRINCIPAL + INTEREST
Compound interest calculation
NEW PRINCIPAL = OLD PRINCIPAL x (1+INTEREST RATE) ( NUMBER OF PAYMENTS NT)
Capital Lease
CONSIDERED AS A PURCHASED AND OWNED ASSET OF A COMPANY.
TYPICALLY THE LEASE NEEDS TO BE AT LEAST 75% FOR THE ASSET’S USEFUL LIFE.
THE OWNERSHIP MUST TRANSFER TO THE LEASSEE AT THE END OF THE LEASE (USUALLY A BARGAIN PURCHASE OPTION).
Operating Lease
HANDLED AS A TRUE LEASE / RENTAL USAGE.
Can be deducted for taxes purposes.
OPERATING LEASE PAYMENT
Cannot be used to deduct for tax purposes. Its amortization (CCA) can.
CAPITAL LEASE PAYMENT
Using the function present value, we can calculate what would a series of future cashflow is worth today.
This can help evaluate the effect of multi-year future cashflow when making business decisions.
It is usually used to evaluate the value of future investments.
This is very important as projects can last multiple years from the start to the finish. Project managers need to understand the power of money and the true return of funds in today’s value in order to evaluate the project overall profitability.
RETURN OF INVESTMENT (NET PRESENT VALUE)
Net return of investment/cost of investment
When a business owner evaluates its return, it calculates the rate on every dollar it had spent
RETURN OF INVESTMENT (ROI)
Asset Evaluation
INCOME APPROACH
COST APPROACH
MARKET / COMPARABLE APPROACH
When an asset is generating a series of future cashflow (ie. Rental buildings), the value is calculated by discounting all future cashflow.
Most common approach for new development projects, new and existing commercial properties, and existing residential buildings.
The approach discounts the future cash flow ( net income without interest / taxes ) based on a capitalization rate.
INCOME APPROACH
Is equal net operation income / current market value.
It’s an estimate of the potential return of a real estate investment.
CAPITALIZATION RATE
An asset valuation can also be done on a cost-to-build or replacement value basis.
Most commonly used in insurance, new construction, and special project.
The approach takes into consideration the cost of land and construction.
It is also a good approach if a building has special add-on features or value - added components.
COST APPROACH
An asset valuation can be valued by comparison to other similar properties.
Direct comparison works best for unzoned land.
Lenders usually accept this valuation at the land loan stage. The land is valued at the as-is stage.
MARKET / COMPARABLE APPROACH
