PRESENT VALUE OF CASH FLOWS

 

PRESENT VALUE OF A CASH FLOW

Present value is what the value of the future cash flows are worth  today.

Example:

A seller of a mortgage note can  sell the full amount, a fraction, or a portion of his interest in the mortgage note.  The seller then assigns the whole or a fraction of his interest of the remaining period of the mortgage note.  A document known as the assignment of interest spells out the terms and conditions involved.  For that document, the present value of the future cash flows are calculated.  the document will spell out what cash flow the purchaser of the note is buying.  The purchaser of the note has to figure out what the value of that mortgage is worth today. The value of the note or trust deed is found by  the present value, the adjustments made are according to today’s market value.

To do that, he does a calculation called the present value of the future cash flow.  The term sounds complicated, but basically it means what the cash flow is worth today. Time value can be described with the simplified phrase, “A dollar today is worth more than a dollar tomorrow”. Here, ‘worth more’ means that its value is greater.

Mortgage note was used in this example but is also true in most notes.

Another way to look at present value is as  follows:

Present value is just the opposite of future value. It is the worth today, of an amount to be received (or paid) in the future.  In the example given in future value the $10,000 beginning amount is the present value of the future $11,000 assuming that the investment is to earn 10% per annum.

The down payment made at the time of purchase often times determines the  determines the safety of the note.  Sometimes the buyer of the note ask for an appraisal, to satisfy his investment.  Present values often increase or decreases the note value.

If balloon payments are part of the contract, they are consider to be a bit riskier than some loans that are amortized, the ideal balloon would be written from 3 to 5 years, limiting the exposure of the note.