How Do You Calculate the Purchase Price of $1?

[Forza]

How would you go about putting a purchase price on an after tax dollar, earned next year? Here is my current thinking which is my attempt at discounted cash flow analysis. I really don't know whether it is correct.

$1.00
Less inflation
Less interest rate (minus the taxes)
If buying a business, less an appropriate margin of safety

Equals less than today's $1.00


Do you agree with this equation, or is it incorrect?

 

Dislike ads? Remove them and support the forum: Subscribe to Fastlane Insiders.

[Russ H]

Read "Your Money or Your Life" by Joe Dominguez and Vicki Robin.

You will never look at a dollar the same way again.

(answer: A dollar costs you WAAAAY more than you think).

-Russ H.

 

[Forza]

You mean inflation is much more than 2-5%?

I agree that prices of certain things seem to go up a lot over the years, however, when you look at government (overall) inflation statistics, they usually indicate that it is low to mid single digits.

 

[australianinvestor]

I think tax confuses the matter, and even though discounting it further is possible, I think that would be more appropriate to risk-bearing investments, not earned income.

In the simplest terms, $1 in a year is equal to $x today. You want to know x.

After inflation (3.5% in this example):
FV/((1+r)^n) = $1/((1+0.035)^1) = $0.966.

So, in English, one future dollar (in twelve months) is worth 96.6 cents in today's dollars, if inflation is 3.5%.


Daniel.

 

Dislike ads? Remove them and support the forum: Subscribe to Fastlane Insiders.

[Forza]

By earned income, I mean income that a business or investment earns.

I always subtract the tax because I don't want to pay for money that I'll be giving away, if that makes sense

And, call me a dumb a$$, but I don't know why the inflation adjusted answer is $0.966 rather than $0.965.

 

[australianinvestor]

By earned income, I mean income that a business or investment earns. I always subtract the tax because I don't want to pay for money that I'll be giving away, if that makes sense And, call me a dumb a$$, but I don't know why the inflation adjusted answer is $0.966 rather than $0.965.

If you want to know the value of your future earned dollar after tax, it's more like working out what the value of $1.66 (or whatever the extra tax you pay) is worth today.

When doing calculations of this nature, there's often a miniscule difference in how it's rounded which means there might be two slightly different answers. They are always pretty close. If you do the same calculations over the life of a 30 year mortgage, you can see larger differences as well

Daniel.

 

[australianinvestor]

Oh, and I meant to add that I thought tax confuses the matter because people pay differing amounts of it.

 

Dislike ads? Remove them and support the forum: Subscribe to Fastlane Insiders.

[Russ H]

You mean inflation is much more than 2-5%?

What I meant is that it's very deceiving to think you can easily calculate the value of a dollar.

A dollar is worth different things to different people.

In some parts of the world, a US dollar could keep a family of four eating well for the better part of a month.

In Manhattan, it won't even buy you a cup of coffee.

The book I recommended goes into MUCH more detail about the value of a dollar in your life.

But I may be recommending the wrong thing to you-- if you're looking for a simple financial calculator, Your Money or Your Life is not it. It's an "outside of the box" way to look at both money, and time.

Thing is, the reader has GOT to be ready for it, of they just miss the point of the whole thing.

Please don't take this the wrong way--we're all journeying on the road to financial freedom. All of ask very similar questions as we learn about planning for our futures.

But those answers-- and how we look at the original questions-- actually change in substantial ways as we learn and grow.

-Russ H.

 

[australianinvestor]

I think the purpose of the post is to determine an appropriate discount rate, not necessarily to put a qualitative value on the dollar.

And I agree with Daniel (AustralianInvestor) in his approach, though I'm not sure it took into account opportunity cost (what you could be doing with the money otherwise).

I agree, I purposely omitted opportunity cost to keep the example simple.