Week 9_John Agbo_ Choice of Finance options.

Problem Recognition / identification

I am from a large family. Each year, we all come together with our spouses and kinds for a reunion. This large family is getting larger by the day and accommodation poses a huge challenge each time we reunite. There is now a need to build a block of flats where each of us and his / her spouse and kids will have a comfortable accommodation for the individual families. We intend to commence this state-of-the-art edifice between now and 2 years time. This project is to cost us about N50m and we are looking for ways to raise the funds. As the only cost estimator in the family, they asked that I advise on possible ways of raising this amount.

Development of feasible alternatives

Owing to the fact that the project is to commence between now and 2 years time, I came up with 2 alternatives thus:

1. Source for Mortgage Loan immediately and pay back within 10 years

2. Make an investment today towards N50,000,000.00 in 2 years

Development of outcomes of alternatives

1. Source for Mortgage Loan immediately and pay back within 10 years – This will entail providing the bank some form of collateral and agreeing on other terms such as management fees, interest rates and payback period. In Nigeria, the maximum payback period must be 60 years minus the current age of the person requesting for the loan. Also, a default of the payment terms / plan will result in the bank charging some penalty. Most banks have zero-tolerance in this regard. The collateral you provide, often times has to be worth the amount you are requesting for. Should we take this option, we will need to put in place, a proper payback strategy that will not disrupt the agreed payment plan.

I had a brief discussion with my bank and they have told me they can give me the loan is I have a reasonable collateral. They intend to charge and interest rate of is 25% p.a, 2.5% of Principal as Management fee (one off):

Principal – N50, 000,000.00(amount invested now)

VAT (5%) - N 2,500,000.00

To compute the future value: P (1+r)ⁿ, where P (amount invested now=N50, 000,000.00, r (rate of interest) = 25% and n (No. of years) = 10 years. Applying the formula, 50,000,000(1.25)¹⁰ = N465, 661,287.31. This value represents the total amount I would have spent over 10years (Principal + interest). The total value of interest after 10 years = Future Value – investment,

i.e. N465, 661,287.31 – N100, 000,000.00 = N 365,661,287.31. Therefore, summary of cost burdens will be: Future Value - N 465,661,287.31

Value added tax (5%) - N 2,500,000.00 (one off on Principal)

Total (at 10 years) - N468, 161,287.31

2. Make an investment today towards N50,000,000.00 in 2 years – this will entail raising some bulk money, depositing it in the bank, and allowing it for the agreed period to yield some interest a negotiated interest rate(some form of fixed deposit). If we go for this option, we will have to join forces to contribute a substantial amount to invest. Should we decide to invest today in order to achieve N50m in 2 years, the bank has agreed to pay an interest rate of 15% p.a. I need to find out how much we need to invest to achieve N50m in 2 years.

Present value = P (1+r)-ⁿ = P/ (1+r) ⁿ, where P = 50,000,000, r = 15% and n = 10yrs. Therefore, amount to be invested = 50,000,000/ (1.15)¹⁰ = 50,000,000/4.05 = N12, 345,679.01

Selection Criteria

1. Easy and less cumbersome banking protocol.

2. Guarantees peace of mind for family members

3. Cost savings in the long run.

Analyzing the options

We all know that getting banks to give you loans entail a lot of rigorous and cumbersome protocols and once you finally get it, you no longer have peace of mind knowing you have put an important asset at stake as collateral. The building in question is not for business purposes. So the first alternative does not meet the criteria.

The second alternative, meets the criteria.

Selection of Preferred Alternative

Based on the above criteria and analysis, I will recommend the second alternative.

Performance monitoring / Post Evaluation

I will ensure that interest rates are closely monitored and applied as at when due. I will request for periodic bank statements to ensure that the right interest rates are paid.

References:

AACE International. Skills & Knowledge of Cost Engineering, 5^th Edition Revised.Chapter-7, P.7.1-7.8 Edited by Dr. Scott J. Amos, PE. 2010. AACE International. Morgantown, WV, USA.

AACE International. Skills & Knowledge of Cost Engineering, 5^th Edition Revised.Chapter-27, P.27.2-27.6 Edited by Dr. Scott J. Amos, PE. 2010. AACE International. Morgantown, WV, USA.

Accounting For Management - Present value and future value (online) - http://www.accountingformanagement.com/concept_of_present_value.htm