Working out the future value of money

By MUNGAI KIHANYA

The Sunday Nation

Nairobi,

08 March 2020

A traffic police officer was recently put to task by the Ethics and Anti-Corruption Commission (EACC) to explain how he accumulated Sh47 million in a period of six years.  When the story broke out, some one quickly posted on the Internet that this money can be shared among all 47 million Kenyans at the rate of one million shillings each.

Upon seeing this post, Nick Maina asked me: “Why does this calculation keep eluding us?” Now, I don’t have an answer for Nick, but I understand where he is coming from. On several occasions different people have done the same mistake when dividing Sh47 million among 47 million people.

The only thing I can do is to help those who might get confused when working with such large numbers. The trick is to deal with the multiples of ten first. In this case, there are millions of shillings and millions of people.

Those millions cancel out in the division and we are left with just 47 divided by 47. The answer is one, and so, each person would get just one shilling.

Now that seems like a trivial calculation, but the principle is very useful when the numbers to be divided are not of the same order of magnitude. Suppose is was Sh47 billion to shared among 47,000 people.

We start by dividing one billion by one thousand. The answer is one million. Then we divide 47 by 47 and find that the answer is now one million shillings per person.

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Dominic Karanu wants to know what the value of today’s Sh100,000 will be in ten years time. It is not a straightforward calculation because many things can happen in that period. The key factor to consider is inflation.

It is easy to work out the current value of Sh100,000 from ten years ago because the inflation rates are already known. However, nobody knows how prices of goods and services will behave in the next one year; let alone one decade. The most we can do is make a guess. But our guessing should be based on some reasonable assumptions.

We may assume, for example, that the inflation rate will maintain the same average value that it has over the last ten years. But I must emphasise that this is MY assumption.

Now, in February 2010, the consumer price index was 105.18; In February this year, it stood at 208.24. Thus, on average, prices of goods and services have doubled over the last ten years. (208.24 divided by 105.18 = 1.980)

If things remain the same as they have been over the past decade, then we can expect prices to double again by the year 2030. Thus, what Sh100,000 can buy today will cost Sh200,000. In other words, the purchasing power of the money will be half the current level, that is Sh50,000. Not a very good prospect, is it?