What is the present value of money invested in failed project?

By MUNGAI KIHANYA

The Sunday Nation

Nairobi,

15 August 2021

After reading the article about payback period of an investment, Linda mustered the courage to ask this related question: “In 2012, I invested Shs1,050,000 in a property investment company.  Things went nowhere.  I am now getting my money back, Sh1,050,000 plus an additional amount to be discussed as compensation.  What would be a figure that would bring my initial principal amount up to today's value in 2021?”

There are two things to bear in mind here. First; the purchasing value of the shilling has gone down due to inflation over the 9-year period. Thus, returning exactly Sh1,050,000 to Linda would be grossly unfair since it would be less money that what she put in.

Secondly, if the discussion is about compensation, the additional amount must be above the inflation adjusted figure. So, the first step is to find out the present value of the money paid in 2012.

According to data from the Kenya National Bureau of Statistics, the Consumer price index in 2012 was an average of about 68 and, currently, it is about 115. This means that, what you could have bought with Sh68 in 2012 will now cost you Sh115. In other words, the purchasing power of a 2012 shilling is equal to that of about Sh1.69 today. We get this by dividing 115 by 68.

It follows that the Sh1,050,000 that Linda paid in 2012 is equivalent to Sh1,690,000 of today. Paying her Sh1,690,000 will simply return her to where she was in 2012. That is, there is no “compensation”!

There are two ways of finding out what the fair compensation would be. First is assuming that the money was placed in a money market account – perhaps, in a unit trust or in treasury bills. The average return over the last 9 years has been between 8 and 10 per cent. We may use the middle ground of 9 per cent. If the Sh1,050,000 was placed in such an account in 2012, it would have grown to almost Sh2,100,000 today.

A latent question, however, is whether this Sh2.1 million would be enough to buy a similar property in the same region today. Now, Linda doesn’t say what kind of property she was buying and where in the country it was. Assuming it was a plot of land, we can apply the typical appreciation rate of about 20 per cent per year to get it present price. The result is that such a plot will now cost her about Sh5.4 million. This is the fair amount that she should demand.