Price Tag —Is Your Outdoor Plant Worth More This Month Than Six Months Ago?
OOH …Here’s One Thing
by Jim Johnsen,
Managing Director, Johnsen, Fretty & Company
While a very few of you out there may be impressed with my agility with “la plume” and conclude that I must have been an English lit or history major, you couldn’t have been more wrong. In fact, as a prerequisite to starting college I was required to take a remedial writing course. The only other guys in the class (and it was all guys) were football players (and apologies in advance as I know I have offended someone with that factual statement). Long short, I was (and still am) a numbers guy through and through. As the Goldman guys like to say, “I’ve never seen a spreadsheet I didn’t like.
So with that said, I thought it would be fun to have a little child’s play with numbers…as in “Is your outdoor plant worth more this month than six months ago, or not?” Have your attention yet? Thought so. What am I talking about? How do recent Federal Reserve interest rate changes affect asset pricing? (Note to file, looks like they are coming with another .75% rate hike this week).
Okay, let’s dive right in.
Let’s say your plant throws off $1MM of net cash flow per year, and to keep it simple, let’s say it will not grow at all year over year (shame on you!). Let’s also say big public bad boy or BIGGY for short, cost of money back in January was 5.5%. Without getting too far in the weeds or making your hair hurt, BIGGY’s cost of money is the amalgamation of two things, his cost of debt and his cost of equity dollars. For purposes of this exercise, I will assume his cost of equity is constant and the only thing that chances is his cost of debt.
So back in January when BIGGY was courting you, he slapped down an NPV calc and said your assets were worth $13.4MM. Sounds pretty good…except, merde, you didn’t take it. On July 25th you wake up in a cold sweat and say to yourself, ‘Self, what was I thinking?’ I should have taken that offer. Whew, BIGGY is happy to take your call, but she tells you “New day. New price. I need to re-crunch the numbers”. She then calls you back and says since the Fed has raised rates 225 bps in 2022, BIGGY’s cost of money has risen to 6.63% and your plant has fallen in value to $12 mill.
WTF, are you telling me I lost over a million dollars just because the idiots at the Fed are masochists and I hesitated? And double WTF Johnsen, why are you writing this article? As a guy that represents sellers in this industry why they hell would you be broadcasting this dribble?
Okay, okay…hold on. Before you go Michael Douglas in Falling Down (Falling Down | IMDb), I have some good news. I screwed up the calcs.
Well screwed up might be a little harsh. What I meant to say, is I forgot one important component: inflation. When inflation is significant, as it is now, then interest rates aren’t exactly what they look like. Okay, now my hair does hurt Johnsen.
Think of it this way. If you gave me a dollar today and charged me 10% interest, and inflation was 50%, I would give you a dollar ten back in a year, but you would only really have .55 cents of purchasing power in your pocket…so you didn’t really earn 10% on your money, did you? Said in reverse, asset prices have to increase to stay the same in real dollar terms. Johnsen, stop, just stop. It’s painful.
Okay, then I will just give you the answer. If we assume inflation over the past 6 months is 7% (annualized) …and I think this is conservative, thenBIGGY’s REAL cost of money actually went to 3.17%, and the value of your plant is now $17.1MM. How about that for a loaded gun? Love me yet?
Jessie J – Price Tag— https://youtu.be/I_-MWKy0jCA (Hope you agree…that’s some raw talent!)
PS, let me know if you want to see my calculations behind this fun Monday math exercise.
Net Present Value (NPV) Definition (investopedia.com)
Adjustment for Inflation in NPV Calculation (xplaind.com)
Real Interest Rate Formula | Calculator (Examples With Excel Template) (educba.com)
And last but not least a great article that puts it in perspective: Endless Uncertainty · Collaborative Fund
Securities transacted through StillPoint Capital Member firm FINRA/SiPC