Calculate NPV for premium savings product

hellothere

Registered User
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2
Dear all,
I am looking for the NPV calculation for a premium savings product. >10yrs ago I got a special/premium savings product with my local bank. The idea is to save every month a given amount of money. Doing so, at the end of the year you receive the regular interest rates (today basically at 0) and, more importantly, a premium interest payment on your annual savings. This premium interest increases constantly over the years until it is capped at 50%. Obviously, this product for years is not any more offered.

Let me illustrate the above with some numbers:
Assume you are saving each year 100€ (lets go for the annual amount for illustration purposes instead for the monthly saving). This amount is fixed, i.e., no dynamics.
  • 1. year your savings are at 100€: 0% interest, 0% premium interest
  • ...
  • 10. year your savings net of interests are at 1,000€: 0% interest, 25% premium interest on your annual savings, i.e., 25€
  • ...
  • 15. year your savings net of interests are at 1,500€: 0% interest, 50% premium interest on your annual savings, i.e., 50€
  • remember that this last year is the standard for the rest of the premium savings products. There is no limit on the timeline contract wise which would it make a perpertuity. Practically, you probably will run this model for another 10years and then get your money out.
My question now is how to calculate the NPV considering that the product is already in the 50% premium interest mode, i.e., each year there is an interest cashflow of 50€. We assume there is no cashflow from regular interests. At the same time the annual savings payment of 100€ continues. This means netting savings payment against interests there is a negative of -50€ per year. Is there a way to calculate the net present value of the product? For instance, if you are willing to sell it to another person who would like to benefit on your patience for the last 15years.

Looking forward to your help/answers.

Best!
 
I can't help feeling the product as described has the hallmarks of a ponzi scheme in the making, but I'll take a crack and discuss the question at a high level and hope I'm not aiding and abetting :)

Before you can perform the NPV analysis you need to identify the cashflows to include, over a finite future period, say 10 years. As the seller - a term used loosely as I doubt the small print of such a savings product from a mainstream bank would permit the sale or assignment of benefits to a third party - this will include the current savings capital balance and the future 50% interest premiums. Specifically, you would exclude the ongoing savings cashflows of the intended purchaser, so there is no netting off.

Next you would need to decide what rate to use in discounting the future values to a present value, and here you could choose to use the current inflation rate as a proxy.

Then simply perform the standard NPV calculation to determine your "sale price", which can only be considered a rough guide given your discount rate assumption/s and the absence of tax cashflow considerations.

That's it.

Incidentally, I'd expect the buyer to perform the same exercise to evaluate your "sale price" and compare and contrast that with the returns that could be had from investing the savings balance and ongoing savings in alternative and mutually exclusive opportunities.
 
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Hi Andrew!

Many thanks for your swift reply. Seems all logic to me. Except one point which I do not yet understand fully. Why do I not to take into consideration the ongoing savings cashflows? I mean, these are hurting the new owner of the product, don't they?

Btw, seems like a ponzi system, maybe it even is, but the riskiness is somewhat limited. So no worries on that end ;)

Thanks.
 
Great to hear you have a risk-free investment in a ponzi scheme. With such high returns why offload now? What is the name of the bank?
 
investment in a ponzi scheme
It's not completely inconceivable.

If I understand correctly, now after 15 years, you receive 50% special interest on the current years savings? So about 3.3% per annum on the entire balance (less if the interest is rolled up into the balance).

I would be sceptical if it has any real value, unless you're talking about large sums. The reason I say that is 2 fold:
1. Although there's no end date, it'd be unusual not to have some over riding clause that would allow the bank to terminate the product, and
2. It's already past the highest rate, so there's a decreasing annual return on the balance from here. Essentially you're asking how to value now, a guaranteed 2.5% return per annum 5 years from now.
Assuming subject to DIRT, you're comparing with tax free returns on state savings. OK, it's a very decent return in current market, but put lump sum into state savings, and regular monthly into best regular saver, and it's not earth shattering by comparison.
 
@RedOnion thanks for your input, your interpretation puts a different perspective on the original post.

@hellothere, apologies for the sarcasm contained in my previous post.

Why do I not to take into consideration the ongoing savings cashflows? I mean, these are hurting the new owner of the product, don't they?

When calculating the NPV from a buyers perspective you would certainly include the ongoing savings cashflows. If you take onboard RedOnion's 2 points it may be prudent to reduce the analysis period too. The benefit is simply the difference between the NPV result and current savings balance.

Edit: Too busy eating humble pie and need to amend the incorrect statement in the last sentence. The benefit passed from the seller to purchaser is in fact the NPV of future interest premiums. It does not include the NPV of the purchasers ongoing savings cashflows which the statement implies.
 
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