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Maxed out

A Comedy of Errors: Part II



Unfortunately, before we get to the comedy part of the comedy of errors, we have to understand a wee bit about the math of finance. Don't panic; this won't be on the test. But it is important to any fair analysis of the difference between a strata-titled condo hotel and a more traditional hotel, which is to say the difference between your house and your business, assuming you had both.

The math of finance is all about delayed gratification. One plus one still equals two but if you don't get that two for a while, you have to figure out what it's worth today. Finance math lets you decide how you're going to invest your capital based on what you expect in the way of a return. In short, it's about the future cash flow your investment will yield and your risk-return appetite.

Think of it this way. You've got $100 to invest. You could buy a Government of Canada bond. That's considered riskless because the Canadian government is a stable, if slightly batty, institution and always pays its debts. Problem is, Canada bonds don't pay much interest; your return on your investment is small. For the sake of this illustration, let's say it's 2 per cent. At the end of a year, your $100 will be worth $102. Obviously you're not going to get rich on this deal. On the other hand, you're not going to lose your hundred bucks either.

Now, if you took that same $100 and invested it in, say, a cocaine deal, you might expect to earn $1,000. Clearly that's a way better return on your capital. But the risk? Off the scale. You could lose your hundred bucks, get arrested, do serious time or wind up with some sleazy dealer stealing your money and leaving you dead on the floor.

Let's say those two examples anchor the ends of an investment continuum. One end is low risk, low return; the other, high risk, high return.

Most commercial investments, and certainly hotels, fall somewhere in between. While there are a lot of variables that have to be measured and guessed at in making an investment decision as complex as a hotel, once they've been determined, it all comes down to this: How much cash will this investment earn every year for its useful life? In doing this kind of cash flow analysis, no one cares what happens 20 years from now. The - I apologize in advance for this bit of jargon - net present value of cash flow 20 years down the road is irrelevant. That's actually important. The further in the future you get, the less valuable the presumed cash flow is to your decision today.

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