In this excel (attached screenshot), the multiple is 525,000 / 400,000 but is the 525,000 in terms of today's money? (is it already the NPV?) And if not, why can you divide 2 sums of money that are from different time periods?
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coming from real estate, but i doubt its different in whatever you're looking at, multiple is not a time sensitive metric. It basically says, if i give you x, how much will i get back?
No the 525k is not in "today's" money.
The purpose of a Money-on-money multiple is simply what it shows- how many times over you have made on a given investment (cash returned / cash invested). The time period is irrelevant. In this case, you make 1.3x your investment and it is up to the investor to decide whether that 1.3x multiple satisfies their own hurdle rate (often seen in venture capital when investors want to boast a "10x" return, regardless of it taking 3 years or 5 years or 7 years).
Now, the IRR tells you what the annualized return is based on the period of the project. If you had a discount rate (opportunity cost of the initial investment), you can calculate NPV. When the discount rate is equal to your IRR, the NPV of 525k is 400k.. so your discounted return would be 0% (400k/400k-1).
People will think in terms of NPV when you can accurately calculate the annual opportunity cost (the discount rate). We often see this when trading markets where there are virtually "risk-free" alternatives.
Thank you for taking the time to provide such a detailed and comprehensive answer, I really appreciate it.
If the multiple does not adjust for inflation or the time of value (money today is worth more than tomorrow because you can invest it), then how is it a fair comparison?
ie: How can I say I will get back 1.3x on my investment when I invested 400k today, and made 100k in 2011 (not adjusted), 100k in 2012 (not adjusted) etc. and sum up the amounts as if 100k each year means the same amount of money?
Because MoM is not the only measure of return you should be looking at. You also look at IRR, which incorporates time but not magnitude.
Knowing I had a 25% IRR doesn't mean much if the investment period was 1 week (the MoM will be tiny). Similarly, a MoM of 2.0x is not very impressive if the time period was 30 years (IRR will be very low).
It's best to state returns as "20% / 2.2x" which tells you both the time and magnitude components.
Agreed
Thank you for providing such a clear response; so MoM is a less reliable metric.
However, it seems strange to me that we put out unreliable numbers, so I just wanted to make sure I understood everything correctly - adding up 100k in 2011 (in terms of 2011, not today), then 100k in 2012 (in terms of 2012, not today) etc. to 525k without adjusting for inflation or the time value of money is acceptable.
Would this mean the only reason we haven't changed MoM to adjust for inflation and the time value of money is for efficiency / lack of information? In other words, it's good enough for an approximate metric to get the main point across (ie: 20% / 5x vs. 20% / 1.2 x)
Why are you so worried about inflation? Returns are measured in nominal amounts, always. Inflation expectations are already baked into whatever hurdle rate one is using. For example, in a CAPM model inflation is already a component of the risk-free rate, so if I am a company and I evaluate a project on the merits of its returns, if the project meets my hurdle rate then it is a good project. Let's say my hurdle rate was 10%. If a project yields 15% and a 3.0x over 10 years, should I worry about the fact that my 3.0x dollars can purchase less stuff in year 10? No, because when I calculate my 10% hurdle rate I already take inflation into account.
Thank you for the detailed explanation. A better way to phrase my question, then, is if we have the IRR and hurdle rate what is the point of MoM if it is less accurate and not adjusted? I know it tells you how many times over you have made on a given investment, but it doesn't seem logical to provide an inaccurate and unadjusted number. Why haven't we changed the formula for MoM so it better represents what it's supposed to?
Because it IS useful in certain scenarios. If I am a bond trader and I buy a bond at 55/100, collect a coupon payment and sell the bond for 57/100 a couple of weeks later, does it make sense for me to brag to my boss about the 3500% IRR I made over the course of the month? In reality, My MoM may have been 1.05x, meaning I only turned $1 into $1.05. IRR's are only impressive if sustained over a long period of time. MoM's are only impressive is achieved within a reasonable period of time. A high IRR means nothing if you don't know the MoM, and vice versa - they are supposed to be evaluated together because together they give you a more complete picture of investment performance (I turned X into Y and did so with Z% rate of return).
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