The sinking fund factor provides the annuity payment that must be made each conversion period at a given rate of compound interest to have available a specified sum at some given future time period to take care of scheduled capital expenditures or other expenses.
For instance, when a real estate investor wants to start setting aside money in order to have enough available at some future date to replace (let’s say) a roof or siding on an apartment complex, the real estate investor would create a sinking fund to insure that the money will be there when needed.
The factor simply tells the investor the amount of each deposit that must be made into an interest-bearing account so the combination of principal and earned compound interest total the future amount desired.
P = 1 / Sn
P = Cash flow payments of equal size at equal intervals
Sn = Future value of a series of annuity cash flows
Making the Calculation
Say a real estate investor needs $10,000 in five years to replace refrigerators in an apartment complex that he or she owns. The investor is prepared to make a deposit immediately and at the beginning of each of the following years into an account that yields 15% per year. What amount should the investor deposit each time in order to accumulate the $10,000?
This is not a calculation most of us can make in our head so we will have to consider a spreadsheet program or financial calculator. Three methods are illustrated below to show you how you can arrive at the answer.
1. Excel Spreadsheet
PMT (15%,5,,10000,1) = $1,289.70
2. HP-10B/12C Calculators
N = 5
%i = 15
FV = 10,000
PMT = -1,289.70
Note: The HP-I0B/12C calculator must be set for payments to be made at the beginning of each conversion period to make this calculation.
The method required to make the necessary calculation is illustrated in the image below. Click image to enlarge.
PMT = $1,289.70
A sinking fund is a prudent way for real estate investors to plan for future capital expenditures. The idea is straightforward. Start depositing some amount of money into an account yielding compound interest at regular intervals so you have the total amount of money you need at some prescribed future time.
So You Know
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