Net Present Value: The "time value" of money

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Wednesday, October 15, 2003

The "time value" of money

The wonderful article by David Bank from the Wall Street Journal (subscription required) that encapsulates my own thoughts on foundations and the need for funds now. This article focuses on a new trend among donors which surmises that a dollar given today has much more value than a dollar saved and given in the future. And that despite the economic downturn there will be new funds available in the future to deal with future problems.

Bank gives the example of Charles Feeney who made his fortune thru the Duty Free Shops in airports around the world. "Earlier this year, Mr. Feeney pushed his foundation, the Atlantic Philanthropies, to adopt a plan to exhaust its $4 billion endowment over 15 years or so. Now 70 years old, Mr. Feeney told his board that the prospect of going out of business would focus the foundation on bold problem-solving rather than self-perpetuation."

Atlantic is among a small group of charities that are bucking the prevailing approach of established foundations, which have traditionally sought to sustain their endowments and their grant-making forever. A federal tax-code change in 1981 relieved foundations of the obligation to distribute at least as much as they earned on their assets each year. Since then, overall foundation "payout" rates have drifted down to near the legal minimum of 5% of assets.

In the same period, according to the Foundation Center in New York, foundation assets have greatly increased, from $47.6 billion in 1981 to $486.1 billion in 2000, the most recent year for which full information is available. Last year, foundations paid out about $29 billion in grants.

The Director of McKinsey's Institute on the Nonprofit Sector, Paul Jansen, has calculated what this thinking vs the status quo means in stark financial numbers, and the results are just staggering. A $100M foundation that paid out only 5% or $5M a year has a Net Present Value of only $50M!

Weighing social and financial returns, Mr. Jansen says, forces foundations to confront a provocative question: "Would we all have been better off if you had given that money out last year and had it deliver benefits, than we are now, with your having lost 15% to 30% of it in the stock-market decline?"

In making his calculations, Mr. Jansen used a standard business analysis of the time value of money. Just as financial returns need to be more heavily discounted the further in the future they are likely to occur, so must social returns that are delayed by conservative spending policies. Factoring in a typical discount rate, Mr. Jansen found that a $100 million endowment of a foundation that paid out only 5%, or $5 million, a year in grants really had a "net present value" of just $50 million or so.

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