Oct 21,2016:
Please see our article on ASC 842 Lease Accounting just published at http://www.monitordaily.com/article-posts/lessee-side-balance-sheet-reporting/.
Limited to 1,600 words we have tried to present the essence of the new pronouncement to guide management planning. Our accounting system is close to final completion and testing and addresses Lessor and Lessee side reporting optionally. Hopefully, the next 3 months will be quite enough from a tax compliance standpoint to complete the system. On it goes!
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Showing posts with label Discounted Cash Flow. Show all posts
Showing posts with label Discounted Cash Flow. Show all posts
Friday, October 21, 2016
Thursday, May 19, 2016
What I have been able to discern from articles I have read
is that a great deal of flexibility is going to be needed on the lessee side to
accommodate an ever changing portfolio of leased equipment. Our company,
PAMS-DCF, Inc has the newly created (2015) exact system required based on USING EXCEL AS A DATA BASE only, enhanced by powerful front end hard coded programs that are designed to be very
flexible. Our system will do the present value analysis on any
cash flow, the asset booking entries and a portfolio analysis capable of easy
update and immediate recompilation of
the effective yield or present value for the updated composite assets providing
an accurate rolling present value balance and amortization analysis through
it's portfolio features. Go to PAMSDCF.com for a detailed capability overview.
Obviously, there are many more lessees than lessors. Any worthy systems should be very expandable. The job handed down by the
FASB is much larger than I believe the FASB realizes. A system such as PAMS-DCF is
the only way to manage a large portfolio of leased equipment from the lessee
side assuming the company really intends to comply with the new standards, and
that may be a larger than life assumption and some time in coming. Scalability and accuracy into the trillions of dollars are a must. Look us over before you decide.
Tuesday, May 17, 2016
It's all about the balance sheet, the balance sheet, the balance sheet!
What can you say? I have concluded that requiring the recording of leases on the books of the lessee is what the new pronouncement is all about. In general, requiring the recording of legal obligations and attendant rights is what has been accomplished. To be sure, it will change the look and feel of many a balance sheet on the lessee side of the equation. That is a big deal! Not so much on the lessor side. It is more than a question of cosmetics when liabilities hit the balance sheet that were previously never shown. On the lessee side again, the operating statement is changed very little if you look at the net Profit impact. PAMS-DCF is very well suited to computing present values and amortization schedules for recorded leases. PAMS will handle complex flows and create permanent records that can be introduced into its portfolio capabilities to create a composite rate and amortization schedule for each reporting period and be easily updated as new lease transactions are added. You would have to set up a portfolio for operating leases and one for finance leases due to the differences in Profit reporting, but that is simple enough to do. We can provide one time or ongoing service and reports in both hard copy and EXCEL file formats without the need to acquire the system or learn it. We would prepare booking entries, monthly amortization and balance sheet balances, monthly amortization expenses, interest expenses, individually or in a composite portfolio format. Give us a shout and make your life a bit easier. We need the work.
What can you say? I have concluded that requiring the recording of leases on the books of the lessee is what the new pronouncement is all about. In general, requiring the recording of legal obligations and attendant rights is what has been accomplished. To be sure, it will change the look and feel of many a balance sheet on the lessee side of the equation. That is a big deal! Not so much on the lessor side. It is more than a question of cosmetics when liabilities hit the balance sheet that were previously never shown. On the lessee side again, the operating statement is changed very little if you look at the net Profit impact. PAMS-DCF is very well suited to computing present values and amortization schedules for recorded leases. PAMS will handle complex flows and create permanent records that can be introduced into its portfolio capabilities to create a composite rate and amortization schedule for each reporting period and be easily updated as new lease transactions are added. You would have to set up a portfolio for operating leases and one for finance leases due to the differences in Profit reporting, but that is simple enough to do. We can provide one time or ongoing service and reports in both hard copy and EXCEL file formats without the need to acquire the system or learn it. We would prepare booking entries, monthly amortization and balance sheet balances, monthly amortization expenses, interest expenses, individually or in a composite portfolio format. Give us a shout and make your life a bit easier. We need the work.
Friday, May 13, 2016
FASB on Feb 25, 2016 and the IASB somewhat earlier, have published and implemented their new accounting standards for leases. The FASB standard is designated LEASES(ASC 842). I have had the opportunity just this month (May 2016 ) to review some of the articles available, coming off a very hectic tax season.
To the point, just about every lease that goes beyond a year now has to show itself on the balance sheet as both an asset and offsetting liability. The leases break down into three broad categories as operating leases, finance leases and sales type leases. Leveraged lease are no longer recognized as a separate category, but presumably will squeeze themselves into the finance lease category if any are newly done. There is no advantageous earnings treatment from the lessor reporting side, nor any advantageous balance sheet treatment from the lessee side. If one is done it would have to be on it's economic merits only. After tax analysis is still a viable tool and can be applied to any leveraged tax advantaged transaction not only leases, but including leveraged leases. There is no longer an up-fronting of income and hence no great EPS impact can be expected for lessors.
It is all too new for me to start making any generalizations other than to say all leases will be outed on the balance sheets of lessees and will carry the force of contractual debt in ratio and income measurements. Present value analysis can be done for the simpler payment streams using any tool such as EXCEL or a hand held HP Financial calculator. For more complex flows and for a permanent record or portfolio computations, a system such as PAMS-DCF will be required above and apart from the rate analysis aspects of such a tool. Over-all, I believe Present Value tools will be in more demand now than ever before, in spite of the loss of the need for accounting use of extended yield analysis methods. It should prove to be a net win for products such as PAMS-DCF. More will come as the accounting package is completed and some attempts are made to implement portfolio booking methods for leases on the lessee side. It is a new world, but hey, look what's happening to the political world.
To the point, just about every lease that goes beyond a year now has to show itself on the balance sheet as both an asset and offsetting liability. The leases break down into three broad categories as operating leases, finance leases and sales type leases. Leveraged lease are no longer recognized as a separate category, but presumably will squeeze themselves into the finance lease category if any are newly done. There is no advantageous earnings treatment from the lessor reporting side, nor any advantageous balance sheet treatment from the lessee side. If one is done it would have to be on it's economic merits only. After tax analysis is still a viable tool and can be applied to any leveraged tax advantaged transaction not only leases, but including leveraged leases. There is no longer an up-fronting of income and hence no great EPS impact can be expected for lessors.
It is all too new for me to start making any generalizations other than to say all leases will be outed on the balance sheets of lessees and will carry the force of contractual debt in ratio and income measurements. Present value analysis can be done for the simpler payment streams using any tool such as EXCEL or a hand held HP Financial calculator. For more complex flows and for a permanent record or portfolio computations, a system such as PAMS-DCF will be required above and apart from the rate analysis aspects of such a tool. Over-all, I believe Present Value tools will be in more demand now than ever before, in spite of the loss of the need for accounting use of extended yield analysis methods. It should prove to be a net win for products such as PAMS-DCF. More will come as the accounting package is completed and some attempts are made to implement portfolio booking methods for leases on the lessee side. It is a new world, but hey, look what's happening to the political world.
Monday, February 8, 2016
February 8, 2016 ...The FASB on Leasing and Lease Reporting
I have yet to see a definitive publication on lease reporting coming from the FASB (Financial Accounting Standards Board) explaining the new but not yet implemented accounting rules. That is, a written dissertation on this is how you do it (also serving as a codification) may not yet be available. I think it is safe to say that leveraged leasing is dead for the foreseeable future. I have read that it was pretty much dead for the past few years anyway. If there was any question about it's health, the general opting to treat a leveraged lease as a finance lease essentially kills all hope of it's use in the future. As a straight financing transaction on paper, the EPS impact would be negative or weak at best, the real economics of the transaction not withstanding. The general trend of corporations not paying any taxes via other shelters and techniques probably had as much to do with the demise of the leveraged lease as anything else. When you can just off-shore the income and avoid all taxes, at least for the immediate future, why bother with tax shelters. Jesse James did not need any tax shelters. Someone should do a new book on modern tax sheltering techniques for Internationals. Maybe Bernie Madof could write something while he is doing his time? By the by, FASB, the technique of putting off implementation amounts to avoidance behavior, which is not the mark of good leadership.
The economics of tax sheltered leases of equipment still requires measurement via some sinking fund method enhanced yield approach to measure an after tax rate, if rate is to be used as one of the measuring tools. Systems that are able to do that will be harder to find. PAMDCF still provides sinking fund analysis of transactions including one sound method, the Standard Sinking Fund Method to do rate analysis when after tax analysis is sought, and equivalent pre-tax rates are sought. Using EXCEL as it's data base provides the flexibility to introduce any computed tax benefits to the flows and using the SSFM to establish a sinking fund provides a mathematically and logically sound approach to handing the sign change issues that create multiple yield problems. As an example, the SSFM model could be used to determine how much investors would have to invest up front to assure a business would succeed where it's projections cause sign changes over the projected period. Nothing to do with leasing, but the same concept as a leveraged lease. As long as there remains gaping holes in the tax code that permit Multi-nationals to avoid taxes entirely, who needs any tax shelters? Maybe some of theses pillars of independence running for election can fix things? Right!
I have yet to see a definitive publication on lease reporting coming from the FASB (Financial Accounting Standards Board) explaining the new but not yet implemented accounting rules. That is, a written dissertation on this is how you do it (also serving as a codification) may not yet be available. I think it is safe to say that leveraged leasing is dead for the foreseeable future. I have read that it was pretty much dead for the past few years anyway. If there was any question about it's health, the general opting to treat a leveraged lease as a finance lease essentially kills all hope of it's use in the future. As a straight financing transaction on paper, the EPS impact would be negative or weak at best, the real economics of the transaction not withstanding. The general trend of corporations not paying any taxes via other shelters and techniques probably had as much to do with the demise of the leveraged lease as anything else. When you can just off-shore the income and avoid all taxes, at least for the immediate future, why bother with tax shelters. Jesse James did not need any tax shelters. Someone should do a new book on modern tax sheltering techniques for Internationals. Maybe Bernie Madof could write something while he is doing his time? By the by, FASB, the technique of putting off implementation amounts to avoidance behavior, which is not the mark of good leadership.
The economics of tax sheltered leases of equipment still requires measurement via some sinking fund method enhanced yield approach to measure an after tax rate, if rate is to be used as one of the measuring tools. Systems that are able to do that will be harder to find. PAMDCF still provides sinking fund analysis of transactions including one sound method, the Standard Sinking Fund Method to do rate analysis when after tax analysis is sought, and equivalent pre-tax rates are sought. Using EXCEL as it's data base provides the flexibility to introduce any computed tax benefits to the flows and using the SSFM to establish a sinking fund provides a mathematically and logically sound approach to handing the sign change issues that create multiple yield problems. As an example, the SSFM model could be used to determine how much investors would have to invest up front to assure a business would succeed where it's projections cause sign changes over the projected period. Nothing to do with leasing, but the same concept as a leveraged lease. As long as there remains gaping holes in the tax code that permit Multi-nationals to avoid taxes entirely, who needs any tax shelters? Maybe some of theses pillars of independence running for election can fix things? Right!
Monday February 8, 2016-Accounting System coming soon!
We have very neatly formatted amortization schedules going to excel files directly. We are cleaning up rounding differences and should be ready to publish as part of the standard package shortly Next will be carrying the reports directly to an accounting sheet for cumulative accounting reporting of earned income , remaining unearned income and remaining principal balances. This will effectively permit both balance sheet reporting and income reporting of the key eliminates of investment receivables. We have also cleaned up readability of reports by eliminating sometimes confusing negative signs preceding some columns .
Monday, September 28, 2015
Here is a brief discussion long promised on advance vs arrears payments.
Advance or Arrears Payments:
Typically, payment of interest for the use of money is made
at the end of the period of use of the money.
As an example, most mortgages are paid at the end of the month for the
use of money during that month. Similarly,
the principal portion of the payment is made together with the interest after
the month expires or in "arrears". In some cases, loans or lease payments
are made having payments in the beginning or the inception of the loan or lease before
the lapse of any time in the contract. This loan would be referred to as having
an "in advance" payment structure. So, what's the difference in rate
effect and cash flow? Why is it done?
The change between advance and arrears can have a major impact on the rate of
interest in the loan or lease. Some loans or leases can require two or more
payments in advance, or other in advance payments for fees etc. The impact of any "in advance"
payments for any reason by whatever they may be called, is to reduce the amount
of initial investment by an amount equal to the in advance payments. Making the
initial investment for the same loan/lease smaller while the pay back stream
remains the same increases rate of return. The smaller the investment the
higher the rate of return on the investment, all other things being equal.
There is an endless list of fees and expenses a lender can charge or pass on to
the borrower. Whatever the name, if the borrower pays over to the lender some
amount, that amount serves to enhance the lenders yield or rate on the deal.
Assume a business loan
of $95,000 to be paid back monthly over 18 months with a rate of interest at 18% and
an in arrears payment of $6,061.55. The stream rate is given as 18% and could
be quoted as such.
If the lender were to require one payment in advance then
the amount being loaned would reduce to (95,000-6061.55) or 88,938.45. The
resulting rate to present value the stream of payment back to 88,938.45 is
26.95%,
If the lender required the 1st two in advance the rate jumps
to 36.84%. The stream rate can still be said to be 18% while the actual rate is
36.84%.
If the lender required the 1st plus the last two payment in
advance we get 95,000-(3 X 6061.55)) or
an net investment of 76,815.35. The rate increases to 47.85% with three in
advance. The stream rate is still quoted as 18% while the effective rate has
jumped to 47.85%. Wow...big difference.
Next let's assume a placement fee is charged, or call it a
set up fee of 3% or 3,135 (.03 X 95,000). The net out of pocket to the lender
drops from 76,815.35 to 73,680.35. The rate now goes to 54.06%.
So we have the first and last two in advance and a set up
fee of 3%. We quote 18% on the stream and create a transaction returning 54.06% effective rate. That is what "in
advance vs. in arrears" can do to
the bottom line. The borrower needs the money and is often thankful that he has
a resource at any rate, so he is willing
to pay it even if he is aware of the material increase in rate created by in
advance payment requirements. Many a small business would not survive without
this resource. Banking requirements are unrealistically restrictive, and poorly
executed. Too much emphasis on rate will often mislead a borrower.
These rates can be developed using a financial calculator. Having
PAMS-DCF software to produce amortization schedules gives a better picture of
the earnings spread over the term. This concludes our discussion of in advance in
arrears scenarios.
Friday, August 14, 2015
Thursday August 13, 2015.
We demonstrated the system in the NY area at two locations. We returned to home base yesterday. After considerable thought, we have concluded that our book should be listed as a stand alone item on AMAZON for a modest price. It involves the loss of some control over the book's circulation, but we are of the belief that the benefits outweigh the risks. We are planning to offer the book alone at $29.95. The book is a walk through from beginner to expert in the area of Discounted Cash Flow Analysis and includes a comprehensive glossary. It is easy to read and very empowering for those new to the art. Full credit will be given for the purchase price of the book should the software be purchased at some latter date.
We demonstrated the system in the NY area at two locations. We returned to home base yesterday. After considerable thought, we have concluded that our book should be listed as a stand alone item on AMAZON for a modest price. It involves the loss of some control over the book's circulation, but we are of the belief that the benefits outweigh the risks. We are planning to offer the book alone at $29.95. The book is a walk through from beginner to expert in the area of Discounted Cash Flow Analysis and includes a comprehensive glossary. It is easy to read and very empowering for those new to the art. Full credit will be given for the purchase price of the book should the software be purchased at some latter date.
Friday, July 17, 2015
Thanks God it's Friday! I would love to hear from some of the readers around the world that have been reading our "Shop Talk" discussions. I was thinking of having a brief talk about advance and arrears payments and how they impact yield. Not a lot of meat there but something worth looking at using PAMS-DCF generated examples. Does anyone have some area they would like us to explore with some examples and models? Let's hear from you. No question is too trivial if it is distracting you, and I realize that most do not have (yet) access to a discounted cash flow software system to help you answer questions. We do, so give us the opportunity to put it to good use. Off to see my "Buds" and down a wine or two at our local pub and Jazz club. It is Friday night! Music is my other great passion.
Thursday, July 9, 2015
We now have a clearly defined mission. It follows:
Doing DCF analysis without access to a computerized system is impossible given our life spans. The use of a capable, versatile, easily and quickly manipulated computerized system is absolutely necessary. PAMS-DCF is just such a system thanks in part to the choice of EXCEL as its database, which most people have and are familiar with. Excel, when coupled to the front-end input software and powerful yield analysis engine make an unprecedented combination for dealing with DCF analysis.
PAMS-DCF is a tool that is affordable and easily learned and should be as basic to the tool box of every financial industry person and financial educator as a hammer is to a carpenter.
We at PAMS-DCF Inc. intend to see to it that everyone can afford to have access to this tool and the knowledge to use it, that is our Mission.
Doing DCF analysis without access to a computerized system is impossible given our life spans. The use of a capable, versatile, easily and quickly manipulated computerized system is absolutely necessary. PAMS-DCF is just such a system thanks in part to the choice of EXCEL as its database, which most people have and are familiar with. Excel, when coupled to the front-end input software and powerful yield analysis engine make an unprecedented combination for dealing with DCF analysis.
PAMS-DCF is a tool that is affordable and easily learned and should be as basic to the tool box of every financial industry person and financial educator as a hammer is to a carpenter.
We at PAMS-DCF Inc. intend to see to it that everyone can afford to have access to this tool and the knowledge to use it, that is our Mission.
07/9/2015 A picture is worth 1K words....Part 5 Final on Extended Yield Methods
"WILL THE REAL YIELD PLEASE STAND UP!"
At this date, it looks very much like the MISFM-Legacy may not survive expected changes in accounting rules now close to a decision. Be that as it may, The MISFM-Legacy remains a good example of what good discounted cash flow techniques should not be. We will continue to use it as a model of what not to do even if it survives. I will refer to the MISFM as MISF-Legacy to denote the issues surrounding its' continued use.
We can start by looking at the first picture, a picture of the MISF-Legacy method's investment amortization schedule or proof of yield report. This is the report that shows the source of the rate used by FASB13 of 8.647% and all the related tables associated with computing that rate. We can call that Exhibit A-2. It is conspicuously absent from Appendix E of FASB13. It is difficult to explain an issue if the foundational schedule supporting the computations is not presented. FASB13 failed to present this schedule as best as we can tell after reviewing Appendix E. Along with the MISFM amortization schedule we are presenting the other two schedules PAMS-DCF produces on all cash flows, The IRR (XX-1)schedule and the SSFM (XX-3) schedule. So each different cash flow will always be analyzed 3 different ways. By doing this 3 way approach (A-1, A-2, A-3, etc.) we will have comparative analysis and we will be prompted to ask pertinent questions.
The first observation to be made is that the raw, un-extended or unmodified flows discount to a PV of zero at a rate of 9.257543% (IRR Schedule A-1), hence this rate can be added to a bucket of "Pick Your Rate" options that discount to zero It is a mathematical solution to a series of flows that discounts to a zero PV(present value) . This begins to demonstrates that a rate can generally be found for any cash flow that will discount to zero mathematically The flow does not meet the Sign test criteria of only one change in rolling flows. There are 3 changes. This should not stop us from using it since the MISFM-Legacy modified flow does not meet the sign test either. That is the flow that gives rise to the 8.647% yield that we are using to distribute income. So by any logical measure, the raw flow used in the IRR analysis and the modified flow used in the MISFM analysis should have equal standing before the court, at least as far as the sign test for a unique rate or yield existing is concerned.
"WILL THE REAL YIELD PLEASE STAND UP!"
At this date, it looks very much like the MISFM-Legacy may not survive expected changes in accounting rules now close to a decision. Be that as it may, The MISFM-Legacy remains a good example of what good discounted cash flow techniques should not be. We will continue to use it as a model of what not to do even if it survives. I will refer to the MISFM as MISF-Legacy to denote the issues surrounding its' continued use.
We can start by looking at the first picture, a picture of the MISF-Legacy method's investment amortization schedule or proof of yield report. This is the report that shows the source of the rate used by FASB13 of 8.647% and all the related tables associated with computing that rate. We can call that Exhibit A-2. It is conspicuously absent from Appendix E of FASB13. It is difficult to explain an issue if the foundational schedule supporting the computations is not presented. FASB13 failed to present this schedule as best as we can tell after reviewing Appendix E. Along with the MISFM amortization schedule we are presenting the other two schedules PAMS-DCF produces on all cash flows, The IRR (XX-1)schedule and the SSFM (XX-3) schedule. So each different cash flow will always be analyzed 3 different ways. By doing this 3 way approach (A-1, A-2, A-3, etc.) we will have comparative analysis and we will be prompted to ask pertinent questions.
The first observation to be made is that the raw, un-extended or unmodified flows discount to a PV of zero at a rate of 9.257543% (IRR Schedule A-1), hence this rate can be added to a bucket of "Pick Your Rate" options that discount to zero It is a mathematical solution to a series of flows that discounts to a zero PV(present value) . This begins to demonstrates that a rate can generally be found for any cash flow that will discount to zero mathematically The flow does not meet the Sign test criteria of only one change in rolling flows. There are 3 changes. This should not stop us from using it since the MISFM-Legacy modified flow does not meet the sign test either. That is the flow that gives rise to the 8.647% yield that we are using to distribute income. So by any logical measure, the raw flow used in the IRR analysis and the modified flow used in the MISFM analysis should have equal standing before the court, at least as far as the sign test for a unique rate or yield existing is concerned.
Let's look at the original FASB13 MISFM-Legacy schedule that was never presented in the publication. This is represented by Exhibit A-2. It uses an algorithm or routine wherein it starts by picking a test rate, Discounts the flows to the point where the inflows plus interest at the rate being tested recoup the initial investment and the interest computed. It then transfers to a fund the remaining cash flows or portions thereof until it encounters outflows that are then paid from the sinking fund( the transferred money) until the sinking fund is used up. Thereafter, any outflows encountered are deemed by the rules of the algorithm set somewhere in the universe to come from new investment or multiple investments with no cost or time value associated with them for prior years. So we have a scheme that uses a sinking fund created on the basis of some logic associated with positive and negative investment periods, (the negative investment period is when the investment is eradicated by the payback and the positive investment period is when the out flowing funds turn the PV back to a negative number again on which interest is earned). Other terminology used in describing this somewhat convoluted reasoning includes asset and liability phases of the investment. The rate of 8.647% (Exhibit A-2) is the first rate iterative solution routines land on when following this algorithm. So let's add this rate to our bucket of potential rates as a possible solution. That makes two potential rates and counting,
Therefore the MISFM-Legacy is a method that uses both the sinking fund concept and additional new investment as sources to cover outflows, the sinking fund first and then thereafter, new investment as needed. The process of going outside the transaction for new investment can introduces sign change swings and begs the question of why are we using an extended method in the first place? It allows and promotes more than one sign change to exist or remain in the flow series. Why not just use the first rate we landed on for the raw flows of 9.2575% (IRR Exhibit A-1)if in fact we are going to allow the sign changes to remain at more than one (three in this case)? I do not have a logical answer to that question because there probably is none. Absent an amortization schedule to study we can't begin to discern this. Again, no such schedule was apparently provided in FASB13?
Continuing the examination of the logic surrounding the MISFM -Legacy algorithm, we can ask if new investment is allowed into the transaction towards the end of the deal to pay the negative flows, then why not allow the introduction of new money via loans or new investment in the beginning of the deal that can be paid back towards the end or retained? New investment that is paid back can be viewed as loans and visa versa. Let's look at how early new inflows or indirectly, early existing inflows that are allowed to stay when they should be set aside in a sinking fund for future outflows (exactly what the MISFM -Legacy is doing)impact yield and earnings per share.Exhibit B-2shows that by introducing a loan of $200,000 into the deal in year 4 (can be viewed as temporary equity) and paying it back in year 15th we have increased the reported yield to 10.585% This is exactly the same impact as leaving money that should be put into the sinking fund( but instead is left to enhance early year flows), has on yield and EPS. Again, the unmodified flows continue to have more than one sign change in the rolling forward total flows as does the modified flows for this scenario. Same question, why bother changing the flows or modifying or extending the flows if they do not eliminate the multiple yield issue? So we now have a third yield of 10.585% for the MISFM to throw into the bucket of possible rates to use. Oh yes, there is no apparent reason to disqualify the IRR rate under Exhibit B-1 as yet another potential rate to use. It is given as 21.4273%. That make two more rates we can add to the bucket or a total of 4 and counting. After all, these rates are only being used to distribute the same total income over the term, only using different mix of proportions by year.
As long as we can introduce new capital and thereby leave existing flows to enhance yield early on or introduce new money via loans early on to be paid back late in the deal, or return the capital investment later in the deal, then we have a large scenario of rates we can orchestrate. It is all about timing of flows....the time element which we are trying to eliminate when doing DCF. Yes. we will consistently get the same unique yield using the MISFM-Legacy on the first iterative pass (remember other rates may exist if the yield engine continues searching per Descartes Rule of signs). The first yield landed on has absolutely no basis in reason. It is a consistently arrived at wrong and illogical answer. It is no more logical to leave money that should be set aside in a sinking fund for future payments and then rely on expense free new investment to meet the payment than it is to lend new money in via cost free loans early on and pay it back towards the end. New money from investment or loans destroys the integrity of the rate analysis by allowing the continuation of the multiple rate potential, and distorting the original cash flow using an endless number of arbitrarily arrived at cash flow solutions.
We could recode the yield engine so as to keep searching for potential rates that discount to zero. This would be an academic exercise of little value. Descartes rule states that not in all cases will there be multiple yields so if you use the MISFM-Legacy it may be a unique rate. Is that any way to roll? We do not think so nor do the people that invented the extended yield methods. They would not have gone to such lengths to avoid multiple sign changes if they felt they could work with a "may be". Can you tell an investor that the rate he thinks he is earning may not be the only rate existing for his investment?
There are complex cash flows wherein the modifications under the MISFM -Legacy result in the same adjusted cash flow as the SSFM adjusted cash flow, thereby giving the same rate answer and being correct in that they both meet the single sign change test. Most of the time the MISFM-Legacy will give a different answer from the SSFM. Only on rare occasions will the nature of the flows produce this same result. We have examples of this among our 65 examples supplied with PAMS-DCF software.
Enough said about the MISFM-Legacy and its' issues. As far as PAMS-DCF and good DCF techniques is concerned, the MISFM-Legacy is a non-starter in the vast majority of cash flows. That is why we test every adjusted flow for Descartes rule. We have demonstrated how arbitrary and illogical the MISFM-Legacy's algorithm is , and how easily it can be manipulated once you accept the logic of ADDING NEW MONEY .Lets discuss the 3rd method that PAMS_DCF's yield engine uses, the Standard Sinking Fund Method or the SSFM. Sometimes this method is referred to as the "Traditional sinking fund Method". See Exhibit A-3, B-3 and C-3. All Exhibit C schedules begin with the SSFM cash flow as modified by its' algorithm which results in a modified flow that does pass the single sign change test and then we modify it again to include new capital or debt by adding a $ 200,000 flow to year 4 and a negative offsetting flow to year 15 for the payback or removal of the equity. We did this as one of many efforts to manipulate the rate using this method. As you can see fromExhibit C-1 and C-2, the rate is manipulated upwards, but does not change in Exhibit C-3. In fact if you look at all three Exhibits, A, B and C you will note that the SSFM(X-3) has remained the same at 5.367%. We tested many other scenarios and the same result was found to hold true. At most, a relatively small change in rate will result (under 10 basis points as compared to the hundreds of basis point changes in the MISFM-Legacy). You may also notice that the interest earnings in the first 5 years is substantially lower under the SSFM than under the MISFM-Legacy by about 80%, hence EPS are 80% lower in the first 5 years. Is this good Economic Incentive enhancement ? "Not so much" as compared to the MISFM-Legacy. Exhibit C-1 and C-2 produce two more different rates we can throw into the bucket, making 6 and counting. We could go on making an infinite number of cash flow scenario's all returning a net income of $116,600 over the same term or years. The IRR is 14.285% and the MISFM is 10.4887%. They both fail the sign change test in unmodified (IRR) or modified (MISFM) cash flows. This method with the $200,000 added to the SSFM modified flow is just another Pick Your Rate method. We can call this method the Enhanced Standard Sinking Fund Method. It is useless other than to demonstrate that different rate scenarios can be orchestrated to amortize the same amount of income for an infinite number of cases. The only method that consistently returns a rate that is guaranteed unique and is always or nearly always (varying only slightly if at all) the same for the flows presented even when enhanced or modified by manipulation in timing and/or introduction of new flows from capital or loans seems to be the SSFM ( Traditional Sinking Fund Method). A manual or computer driven adjustment to cash flows that results in only one sign change will result in one unique rate and can be a qualifying method, whatever name we give it!
As an aside, adding a realistic sinking fund rate to earn interest on the sinking fund results in a whole new set of rates and considerations. As an example, a sinking fund rate of 6.5% will increase the SSFM return yield to 8.4155% nearing the same rate as the MISFM-Legacy with a zero SFR assumed. Another words if the company owning the leveraged lease had a means of investing the sinking fund at 6.5% doing the SSFM would return nearly the same rate as the MISFM-Legacy since the method creating the larger sinking fund (SSFM)will tend to catch up on earnings with the MISFM-Legacy all other things being equal... Ignoring Sinking Fund Earnings opens up a whole new can of worms best left for future discussion.CONCLUSION:
We have tried to explain what "Extended Yield Methods" are and what their purpose is. In trying to do so we covered some mathematical territory driving home the importance of Descartes Rule of Signs and its' impact on cash flow analysis. We have examined just two of many potential extended yield methods or concepts that can be created. The MISFM-Legacy which provides for future flows partly from a sinking fund (created for a short period early in the transaction), but mostly through reliance on new investment , and the SSFM which generally relies solely on earlier flows from within the transaction with which it creates a sinking fund to cover all the subsequent out flows. It was our intention to present the fundamental reasons for doing extended yield analysis and providing you with the necessary understanding to help you develop your own scenarios in addition to the two extended methods PAMS uses. We have computer power at our disposal that was not available to Joe Blow at the time the MISFM-Legacy was conceived.
Doing DCF analysis without access to a computerized system is impossible given our life spans. The use of a capable, versatile, easily and quickly manipulated computerized system is absolutely necessary. PAMS-DCF is just such a system thanks in part to the choice of EXCEL as its database, which most people have and are familiar with. Excel, when coupled to the front-end input software and powerful yield analysis engine make an unprecedented combination for dealing with DCF analysis.
PAMS-DCF is a tool that is affordable and easily learned and should be as basic to the tool box of every financial industry person and financial educator as a hammer is to a carpenter. We at PAMS-DCF Inc. intend to see to it that everyone can afford to have access to this tool and the knowledge to use it,
that is our Mission.
Therefore the MISFM-Legacy is a method that uses both the sinking fund concept and additional new investment as sources to cover outflows, the sinking fund first and then thereafter, new investment as needed. The process of going outside the transaction for new investment can introduces sign change swings and begs the question of why are we using an extended method in the first place? It allows and promotes more than one sign change to exist or remain in the flow series. Why not just use the first rate we landed on for the raw flows of 9.2575% (IRR Exhibit A-1)if in fact we are going to allow the sign changes to remain at more than one (three in this case)? I do not have a logical answer to that question because there probably is none. Absent an amortization schedule to study we can't begin to discern this. Again, no such schedule was apparently provided in FASB13?
Continuing the examination of the logic surrounding the MISFM -Legacy algorithm, we can ask if new investment is allowed into the transaction towards the end of the deal to pay the negative flows, then why not allow the introduction of new money via loans or new investment in the beginning of the deal that can be paid back towards the end or retained? New investment that is paid back can be viewed as loans and visa versa. Let's look at how early new inflows or indirectly, early existing inflows that are allowed to stay when they should be set aside in a sinking fund for future outflows (exactly what the MISFM -Legacy is doing)impact yield and earnings per share.Exhibit B-2shows that by introducing a loan of $200,000 into the deal in year 4 (can be viewed as temporary equity) and paying it back in year 15th we have increased the reported yield to 10.585% This is exactly the same impact as leaving money that should be put into the sinking fund( but instead is left to enhance early year flows), has on yield and EPS. Again, the unmodified flows continue to have more than one sign change in the rolling forward total flows as does the modified flows for this scenario. Same question, why bother changing the flows or modifying or extending the flows if they do not eliminate the multiple yield issue? So we now have a third yield of 10.585% for the MISFM to throw into the bucket of possible rates to use. Oh yes, there is no apparent reason to disqualify the IRR rate under Exhibit B-1 as yet another potential rate to use. It is given as 21.4273%. That make two more rates we can add to the bucket or a total of 4 and counting. After all, these rates are only being used to distribute the same total income over the term, only using different mix of proportions by year.
As long as we can introduce new capital and thereby leave existing flows to enhance yield early on or introduce new money via loans early on to be paid back late in the deal, or return the capital investment later in the deal, then we have a large scenario of rates we can orchestrate. It is all about timing of flows....the time element which we are trying to eliminate when doing DCF. Yes. we will consistently get the same unique yield using the MISFM-Legacy on the first iterative pass (remember other rates may exist if the yield engine continues searching per Descartes Rule of signs). The first yield landed on has absolutely no basis in reason. It is a consistently arrived at wrong and illogical answer. It is no more logical to leave money that should be set aside in a sinking fund for future payments and then rely on expense free new investment to meet the payment than it is to lend new money in via cost free loans early on and pay it back towards the end. New money from investment or loans destroys the integrity of the rate analysis by allowing the continuation of the multiple rate potential, and distorting the original cash flow using an endless number of arbitrarily arrived at cash flow solutions.
We could recode the yield engine so as to keep searching for potential rates that discount to zero. This would be an academic exercise of little value. Descartes rule states that not in all cases will there be multiple yields so if you use the MISFM-Legacy it may be a unique rate. Is that any way to roll? We do not think so nor do the people that invented the extended yield methods. They would not have gone to such lengths to avoid multiple sign changes if they felt they could work with a "may be". Can you tell an investor that the rate he thinks he is earning may not be the only rate existing for his investment?
There are complex cash flows wherein the modifications under the MISFM -Legacy result in the same adjusted cash flow as the SSFM adjusted cash flow, thereby giving the same rate answer and being correct in that they both meet the single sign change test. Most of the time the MISFM-Legacy will give a different answer from the SSFM. Only on rare occasions will the nature of the flows produce this same result. We have examples of this among our 65 examples supplied with PAMS-DCF software.
Enough said about the MISFM-Legacy and its' issues. As far as PAMS-DCF and good DCF techniques is concerned, the MISFM-Legacy is a non-starter in the vast majority of cash flows. That is why we test every adjusted flow for Descartes rule. We have demonstrated how arbitrary and illogical the MISFM-Legacy's algorithm is , and how easily it can be manipulated once you accept the logic of ADDING NEW MONEY .Lets discuss the 3rd method that PAMS_DCF's yield engine uses, the Standard Sinking Fund Method or the SSFM. Sometimes this method is referred to as the "Traditional sinking fund Method". See Exhibit A-3, B-3 and C-3. All Exhibit C schedules begin with the SSFM cash flow as modified by its' algorithm which results in a modified flow that does pass the single sign change test and then we modify it again to include new capital or debt by adding a $ 200,000 flow to year 4 and a negative offsetting flow to year 15 for the payback or removal of the equity. We did this as one of many efforts to manipulate the rate using this method. As you can see fromExhibit C-1 and C-2, the rate is manipulated upwards, but does not change in Exhibit C-3. In fact if you look at all three Exhibits, A, B and C you will note that the SSFM(X-3) has remained the same at 5.367%. We tested many other scenarios and the same result was found to hold true. At most, a relatively small change in rate will result (under 10 basis points as compared to the hundreds of basis point changes in the MISFM-Legacy). You may also notice that the interest earnings in the first 5 years is substantially lower under the SSFM than under the MISFM-Legacy by about 80%, hence EPS are 80% lower in the first 5 years. Is this good Economic Incentive enhancement ? "Not so much" as compared to the MISFM-Legacy. Exhibit C-1 and C-2 produce two more different rates we can throw into the bucket, making 6 and counting. We could go on making an infinite number of cash flow scenario's all returning a net income of $116,600 over the same term or years. The IRR is 14.285% and the MISFM is 10.4887%. They both fail the sign change test in unmodified (IRR) or modified (MISFM) cash flows. This method with the $200,000 added to the SSFM modified flow is just another Pick Your Rate method. We can call this method the Enhanced Standard Sinking Fund Method. It is useless other than to demonstrate that different rate scenarios can be orchestrated to amortize the same amount of income for an infinite number of cases. The only method that consistently returns a rate that is guaranteed unique and is always or nearly always (varying only slightly if at all) the same for the flows presented even when enhanced or modified by manipulation in timing and/or introduction of new flows from capital or loans seems to be the SSFM ( Traditional Sinking Fund Method). A manual or computer driven adjustment to cash flows that results in only one sign change will result in one unique rate and can be a qualifying method, whatever name we give it!
As an aside, adding a realistic sinking fund rate to earn interest on the sinking fund results in a whole new set of rates and considerations. As an example, a sinking fund rate of 6.5% will increase the SSFM return yield to 8.4155% nearing the same rate as the MISFM-Legacy with a zero SFR assumed. Another words if the company owning the leveraged lease had a means of investing the sinking fund at 6.5% doing the SSFM would return nearly the same rate as the MISFM-Legacy since the method creating the larger sinking fund (SSFM)will tend to catch up on earnings with the MISFM-Legacy all other things being equal... Ignoring Sinking Fund Earnings opens up a whole new can of worms best left for future discussion.CONCLUSION:
We have tried to explain what "Extended Yield Methods" are and what their purpose is. In trying to do so we covered some mathematical territory driving home the importance of Descartes Rule of Signs and its' impact on cash flow analysis. We have examined just two of many potential extended yield methods or concepts that can be created. The MISFM-Legacy which provides for future flows partly from a sinking fund (created for a short period early in the transaction), but mostly through reliance on new investment , and the SSFM which generally relies solely on earlier flows from within the transaction with which it creates a sinking fund to cover all the subsequent out flows. It was our intention to present the fundamental reasons for doing extended yield analysis and providing you with the necessary understanding to help you develop your own scenarios in addition to the two extended methods PAMS uses. We have computer power at our disposal that was not available to Joe Blow at the time the MISFM-Legacy was conceived.
Doing DCF analysis without access to a computerized system is impossible given our life spans. The use of a capable, versatile, easily and quickly manipulated computerized system is absolutely necessary. PAMS-DCF is just such a system thanks in part to the choice of EXCEL as its database, which most people have and are familiar with. Excel, when coupled to the front-end input software and powerful yield analysis engine make an unprecedented combination for dealing with DCF analysis.
PAMS-DCF is a tool that is affordable and easily learned and should be as basic to the tool box of every financial industry person and financial educator as a hammer is to a carpenter. We at PAMS-DCF Inc. intend to see to it that everyone can afford to have access to this tool and the knowledge to use it,
that is our Mission.
Saturday, June 27, 2015
06/18/2015
Extended Yield
methods:Part 4
Where's the Sunshine?
To sum up, extended
yield methods were designed to deal
with complex cash flows (cash flows wherein the rolling sum of the flows change
signs more than once). they go from negative to positive and back to negative
then to positive again such that their rolling forward sums give rise to yield
curves that cross the zero rate axis more than once. The intent was and is to eliminate the wild swings in cash flows so
as to limit the sign changes to only one. Doing so eliminates the potential for other
positive rates existing in the modified flow.
Any method that does not
eliminate the multiple yield potential from the cash flows is not doing its'
job. It leaves us with a transaction that can't be represented by rate of
return, as many or more than one rate may exist. To pick one rate ignores the
rest. It also facilitates the manipulation of rate by making it easy to
move cash flows around the term as long the total flows remain the same. Many
yield rates can be sought and landed on for many different adjusted flows using
the "Pick Your Rate" method. This makes the model entirely arbitrary
and hence unacceptable. It is not logically computed and does not provide a unique
computation of rate inherent to the flow. It
is just one of many rates that performs a mathematical function of resolving
the present value to zero and nothing more.
We have tried to relate in this discussion how and why rate analysis must adhere to the
mathematical principles espoused by Descartes' rule of signs. The genesis of extended yield methods was created
for the sole purpose of making it possible to adhere to Descartes rule of signs.
PAMS-DCF's yield
engine checks for adherence to Descartes' rule of signs in both the initially
presented unmodified flow and the modified flow, giving appropriate warnings when necessary.
If someone wishes to use a non-unique rate to distribute income over the
transaction term, then they can do so.
It may be a misrepresentation of the return on the transaction, and it may give
rise to violations of good accounting principles that call for using a
distribution that matches costs against revenues, full disclosure, a
non-arbitrary basis for computation, etc., but so be it. The Investment Tax
Credit (does anyone remember the ITC ?) was
taken into income all in the year of acquisition and not amortized over the
life of the asset as good accounting demanded. The accounting profession objected loudly but
with little success. Congress said it
was OK.
Similar to the MISFM (Legacy), the ITC
accounting served as an immediate economic incentive resulting in increased
earnings per share in the early years. Rules are broken all day long, and
principals are violated over and over again, but one should be aware of the
what and wherefore of these issues so that they are not misapplied to other
situations. I repeat, the MISFM-Legacy had and
may have a place, but not as representing a good example of yield analysis
techniques.
We intend to
demonstrate that new investment is a
non-starter in building cash flow models and using discounted cash flow
analysis. We will be using examples of FASB13 in the next installment of
this discussion on "Extended Yield Methods" because it is a well known example and easily
available for study. It will clearly show
that the modified cash flow generated by the MISFM-Legacy results in arbitrarily
adjusted cash flows distribution of income and is not the only rate that , once
given the freedom to introduce "new Capital", that will discount other adjusted flows to zero within the confines of the
transactions net income. We will
then proceed to review one or two methods that do work to eliminate the
multiple yield issue and what their impact is on the timing of profit
recognition within the transaction.
The
entire purpose of this exercise is to demonstrate that Descartes Rule of Signs must be adhered to and that
"Extended Methods" were created to for the sole purpose of making
this possible. To have created a method
such as the MISFM-Legacy that only partially adheres to the " rule of signs"
by providing for only the first few negative flow and ignoring the remaining negative flows is at best
obscuring the technically correct approach, demonstrating incorrect concepts
and principals and causing confusion about the techniques used in DCF analysis. It is an example of obfuscation at its' best. That is perhaps one reason it is being abandoned, except that the current thought is to abandon all after tax accounting recognition done using good DCF techniques or bad ones. On the positive side the MISFM-Legacy added incentive
to do these transactions. I do not see why EPS has to be tied to good DCF
techniques! Let the EPS issue be whatever the parties agree to, but the
mathematical truisms should always be honored.
As an aside, FASB13
is a great publication and it broke new ground in accounting in many areas. The concepts as noted in our book that accompanies PAMS-DCF, should not be discarded. They included the "Economic Reality" concept, and substance over form concepts that FASB13 dealt with. That FASB13 did not land on a proper method for
use in distributing leveraged lease income
is a minor flaw in the overall achievement, and can be easily fixed by simply clarifying the need to adhere to Descartes Rule of Signs. Any method that results in an inherent unique yield should be acceptable to spread
income with. Yes, changes can be made that will improve FASB13 in several areas, but discarding after tax analysis and reporting is not necessarily one of them.
An argument can be made that leveraged leases are less needed in today's tax environment as companies are paying much lower effective tax rates than in the past, but that can change quickly. Further, leveraged lease accounting may be more trouble than it is worth from some peoples perspective, however, it was the segue into areas of finance that accounting types such as myself never had cause to look at. Perhaps it is simply to complex to deal with from a practical standpoint. The economic analysis of a leveraged lease or a leveraged real estate transaction, or business acquisitions, etc..will always require good DCF understanding and techniques regardless of what happens to FASB13.
An argument can be made that leveraged leases are less needed in today's tax environment as companies are paying much lower effective tax rates than in the past, but that can change quickly. Further, leveraged lease accounting may be more trouble than it is worth from some peoples perspective, however, it was the segue into areas of finance that accounting types such as myself never had cause to look at. Perhaps it is simply to complex to deal with from a practical standpoint. The economic analysis of a leveraged lease or a leveraged real estate transaction, or business acquisitions, etc..will always require good DCF understanding and techniques regardless of what happens to FASB13.
Congress would not allow accounting firms to
write an exception when ITC was taken in year one. I don't know of any firms that
did. The Financial Accounting Standards Board may not allow pretax income to be distributed on an after tax proportional basis as conceived of when the deal is done, but that does not change the reality of why it was done and how it will be earning real cash. It is a step backwards for the accounting profession to throw it all out ( in my humble opinion).
(to be continued using examples as Part 5 " A Picture is Worth 1,000 Words")
Sunday, June 21, 2015
Extended Yield Methods: Part 3 Smoke and Mirrors
Extended Yield Methods: Part 3 Smoke and Mirrors
Let's look at the second source of funds into which we lumped loans and new investment. Let's discuss loans first as they are less problematic than new investment. In order to make the transaction logically supportable, with all loose ends sewed up, a loan commitment along with interest rates would have to be put in place. The loan proceeds would be used to zero the negative flows and thereby avoid a sign change situation. The payback of the loan plus interest would come from subsequent positive inflows. This approach is the only approach where the prior flows are not adequate to meet subsequent outflows or set up a sinking fund of adequate size, unless you resort to the "new investment assumption".
The new investment or multiple investment assumption has many issues that are inherent in it. Unlike a loan, it is not assumed to be paid back by the end of the transaction. Neither is there a cost introduced to the deal to cover its availability and use as in a loan. A loan has a commitment fee and interest for the use as part of the transaction costs. A commitment from investors could be gotten and put in place similar to a loan commitment. With or without a commitment, new investment is being introduced at a later date. Even if early flows are adequate to meet future outflows, they must be set aside in a sinking fund and not left in the transaction to enhance yield by relying on new expense free investment to cover outflows. The question becomes how do you cost the new investment such that it factors into the computations of the return on the original investment which is often years earlier? Simply put, the answer is you can't. The new investment destroys the present value computations on the original investment, and effectively starts a new deal. Hence, multiple rates arise. It is a non-starter and a red herring to include new investment in a model if it changes the rolling total of flows sign. There can't be any significant outflows such that they cause the sign of the rolling forward sum of the flows to change without creating a meaningless yield that will resolve to zero mathematically. That is the primary issue with the use of cost free new investment . You have to ignore the sign change requirement of Descartes rule of signs.
What happens if you ignore the single sign change requirement? What would govern the amount of capital you would need? The simple answer is very little would constrain the amount of capital that could be introduced to meet negative flows. In fact, scenarios or modifications could be easily formulated for pushing positive flows anywhere in the flow stream and making up for them with new investment in other years within the flow steam so that they total to the same overall income. You could call that method the PYR method or "Pick Your Rate" method. There are only limited constraining requirements to the modifications. Consider also that it would not be possible to assure an investor that the return on investment presented is the only positive return that would discount the flows to zero. The rate can be easily manipulated over a wide spectrum of rates, each giving rise to a different earnings curve. This makes the periodic earnings arbitrary at best.
The above noted situation will be demonstrated later on in this series by using many examples of the FASB13 leveraged lease model in which the modified flows do not meet the single yield rule test. Again, the unmodified flows fail to meet the single yield requirement and the modified flows also fail! The early year's flows can be enhanced by some arbitrary amount, and future negative investment can be increased to offset the early enhancement resulting in a new rate of earnings curve amortizing the same total income. You could as the MISFM-Legacy does, just set up a sinking fund to cover the first few negative flows and ignore the rest of the negative flows saying new investment will cover them. You could say the MISFM is a mix of a Sinking Fund Method and the PYR method since it does both. The MISFM-Legacy kind of introduces the sinking fund idea but does not execute it across the term of the deal. As long as you accept the notion that you can introduce expense free capital at any time during the transaction life cycle you have an infinite number of potential rates you can orchestrate. The rates do not reflect any meaningful solution. The rates are simply mathematical solutions to the new flow series you have created. The example in FASB13 of a leveraged lease (using MISFM-Legacy) is a very poor example of the use of discounted cash flow analysis as it demonstrates the improper use of techniques and promulgates an arbitrary answer. This can only lead to confusion and distrust.
Any cash flow analysis system worth its salt must have a test for multiple sign changes and clearly report on that test. Whether the cash flow is modified by hand or using a computerized algorithm, the system should test and report on the modified flows as well. Modifications and testing has to be done until the multiple yield issue is eliminated. If the modifications can't be done and still provide a viable transaction investment, then the transaction may have to be abandoned. The key point is that there can be only one real yield, the one that discounts the flows to zero with the knowledge that no other positive rates will do the same. To find that rate, the flow must show only one sign change over the term. This is the only purpose of using extended methods. Telling an investor that he is earning at a rate that may not be inherent in the transaction is at best misleading.
It does not matter what the nature of the investment is, real estate construction and sales, business projections, leveraged leases etc. , the same principals will apply. A polynomial is still a polynomial, a cash flow is still a cash flow, that will not change.
(to be continued) . . . parts 1, 2 and 3 are now completed
Saturday, June 20, 2015
Extended Yield Methods: Part 2 Sources of Funds
Page 2 of the Discussion Page at PAMSDCF.com
06/19/2015
Let's try to answer the first question and watch what happens. Where is the money going to come from? There are two main sources of the money, one would be from within the transaction, and the other would be from outside the initial transaction, such as a loan or additional investment. Let's look at the source from within the transaction flows first. In many instances the cash flows we are examining will have sufficient prior inflows to adequately meet the subsequent required outflows. In those cases we could set aside some of the inflowing money in sufficient amounts to meet the subsequent required outflows. The transaction will be fully self-supporting and all outflows, after the initial investment, will be expensed to the transaction by being part of the net flows. The set-aside money needed to pay out the negative periods is conceptually provided for by putting the money in an account called a sinking fund. A physical fund may not be set up. The savings may be viewed as being held by the parent company. In that case it is valued at the parent's marginal cost of borrowing (or some other agreed rate). The earnings on the fund, real or conceptual, would be the interest rate paid by the institution holding the money. If it is in a bank, then it is at some bank savings rate, if used by the parent, then it should be the parent's marginal cost of funds. The fund money can be viewed as an offset to existing debt until returned to the transaction by the parent company. The governing limits of the sinking fund are usually to put aside just enough money to meet the negative flows. Taking more money than minimally needed and placing it in a savings account will usually be detrimental to the profitability of the transaction since the transaction is presumed to be earning more than can be earned at the sinking fund institution, all other things being equal. If this is done precisely, it will have the effect of smoothing out the cash flow's swings from positive to negative and eliminate the multiple sign change issue introducing zero cash flows in some of the periods that were formerly negative. More importantly, the transaction model is now pictured and set up as a logical flow of cash that defines all of the sources of the flows, income and expenses associated with the model. Since all of the funds are from within the transaction after the initial investment, the profitability (or lack thereof), as measured by the rate of return within the flows, is all-inclusive recognizing all costs and income associated with transaction. By addressing the issue of "where does the money come from" we have solved three issues: where is it from, what is the cost, and is the rate so determined reliable and unique. For the case where the money comes from within we have solved it all. Voila! In case anyone hasn't noticed, we also explained what an "Extended Yield Analysis Method " is and why it is needed. Simply put, it is needed to present a logical, all inclusive, verifiable and complete flow model and develop a unique and implicit rate from an otherwise incomplete, illogical arbitrary multiple rate potential flow scenario.
(to be continued)
06/19/2015
The answer to the question "who cares" is " everyone should care".
Firstly, if a flow fails Descartes' rule of signs test it will be because
contained in the flows are negative outflows after the first initial investment
outflow. That is what causes the sign changes of the rolling forward totals.
The first question that should come to mind is "Where will these negative subsequent flows come
from? " The second question is what cost, if any, should
be introduced to the analysis and how will it be introduced.
Let's try to answer the first question and watch what happens. Where is the money going to come from? There are two main sources of the money, one would be from within the transaction, and the other would be from outside the initial transaction, such as a loan or additional investment. Let's look at the source from within the transaction flows first. In many instances the cash flows we are examining will have sufficient prior inflows to adequately meet the subsequent required outflows. In those cases we could set aside some of the inflowing money in sufficient amounts to meet the subsequent required outflows. The transaction will be fully self-supporting and all outflows, after the initial investment, will be expensed to the transaction by being part of the net flows. The set-aside money needed to pay out the negative periods is conceptually provided for by putting the money in an account called a sinking fund. A physical fund may not be set up. The savings may be viewed as being held by the parent company. In that case it is valued at the parent's marginal cost of borrowing (or some other agreed rate). The earnings on the fund, real or conceptual, would be the interest rate paid by the institution holding the money. If it is in a bank, then it is at some bank savings rate, if used by the parent, then it should be the parent's marginal cost of funds. The fund money can be viewed as an offset to existing debt until returned to the transaction by the parent company. The governing limits of the sinking fund are usually to put aside just enough money to meet the negative flows. Taking more money than minimally needed and placing it in a savings account will usually be detrimental to the profitability of the transaction since the transaction is presumed to be earning more than can be earned at the sinking fund institution, all other things being equal. If this is done precisely, it will have the effect of smoothing out the cash flow's swings from positive to negative and eliminate the multiple sign change issue introducing zero cash flows in some of the periods that were formerly negative. More importantly, the transaction model is now pictured and set up as a logical flow of cash that defines all of the sources of the flows, income and expenses associated with the model. Since all of the funds are from within the transaction after the initial investment, the profitability (or lack thereof), as measured by the rate of return within the flows, is all-inclusive recognizing all costs and income associated with transaction. By addressing the issue of "where does the money come from" we have solved three issues: where is it from, what is the cost, and is the rate so determined reliable and unique. For the case where the money comes from within we have solved it all. Voila! In case anyone hasn't noticed, we also explained what an "Extended Yield Analysis Method " is and why it is needed. Simply put, it is needed to present a logical, all inclusive, verifiable and complete flow model and develop a unique and implicit rate from an otherwise incomplete, illogical arbitrary multiple rate potential flow scenario.
Thursday, June 18, 2015
Extended Yield Methods: Introduction
What are Extended Yield Analysis Methods ?Introduction Part 1:
06/13/2015
One of PAMS-DCF's goals was to introduce a new way of learning about Discounted Cash Flow Analysis that provided a hands on approach using sophisticated yield analysis software that here- to- fore was available only to the big guys on the block. This forum will discuss definitions and issues of various topics, many of which are covered by the glossary contained in our book. I'd like to start by discussing the mathematical principals that are required in the use of DCF. We intend to keep the discussion in strictly laymen's terms. Our first goal is to explain the geniuses of "Extended Yield Methods" and why they are needed.
DCF (discounted cash flow ) analysis uses various formulas in computing Present Values and Future Values , payment amounts and terms depending on the given information. Some of theses formulas in mathematics' jargon are generally referred to as Polynomials. They are equations that have certain attributes common to all in their class and they behave in a fixed and determinable way across their entire spectrum. There are certain rules that should always be tested for when dealing with this class of equations known as or called Polynomials. We don't really care what the attributes are or what most of the rules are for theses equations, but (and there is always a "but") there is one rule that does effect DCF analysis that we must learn to deal with in order to avoid making some very serious miscalculations. We don't have to learn the proof of this rule, or why it is always true. The appendix of our book covers a proof and extended discussion, but you had better be a mathematician of sorts to follow it. We simply have to learn how to test for cash flows that have the potential of breaking this rule and do something to reestablish the rule's principal in the flows we are examining.
Some of you are already familiar with the name Descartes. He was a great mathematician of the 18th century. He demonstrated that when dealing with equations in the class of "polynomials" in general, (here as they are applied to cash flows), certain conditions arise that allow us to have multiple positive rates that will discount to zero (NPV=0). Obviously, Descartes was not doing DCF problems when he formulated this principle. It applies to all polynomials including those representing cash flows. The rule he discovered was that if there is more than one sign change in the polynomial's terms (which in DCF are determined by the flows which starts out negative, otherwise there is no investment), then there is a potential for, but not necessarily always, more than one positive solution that will resolve the polynomial equation to zero. Putting this statement differently, if there is only one sign change in the rolling total, then there is only one rate that will resolve to a zero NPV. This rate is unique or it can be said to be "inherent" in the cash flows.
So who cares? If we have five different sign changes in the rolling total of the flows and potentially five different positive rates that will resolve to a zero present value, then let's just pick one that we like and use it to distribute the income over the term of the deal on that rate basis (interest basis). After all the total earnings remains the same (total interest income) at the end of the day, only the timing of income changes as the rate changes.
It is noted that in the leasing arena much is changing, however, whatever the outcome, the financial analysis of the transaction's economics will always require a comprehensive understanding of Discounted Cash Flow Analysis. That being said, when reference is made to FASB 13, it should be understood that it may be a legacy document in many respects going forward, particularly in the lessor leveraged lease area. As PAMS-DCF uses an extended yield method called MISFM which should never have been adopted in the first place, and will have no good reason to remain other than to do review type work with, it will be referred to as "MISFM Legacy".
(to be continued)
(Completed through page 2)
06/13/2015
One of PAMS-DCF's goals was to introduce a new way of learning about Discounted Cash Flow Analysis that provided a hands on approach using sophisticated yield analysis software that here- to- fore was available only to the big guys on the block. This forum will discuss definitions and issues of various topics, many of which are covered by the glossary contained in our book. I'd like to start by discussing the mathematical principals that are required in the use of DCF. We intend to keep the discussion in strictly laymen's terms. Our first goal is to explain the geniuses of "Extended Yield Methods" and why they are needed.
DCF (discounted cash flow ) analysis uses various formulas in computing Present Values and Future Values , payment amounts and terms depending on the given information. Some of theses formulas in mathematics' jargon are generally referred to as Polynomials. They are equations that have certain attributes common to all in their class and they behave in a fixed and determinable way across their entire spectrum. There are certain rules that should always be tested for when dealing with this class of equations known as or called Polynomials. We don't really care what the attributes are or what most of the rules are for theses equations, but (and there is always a "but") there is one rule that does effect DCF analysis that we must learn to deal with in order to avoid making some very serious miscalculations. We don't have to learn the proof of this rule, or why it is always true. The appendix of our book covers a proof and extended discussion, but you had better be a mathematician of sorts to follow it. We simply have to learn how to test for cash flows that have the potential of breaking this rule and do something to reestablish the rule's principal in the flows we are examining.
Some of you are already familiar with the name Descartes. He was a great mathematician of the 18th century. He demonstrated that when dealing with equations in the class of "polynomials" in general, (here as they are applied to cash flows), certain conditions arise that allow us to have multiple positive rates that will discount to zero (NPV=0). Obviously, Descartes was not doing DCF problems when he formulated this principle. It applies to all polynomials including those representing cash flows. The rule he discovered was that if there is more than one sign change in the polynomial's terms (which in DCF are determined by the flows which starts out negative, otherwise there is no investment), then there is a potential for, but not necessarily always, more than one positive solution that will resolve the polynomial equation to zero. Putting this statement differently, if there is only one sign change in the rolling total, then there is only one rate that will resolve to a zero NPV. This rate is unique or it can be said to be "inherent" in the cash flows.
So who cares? If we have five different sign changes in the rolling total of the flows and potentially five different positive rates that will resolve to a zero present value, then let's just pick one that we like and use it to distribute the income over the term of the deal on that rate basis (interest basis). After all the total earnings remains the same (total interest income) at the end of the day, only the timing of income changes as the rate changes.
It is noted that in the leasing arena much is changing, however, whatever the outcome, the financial analysis of the transaction's economics will always require a comprehensive understanding of Discounted Cash Flow Analysis. That being said, when reference is made to FASB 13, it should be understood that it may be a legacy document in many respects going forward, particularly in the lessor leveraged lease area. As PAMS-DCF uses an extended yield method called MISFM which should never have been adopted in the first place, and will have no good reason to remain other than to do review type work with, it will be referred to as "MISFM Legacy".
(to be continued)
(Completed through page 2)
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