15 whitepaper - pretax income- jan 20051 (1)

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Oracle Lease Management

Pre-Tax Income

by Alvaro Montenegro & Santhosh SiruvoleAn Oracle White PaperJanuary, 2005


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EXECUTIVE SUMMARY ................................................................................................2OVERVIEW ......................................................................................................................... 3

Streams............................................................................................................................... 3Internal Stream Generation ............................................................................................ 3

ASSUMPTIONS................................................................................................................... 3IMPLICIT INTEREST RATE AND BOOKING YIELD LOGIC.........................4

Pre-Tax Income for Leases with Residual Value ........................................................ 6


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Oracle Lease Management Page 2


EXECUTIVE SUMMARY

OLM utilizes the interest method of income recognition to calculate Pre-TaxIncome. This method requires the calculation of a booking yield, which is appliedto the lessors investment balance in the lease to obtain the pretax income amount.


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OVERVIEW

Streams

Streams are sets of amounts and dates associated to cash flows. Streams are generated

based on the payments set up on the contract. The payments parameters a user sets on

the contract are:

1. Contract Start date

2. The asset line to which the payments are associated

3. Frequency

4. Payment stream type

5. Term

6. Advanced or Arrears

7. Payment levels. Each payment level number of periods and a payment

amount. If a payment level is a stub then the level has stub days and stub

amount.

Internal Stream Generation

An internal Lease Management program can generate streams during contract

activation. The internal logic calculates the contract yield and all required billing and

accounting streams

ASSUMPTIONS

The following are the basic assumptions under which OLM operates to calculate yields

and generate streams:1. Day Convention: 30/360

2. Frequency: Four periodicities are assumed: Monthly, Quarterly (3 months), Semi-

Annually (6 months) and Annually (12 months).

3. Stream Dates: For an advance payment, the start date of the period is the stream

element date whereas in case of arrears, the end date of the period is the stream

element date.


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IMPLICIT INTEREST RATE AND BOOKING YIELD LOGIC

The interest rate implicit in the lease is the rate that, when applied to rent payments

and the residual value, results in an aggregate present value equal to the total capital

cost of the assets at the beginning of the lease term.

The Implicit Interest Rate differs from the Internal Rate of Return in that it

excludes from the yield calculation fees and other periodic income or expenses that

are normally considered in the determination of the internal rate of return.

The IIR is calculated through an iterative process using the following present value

formula.

Present Value = Sum of (CF/(1+IIR/N)^n

Where: CF = Cash flow amount

n = number of equal periods from the initial cash flow (t=0)

IIR= the implicit interest rate

N = the number of payment periods in the year

The first iteration is computed using an IIR of 10%. This value is adjusted until a

present value of zero is achieved. In our example this is equivalent to finding the

IIR that equals the sum of Principal Payments to the Asset Capital Cost.

The following example illustrates how OLM calculates the Implicit Interest Rate

(IIR).

Contract Start Date 1-Jan-04

Asset Capital Cost 1000 Rent Payment Start Date 1-Jan-04

Periodic Rent Amount 300

FREQUENCY Quarterly

PERIODS 4

Days in Year 360

Rent Payment in Arrears (Y/N) Arrears

Step 1: Iteratively sol ve for Asset-Level Implicit Interest Rate (IIR) andInterim Interest. Target is to makeTotal of Principal Payments equal to

Asset Cos t.

Date Days Applicablebalanceinterest

calculation

Interest for thePeriod

TotalPayment(RENT)

PrincipalPayment

IIR 1-Jan-04 0 700 0 300 300

54.804 1-Apr-04 90 495.91 95.91 300 204.09

1-Jul-04 90 263.85 67.94 300 232.06

1-Oct-04 90 0.00 36.15 300 263.85

TOTAL 1000

ISG will generate the following streamson the dates specified ----->

INTERESTPAYMENT

RENTPRINCIPALPAYMENT


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Once OLM determines the IIR, it calculates the Booking Yield using a similar

iterative process. The booking yield, also know as Accounting yield, is very similar

to the IIR. Its main difference with the IIR lies in the fact that the booking yield

assumes monthly compounding of interest.

Step2: Iteratively solve fo rAsset-Level BookingYield. Target is a ClosingBook Balance of zero onOCT-15

Payment InterestPayment

PRE TAXINCOME

(Interest forthe Month)

Accumint sincelast pymt

CapitalRecov

Close Book(PRINCIPALBALANCE)

Open Book Valueor Investment

Balance (used forPre Tax Income

Calculation)

Booking Yield 1-Jan-04 300 0.00 300.00 700 700.00

30-Jan-04 30.61 30.61 700 730.61

52.475 29-Feb-04 31.95 62.56 700 762.56

30-Mar-04 33.35 95.91 700 795.91

1-Apr-04 300 95.91 204.09 495.91

30-Apr-04 21.69 21.69 495.91517.59

30-May-04 22.63 44.32 495.91 540.22

30-Jun-04 23.62 67.94 495.91 563.85

1-Jul-04 300 67.94 232.06 263.85

30-Jul-04 11.54 11.54 263.85 275.39

30-Aug-04 12.04 23.58 263.85 287.43

30-Sep-04 12.57 36.15 263.85 300.00

1-Oct-04 300 36.15 263.85 0.00

30-Oct-04 0.00 0.00 0.00 0

30-Nov-04 0.00 0.00 0.00 0

30-Dec-04 0.00 0.00 0.00 0

1200 200.00 200.00 1000.00

ISG will generate thefollowing streams on thedates specified ----->

PRE TAXINCOME

In our example, the Booking Yield results in a value of 52.475%, as shown in the table

above. This yield is used to calculate the Pre tax Income stream by applying the

following formula:

Pre-Tax Income = OPV * (Booking Yield / 360) * N days

Where, N is the number of days in the month and OPV is the Open Book Value or

Investment Balance.


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Pre-Tax Income for Leases with Residual Value

The calculation methodology for leases with residual value is identical as described in

the tables above except that in the calculations of IIR and Booking Yield the total of

principal payments targeted is not the asset cost but the asset cost minus the residual

value.


January, 2005

Author s: Alvaro Monten egro

Santhosh Siruvole

Oracle Corporation

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15 whitepaper - pretax income- jan 20051 (1)

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