Oracle Lease Management

Pre-Tax Income

by Alvaro Montenegro & Santhosh Siruvole
An Oracle White Paper
January, 2005

Oracle Lease Management
EXECUTIVE SUMMARY................................................................................................ 2
OVERVIEW......................................................................................................................... 3
Streams ............................................................................................................................... 3
Internal Stream Generation............................................................................................ 3
ASSUMPTIONS................................................................................................................... 3
IMPLICIT INTEREST RATE AND BOOKING YIELD LOGIC......................... 4
Pre-Tax Income for Leases with Residual Value ........................................................ 6

Oracle Lease Management Page 2
Oracle Lease Management
EXECUTIVE SUMMARY

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

Oracle Lease Management Page 3

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.


Oracle Lease Management Page 4

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-J an-04

Asset Capital Cost 1000

Rent Payment Start Date 1-J an-04

Periodic Rent Amount 300

FREQUENCY Quarterly

PERIODS 4

Days in Year 360

Rent Payment in Arrears (Y/N) Arrears

Step 1: Iterati vely sol ve for Asset-
Level Implicit Interest Rate (IIR) and
Interim Interest. Target is to make
Total of Principal Payments equal to
Asset Cost.
Date Days Applicable
balance
interest
calculation
Interest for the
Period
Total
Payment
(RENT)
Principal
Payment

IIR 1-J an-04 0 700 0 300 300
54.804 1-Apr-04 90 495.91 95.91 300 204.09
1-J ul-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 streams
on the dates specified ----->
INTEREST
PAYMENT
RENT
PRINCIPAL
PAYMENT

Oracle Lease Management Page 5

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: Iterati vely sol ve for
Asset-Level Booking
Yield. Target is a Closing
Book Balance of zero on
OCT-15
Payment Interest
Payment
PRE TAX
INCOME
(Interest for
the Month)
Accum
int since
last pymt
Capital
Recov
Close Book
(PRINCIPAL
BALANCE)
Open Book Value
or Investment
Balance (used for
Pre Tax Income
Calculation)


Booking Yield 1-J an-04 300 0.00 300.00 700 700.00
30-J an-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 21.69 495.91
517.59
30-May-04 22.63 44.32 495.91
540.22
30-J un-04 23.62
67.94
495.91
563.85
1-J ul-04 300 67.94 232.06 263.85

30-J ul-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 the
following streams on the
dates specified ----->
PRE TAX
INCOME


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.


Oracle Lease Management Page 6
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.






Oracle Lease Management
January, 2005
Authors: Al varo Montenegro
Santhosh Siruvole


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