TEST TIME! John Behle - Posted by ChuckP

Posted by John Behle on March 14, 2000 at 22:04:10:

I’ll take a look at your numbers later. Mine were figured on one half the note being one half of the payments. Pete received the correct answers below if you want to look at those calculations.

TEST TIME! John Behle - Posted by ChuckP

Posted by ChuckP on March 14, 2000 at 21:08:05:

Hi John,

I just found your web site today and the Cashflow page. I wold like to take a stab at an answer to your “test” question.

Let me make some assumptions, we engineers like to call them givens, before I start:

The loan has two parts. This first part is for two years @ 7.325 and the remainder ( 28 years ? ) @ 8.69. Ernie wants to sell the first part, two years, of the note. Is this what is meant by the first half?

Bert has put down $20K (20%)

The principle balance of the loan is now 80K.

Bert starts off by making payments of 500 for 12 months and at 13 months, the payments go up 100 each month.

So our cashflow looks some like this:

PMT = 500.00

PMT*12 then at MTH = 13, PMT + 100 for MTH = 13, 14, 15, ? 24

500 @ 1, 2, 3, ?12

600 @ 13
700 @ 14
800 @ 15
900 @ 16
1000 @ 17
1100 @ 18
1200 @ 19
1300 @ 20
1400 @ 21
1500 @ 22
1600 @ 23
1700 @ 24

Now! Ernie discounts his note of two years at 50%, which means he wants 40K. Just on the face of this, I don’t see how an investor is going to make money on this. Anyway, calculating the Internal Rate of Return (IRR), the investor is at about -54%. Upside down. I hope I didn’t miss anything.

Now if Ernie wants to make this work and knowing that investors, note buyers, like to see at least an 18% yield, nominal annual rate of return (NAROR), Ernie would have to discount his first note to 80% to get the most money and to at least give the investor a decent rate of return.

So Ernie would take away 16K with an 80% discount and the investor, for the first two years of the note, would see a yield of about 18%, that would be the NAROR.

I have to thank Tony Collela for this insight, as I was structuring a note on some owner finance deal I had he pointed out the ROR investors like to see.

SIDE NOTE: Given Bert’s past drug habit, the investor might ask for a even deeper discount due to the volatility of the cashflow source, but Ernie still gets his better than 20K up front money any way. He’s at 36K now which would be equivalent to 36% down.

I am always open to analysis and if somebody sees some errors, please don’t hesitate to point them out.