Dimension 5 - Evaluate Collateral Values Flashcards
Collateral Concerns
Quality
Verfiability
Several factors to consider in valuing AR
Account Customers Credit Practices Accuracy (ie. dilution) Allowances, discounts, or co-op advertising Returns Bad debt write-offs Contra Accounts
Typical Cash Accounts Exam procedures
Verifiy deposit activity
Identify unusual disbursements
Investigate suspicious transactions
A/R exam objective
To determine if the receivables are fairly stated and ifthey are valid and collectible
Some areas of exposure in A/R
Bill and Hold Prebill Partial shipments Prepayments Dilution Poor credit quality Interco receivables Ficitious receivables
Inventory Quality - Key Considerations
Contents - RM, FG, WIP Costing/Accounting Methods Physical Condition Marketability Verifiabilty
Which is most valuable RM, FG or WIP?
Finished goods is considered the most valuable (per RMA)
Inventory exam objective
To determine if the borrower’s representation of inventory is accurate and to assess the adequacy of the inventory as collateral for the company’s borrowings.
Some areas of exposure in Inventory
Theft
Component Manipulation
Overstatement of Quantity or Value
Impaired Marketability - obsolescence, substitute
Appraisal - Three approaches to value
Cost Approach - Land Value plus replacement cost of improvements minus depreciation
Sales Comparison Approach - Comparing Sq. footage based on selling price or Gross Income Multiplier
Income Capitalization Approach - Converts future income into a stabilized value estimate
Market Extraction
The primary method used by appraisers to determine cap rates
Discounted cash flow analysis
- Method of capitalizing income property cash flow, by using the estimated property cash flow (NOI) to determine the value of the property by applying an expected rate of return to that cash flow stream. It is similar to and builds on or refines the analysis provided in the income capitalization approach
- Capitalizes the expected cash flow profile of the property for the expected holding period of the owner of the property. It then discounts the future property cash flows and the estimated proceeds from an assumed future sale of the property at the end of the holding period, to arrive at an estimate of the present value of this cash flow stream (i.e., the value as determined by the DCF analysis).
The income capitalization approach
Calculates the value of an income property based on current rental rates, vacancy factors, and expenses
Five basic steps for completing the discounted cash flow analysis
1) Estimate the net operating income (NOI) for each year in an assumed holding period
NOI Year 1 $1,102 Year 2 $1,135 Year 3 $1,169 Year 4 $1,204 Year 5 $1,240
2) Calculate the present value of the annual cash flows for the holding period at an estimated Discount Rate.
Discount Rate
11%
Present Value of NOIs
$4,299
3) Calculate the reversion value of the property using an assumed capitalization rate.
NOI year 5 $1,240M / Capitalization Rate 9%
= Reversion Value $13,782M
4) Deduct estimated disposition cost to calculate net reversion cash flow at the end of the holding period.
Reversion Value $13,782M
+ Disposition Cost $413M
= Reversion Cash Flow $13,369M
5) Calculate the present value of the reversion cash flow at an assumed discount rate and add that present value to the present value of the cash flow stream during the holding period
Present Value of Reversion Cash Flow $7,934M
+ Present Value of Annual Cash Flow $4,299M
= Discounted Cash Flow Value $12,233M
Commercial Property values - Weighing the values
For most income producing property, the income capitalization/cash flow approach should figure prominently in the appraiser’s correlation of final value. In an owner-occupant transaction, the sales comparison (market) approach typically carries the most weight.
