Cash flows allocation

The heart of the credit protection in a RMBS transaction is governed by rules that determine how the cash flow in the transaction is allocated. Exhibit 11.7 illustrates a generic cash flow allocation scheme (the cash flow waterfall). 

The method of allocating overheads can seriously affect the assigned costs of a project and hence the apparent cash flows for that project . Since these cash flows are used to assess profitability by the net-present-value (NPV) and discounted-cash-flow-rate-of-return (DCFRR) methods, unfair allocation of overhead costs can result in a wrong choice between alternative projec ts. 

Assumptions on temporal allocation of cash flows and discounting period need to be consistent (e.g., beginning, middle or end of period) which is sometimes not the case in mathematical optimization models (cf. Erlenkotter 1981, p. 134). Generally, it is assumed that cash flows are realized at the end of a period. Alternatively, continuous payments can be assumed but the error caused by the year-end assumption is limited (cf. Brealey et al. 2006, pp. 46-48). 

Business valuation literature provides various other methods for estimating terminal values (for an overview see Koller et al. 2005, pp. 271-290). Unfortunately, as cash flows cannot be allocated to individual decisions in a network design model, a cash flow-based estimate is not possible. Instead, book value or liquidation value at the end of the planning horizon could be used. For example, Fong and Srinivasan (1981, p. 790) include a terminal value function in the unit capacity acquisition cost function. However, they do not specify how this function can be quantified in real-world applications. The major disadvantages are that it is difficult to justify the assumptions underling the terminal value estimate and that restructuring expenditures cannot be properly evaluated. 

In order to incorporate tax regimes into supply network design, the respective model has to maximize after-tax cash flows and be able to allocate transportation costs and determine optimal transfer prices. Determining optimal transfer prices is the most complex aspect because tax authorities have adopted strict rules regulating transfer pricing in order to... 

Without any changes to the production network, the operating cash flows and the NPV of the network would be reduced by approximately 10% in comparison to the baseline values. However, by re-allocating production volumes within existing capacities, it is possible to restore previously earned operating cash flows. To do so, production volumes are shifted to the major site A, which is located in the Euro zone. Contrarily, site C, which is located in the USA, would not be utilized at all by the product groups included in the example. It should be noted that this does not imply a closure of the US site since only a subset of the product portfolio was included in the analysis. The net present value of the network is nevertheless affected by the US appreciation because of the restructuring costs associated with the re-allocation of production volumes. 

Operating cash flows with US appreciation to 2001 level and product re-allocation... 

The levelized prices of PV electricity and H2 are derived by net present value cash flow analysis. The net present value cash flow method is described in Appendix A.l. A straight tine, ten-year depreciation schedule is applied with an annual depreciation rate of 9% of capital. The levelized PV electricity and H2 prices are derived by choosing PV electricity and H2 prices to generate a revenue level that results in a cumulative, net cash flow stream with a 0 net present value over the thirty-year capital recovery period. The annual net cash flow streams are discounted at the present value of the 6%-discount rate. Investment funds are allocated in year 1 construction occurs in year 2 and H2 cash flow begins in year 3. The modular design of PV electrolysis plants and H2 distribution systems enables the rapid initiation of H2 marketing and cash flow. 

The typical credit card transaction structure has three different cash flow periods revolving, accumulation, and early amortisation. Each period performs a distinct function and allocates cash flows differently. Credit card transactions are usually structured as soft bullets in order to mimic a traditional corporate bond, that is, investors receive monthly or quarterly payments of interest with one single payment of principal on the scheduled redemption date. 

However, the very flexibility of synthetics mean that there are a variety of other important decisions to be made regarding the allocation of cash flows. For example, in a traditional structure, the equity holder in our deal would undergo what is shown in Exhibit 22.9 upon the experience of a loss. The tranche size is reduced by the amount of the loss. The coupon will remain at the same spread, but the spread will be paid only on the reduced notional amount. 

FIGURE 14.4 shows a typical generic CMO sequential structure. The collateral cash flows are allocated to each tranche in specified order. The first tranche is allotted both its coupon and any prepayments. The remaining tranches receive only their coupon payments until the first one is fully retired. 

Subordination. Each tranches rights to and priority in receiving interest and principal payments are set out in an issues offering circular, which provides a detailed description of the notes and their legal structure. In allocating cash flows, typically, fees and expenses are subtracted from the cash flows, then the most senior tranches are serviced, followed by the junior tranches, and finally the equity tranche. This method of cash flow is sometimes referred to as a cash flow waterfall. 

Note holders expected losses are determined by considering the impact on their cash flows of the credit losses—losses from loan defaults— occurring in various scenarios, taking into account how such losses are allocated to the issue s tranches. The cash flows to the note holders depend on whether a default has occurred and the size of the resulting loss. The severity of the loss equals the par value of the note less the recovery rate. The probability of default may be inferred from the rating of the underlying credit exposures. Expected losses are calculated using Monte Carlo techniques, which simulate thousands of scenarios and cash flows and so require sophisticated computational models. 

Since 1991, the stand-alone trust has been replaced with a master trust as the preferred structuring vehicle for credit card ABS. The master trust structure allows an issuer to sell multiple issues from a single trust and from a single, albeit changing, pool of receivables. Each series can draw on the cash flows from the entire pool of securitized assets with income allocated... 

Rarely, all of the information needed for analysis is made obvious on the balance sheet, income statement, or statement of cash flows. Instead, it may require closer examination to find the necessary information. The numbers reported in the financial statements may not be exactly what is needed for financial analysis and day-to-day decision making by those in supply chain and operations because of the assumptions made by a company s financial experts. Accountants have the liberty to make assumptions based on historical trends when preparing financial statements. Examples of these assumptions include the amount of accounts receivable will not be collected, or what liabilities exist, such as tax, pension, and legal liabilities. Accountants also make assumptions about how to value tangible assets, how to value brand and intangible assets, and an amount to allocate to goodwill. As a result of these assumptions, financial results can vary widely. 

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