Posted by David Butler on March 15, 2004 at 12:33:41:
Personally, I believe Lonnie’s own formula for the measurement of this scenario is best… “What’s the rate of return?.. Good enough”. 
Couple of things to consider though - all of which have been covered here before in various threads.
First… if that $500 was YOUR capital, and you had it invested in the deal even five seconds, you have a measurable rate of return. The biggest part of the problem though is finding a calculator program that would handle that large of a yield measurement.
You can see visually for example that in this scenario, you are actually doing the equivalent of purchasing two cash flows. One that brings a one-time lump sum payment of $1,000; and a second that brings you 36 monthly payments. Also, each of these has to have some “known” future start date, and end date. And to be able to do any calculations, you’ll have to provide at least three “known” variables for each of the respective cash flows, including those dates.
Some of that “gamesmanship” would involve your selection of how the original investment capital ($500) is allocated to each of the cash flows; and some would be your assumptions for periodic receipt of each of those cash flows, from the time the investment capital left your jeans, and flowed into the investment.
Not sure of the limitations in every hand-held calculator, but like you, my TI BA IIPlus hits the “error” mode in trying to figure the calculation. And my desktop TValue 4.0 maxes out at 265% return. But even with a calculator that would handle the sky-high ROI here, the difficult part would be in measuring that return in relation to the rest of your periodic payments - at least with a handheld calculator. It does become much easier with software programs such as TValue, and even Excel.
In any event, let’s say you put in $500, and swung the “turnaround” on this deal, in 30 days.
That $1,000 down payment you receive gives you a 100% return on your invested capital, and since it happened in only one month instead of 12 months, that return equates to annualized yield of 1200%. The 36 payments coming after that give another 247% return on the original $500 - but that yield would be discounted a tiny bit more, for the fact that those 36 payments don’t start until one more month AFTER you receive the $1,000 down payment… so in this scenario, you would be waiting 60 days from date of investment, before you started receiving those payments. In the meantime, how was the original $500 apportioned in relation to each of these cash flows?
Taking those steps, I could go through several iterations and develop a reasonable basis for coming up with a WAC (weighted average coupon - or blended rate) for the whole investment - which would give me a more accurate ROI by allowing some “weighting” in the equation for the fact that a large part of my return is “front-loaded” in the overall term of the investment. Depending on how I apportion the original investment, I could likely go through several iterations to conclude that I received a “blended return” approximating 1,400% annualized… perhaps even higher.
Or, I could simply look at the total profit received on the original investment, and give myself a simple “average” annual return on investment. Here for example, I would have a profit of $5,335 on my $500 investment, giving me a total return of 1067%. I could divide that by three years for the time it took to recover the entire investment, and call the average annual return 356%.
Or I could divide the 1067% by the 37 months it actually took to recover the investment, then multiply that figure by 12, to gain a revised annual average return of 346% - on that investment… and assuming no reinvestment of the front-loaded capital I received.
Rather than go through all those hoops though, I prefer to take Lonnie’s recommendation here, and simply call it “good enough”. ;-))))
And best wishes for your success in finding some of those!
When you do though - be sure to weigh in two other very important factors that come into play. Total dollar profits vs. yield; and deduction for time and effort managing the investment - BEFORE allocation of remaining profits to yield. Those two measurements are as important to every investment as the yield is.
I frequently earn 25% to 30% yield rates on the MH paper I purchase. At the same time, I spend an inordinate amount of time chasing payments, and especially in dealing with insurance cancellations and park management issues.
The insurance thing is a constant it seems like. Just a part of the game - but I charge out of my total returns for the time and effort. At the end of the day then, my true investment return is closer to the 12% to 14% I earn on my less troublesome real estate notes, and somewhat surprisingly, the business notes I own.
Also, since I make extensive use of credit lines to fund my note purchases, I technically do have the “infinite” return on MY money - since I am not using my money in those circumstances. But for effective management purposes, I still measure my returns on the basis of the “invested” capital in each investment.
In any event… Many Happy Returns on your own investing endeavors!
David P. Butler