economics of timber production on private land in indiana l.
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Economics of Timber Production on Private Land in Indiana. Economics or Finance?. Economics Timber owner is in general a price taker Competitive market position Market for high quality timber of preferred species is global, unitary to slightly elastic demand

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economics or finance
Economics or Finance?
  • Economics
    • Timber owner is in general a price taker
    • Competitive market position
      • Market for high quality timber of preferred species is global, unitary to slightly elastic demand
      • Market for low quality timber and non-preferred species is local, highly inelastic demand
weighted average price quality stand
Weighted Average Price, Quality Stand

Nominal

1982 $’s

Trend line – 1.4%

slide6

1982 $’s

Trend line - 1.3%

Nominal $’s

economics or finance7
Economics or Finance?
  • Finance
    • Capital intensive
      • Land
      • Growing stock
    • Long-term
    • Highly appreciated
position in investment markets
Position in Investment Markets
  • Primarily a “life-style” investment
    • Highest and best use not timber production
      • Cost of entry may exceed income potential
  • Some vertical integration
  • Not attractive to institutional investors and private equity capital
    • Can’t capture economies of scale
    • Can’t economically accumulate tracts into investment grade bundles
  • Limits resale market to other lifestyle investors
standard measures of financial return
Standard Measures of Financial Return
  • Net present value (NPV)
    • Present value of discounted stream of revenues and expenses
    • V0 = Vn/(1+i)n
  • Internal rate of return
    • Discount rate that makes NPV zero
npv calculation
NPV Calculation
  • Enter land and timber growing stock as up-front CAPITAL cost
    • Standard assumption – capital costs based on fair market value,
    • Life style assumption – capital cost based on actual cost, or zero if inherited
  • Discount (interest) rate used
    • Nominal – rate on long-term corporate bonds
    • Real – nominal reduced by average inflation rate
npv calculation12
NPV Calculation
  • Time period
    • Date of acquisition, to
    • Expected date of death, or date of liquidation
  • Ending return on capital
    • Bequest - none
    • Standard - sale price (FMV) of land and growing stock
operating costs
Operating Costs
  • Allocate between personal and business use
  • Property taxes
  • Management fees
  • Depreciation on equipment
  • Other
operating revenues
Operating Revenues
  • Timber income
    • Generally assume all-age management with periodic harvests
    • Estimate mean annual increment
    • Project timber price
  • Other income
    • Hunting lease payments
    • Non-timber forest products
    • Sale of development rights
willingness to pay for land wpl
Willingness to Pay for Land (WPL)
  • Net present value of stream of revenues and expenses
  • Represents amount that can be paid for land and growing stock
    • Discount rate represents opportunity cost of tying up capital in timber production instead of next best opportunity
base case wpl no bequest
Base Case, WPL, No Bequest
  • Liquidate at dod, assumed to be 40 years
  • 3% real discount rate
  • Liquidate land at $1,500 per acre
  • Liquidate all timber at $587/MBF real
base case wpl no bequest17
Base Case, WPL, No Bequest
  • Per acre costs
    • Annual - $20.00
    • Every 5 years - $250
    • Mean annual increment – 250 mbf
    • Harvest revenue
      • Every 10 years, 2.5 MBF
      • Price – quality stand price series, $643 nominal, $397 real
        • Linear real price increase, $4.33 per year
base case wpl no bequest liquidate
Base Case, WPL, No Bequest – Liquidate
  • WPL40 = $1,755 per acre, real
  • WPL40 = $2,845 per acre, nominal
base case wpl bequest
Base Case, WPL, Bequest
  • WPL40 = $755 per acre, real
  • WPL40 = $1,208 per acre, nominal
barton tree farm btf
Barton Tree Farm (BTF)
  • Acreage – 292
  • Initial acquisition in 1980
  • Acquisition cost - $175,250
  • Total timber revenue - $324,800
btf rate of return no expenses bequest
BTF Rate of Return, No Expenses, Bequest
  • No operating or holding costs included
    • i = ($324,800/$175,250)1/25 -1 = 7.4%
    • IRR = 2.50% nominal
    • Internal Rate of Return
      • 3.65% nominal
      • 2.65% nominal after-tax
    • Inflation averaged 2.31% from 1980 to 2005
btf rate of return bequest
BTF, Rate of Return, Bequest
  • Annual cost - $15.05 per acre per year, $4,400 per year
    • Before tax
      • IRR – 0.89%
    • After tax – 28% ordinary, 15% capital gain
      • IRR – 0.5% after-tax
no bequest liquidate
No Bequest, Liquidate
  • $15.05 per acre per year cost
  • Sell land for $1,500 per acre
    • $438,000
  • Sell 2,354 MBF timber for $660/MBF
    • $1,553,640 ($5,320/acre)
  • IRR
    • Before tax – 10.8%
    • After tax – 10.2%