lev and the forest value lecture 5 (04/13/2015). the financially optimal rotation age
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LEV and the Forest Value
Lecture 5 (04/13/2015)
The Financially Optimal Rotation Age
0
5
10
15
20
25
0 10 20 30 40 50 60 70 80 90 100 110 120 130 140 150 160
Rotation Age (years)
Yie
ld (
mb
f/a
c)
0
50
100
150
200
250
300
350
400
LE
V (
$/a
c)
Yield LEV
LEV and MAI
0
0.02
0.04
0.06
0.08
0.1
0.12
0.14
0.16
1 11 21 31 41 51 61 71 81 91 101 111 121 131 141 151 161
Rotation Age (years)
MA
I (m
bf/
ac/y
r)
0
50
100
150
200
250
300
350
400
LE
V (
$/ac
)
MAI LEV
CMAI
Marginal Analysis of the Rotation Decision
• The marginal benefits:
• The marginal costs:
1 (1 )a a incMB P Y t Price of wood Income tax rate
Growth of wood b/w age a and a+1
(1 )a inc
annual management costs
MC A t
(1 )prop inc
property taxes
t t
*
land rent
r LEV
(1 )a inc
inventory cost
r P Y t
Marginal Costs and Revenues and the LEV
0
50
100
150
200
250
300
350
400
0 10 20 30 40 50 60 70 80 90 100 110 120 130 140 150 160
Rotation Age (years)
Ma
rgin
al C
os
ts a
nd
Be
ne
fits
($
/ac
/yr)
LEV MBa MCa
0
50
100
150
200
250
300
350
400
0 10 20 30 40 50 60 70 80 90 100 110 120 130 140 150 160
Rotation Age (years)
Ma
rgin
al C
os
ts a
nd
Be
ne
fits
($
/ac
/yr)
LEV MBa MCa
Establishment Cost (E ) 200Price of Wood(P) 600Property Tax (tinc) 2Annual Management Costs (A) 1Income Tax (tinc) 0.22Interest Rate r 0.03
1 (1 )a a incMB P Y t
*
(1 ) (1 )
(1 )
a inc prop inc
a inc
MC A t t t
r LEV r P Y t
An increase inthe Interest Rate
Establishment Cost (E ) 200Price of Wood(P) 600Property Tax (tinc) 2Annual Management Costs (A) 1Income Tax (tinc) 0.22Interest Rate r 0.04
0
50
100
150
200
250
300
350
400
0 10 20 30 40 50 60 70 80 90 100 110 120 130 140 150 160
Rotation Age (years)
Mar
gin
al C
ost
s an
d B
enef
its ($
/ac/
yr)
LEV MBa MCa
1 (1 )a a incMB P Y t
*
(1 ) (1 )
(1 )
a inc prop inc
a inc
MC A t t t
r LEV r P Y t
An increase inStumpage Price
Establishment Cost (E ) 200Price of Wood(P) 800Property Tax (tinc) 2Annual Management Costs (A) 1Income Tax (tinc) 0.22Interest Rate r 0.04
0
50
100
150
200
250
300
350
400
0 10 20 30 40 50 60 70 80 90 100 110 120 130 140 150 160
Rotation Age (years)
Mar
gin
al C
ost
s an
d B
enef
its ($
/ac/
yr)
LEV MBa MCa
• In increase in establishment costs?
• In increase in annual management costs and property taxes?
• In increase in severance tax?
• In increase in income tax?
An increase in…Financially Optimal
Rotation Age (R*)
LEV
r Real rate Negative Negative
P Price of wood E=0
0
E>0
Neg.Positive
E Establishment Cost Positive Negative
A Annual man. costs 0 Negative
tprop Property tax 0 Negative
tinc Income tax 0 Negative
tsever Severance tax E=0
0
E>0
Pos.Negative
The impact of changes in economic variables on the financially optimal rotation
age and LEV
Forest Value
• Land Expectation Value: present value of costs and revenues from an infinite series of identical even-aged forest rotations starting from bare land;
• Forest Value (a generalization of LEV): the present value of a property with an existing stand of trees + the present value of a LEV for all future rotations of timber that will be grown on the property after harvesting the current stand.
The Forest Value allows us:
• To determine when a given stand should be cut;
• To separate the management of the current stand from that of future stands;
• To account for price changes that might occur during the life of the current stand;
Note: We will still assume that the rotations and prices associated with the future stands (i.e., the stands that are established after the current stand is cut) will be the same.
Time (years)
0 1 2 3 29 30 31 59 60
$5/acProperty tax
$84/acStand impro-vement cut
$5,948/acCut currentstand now
$4,400/acCut future
stand
…
Time (years)
$84/acStand impro-vement cut
$4,400/acCut future
stand
…0 1 2 3 9 10 11 39 40 41 69 70
$7,884/acCut after10 yrs
When to cut the stand?
• Cut it now:– Forest Value = Current Timber Value + LEV
1( )
,1 1
(1 ) (1 )
(1 ) 1
R nR R t
t p p R ht p
R
E r I r P Y CA
LEVr r
(60 30)
60
$84(1.05) $4,400 $5
(1.05) 1 0.05
$363.04316 $4,400$100 $169.42 /
17.67919ac
$5,948/ac
0 $5,948 / $169.42 / $6,117.42 /FV ac ac ac
When to cut the stand?
• Cut it 10 years from now:
– Forest Value = Present Value of Costs and Revenues for first 10 years + Present Value of
LEV
10
$169.42$104.01/
(1 0.05) 1.62889LEV
LEVPV ac
10
$7,884
(1.05)CurrentRotationPV
$4,840.09 $38.61 $4,801.48 / ac
10
10
$5(1.05 1)
0.05(1.05)
10 $4,905.49 /CurrentRotation LEVFV PV PV ac
Forest Value
• Assumptions:1. The current stand will be harvested;
2. A new stand will be established;
3. All future rotations of the new stand will be identical.
• Definition:– The Forest Value is the present value of the projected
costs and revenues from an existing forest tract, plus the present value of an infinite series of identical future forest rotations that starts after the current tract is harvested.
Calculating the Forest Value
• New notation:
• Forest Value formula:
0
0
p,T 0
Ch
the time when the currect stand is to be cut;
Y the expected yield of product p from the current stand at time T ; and
C the cost of selling the current stand of timber.
C
T
0 0
0 0
,1
of harvest revenues present value of annualfrom the current stand revenues up to when the current
stand is cut
[(1 ) 1]
(1 ) (1 ) (1
nC C
p p T h Tp
T T
Net present value Net
P Y CA r LEV
FVr r r r
0
LEV of future rotations
)T
Discounted
Land value and timber value
• Forest Value = Land Value + Timber Value– Land Value = LEV– Timber Value = Forest Value – LEV
0 0
0 0
,1 ( ) [(1 ) 1]
(1 ) (1 )
nAnnual Land CostC C
p p T h Tp
T T
P Y Cr LEV A r
Timber Valuer r r
What if real prices change?
• Assumption: the price changes will end by the end of the current rotation
0 0 0
0 0
, ,1 ( ) [(1 ) 1]
(1 ) (1 )
nAnnual Land CostC C
p T p T h Tp
T T
P Y Cr LEV A r
Timber Valuer r r
When calculating the LEV, use the new, steady state price: Pp,∞
An exampleItem Amount Assumptions for the Current and Future Stands Current sawtimber volume 18 mbf/ac Current pulpwood volume 14 cords/ac Current sawtimber price $325/mbf Current pulpwood price $7/cord Expected sawtimber volume in 10yrs 24 mbf/ac Expected pulpwood volume in 10yrs 12 cords/ac Expected real sawtimber price in 10yrs $450/mbf Expected real pulpwood price in 10yrs $15/cord Property tax $5 Real alternate rate of return 5% Assumptions for the Current and Future Stands Timber stand improvement cut (age 30 yrs) pulpwood harvest
12 cords/ac
Final (age 60) sawtimber harvest 13 mbf/ac Final (age 60) pulpwood harvest 25 cords/ac
2
,0 ,01
$325/ 18 $7/ 14 $5,948Cp p
p
Timber value P Y mbf mbf cd cd
Cut now:
301' 12 $15 (1.05) 13 $450 25 $15 $7,002.95RFV
160
' $7,002.95 $5$296.11
(1 ) 1 (1.05) 1 0.05RR
FV taxLEV
r r
$5,948 $296.11 $6,244.13CutNowForestValue
Cut in 10 yrs:
2
,10 ,101
$450/ 24 $15/ 12 $10,980Cp p
p
Timber value P Y mbf mbf cd cd
10
$10,980$38.61 $6,740.77 $38.61 $6,702.16
(1.05)timberPV
10
$296.11$181.79
(1.05)LEVPV
10 $6,702.16 $181.79 $6,883.95CutIn yrsForestValue
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