Understanding the cost of capital

• Agricultural businesses rely on borrowed capital for inputs, machinery, equipment, and land

• Managing debt capital requires a farmer to choose from among multiple financing sources offering differing interest rates, rebates, points, and other non-interest costs.– Debt can increase the rate of growth in equity capital– Debt will increase risk of equity loss

Financing decision aids

• Short-term financing alternatives– Trade credit– Credit cards/Lines of credit

• Intermediate-term financing alternatives– Machinery and equipment loans

• Long-term financing alternatives

- Real estate loans

Design Considerations

• Developed to be easy to use and flexible to encourage producers to compare financing alternatives

• Uses Microsoft Excel and Visual Basic for Applications (VBA) so that is readily available to a wide range of users

• Macros are used to prevent accidental corruption of code by user

Short-term Financing Module

• Uses the economic concept of opportunity cost and the financial concept of time value of money to determine the cost of capital from supplier financing.

• Many agricultural input suppliers offer terms of sale that offer cash discounts for early payment. Such terms of sale typically have a very high implicit cost of capital.

Example of short-term financing alternative

Intermediate-term Financing Module

• Uses time value of money concepts for machinery and equipment purchases.

• Alternative sources of financing have different interest rates and non-interest costs.

• Dealers often offer a choice between rebate dollars or lower interest rates.

Example of intermediate-term financing alternative

Long-term Financing Module

• Different lenders often have different terms, interest rates, and non-interest costs.

• Many lenders also allow borrowers to pay points to lower their interest rate.

• Also important are any stock requirements such as that required by the Farm Credit System (still working on impact of patronage dividends on cost of capital).

Example of long-term financing alternative

Potential farm decision analysis tools:

• Leasing options calculator– Will help farmers understand the risks inherent in leasing farm

assets including options to buy in leveraged leases

• Contracting options calculator– Designed to analyze the risks associated with typical production

contracts including those common in poultry and swine production

• On-farm methane digester capital budgeting model– Will assist producers considering the implementation of an on-

farm methane digester and would help them evaluate the risk associated with bearing a large and irreversible investment