FARM MANAGEMENT

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FARM MANAGEMENT
MM WATERLOO

• WK 5 CAPITAL BUDGETS
• (INVESTMENT ANALYSIS)

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Farm Mtg Concepts

• Wk 1 Introduction
• Wk 2 Economics Farm Records
• Wk 3 Budgets
• Wk 4 Whole Farm Budgets
• WK 5 CAPITAL BUDGETS
• Wk 6 Machinery Management
• Wk 7 Land Management
• Wk 8 Credit Management
• Wk 9 Human Resource Management
• Wk 10 Estate Planning

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Discussion Points
Wk 5 Capital Budgets

• I. Introduction
• II. Capital Budget Steps
• III. Non-time Methods
• A. Payback
• B. Acct Rate Of Return
• C. Book Rate Of Return
• IV. Summary

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I. Introduction
Wk 5 Capital Budgets

• A. Definition Allocation Of Resources For Major
  And/Or Long Term Projects
• B. Assumptions
• 1. Unlimited Projects
• 2. Limited Resources

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Wk 5 Capital Budgets

• C. Types Of Investment Choices

1. Screening Which Are Good
2. Preference Which Is Best
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D. Basis Of Decisions
Wk 5 Capital Budgets
1. Qualitative What I Want
2. Quantitative Will It Pay

• A. Style, Paint Color
• B. Prestige, Image

A. Profitability B. Rate Of Return
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II. Capital Budget Steps
Wk 5 Capital Budgets

• A. Determine Cost Of Capital
• Aft Tx Rate Int Rate(1-tx Rate)
• Inflation Rate
• Risk Factor
• Cost Of Capital
• B. Determine Initial Investment
• C. Determine Net Cash Flows
• Net Cash Cash Rec- Cash Exp
• D. Estimate Terminal Value
• E. Calculate Investment Measures

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III. Non-time Methods
WK 5 Capital Budgets

• A. Payback
• 1. Advantages
• A. Simple Easy
• B. Widely Used
• C. Emphasizes Liquidity
• 2. Disadvantages
• A. Profitability Not Considered
• B. Cash Flows After Payback
• Are Ignored
• C. Time Value Of Money Ignored

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3. Pay Back Calculation
WK 5 Capital Budgets
Lump 10,000 0 0 0 0 15,000
Equal 48,000 10,000 10,000 10,000 10,000 10,
000
Unequal 4,000 2,000 2,000 3,000

• Investment
• Cash Flow 1
• Cash Flow 2
• Cash Flow 3
• Cash Flow 4
• Cash Flow 5
• Salvage Val
• Tot Revenue
• Profit
• Payback

0
0
0
15,000
50,000
7000
5,000
2,000
3,000
4.66 Yr
4.8 Yr
2.0 Yr
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WK 5 Capital Budgets

• B. Acct Rate Of Ret Book Rate
• 1. Advantages
• A. Calculation Ease
• B. Good For Screening
• C. Gd For Short Life Projects
• 2. Disadvantages
• A. Time Val Of Not Considered
• B. Doesnt Consider The Timing
• Of The Flows

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3. Acct Rate Of Ret Calculation

• Investment
• Cash Flow 1
• Cash Flow 2
• Cash Flow 3
• Cash Flow 4
• Cash Flow 5
• Salvage Val

Lump 10,000 0 0 0 0 15,000
0
Cash-Invest Time gt Investment
15,000-10,000 5 gt 10,000
5,000 5 gt 10,000
1000 gt 10,000
10
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WK 5 Capital Budgets

• Investment
• Cash Flow 1
• Cash Flow 2
• Cash Flow 3
• Cash Flow 4
• Cash Flow 5
• Salvage Val

Equal
48,000
10,000
10,000
10,000
10,000
10,000
0
Cash-Invest Time gt Investment
50,000-48,000 5 gt 48,000
2,000 5 gt 48,000
400 gt 48,000
.8
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WK 5 Capital Budgets
Unequal

• Investment
• Cash Flow 1
• Cash Flow 2
• Cash Flow 3
• Cash Flow 4
• Cash Flow 5
• Salvage Val

4,000
2,000
2,000
3,000
0
Cash-invest Time gt Investment
7,000-4,000 3 gt 4,000
3,000 3 gt 4,000
1,000 gt 4,000
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4. Book Rate Of Ret Calculation
Lump

• Investment
• Cash Flow 1
• Cash Flow 2
• Cash Flow 3
• Cash Flow 4
• Cash Flow 5
• Salvage Val

10,000
0
0
0
0
15,000
0
Cash-Invest No Of Flows Invest Salv 2
15,000-10,000 5 gt 5,000
5,000 5 gt 5,000
1000 gt 5,000
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WK 5 Capital Budgets
Equal
48,000

• Investment
• Cash Flow 1
• Cash Flow 2
• Cash Flow 3
• Cash Flow 4
• Cash Flow 5
• Salvage Val

10,000
10,000
10,000
10,000
10,000
0
Cash-Invest No Of Flows
Invest Salv 2
50,000-48,000 5 gt 24,000
2,000 5 gt 24,000
400 gt 24,000
1.6
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WK 5 Capital Budgets

• Investment
• Cash Flow 1
• Cash Flow 2
• Cash Flow 3
• Cash Flow 4
• Cash Flow 5
• Salvage Val

Unequal
4,000
2,000
2,000
3,000
0
Cash-Invest No Of Flows I
nvest Salv 2
7,000-4,000 3 gt 2,000
3,000 3 gt 2,000
1,000 gt 2,000
50
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Non-time Summary
WK 5 Capital Budgets
Lump Equal Unequal

• Tot Rev
• Profit
• Payback
• Acct Rate
• Book Rate

50,000 20,000 7,000
5,000 2,000 3,000
4.66 Yr 4.8 Yr 2.0 Yr
10 .8 25
20 1.6 50
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IV. Time Value Of Money
WK 5 Capital Budgets
A. Future Value
Looking Ahead
(Compounding)
1 ...Of A Lump Sum
2 ...Of An Annuity (Regular Deposits)
B. Present Value
Looking Now
(Discounting)
1 ...Of A Lump Sum
2 ...Of An Annuity (Regular Deposits)
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IV. Time Value Of Money
WK 5 Capital Budgets
A. Future Value (Compounding) 1. ...Of A Lump
Sum
3rd YR INTEREST 10 (1001011)12
2nd YR INTEREST 10 (10010) 11

• Year 1 100 .10 1 Yr 110.00
• Year 2 110 .10 1yr 121.00
• Year 3 121 .10 1 Yr 133.10

1st YR INTEREST 10 100 10
FUT VAL LUMP Sum(1i)n 100 (1.10)3
133.00

• Lump Sum
• Investment
• 100

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Using Calculator
WK 5 Capital Budgets

• Instruction Result

Enter 1 1
Press
Enter Interest As Decimal .1
Press 1.1
PRESS 2nd OR SHIFT
Press Xy
Enter Number Of Years 3
Press 1.331
Press
Enter Lump Sum (Present Value) 100
PRESS Val Of 100 3 Yrs From Now
If 133.10 Left To Compound
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2. Of A Yr End Annuity
WK 5 Capital Budgets

• END 1st YR 100 (1 .1)2 121.00 END OF 3rd
  YR
• END 2nd YR 100 (1 .1)1 110.00 END OF 3rd
  YR
• END 3rd YR 100 (1 .1)0 100.00 END OF 3rd
  YR
• 331.00

• 331

FUT VAL INV STREAM(1 I)n -1 I
Yr 3 Int 11
Yr 2 Int 10
Yr 3 Int 10
Yr 1 Invest 100
Yr 2 Invest 100
Yr 3 Invest 100

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B. Present Value (Discounting) 1. ... Of A
Future Lump Sum
WK 5 Capital Budgets

• Pres Val (_at_10) Of 100 Received 3 Yr From Now?
• Pres Val Future Value 1/((1.1)n)
• Pres Val 100 1/(1 .1)3 75.13
• Proof 75.13(1 .1)3 99.998

100 Future Value In 3 Yrs
9.09
8.31
90.01
? Lump Sum
7.47
82.60
75.13
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2. .... Of An Investment Stream
WK 5 Capital Budgets

• END 1st YR 100 .909 90.90 (Pres Val)
• END 2nd YR 100 .826 82.60 (Pres Val)
• END 3rd YR 100 .751 75.10 (Pres Val)
• 248.60
• 248.60 Is Max To Pay For Invest That Pays
  100/Yr Annuity _at_ 10 Interest
• PRES VAL INV STRM1-(1 I)-n /I

Present Value At 10 To Give 100 A Yr For 3
Yrs
9.09
9.09
9.09
248.60 75.13 82.60 90.91
8.31
8.31
90.91 Pres Val
82.60 Pres Val
7.47

• 75.13
• Pres
• Val

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IV. Present Value Methods
WK 5 Capital Budgets

• A. Net Present Val Benefit/Cost
• 1. Advantages
• A. Considers Time Val Of
• B. Focus On Cash Flows
• 2. Disadvantages
• A. More Complex Calculations
• B. Assumes Reinvestment At
• Rate Of Return

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B. Net Present Val Calculation
Lump 10,000
Pres Val
Table 2 10

• Investment
• Cash Flow 1
• Cash Flow 2
• Cash Flow 3
• Cash Flow 4
• Cash Flow 5
• Salvage Val

0.909
0
0
0.826
0
0
0.751
0
0
0.683
0
0
0.621
15,000
9,315
Present Value -Investment Net Present Value
9,315
-10,000
(685)
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B. Net Present Val Calculation
WK 5 Capital Budgets
Lump 10,000 0 0 0 0 15,000

• Investment
• Cash Flow 1
• Cash Flow 2
• Cash Flow 3
• Cash Flow 4
• Cash Flow 5
• Salvage Val

Calculator Enter 1, Press Enter Int
As..Xx Press Press 2nd/Shift Press Xy Ent Yrs,
Press
Present Value -Investment Net Present Value
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WK 5 Capital Budgets
Pres Val 9,090 8,260 7,510 6,830 6,210 37900
Table 2 10
Equal 48,000 10,000 10,000 10,000 10,000 10,
000

• Investment
• Cash Flow 1
• Cash Flow 2
• Cash Flow 3
• Cash Flow 4
• Cash Flow 5
• Salvage Val

0.909
0.826
0.751
0.683
0.621 3.790
Present Value -Investment Net Present Value
37,900 -48,000 (10,100)
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WK 5 Capital Budgets
Unequal 4,000 2,000 2,000 3,000
Pres Val 1,818 1,652 2,253 5,723
Table 2 10 0.909 0.826 0.751

• Investment
• Cash Flow 1
• Cash Flow 2
• Cash Flow 3
• Cash Flow 4
• Cash Flow 5
• Salvage Val

Present Value -Investment Net Present Value
5,723 -4,000 1,723
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B. Benefit- Cost Calculation
Equal 48,000 10,000 10.000 10,000 10,000 10,
000
Unequal 4,000 2,000 2,000 3,000
Lump 10,000 0 0 0 0 15,000

• Investment
• Cash Flow 1
• Cash Flow 2
• Cash Flow 3
• Cash Flow 4
• Cash Flow 5
• Salvage Val

9,315 10,000
37,900 48,000
5,723 4,000
Present Value Investment Benefit/Cost



1.43
.790
.932
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WK 5 Capital Budgets
B. Internal Rate Of Return

• 1. Advantages
• A. Considers All Cash Flows
• B. Provides Base For Comparison
• 2. Disadvantage
• A. Most Complex
• B. Assumes Reinvestment At
• Internal Rate Of Return

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3. Internal Rate Of Ret
WK 5 Capital Budgets

• 1. Use Payback Period
• 2. Find Approp Row In Table1
• 3. Go Across To Find Payback
• 4. Read Up To Find Ret

Lump 4.66 5 Yr X.X - X.X 3 - 4
Equal 4.8 5 Yr X.X- X.X 3 - 4
Unequal 2.0 5 Yr X.X - X.X 3- 4
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Time Summary
WK 5 Capital Budgets
Lump Equal Unequal

• Net Pres Value
• Benefit Cost
• Internal
• Rate

-685 -10,100 1,723
.932 .790 1.43
Xx
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Summary
WK 5 Capital Budgets

• 1. Capital Budgeting Looks At The Profitability
  Of Lg. Investments
• 2. Results Of Non-time Methods ( Payback,
  Acct Rate Of Ret, Book Rate Of Return) Can Not
  Be Compared To Bank Rates.
• 3.Results Of Time Methods (Net Present Val,
  Benefit-cost, Internal Rate Of Ret) Can Be
  Compared To Bank Rates

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Associated LabActivities
WK 5 Capital Budgets

• Calculation Of Investment Measures
• -- Payback
• -- Acct Rate Of Return
• -- Book Rate Of Return
• -- Net Present Value
• -- Benefit/Cost
• -- Internal Rate Of Ret

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Self Test
WK 5 Capital Budgets

• Pres Val / Investment

• Benefit- Cost

Simplest Method
Payback
Budget For Big Items
Capital
Quantative Basis
Will It Pay
Non-time Method W/O Salv
Acct Rate
Compared To Bank Rates
Time Methods
Qualitative Basis
Image, Pretige
Non-time Method With Salv
Book Rate
Time To Recover Investment
Payback
Pres Val - Investment
Net Pres Val
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Evaluation
WK 5 Capital Budgets

• Your Understanding Of These Capital Budget
  Concepts Will Evaluated On The Midterm To Be
  Given The Fifth Friday Of The Quarter (This
  Week!!!!!!!!)

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MidtermThis Friday !!!!!

• Part 1 Objective Questions (T/F, Mc, Etc)
• 10 Pts Wk 1- Introduction
• 10 Pts Wk 2- Economics Records
• 10 Pts Wk 3- Budgets (Cash, Ent, Etc)
• 10 Pts Wk 4- Linear Programming
• 10 Pts Wk 5- Capital Budgets
• Part II. Problems
• 20 Pts Economics 5 Pts Budgets
• 18 Pts Linear Prog 9 Pts Investment

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NEXT TOPIC
INTERNATIONAL HARVERSTER W4

• TIMELINESS