Estimating the Profitability of Your Forestland Enterprise
http://edis.ifas.ufl.edu/ ( Publisher's URL )
Full Citation
Permanent Link: http://ufdc.ufl.edu/IR00001813/00001
 Material Information
Title: Estimating the Profitability of Your Forestland Enterprise
Physical Description: Fact Sheet
Creator: Hubbard, WIlliam G.
Publisher: University of Florida Cooperative Extension Service, Institute of Food and Agriculture Sciences, EDIS
Place of Publication: Gainesville, Fla.
Publication Date: 1989
Acquisition: Collected for University of Florida's Institutional Repository by the UFIR Self-Submittal tool. Submitted by Melanie Mercer.
Publication Status: Published
General Note: "First published November, 1989. Reviewed AUgust, 1998."
General Note: "Circular 836"
 Record Information
Source Institution: University of Florida Institutional Repository
Holding Location: University of Florida
Rights Management: All rights reserved by the submitter.
System ID: IR00001813:00001


This item is only available as the following downloads:

fr01500 ( PDF )

Full Text


1.This document is Circular 836, one of a series of the School of Forest Resources and Conservation, Florida Cooperative Exten sion Service, Institute of Food and Agricultural Sciences, University of Florida. First published: November, 1989. Reviewed August, 1998. Please visit th e FAIRS Web site at http://hammock.ifas.ufl.edu 2.William G. Hubbard, southern regional extension forester; Robert C. Abt, Ph.D., associate professor, N.C. State; Mary L. Dury ea, Ph.D., professor; Michael G. Jacobson, Ph.D., professor, School of Forest Resources and Conservation, Cooperative Extension Service, Institute o f Food and Agricultural Sciences, University of Florida, Gainesville, 32611.The Institute of Food and Agricultural Sciences is an equal opportunity/affirmative action employer authorized to provide resea rch, educational information and other services only to individuals and institutions that function wit hout regard to race, color, sex, age, handicap, or national origin. For information on obtaining other extension publications, contact your county Cooperative Extension Servi ce office. Florida Cooperative Extension Service / Institute of F ood and Agricultural Sciences / University of Florida / Christine Taylor Waddill, DeanCircular 836Estimating the Profitability of Your Non-Timber Forestland Enterprise1William G. Hubbard, Robert C. Abt, Mary L. Duryea, and Michael G. Jacobson2BackgroundForest and farmland owners today have a variety of investment opportunities available to them on their land. Depending on the characteristics of the property, the interested owner can--in addition to growing trees-harvest pine straw, grow Christmas trees or mushrooms, or lease hunting, fishing, or grazing rights. Some of these enterprises are added by owners as hobbies--without financial expectations. Many landowners, however, are interested in the potential for increased income. This is especially true for owners of forestland who must often wait years before harvesting and selling timber. When the landowner becomes interested in managing an enterprise, a written management plan should be prepared. Management plans include a definition of objectives and level of involvement, an analysis of the market situation for the enterprise in question, a timetable of important activities, and an identification of major factors that may limit the success of the enterprise (Duryea et al .1988). The management of a successful forestry enterprise needs careful planning and decision-making, much like the management of a successful business. If a landowner is interested in making additional income from the land, the management plan should include a financial analysis. If properly done, the analysis can be among the most valuable tools used in the planning and decision-making process. Financial analyses give needed information on the profitability of an enterprise, or provide assistance in choosing between two or more potential enterprises. The purpose of this publication is to introduce the landowner to the financial concepts necessary to properly evaluate alternative forestry enterprises. This publication emphasizes the financial benefits and costs. However, landowners often undertake projects for a variety of reasons other than financial return. These nonmarket objectives, such as management for recreation, nongame wildlife habitat, aesthetics, or soil conservation can also be included in an analysis. Although the concepts are very similar; placing values on these benefits and costs can be a time-consuming task. A variety of natural resource economic texts provide detailed methods for valuing non-market goods and services. After an introduction of the general steps involved in financial analysis a number of detailed examples will be examined. The costs and returns for the investments in the examples represent rough averages. The costs and revenues for a potential enterprise should be researched and estimated by the landowner and/or a professional.Steps in Financial AnalysisSound financial analysis depends on a complete accounting of costs and benefits over time. Keeping track of the costs and revenues and when they occur is


Estimatin g the Profitability of Your Forestland Enterprise Pa g e 2October 1998 Figure 1 Flowchart of major financial analysis steps. Figure 2 Sample time line (Christmas tree farm objective).important for management of cash flow. The timing andThe flowchart in Figure 1 illustrates the steps taken in amounts of these cash flows determine the profitabilitythe financial analysis. of the forest resource enterprise.1. Identify the ObjectivesIn the first step the owner's objective and level of involvement are determined. This step may seem simple. However; simple is seldom easy. It is at this stage that you must ask yourself, honestly, how involved you want to be in the enterprise. Will the project be a hobby or do you wish to make it your major line of work?who can assist you in this step. The events should be placed in the appropriate spots on a time line. The time How much time do you want to devote to the project? How much money are you willing to invest? Because the amount of involvement often depends on the perceived returns, leave room for flexibility. Objectives can be changed and the analysis modified. This is a major advantage of sound planning. The project can be changed much more easily and cheaply on paper than on the ground.2. Determine the Schedule of ActivitiesIn the second step the schedule of activities is determined. Contact someone familiar with the product line is a convenient way to track these activities over time. A sample time line for a Christmas tree farm is shown in Figure 2. In this case, planting, pruning, mowing, fertilizing, andrequire. A full rotation or production cycle should be marketing are needed. Make sure you include any andstudied including costs of preparation and postharvest all activities, including your own, that the project willcleanup. Identify as closely as possible the time of year


PV n FV (1 b i )nEstimatin g the Profitability of Your Forestland Enterprise Pa g e 3October 1998(or period) that the activity takes place. Activities that occur at the beginning of the year (or period) rather than the end may have a significant effect on the outcome of your analysis.3. Attach Dollar values to ActivitiesThe third step is to attach dollar values to the schedule of activities. Determining the timing, and amounts of cash flows can be difficult. If you are going to be personally involved in the management of your land it is important to include your time as a cost. There are two ways to incorporate your time into the financial analysis. The most straightforward way, is to enter an hourly wage for your time into the cost calculations. This wage should reflect the value of your time. For example, if you were considering quitting a job to work on your land, the value of your time is your current wage. If, on the other hand, you consider working on your land as recreation or therapy, you might charge yourself a lower or even zero wage. The alternative way to evaluate your time is to estimate the hours you will invest, but not to include your wages for these hours as a cost. Financial returns calculated this way include both profits and wages. This figure and the number of hours invested can be used to determine whether your time is worth the returns. Predicting other costs and revenues throughout the analysis period will probably require professional assistance or at least contact with persons currently in the business. Dollar figures depend on the present and future supplies and demands of the product and any input needs. The economic environment constantly changes. It is therefore important to have the best and most current information available. For example, if the economics of Christmas trees appeared very favorable five years ago, then many people may have planted trees then and today, the increased competition and supply may keep future prices too low to justify current investment. So even if demand for Christmas trees has not changed in the last five years, the changes in supply may affect your investment decision.Note: Some products have grower associations: the Florida Christmas Tree Association and the Shiitake Mushroom Association. These associations may be of assistance in determining present and future costs and revenues. Other products do not yet have well-defined markets and prices. In these cases, county extension agents and foresters, as well as consultants, may be of some assistance.4. Discount Values to the PresentBecause the costs and revenues are spread out over the length of the planning period we must take into account that future dollars are not worth as much as today's dollar. In financial terms you can see this is true since you could put less than a dollar in the bank today to get a dollar back sometime in the future. How long you have to wait depends on how much less than a dollar you started with, the interest rate, and the frequency of compounding at your bank. The key factor in analyzing the time value of money is the discount rate or alternative rate of return. This is the cost of borrowing money or the rate of return available in other investments. These other investments may be alternative land uses or simply the rate of return available in a savings account or money market fund.Example. Suppose you were given the choice of receiving $100 today or receiving $1,000 in 20 years. We can use financial analysis and the discount rate to compare these two "costless" investments. The objective is to determine the present value of these investments. For the first investment this is easy: the present value of receiving $100 today is $100. Determining the present value of receiving $1,000 in 20 years, however; is more complicated. If we consider our alternative rate of return to be the rate that we earn on our savings account, then we want to determine how much money would we have to put in our savings account today, to be able to withdraw $1,000 in 20 years. If this "present value" is greater than $100 then it is the preferable investment. The present value is calculated as shown in Equation 1: where n is the number of years, i is the alternative rate of return (expressed in decimal form), and FV is the future value. If your savings account pays 7 percent interest, then n=20, i=.07 (for 7 percent), and FV= $1,000. The calculated PV is $258.42. This proves receiving $1,000 in 20 years at 7 percent is a better investment since $258.42 is greater than $100. You can verify the accuracy of the formula by noting that one year after depositing $258.42 in your account you would have $258.42 + (.07 x $258.42) or $258.42 x (1.07) which is equal to $276.51. After two years you would have $276.51 x (1.07) and so on until year 20 in which you would have, except for a rounding error; $1,000.


Estimatin g the Profitability of Your Forestland Enterprise Pa g e 4October 1998 Figure 4 Time lines of two hypothetical investments: A and B.value of returns less the present value of costs. AssumeCalculating the Net Present Value (NPV)Unfortunately, most investments involve costs. To examine investments with costs you compare their net present values (NPV), which is simply the present that there are now two investments and both require you to invest $60 today and $50 at the end of five years. Investment A returns $150 in five years while investment B returns $250 in seven years. Are these investments profitable? If so, which is better? The time line for these two investments is shown in Figure 3. Assume a discount rate of 7 percent. Usingthe investment over and above an investment that Equation 1 as the PV for investment A, the PV ofyields the alternative rate of return (7 percent in this returns is $106.95 (FV= $150, n=5, i=.07). The PV ofcase). Any investment with a positive NPV will return the costs is equal to the $60 paid today plus the PV ofmore than the alternative rate of return used in its the $50 in five years. Discounting the $50 for fivecalculations. In other words, the decision to invest in A years (using Equation 1) gives $35.65. The totalwill return $11.30 more than simply putting $60 in the present value of costs, therefore, is $60 + $35.35 orbank today and $50 in the bank in five years. Similarly, $95.65. The net present value of investment A isin investment B the return (NPV) of $60.04 is that therefore $106.95 $95.65 or $11.30.much better than putting the money in a savings Because these investments have the same costs,account. only the revenues need to be calculated for investmentFor simplicitys sake, the above examples have not B. In this case, the FV=$250, n=7, and i=.07. The PVincluded inflation or changes in the purchasing power of investment B therefore is equal to $155.69 (usingof the dollar. There are two ways to incorporate Equation 1). The NPV of investment B is thereforeinflation into your analysis. You can do the analysis in $155.69 $95.65 or $60.04. So investment B isreal (constant) dollars or current (inflated or nominal) preferred. This $60.04 represents the current value ofdollars. Real dollar analyses net out the effect of


AE n NPV [ i (1 b i )n] [(1 b i )nt 1]Estimatin g the Profitability of Your Forestland Enterprise Pa g e 5October 1998inflation from all costs, revenues, and interest rates. Current dollar analyses include the effects of inflation. For these reasons, it is important to determine if your cost and revenue forecasts include inflation. Your discount rate may also need to be adjusted depending on what type of analysis you undertaken.Calculating the Internal Rate of Return (IRR)Sometimes it is desirable to calculate an investment's internal "rate of return" (IRR). This is simply the discount rate that makes the NPV equal to zero. For investment A the IRR is 10.8 percent and for investment B, the IRR is 17.1 percent. Unfortunately, there is no shortcut formula for calculating this rate of return. To calculate the IRR by hand requires changing the discount rate in the NPV calculations by trial and error until you find the discount rate that makes the NPV zero. Most financial calculators can calculate it easily. Calculation of a unique IRR for an investment is not always possible, and rankings of investments by IRR are not always the same as rankings by NPV It is generally preferable to rank investments by NPV For an in-depth discussion of differences in IRR and NPV criteria see any finance or capital budgeting textbook. Before move on to detailed examples, one other concept of the time value of money should be introduced. Often an investor would like to compare forestry investments to annual crops or leasing land on a yearly contract. Once the NPV is calculated it is easy to convert to an annual basis. This is especially important to those who are comparing two projects whose production lengths are different. Christmas trees and shiitake mushrooms are examples.Calculating the Annual Equivalent (AE)While it takes four or five years to grow a Christmas tree in Florida, mushroom production may only take one year. Comparing the annual returns expected between the two makes it easy to decide which is more profitable. The calculated amount is defined as the yearly payment that would pay off the NPV of the project. To calculate the yearly, or annual equivalent (AE), the present value should first be calculated for the analysis period. Then, using the traditional formula favored by many financial analysts to calculate payments, an annual equivalent can be found using Equation 2: where AE= Annual Equivalent and the other symbols are the same as before. The AE is very useful in comparing investments of different project lengths as long as reinvestment assumptions are made.Financial Analyses of Forestland AlternativesIn this section, steps in a financial analysis will be presented for a number of alternative forestland uses. An example of an enterprise with yearly returns will be followed by an example of less frequent returns. Finally, a mixture of the two types of investments will be presented in a Christmas tree farm case. The following examples are designed to give the landowner an idea of the steps involved in financially analyzing a forestry enterprise. It should be emphasized that financial analysis of these forestry investments is basically no different than most business analyses. The procedures outlined in each example, along with estimates of cash flows, provide valuable information. In the examples, the land is assumed to be owned by the individual doing the analysis. If this is not the case, the land rent or purchase price must be included in the analysis.Example 1: Hunting LeasesThe situation : Wayne Baker owns 300 acres of natural pine and hardwood. A local hunting club is interested in leasing the land for hunting for 10 years. Wayne knows two neighbors who have leases with the club. The first neighbor leases a similar partial of land for $4/acre. The second neighbor has made some improvements that cost him $3,000 up front. He also has maintenance costs of $500/ year. This neighbor is able to lease the tract for $7.50/ acre. Wayne would like to decide which hunting arrangement, if any, to pursue. To evaluate the profitability of the investment, Wayne must determine his discount rate. As explained earlier; it is often determined by the next best alternative he may have. In this case Wayne could put his money in a Certificate of Deposit (CD) at his bank


PV n a [(1 b i )nt 1] i (1 b i )nEstimatin g the Profitability of Your Forestland Enterprise Pa g e 6October 1998 Figure 6 Low-intensity huntin g : schedule of activities. Figure 7 Low-intensity huntin g : dollar value.for 8%. At this rate, if the NPV/earning of his investment is positive, he will be earning more than he would with the CD. If the NPV is negative, the CD will return more. Each of the hunting lease arrangements should be analyzed independently and the one with the highest positive NPV chosen. The projects can be identified as a low-intensity (do nothing) lease and high-intensity lease (improvements and maintenance). The lowintensity lease follows:1. Low-intensity hunting lease To begin the analysis, follow the steps outlined before: Step 1. Identification of the objective. The landowner wishes to increase his annual income. In this case, a ten-year hunting lease is to be arranged in which the landowner has very little or no active participation.Step 2. Identification of activities. With the lowintensity arrangement, the only activities are the execution of the lease and the yearly collection of hunting fees (Figure 4).Step 3. Attach dollar values to the activities.Assuming no cost of lease execution or fee collection to Wayne, the yearly expected income is equal to the per-acre revenue times the total acres in the tract, or $4.00/acre x 300 acres for $1,200 (Figure 5).Step 4. Discount the cash flows to the present.To calculate the NPV of a yearly return, the present value of each payment needs to be determined. Although this is simply calculating 10 present values (one for each lease payment received) and adding them together; it can become quite time-consuming. Imagine a 50-year lease! So, heres a formula to make calculations easier. This formula is used when costs or revenues are incurred at a regular rate throughout the project length. This formula saves the repetitious computations involved in yearly discounting. The formula in Equation 3 is simply a derivation of the present value formula (Equation 1):


PV n $1,200[(1 b .08)10t 1 .08(1 b .08)10n $8,052.10Estimatin g the Profitability of Your Forestland Enterprise Pa g e 7October 1998 Figure 10 Hi g h-intensity huntin g : schedule of activities. Figure 11 Hi g h-intensity huntin g : dollar values.where a is the yearly cost or revenue and the others are as before. With low-intensity hunting as shown in Equation 4 (where numbers from Waynes first neighbor in the case situation replace the letters in Equation 3)--there are no costs involved: Because there are no costs involved, the NPV will be positive and equal to the PV In this case it is $8,052.10. This is the present value of $1,200 per year for 10 years at an 8 percent discount rate. This NPV can now be compared to the more intensive hunting operation of Wayne's other neighbor.2. High-intensity hunting leaseStep 1. Identification of the project and objectives. The project now involves putting in wildlife food plots, fencing, and shelters. It involves some start-up cost (and time) as well as intermediate management activities. The lease is 10 years. Objectives are to obtain additional income with some involvement in the operation.Step 2. Identification of activities. With the highintensity arrangement, Wayne, with the help of his neighbor; has identified the following activities and their timings (Figure 6).Step 3. Attach dollar values to the activities.Wayne's second neighbor paid a start-up cost of $3,000 and $500/year for the hunting operation. Wayne believes these figures are close to average for the type of hunting lease arrangement and will probably remain the same for the next few years. The revenues are equal to $7.50/acre x 300 acres or $2,250/ year. These along with the costs are summarized in Figure 7.


PV n $2250[(1 b .08)10t 1 .08(1 b .08)10n $15,097.68 PV n $500[(1 b .08)10t 1 .08(1 b .08)10n $3,355.04Estimatin g the Profitability of Your Forestland Enterprise Pa g e 8October 1998 Figure 14 Pine-straw production: schedule of activities.Step 4. Discount the cash flows to the present.The present net value is calculated in Equation 5 in a manner similar to that of the low-intensity lease: Yearly management costs are calculated similarly as shown in Equation 6: Add $3,355.04 to the original $3,000 start-up cost to obtain a total cost of $6,355.04. Using Equation 3, the NPV of the high-intensity project, therefore, is the net present revenues minus the net present costs = $15,097.68 minus $6,355.04 or $8,742.64. The two projects can now be compared to determine which project has a higher financial return. The low-intensity lease agreement has a net present value of $8,052.10 while the high-intensity lease agreement has a NPV of $8,742.64. If all costs (including Wayne's time and effort) and revenues have been taken into account, the high-intensity project returns $690.54 more than the low-intensity project. Now Wayne can bring in any other nondollar variables to assist him in deciding which (if any) level of intensity he will choose.Example 2: Pine Straw ProductionAn enterprise may produce periodic revenues instead of annual revenues. Pulpwood production, for example, can provide a return every 20 to 25 years if trees are replanted after each harvest. An alternative enterprise compatible with timber production that has received attention lately is the production of pine straw. The following example shows the steps involved in calculating the NPV of periodic returns for a 5-year raking cycle associated with-pine straw production. The situation: Mary Smith is contemplating the possibility of harvesting pine straw on her 10-acre site of 5-year-old slash pine. She has heard that plantations 10 years and older with no vegetation in the understory can provide a profit of $60 per acre if raked and baled every five years. She has been advised however that her stand has too many shrubs and hardwoods and it will cost her $1,000 to clear away unwanted vegetation. She would like to know if the $1,000 investment needed to clean the stand will be profitable or not. She has a discount rate of 7 percent.Step 1. Identification of the project and objective.The project is pine-straw production with an initial cost, and delayed periodic revenues. The landowner would like to obtain additional income to pay property and other taxes. Participation in the enterprise is low.Step 2. Identification of activities. Converting the present stand to a rakeable one may include herbicide application, burning, and mowing. When the plantation reaches 10 years of age, Mary will need to collect the pine-straw fee (Figure 8).


PV n a [(1 b i )nt 1] [(1 b i )tt 1](1 b i )nPV n $600[(1 b .07)15t 1] [(1 b .07)5t 1](1 b .07)15n $950.27Estimatin g the Profitability of Your Forestland Enterprise Pa g e 9October 1998 Figure 15 Pine-straw production: dollar values.Step 3. Attach dollar values to the activities.Assuming no cost of collection to Mary, the periodic expected income in years 10, 15, and 20 is equal to the per acre revenue times the total acres in the tract, or $60.00/acre x 10 acres for $600 (Figure 9).Step 4. Discount the cash flows to the present. A periodic formula shown in Equation 7, similar to the annual formula (Equation 3), can be used to discount the periodic cash flows to the present so Mary can determine whether the $1,000 investment will return at least 7 percent: where n is the number of years (or interest bearing periods) in the analysis and t is the interval in years between the periodic payments. In Equation 8, n is 15 (age 5 to 20) and t equals 5 (payments are received every five years). Subtracting the cost of $1,000 from the present value leaves -$49.73 or a negative net present value. In this case, the revenues to be received in the future do not justify the $1,000 investment (at a 7 percent discount rate). In this case Mary should look into delaying the investment until year 9 (a year before the first harvest). An analysis of this could be done rather easily using expected costs and revenues.Example 3: Christmas TreesAn example of an enterprise where the economic analysis involves a period of time before annual income is received is the case of Christmas tree growing. In this example, an investment of between four and 10 years is necessary before trees can be harvested. Then, if managed properly, the trees can be grown and cut in such a manner that yearly production can become stable. The situation: Roger Jones owns a small farm in northeast Florida. He has become interested in native-grown Christmas trees. He would like to know if it can be profitable to grow trees on an acre of cropland adjacent to his pines. The acre has traditionally given him a return of 8.35% on his investment. He has the option of maintaining his current crop or investing in Christmas trees. The traditional rate therefore is his discount rate.Table 1. Schedule of activities and dollar values for a hypothetical Christmas tree farm. Plantin g (no site preparation needed)$ 200 (Cost) Prunin g (yearly, startin g at end of year 3)$ 200 (Cost) Other yearly operatin g costs (be g innin g $ 300 (Cost) at the end of year 1) Est. harvest value per year for 4 years: (150 trees/acre x $10 per tree)$ 1500 (Revenue)


Estimatin g the Profitability of Your Forestland Enterprise Pa g e 10October 1998 Figure 18 Christmas tree production: schedule of activities. Figure 19 Christmas tree production: dollar values.Step 1. Identification of the project and objectives. Roger is interested in planting an acre in Christmas trees. He is only interested in one full rotation (selling in years 4 through 7). If a financial analysis looks promising, he may decide to bring the trees into continual production on more acres.Step 2. Identification of activities. With the help of an extension specialist and the local growers' association, Roger has identified a list of activities (Table 1 and Figure 10). Step 3. Attach dollar values to the activities. The with average costs and returns for Christmas tree growers' association was also able to provide Rogergrowing in northeast Florida (Table 1, Figure 11).Step 4. Discount the cash flows to the present.The present value is calculated using first the formula for annual payments (Equation 2), and then the formula for present value (Equation 1). This is necessary because the annual revenues begin in year four and must be discounted to the present. First, calculate the present value of expected revenues. Revenues of $1,500 per acre per year are expected in years 4 through 7. As discussed above, the revenues are not every year from the beginning so using Equation 9, we must first calculate the PV of the four years of revenues as of year 4 and then discount this sum back to the present (from Equation 7):


PV4n $1,500[(1 b 0.0835)4t 1] 0.0835(1 b 0.0835)4n $4,929.73 PV0n $4,929.73 (1 b 0.0835)4n $3,576.91 PV3n $200[(1 b 0.0835)5t 1] 0.0835(1 b 0.0835)5n $791.23 PV0n $791.23 (1 b 0.0835)3n $622.03 PV0n $300[(1 b 0.0835)7t 1] 0.0835(1 b 0.0835)3n $1,543.39 AE n $1,211.50[0.0835(1.0835)8] [(1.0835) t 1] n $213.63 peracreperyearEstimatin g the Profitability of Your Forestland Enterprise Pa g e 11October 1998The "PV4" is the present value at year 4 of the investment. The continue with the analysis, using Equation 10, we must bring the PV at year 4 to the present value at year 0, where the analysis is being conducted from. This is done using the simple discounting formula (Equation 1): Costs are calculated in a similar manner, as shown in Equation 11. Cost of pruning for five years: n=5 in this case because pruning starts at the end of year three and continues through the final harvest at the end of year 7. (Equation 12) Other operating costs for the seven years of operation are shown in Equation 13: Total costs = Planting costs + pruning costs + other operating costs =$200.00 + $622.02 + $1543.39 =$2,365.41 Net Present Value= PV (revenues)-PV(Costs) = $3,576.91 $2,165.41 =$1,211.50 per acre To calculate the annual equivalent of this investment we substitute the variables into the AE equation (Equation 14): Investing in this project returns the equivalent of close to $214 per acre per year. This figure can now be compared to more readily available annual production figures like corn or tomatoes, or leasing the land.Issues In Analysis of Your Enterprise Risk and the Financial AnalysisMany factors influence the financial success of investing in an alternative enterprise. The one that most likely has the greatest influence is uncertainty of the future prices. As mentioned earlier, price is determined by supply and demand. A change in one or the other will change the average market price and profitability of the product. Often, when potential investments are investigated, a range of prices is studied to determine a "break-even" price. This is the lowest price your product could bring and still earn the return you require. For example, in the Christmas tree example above, trees are sold for $ 10 each. Assuming Roger sells 150 trees as before, he could sell them for as little as $ 6.05 each and still make his required rate of return. He could also sell as little as 90 trees per year at the $10 rate. This is known as sensitivity analysis and it can be helpful in finding your production and price targets. It is also helpful in setting goals for your alternative enterprise.Including Taxes in the Financial AnalysisThe Tax Payer Relief Act of 1997 shows the importance of updating financial analyses. Landowners performing analyses under the old laws must now reevaluate their situations. To quantify how income taxes will affect the NPV it is necessary to make assumptions about the tax rate for your income. Since income from most of these operations is presently taxed at the ordinary rate, revenues should be reduced in the year they occur before discounting. Although the new laws have made income tax calculations easier, they have complicated the deduction of expenses related to the management of the business. The kinds


Estimatin g the Profitability of Your Forestland Enterprise Pa g e 12October 1998and amounts now depend on the extent to which you participate in the project. Certain tax breaks are still available and should be incorporated in any financial analysis. Reforestation expenses, for example, are eligible for credit and amortization. A professional tax accountant with forestry/agricultural experience should be contacted for assistance when including taxes in financial analyses. Your county extension agent and forester should also have numerous publications on the tax laws and how they relate to the management of forest resources. MarketingMarketing your product is one of the most important steps in ensuring a profitable investment. It is also one of the most difficult. The markets for many alternative enterprises are relatively new in the south. Getting marketing information and prices and making contact with interested buyers can be frustrating and time-consuming. Some products have better defined markets than others. These often have associations with newsletters and price reports. Other markets depend solely on word-of-mouth. Marketing expenses and risks can be included in the sensitivity analysis (see above) rather easily. These depend on the individual and the market. Try projects where markets are good (i.e., sell all or most of the product), and poor (i.e., sell little or none of the product). For advice in marketing and selling the product, contact local professionals and/or county agents and foresters. It is important to remember that the market can change very quickly. Don't be too greedy and hold out in hopes of higher returns, but on the other hand, don't be too stubborn when the market is not good.RecordkeepingThe new tax laws are one reason it is important to keep detailed records of your time, expenses, and returns although there are many other reasons. Businesses that keep accurate records find that decision-making is easier, success can be detected in a more timely manner, loans can be acquired more easily and paid off more quickly, cash flow management is better, and the "right" price can be better set based on costs of doing business (Cotton, undated). Although the alternative enterprise may be taken on as a hobby or part-time investment, if the landowner wishes to determine the financial success of the operation he or she must keep good business records. Contact your local Small Business Development Center for more information on how to keep records.Using the Computer in the Financial AnalysisRecent developments in personal computers have made financial analysis relatively simple and quick. Although there are only a few programs specifically designed for forestry analysis many general programs can be modified for use. These programs can be used to calculate growth and yield, present and future values, return on investment, and other financial information. Recordkeeping and sensitivity analyses can also be accomplished much easier and with greater accuracy on the computer. Also, when cash flow expectations are not expected to be constant the computation of NPV can be difficult to impossible by hand. Financial calculators and computers handle the task easily. As the supply of personal computers increases, more specific programs should become available. It is important to remember that the results of a computer analysis are only as accurate as the data used.AssistanceThere is more assistance available to the landowner wishing to begin a new enterprise. County extension agents, Florida Division of Forestry foresters, the Natural Resource and Conservation Service, and university personnel, among other public agencies, offer advice and assistance. Often they provide an excellent referral service to private forestry and financial consultants, and growers and marketing associations. When looking for assistance, check credentials and talk with as many people as you can. Assistance is like any product: there is good assistance and bad. Make sure to include any assistance costs in your financial analysis. It is also possible to receive financial assistance. Although cost-sharing is limited to certain agricultural and forestry crops (for example, the Environmental Quality Incentives Program, Forest Stewardship Incentives Program, Forestry Incentives Program, and Conservation Reserve Program), low-cost loans may be available from government (U.S. Small Business Administration) and private sources.SummaryOne of the major reasons new businesses fail is inadequate planning. A landowner interested in


Estimatin g the Profitability of Your Forestland Enterprise Pa g e 13October 1998managing a forestry enterprise needs to develop a This publication was not designed to take the place thorough management plan. A major component of theof qualified professional advice and assistance. It is plan is the financial analysis. This analysis includes anhoped that an understanding of the concepts introduced estimate of the magnitude and timing of all costs andhere will help the landowner communicate more returns involved in production. effectively with those who provide assistance. The usefulness of financial analysis becomes apparent when many costs and revenues are spread out over the production length of the enterprise. Without a structured method of analyzing the situation, the average landowner will have a difficult time determining if a $100 investment today is worth $1,000 in 20 years.This publication was designed as an introduction to the financial concepts involved in planning and decision-making. Although the structure for evaluating your forestry enterprise will remain the same, each landowner must perform his or her own custom analysis. Literature CitedCotton, John. Keeping Records in Small Businesses. U.S. Small Business Admin., Management Assistance and Support Services, Management Aids No.1.017. Duryea, M.L. (Editor). 1988. Alternative Enterprises for Your Forest Land: Forest Grazing, Christmas Trees, Hunting Lease, Pine Straw, Fee Fishing, and Firewood. Fla. Coop. Exten. Serv., IFAS, Univ. Fla., Gainesville. Circular 810. 32pp.