Economic Tools to Evaluate Farm Alternatives

The Goal: An Economical Conservation Plan

Human Element in Natural Resources

• Soil • Water • Air • Plant • Animal • Human• Energy

Rubik’s Cube

• Solving natural resource problems is much like solving a “Rubik’s Cube”…

Why Farm or Ranch?

• Lifestyle• Income Business• Real Estate

Market

Farming Philosophy

Scoping

Stores

Money forHome

FamilyLabor

Church

In-Laws

Neighbors

Money for Retirement

Livestock Management

Farm Loan

Animal Habitat

Seed Costs

Fertilizer Costs

Taxes

Predator Management

Equipment

Death Loss

Commodity ProgramPayments

4H CLUB

Kids

Money for College

Hired Labor

Clubs (HomemakersFarm Bureau)

Pesticide CostsGrandfather

'sLog Cabin

FFA CLUB

Plant Management

Soil Erosion

NutrientManagement

Pasture management

Water Quantity

Water Quality

Soil Condition

Recreation

Fishing - Hunting

Banker

Electric Power Line

Neighbors

Seed Costs

The Social Environment

Equipment

The Business Environment

SPOUSE

SCHOOL

Kids

The Resource Environment

Taxes

Markets

Conservation Compliance

Landlord

The Planning Environment

$ $

$

FloodingSoil Erosion

Crop Yields

LivestockAir Quality

Cultural Resources

Irrigation

Wildlife

RecreationWater Quality

Farm Income

Pests

Fish HabitatGovernment

Water Quality

Farm Income Fish Habitat

SCOPING: Identify all problems & opportunities and focus on those to be considered in the planning process.

Income

Scoping• Identify significant issues to address• Provide a record of issues considered, but

found not to be significant• Provide a record of NEPA compliance• Reduces the number of alternatives

Production Possibility Curve

Economic Effects

• Land• Capital• Labor• Management • Profitability• Risk• Social Well-Being

What Changes?

Land Use

- Is the present land use suitable for the proposed alternative?

- Will land use change after practice installation?

- How will a change affect the operation?

- Will the action affect resources on which people depend for subsistence, employment or recreation?

- Will land be taken in or out of production?

Capital• Does the Producer have the funds or ability to obtain the

funds needed to implement the proposed alternative?

- What are the impacts of the cost of the initial investment for this alternative?

- What are the impacts of an additional annual cost for Operation and Maintenance (O&M)?

• What possible impact does implementing this alternative have on the client’s future eligibility for farm programs?

Labor

- The “Ability to Work” or Hire “Workers”

- Measured in Units of Time (Hours, Years)

- Includes the Landowner, Family, Hired Help or Other Trained Workers

Management Level- Does the client understand the inputs needed to manage

the practice (s) and the client’s responsibility in obtaining these inputs?

- Does the client understand their responsibility to maintain practice (s) as planned and implemented?

- Is it necessary for the client to hire a technical consultant to operate and/or maintain the practice (s)?

- Does the client have the knowledge to install and maintain the conservation plan?

Profitability

- The Benefits and Costs of the Operation

- Often Measured in Dollars

- Profitable if Benefits Exceed Costs

Risk- Will the proposed alternative aid/risk client participation in USDA

programs? How about regulatory action?

- What are the possible impacts due to a change in yield?

- Is there flexibility in modifying the conservation plan at a future date?

- What issues are involved with the timing of installation and maintenance?

- What are the cash flow requirements of this alternative?

- What, if any, are the hazards involved?

- Rather, will the conservation plan contribute to the minimization of cash flow disruptions or debt?

Social Well-Being

- Represents the current social, cultural and economic situation of both the client and local community

- A combination of the previous categories of Client and Community Well Being

Developing Alternatives

Cause and Effect

Why? __________ Cause Why? __________ Why? __________ Why? __________ Why? __________Resource Problem _____________ So What? _________ So What? __________ So What? __________ So What __________ So What? __________ Effect

Neighbors upset Less fish in lake, no swimming

State Fish & Game stocked fish in lake Violate local water quality ordinance

County fines/regulation, less tourist dollars

Loss of income

Cause and Effect

Farm Labor ShortageToo busy managing cows, feeding/milking

Don’t have time to redesign and move manure

Easy access, no gates, always been there Dairy manure stack near the streamNutrients & organics in surface water

Algae Bloom in Lake

Most resource problems are caused by Humans

Future With and

Future Without

Desired Future Condition

“Hea

lth

”

“Benchmark” Condition

“Historical” Condition

Alternative 2 Alternative 3

Future Without Alternative 1

Benchmark Condition The present condition or situation that is used as a point of reference to measure change in resource conditions resulting from conservation treatment.

Planning Concepts

Desired Future ConditionThe ecological, economic, or social condition one is attempting to achieve.

Historical ConditionCondition with little or no influence by humans.

Evaluating Multiple Alternatives

Time

Desired Future Condition

Future Without Alternative

Alternative 1

Alternative 3

Alternative 2

Future Without: Alternative – No Action, Projection of BenchmarkFuture With: Alternative 1 – Management/Vegetative Solution Alternative 2 – Structural Solution Alternative 3– Combination Structural/Vegetative

Benchmark or present condition

Con

dit

ion

ConservationEffects for

Decision Making

Conservation Effects for Decision Making

Conservation Effects for Decision Making

Benchmark

Condition

(Present Condition)

Conservation

Treatment

(Future Condition)

Impacts(Things that Change)

Decision

Maker’s

Values

“T” Chart

T

CONSERVATION TREATMENT EFFECTS INFORMATION

NAME – LOCATION – DATE CONSERVATION MANAGEMENT UNIT

CONSERVATION TREATMENT: RESOURCE PROBLEMS:

“+” POSITIVE EFFECTS (Benefits) “-” NEGATIVE EFFECTS (Costs)

+++++

-----

Benefit-CostAnalysis

Benefit-Cost Analysis

1. Estimate Costs

2. Estimate Benefits

3. Convert to “Like Terms”

4. Compare Costs and Benefits

Estimate Costs, Sprinkler System

Additional Costs• Side Roll Sprinkler

Equipment - $600/Acre

• Operation & Maintenance

$100/Acre/Year

Reduced Revenue• Lost Corners in Field

.10 Ton Hay/Acre

1.

Estimate Benefits, Sprinkler System

Reduced Costs• Lower Labor Costs

3 Hours/Acre/Year

• Financial Assistance

$300/Acre, Cost-Share

Additional Revenue• Alfalfa Hay Yield

2 Tons/Acre/Year

• Water Quantity

2 AcFt/Acre/Year

Sprinkler System

Additional Costs Equipment, Layout - $600/Acre, 10 Years, 9% $93/Acre/Year Operation & Maintenance - $100/Acre/Year

Additional RevenueAlfalfa Hay Yield - 2 Ton/Acre, $70/Ton $140/Acre/YearWater Quantity - 2 AcFt/Acre/Year

Reduced RevenueLost Corners in Field - .10 Ton/Acre, $70/Ton $7/Acre/Year

Reduced CostsLabor Costs - 3 Hours, $10/Hour $30/Acre/YearCost-Share Payment - $300, 10 Year, 9% $47/Acre/Year

Costs

Benefits $200/Acre/Year

$217/Acre/YearNet Benefit: $17/Acre/Year

PartialBudgeting

Partial Budgeting

• Systematically displays the Benefits and Costs

• Only “things that change” are considered

• Simplifies data collection• Use a “T” chart to display the

“effects”

“T” CHART

• Level I Qualitative Statements

• Level II Units of Measurements, Dollars

• Level III Economic and Financial Analysis

Pasture Improvement

Brush Control $50/Acre

Reseed Pasture $65/Acre

Discount Rate 7%

Time Period 10 Years

Weed Control $15/Acre/Year

Forage Increase 3 AUMs/Acre/Year

Forage Value $12/AUM

Forage Quality Improvement

Migratory Spring Goose Habitat/Grazing

Reduced Erosion (2 Tons)

Water Quality Improvement

“T” Chart Example“T” Chart ExamplePROBLEMS

Plant Productivity, Erosion, Profitability

SOLUTIONPasture Seeding, Brush

& Weed Control

CONSERVATION TREATMENT EFFECTSINFORMATION

NAME – H. Gordon, Rocking Raindrop LOCATION – Aloha, Oregon DATE – 7/12/2004

CONSERVATION MANAGEMENT UNIT – Pasture, Willamette Valley, Oregon

CONSERVATION TREATMENT:Pasture Seeding, Brush & Weed Control

RESOURCE PROBLEMS:Plant Productivity, Erosion, Profitability

“+” POSITIVE EFFECTS (Benefits) “-” NEGATIVE EFFECTS (Costs)

Forage Quality ImprovementReduced ErosionWater Quality ImprovementGoose Habitat Improves Bird Watching

Forage Increase

Goose Habitat Increases Trespassing

Brush Control Reseed Pasture

Weed Control

Level I

CONSERVATION TREATMENT EFFECTSINFORMATION

NAME – H. Gordon, Rocking Raindrop LOCATION – Aloha, Oregon DATE – 7/12/2004

CONSERVATION MANAGEMENT UNIT – Pasture, Willamette Valley, Oregon

CONSERVATION TREATMENT:Pasture Seeding, Brush & Weed Control

RESOURCE PROBLEMS:Plant Productivity, Erosion, Profitability

“+” POSITIVE EFFECTS (Benefits) “-” NEGATIVE EFFECTS (Costs)

Forage Quality ImprovementReduced Erosion, 2 Tons/Acre Water Quality ImprovementGoose Habitat Improves Bird Watching

Forage Increase 3 AUMs Year

Goose Habitat Increases Trespassing

Brush Control $50/AcreReseed Pasture $65/Acre $115/Acre

Weed Control $15.00/Acre/Year

Level II

CONSERVATION TREATMENT EFFECTSINFORMATION

NAME – H. Gordon, Rocking Raindrop LOCATION – Aloha, Oregon DATE – 7/12/2004CONSERVATION MANAGEMENT UNIT – Pasture, Willamette Valley, Oregon

CONSERVATION TREATMENT:Pasture Seeding, Brush & Weed Control

RESOURCE PROBLEMS:Plant Productivity, Erosion, Profitability

“+” POSITIVE EFFECTS (Benefits) “-” NEGATIVE EFFECTS (Costs)

Forage Quality ImprovementReduced Erosion, 2 Tons/Acre Water Quality ImprovementGoose Habitat Improves Bird Watching

Forage Increase 3 AUMs Year X $12/AUM = $36/Ac/Year Total Benefits = $36/Ac/Year

Goose Habitat Increases Trespassing

Brush Control $50/AcreReseed Pasture $65/Acre $115/Acre 7% Interest, 10 Years = .142 X $115 = $16.33Annual Installation Cost = $16.33/Acre/YearWeed Control $15.00/Acre/Year Total Costs = $31.33/Acre/Year

Level III

Marginality“The rate of change in one variable

when a small change is made in another variable”

FertilizerRate AUMs per

Lbs/Ac Acre0 3.00

10 3.2020 3.7530 4.5040 5.2050 5.6260 5.7570 5.8080 5.1090 4.00

Total TotalFertilizer Forage Profit

Cost Benefit $/Ac$0 $0.00 $0.00$5 $2.40 ($2.60)

$10 $9.00 ($1.00)$15 $18.00 $3.00$20 $26.40 $6.40$25 $31.44 $6.44$30 $33.00 $3.00$35 $33.60 ($1.40)$40 $25.20 ($14.80)$45 $12.00 ($33.00)

Max Yield = 70 Lbs Fertilizer Max Profit = 50 Lbs Fertilizer

Marginal MarginalCost Benefit

- -$5.00 $2.40$5.00 $6.60$5.00 $9.00$5.00 $8.40$5.00 $5.04$5.00 $1.56$5.00 $0.60$5.00 ($8.40)$5.00 ($13.20)

Economics of Pasture Fertilization

Fertilized Pasture Yields

Max Yield= 70 LbsMax Profit = 50 Lbs

0.00

1.00

2.00

3.00

4.00

5.00

6.00

7.00

0 10 20 30 40 50 60 70 80 90

Fertilizer Rate

AU

Ms

Fo

rag

e

($35.00)

($30.00)

($25.00)

($20.00)

($15.00)

($10.00)

($5.00)

$0.00

$5.00

$10.00

Do

llars

AUMs

Profit

Economics of Pasture Fertilization

More Tomorrow?

InvestmentAnalysis

(Time Value of Money)

Time Value of Money

• Total installation cost• Annual benefits• The loan payments• Years to “break-even”• Change in yield• Rate of return on

investment• Etc…

Farmers and ranchers want to know:

Time Value of Money• “Value” depends on when you receive something• “A bird in the hand is worth two in the bush”• We prefer $100 today over $100 next year

– Invest and receive “interest”– May not get $100 next year

Time Value of MoneyThe same is true for natural resourcesWe prefer 10 ducks today, rather than 10 next

year:- We may not be around next year- Ducks may be gone because of drought, flood or someone else shot them- Ducks could reproduce and we would have more than 10 ducks next year

Time Value of Money

• Time Period (Years)

• Discount Rate (%)

• Present Value ($)

• Future Value ($)

• Payment ($)

Time Value of Money

• Money has a time value attached to it

• $1 today = $1 + interest tomorrow• Comparison of $ today vs. $ future• Useful to compare $ in different

time periods • Use amortization and discounting

$

Years

Years

$

Years

$

Present Value• One-time value• Today• Installation Cost

Annuity• Average annual

values• Annual costs• Annual benefits• O&M costs

Future Value• One-time value• In the Future• Replacement cost

Amortization

• The payment to pay off a loan• Spread the cost of an

investment over it’s life• “Periodic” can be in years,

quarters, months

Amortization Example

No-Till DrillTime Period 15 Years

Discount Rate 8 Percent

Present Value $20,000

Payment ?

AVERAGE ANNUAL COST TABLE

PER $ OF INSTALLATION COST

LIFE % INTEREST RATE

YEARS 6 7 8 9 10 11 12 13

2 0.545 0.553 0.561 0.568 0.576 0.584 0.592 0.599

3 0.374 0.381 0.388 0.395 0.402 0.409 0.416 0.424

4 0.289 0.295 0.302 0.309 0.315 0.322 0.329 0.336

5 0.237 0.244 0.250 0.257 0.264 0.271 0.277 0.284

6 0.203 0.210 0.216 0.223 0.230 0.236 0.243 0.250

7 0.179 0.186 0.192 0.199 0.205 0.212 0.219 0.226

8 0.161 0.167 0.174 0.181 0.187 0.194 0.201 0.208

9 0.147 0.153 0.160 0.167 0.174 0.181 0.188 0.195

10 0.136 0.142 0.149 0.156 0.163 0.170 0.177 0.184

11 0.127 0.133 0.140 0.147 0.154 0.161 0.168 0.176

12 0.119 0.126 0.133 0.140 0.147 0.154 0.161 0.169

13 0.113 0.120 0.127 0.134 0.141 0.148 0.156 0.163

14 0.108 0.114 0.121 0.128 0.136 0.143 0.151 0.159

15 0.103 0.110 0.117 0.124 0.131 0.139 0.147 0.155

16 0.099 0.106 0.113 0.120 0.128 0.136 0.143 0.151

17 0.095 0.102 0.110 0.117 0.125 0.132 0.140 0.149

18 0.092 0.099 0.107 0.114 0.122 0.130 0.138 0.146

Amortization ExampleNo-Till DrillTime Period 15 Years

Discount Rate 8 Percent

Present Value $20,000

Payment $2,340/Year

(.117 X $20,000)

Present X Amortization = PaymentValue Factor (i, Yrs.)

$750 $750 $750 $750 $750 $750 $750 $750 $750 $750

-$5,000

-$6,000

-$5,000

-$4,000

-$3,000

-$2,000

-$1,000

$0

$1,000

$2,000

Years

Dol

lars

One-Time Cost and Annual BenefitsHow do you compare costs and benefits over different time periods?

$5,000 farm improvement creates $750/Year income benefit

-$5,000

-$648 -$648 -$648 -$648 -$648 -$648 -$648 -$648 -$648 -$648

-$6,000

-$5,000

-$4,000

-$3,000

-$2,000

-$1,000

$0

Years

Dol

lars

Amortize the One-Time Cost$5,000 One Time Cost = $648 Annual Cost (10-Year, 5% Interest)

$750 $750 $750 $750 $750 $750 $750 $750 $750 $750

-$648 -$648 -$648 -$648 -$648 -$648 -$648 -$648 -$648 -$648

-$5,000

-$6,000

-$5,000

-$4,000

-$3,000

-$2,000

-$1,000

$0

$1,000

$2,000

Years

Do

llars

Compare Annual Benefits to Annual Costs

The Annual Benefits are Greater than the Annual Costs

$750 Benefit - $648 Cost = +$102/Year

Discounting

Converts future values to a one-time present value

Present value is the value today, here and now

Net Present Value Analysis

$5,791

$750 $750 $750 $750 $750 $750 $750 $750 $750 $750

-$5,000-$6,000

-$4,000

-$2,000

$0

$2,000

$4,000

$6,000

$8,000

Years

Do

llars

Compared One Time Cost to One Time Benefit

Discount $750 Annual Benefit to $5,791 Present Value (10-Year, 5% Interest)

$5,791 Benefit > $5,000 Cost

-$6,959

-$2,500

$5,791

$750 $750 $750 $750 $750 $750 $750 $750 $750 $750

-$8,000

-$6,000

-$4,000

-$2,000

$0

$2,000

$4,000

$6,000

$8,000

Years

Do

llars

Compare “One Time” and “Future One-Time” Costs to One Time Benefit

Discount $2,500 Cost to $1,959 Present Value (5-Year, 5% Interest)$5,000 + $1,959 = $6,959

Benefit Cost Ratios

Measures the benefit of some activity per dollar cost

• Identify benefits and costs• Convert to like terms• Divide the benefits by the costs• If the B/C is greater than 1.00, the project is

economically worth doing

Benefit Cost RatiosFor example:• The forage benefits are $13/Acre/Year • Spend $10/Acre/Year on a pasture

improvement• The B/C ratio is $13 / $10 = 1.3

What if the benefits are not in "dollar" units ?• Improvement costs $100/year• Receive 120 additional ducks/year• B/C ratio is 120 Ducks / $100 = 1.20 ducks / $1

CostEffectiveness

Cost Effectiveness

“Least cost” installing 1,000 feet of terrace?

• Tillage equipment $3.00/Foot• Dozer $2.50/Foot• Road grader $2.00/Foot

The road grader is the most cost effective

Break Even Analysis

Break-Even Analysis

• Solve for:• “How much can I afford”• “How long to get my money back”• “Return on the investment”• “What net gain to pay expenses”

Break-Even Example – Forage Value

Value of Forage, Pasture SeedingTotal Treatment Cost: $60.00/AcreAnnual Treatment Cost: $6.11/Ac/Yr($60/Ac, 20 Years, 8% Interest)

Cost Divide by Forage Increase = Breakeven Value $6.11 1.00 AUM/Ac $6.11 AUM/Ac$6.11 .75 AUM/Ac $8.15 AUM/Ac $6.11 .50 AUM/Ac $12.20 AUM/Ac

Break-Even Example – Forage Cost

Breakeven Cost to Improve Pasture

Value Multiply Forage Increase = Breakeven Cost $12/AUM 1.00 AUM/Ac $12.00 /Ac $12/AUM .75 AUM/Ac $9.00 /Ac $12/AUM .50 AUM/Ac $6.00 /Ac

Financial Analysis versus

Economic Analysis

Financial Analysis vs. Economic Analysis

Economic analysis:• Is it Profitable?• Compare benefits & costs over the project's life

Financial analysis:• Is it Affordable?• Compare benefits & costs over the loan period

-$5,000

-$648 -$648 -$648 -$648 -$648 -$648 -$648 -$648 -$648 -$648

$5,791

$750 $750 $750 $750 $750 $750 $750 $750 $750 $750

-$6,000

-$4,000

-$2,000

$0

$2,000

$4,000

$6,000

$8,000

Years

Do

lla

rs

-$5,000

-$1,155 -$1,155 -$1,155 -$1,155 -$1,155

$5,791

$750 $750 $750 $750 $750 $750 $750 $750 $750 $750

-$6,000

-$4,000

-$2,000

$0

$2,000

$4,000

$6,000

$8,000

Years

Do

lla

rs

Economic Analysis: PV $5,000 = $648 Annual Cost (10-Year, 5%)

Financial Analysis: PV $5,000 = $1,155 Annual Cost (5-Year, 5%)

TaxConsiderations

Do Not Give Tax Advice!

Refer your client to a tax preparer or Internal Revenue Service (IRS)

Tax Considerations

Economic Data• Only use economic data that is useful to farmers

or ranchers• It is more important to know “where” to get

economic data, than to “have” economic data• Economic data is only good “today”

LandownerField Office Technical GuidePayment SchedulesNRCS State EconomistCrop/Livestock BudgetsUniversity/Extension ServiceOther Agencies, Conservation Partners, Etc

Class Exercise

The EndThe End

Class Exercise

Class Exercise: “T” ChartWheat Residue Management

Columbia Plateau, Oregon

No-Till Drill/2,000 Acres $15,000

Discount Rate 7%

Time Period 10 Years

Increased Herbicide Use $25/Acre

Crop Yield Increase 8 Bushels/Acre

Crop Value $4/Bushel

Crop Quality Improvement

Pheasant/Quail Habitat Improvement

Reduced Erosion (2 Tons)

Water Quality Improvement

CONSERVATION TREATMENT EFFECTSINFORMATION

NAME – H. Gordon LOCATION – Aloha, Oregon DATE – July 4, 2004SETTING – Wheat, Columbia Plateau, Oregon

CONSERVATION TREATMENT:Residue Management, Direct Seeding

RESOURCE PROBLEMS: Productivity, Erosion, Water Quality

POSITIVE EFFECTS (Benefits) NEGATIVE EFFECTS (Costs)

Crop Yield Increase 8 Bushels/Year X $4/Bu = $32/Year

Crop Quality Improvement

Pheasant/Quail Habitat Improvement

Reduced Erosion = 2 Tons

Water Quality Improvement

Total Benefits = $32/Acre/Year

No-Till Drill $15,000/2,000 Acres = $7.50/Acre Annual Cost (7%, 10 Years) $7.50 X .142 = $1.07/Acre/Year

Increased Herbicide Cost = $25.00/Acre/Year

Increased Risk of New System

Total Costs = $26.07/Acre/Year

Class Exercise: “T” Chart