introduction / overview financial health problem statement discount rate after tax cash flows...

Introduction / Overview Financial Health Problem Statement Discount Rate After Tax Cash Flows Recommendations & Summary

Patrick Vincent Kelly Grandt Larry Jacques

The Farm: A large cattle producer in the state of MichiganA large cattle producer in the state of Michigan Raise Cattle, Hogs, Corn, Soybeans, and Winter Wheat.Raise Cattle, Hogs, Corn, Soybeans, and Winter Wheat. Average 1,200 headAverage 1,200 head

The Investment: Building a large solid floor confinement facility with capacity for 1,000 yearlingsBuilding a large solid floor confinement facility with capacity for 1,000 yearlings Purchasing 1,000 yearlingsPurchasing 1,000 yearlings

The objective of this project is to project discounted cash flows for a cattle feedlot expansion utilizing an appropriate discount rate for 30 years.

Profitability AnalysisProfitability Analysis Liquidity AnalysisLiquidity Analysis Solvency AnalysisSolvency Analysis

NFINFI ROEROE OMOM ATOATO Cattle ProfitabilityCattle Profitability DuPontDuPont

Net farm income has grown steadily overNet farm income has grown steadily over Two setbacks between 2001- 2002 and 2007-2008Two setbacks between 2001- 2002 and 2007-2008

13.32% Average ROE13.32% Average ROE Peak of 26.7% in 2004Peak of 26.7% in 2004 Trough of -2.1% in 2002.Trough of -2.1% in 2002. 13.32% is similar to the average and median of the Standard and Poors index13.32% is similar to the average and median of the Standard and Poors index from 1956-1995 from 1956-1995

4.5% ROE in 2008 vs. industry rate of 2.5%4.5% ROE in 2008 vs. industry rate of 2.5% 3.6% in 2009 vs. industry rate of 1.6%3.6% in 2009 vs. industry rate of 1.6% Outperformed industry by 80% in 2008; 125% in 2009Outperformed industry by 80% in 2008; 125% in 2009

Fluctuating OMFluctuating OM Averaging 23.94%Averaging 23.94% Trough of 7.8% in 2002Trough of 7.8% in 2002 Peak of 41.10% in 2007Peak of 41.10% in 2007 13.1 % OM in 2008 vs. industry rate of 10.0%13.1 % OM in 2008 vs. industry rate of 10.0% 13.5% OM in 2009 vs. industry rate of 11.3%13.5% OM in 2009 vs. industry rate of 11.3%

Firm outperformed industry average OM by 31% in 2008; 19% in 2009Firm outperformed industry average OM by 31% in 2008; 19% in 2009 No data for industry averages in the period 1999-2007No data for industry averages in the period 1999-2007

ATO steadily declining since 1999 with an average of 43.51%.ATO steadily declining since 1999 with an average of 43.51%. This may suggest the farm enterprises efficiency using its assets has deteriorated somewhat.This may suggest the farm enterprises efficiency using its assets has deteriorated somewhat. Lets compare to the industrys averageLets compare to the industrys average

32.7 % ATO in 2008 vs. market rate of 27.4 %32.7 % ATO in 2008 vs. market rate of 27.4 % Outpaced Industry by 19.3%Outpaced Industry by 19.3% 33.8 % ATO in 2009 vs. market rate of 27.6 %33.8 % ATO in 2009 vs. market rate of 27.6 % Outpaced Industry by 22.5%Outpaced Industry by 22.5% Staggering outperformance of peersStaggering outperformance of peers Declining ATO may be industry problemDeclining ATO may be industry problem

2009 Net loss of $143 per head in yearling feeding operation 2009 Net loss of $143 per head in yearling feeding operation 2008 $128 per head 2008 $128 per head Returns across industry sharply declined in 2009 Returns across industry sharply declined in 2009

Current RatioCurrent Ratio Term-Debt RatioTerm-Debt Ratio focuses on solvency and liquidityfocuses on solvency and liquidity

Averaged 8.3 during periodAveraged 8.3 during period Trough of 4.24 in 1999Trough of 4.24 in 1999 Peak of 20.95 in 2003Peak of 20.95 in 2003 Suggests low liquidity riskSuggests low liquidity risk Cash and Cash Equiv. Ratio increased in 2007Cash and Cash Equiv. Ratio increased in 2007 No industry standard availableNo industry standard available

Term-Debt Coverage RatioTerm-Debt Coverage Ratio High of 26High of 26 Low of 1.67Low of 1.67 2.01 in 20092.01 in 2009

Net farm income from operations + Total non-farm income + Depreciation + Interest on term debt + Interest on capital leases - Total income tax expense -Withdrawals for family living Total is divided by the sum of annual scheduled principal and interest payments on term debt and capital leases.

Debt/Equity ratio has remainedDebt/Equity ratio has remainedacceptable Fluctuating between.26 and.74Fluctuating between.26 and.74 Currently at.45Currently at.45 Lacking Industry Averages Lacking Industry Averages

Nature of CapitalNature of Capital Budgeting Problem S.W.O.T AnalysisS.W.O.T Analysis Risk AssessmentRisk Assessment

To expand or not to expand? To expand or not to expand? Utilizing cumulative cash flows to aid decision making Utilizing cumulative cash flows to aid decision making

Minimum Liquidity Risk if NFI returns to normalMinimum Liquidity Risk if NFI returns to normal Unlevered High Current Ratio Asset Turnover Rate is slightly higher than marketAsset Turnover Rate is slightly higher than market Operating Profit Margin is slightly higher than marketOperating Profit Margin is slightly higher than market 2009 ROA & ROE is higher than2009 ROA & ROE is higher than market market

Firm currently has a Low Return on Equity but we consider this temporaryFirm currently has a Low Return on Equity but we consider this temporary EPA regulationsEPA regulations Relatively high feed costsRelatively high feed costs Low term debt coverage ratioLow term debt coverage ratio This ratio went below 1.8

Rightward shift in demand curve for beefRightward shift in demand curve for beef Emerging market consumers; end of recession Growth of ethanol production is helping corn belt cattle feedersGrowth of ethanol production is helping corn belt cattle feeders Ethanol byproducts (DDGS) can be a cheaper alternative can be a cheaper alternative to corn to corn

Market currently has extremely low ROE in 2008 and 2009Market currently has extremely low ROE in 2008 and 2009 JBS Processing Plant might go out of businessJBS Processing Plant might go out of business Production RiskProduction Risk Input Cost RiskInput Cost Risk Volatile cattle pricesVolatile cattle prices Potential regulationPotential regulation

Internal Risk External Risk

Financial Risk Decrease in liquidity Increase in leverage Volatile cash flow/ROE generation could hinder ability to repay large loan Michigan feedlots require cover Securing financing from a company like Greenstone Rising costs related to fuel, labor, and supplies Disaster Risk Death or Illness of farmer(s)

Macroeconomic changes Decrease in demand for beef Production Risk Natural disaster Shortage of cattle inventory Volatile cattle prices Feed prices increasing JBS processing plant shutting down EPA legal action

WACCWACC Dividend Capitalization ModelDividend Capitalization Model Capital Asset Pricing ModelCapital Asset Pricing Model The Discount rateThe Discount rate

Where: Re = cost of equity Rd = cost of debt E = market value of the firm's equity D = market value of the firm's debt V = Companys enterprise value (debt + equity); E/V = percentage of financing that is equity D/V = percentage of financing that is debt T = farm business tax rate

Dividends per Share Cost of (for next year) Growth Rate Equity of Dividends Current Market Value of Stock = +

RPj = (Rmarket-Rf)Bj RPj is the cost of equity RPj is the cost of equity Bj is the securitys beta and Bj is the securitys beta and Rmarket is the markets expected return Rmarket is the markets expected return Rf is the risk free rate (usually the 10- year or 30-year U.S. Government bond) Rf is the risk free rate (usually the 10- year or 30-year U.S. Government bond)

Chose a 12.5% discount rate Chose a 12.5% discount rate An industry professional recommended a rate between 12% An industry professional recommended a rate between 12% and 13%

After Tax Cash FlowsAfter Tax Cash Flows IRR of the DefenderIRR of the Defender IRR of the ChallengerIRR of the Challenger Initial InvestmentInitial Investment Gross Margin per HeadGross Margin per Head Annual Gross MarginAnnual Gross Margin Net Cattle SalesNet Cattle Sales DepreciationDepreciation Manure CreditManure Credit Operating InterestOperating Interest Operating ExpenseOperating Expense Feed Cost per HeadFeed Cost per Head Total Cost per SpaceTotal Cost per Space Cost per lb. of FeedCost per lb. of Feed Feed Cost per lb. of GainFeed Cost per lb. of Gain Cash ExpensesCash Expenses

Upper Right Lower Right Lower Left Upper Left

IRR : 12.5% Assumption: to continue having similar returns

The IRR is 8.6235%.The IRR is 8.6235%. A discount rate this lowA discount rate this low VolatilityVolatility RiskRisk UncertaintyUncertainty

Initial investment cost of $675,000Initial investment cost of $675,000 Computed by averaging 750 and 1,250 head facilitiesComputed by averaging 750 and 1,250 head facilities Industry professional confirmed number a reasonable figureIndustry professional confirmed number a reasonable figure

Gross margin/Head Total (Weighted Average Beef Sale Price)(Weighted Average Beef Purchase Price) Weighted Average Beef Purchase Price (Purchase Weight/Head) * (Purchase Price/Head)*(dead loss) Weighted Average Beef Sale Price (Sale Weight/Head) * (Sale Price)

Gross margin/Head Total ($1430)($828.24) = $601.76/Head Weighted Average Beef Purchase Price (700) * ($1.16)*($1.02) = $828.24/Head Weighted Average Beef Sale Price (1300) * ($1.10) = $1430/Head

(Gross Margin per Head) * (Annual Turnover) * (Occupancy Rate) Gross Margin per Head is $601.76 Annual Turnover of 1.95 Occupancy Rate is 85% Annual Gross Margin per Head $995.71

(Annual Gross Margin) * (Feedlot Capacity) Annual Gross Margin is $995.71 Feedlot Capacity of 1,000 head Total Annual Net Cattle Sales $995,712.21

Depreciated facility with GDS Method for 20 yearsDepreciated facility with GDS Method for 20 years U.S. FarmU.S. Farm Property Recovery Periods table* ($675,000) / (20 yrs) = $33,750/yr *2010 Farmers Tax Guide pg. 43

Estimation based on per/head basis Estimation based on per/head basis Fluctuates from year - year Fluctuates from year - year $13.00 per head/yr

(Sum of Interest Expense per Turn) * (Annual Turnover)

Total Interest Expense per Turn $45.56 Feeder $34.51 Non Feeding Operating $1.83 Feed $9.22

$45.56 * 1.95 Operating Interest per Space $88.69

(Capacity) * (Operating Interest per Space) Capacity is 1,000 Operating Interest per Space is $88.69 Approx. Interest on Operating Expense $88,690.33

(Weight Gain in lbs / Head) * (Feed Use / lb of Gain) * (Cost / lb of Feed) Weight Gain in lbs / Head is 600 Feed Use / lb of Gain is 7.25 Cost / lb of Feed is $0.1017 Feed Cost per Head $442.40

(Feed Cost/head) * (Annual Turnover) Feed Cost per Head is $442.40 Annual Turnover is 1.95 Total Cost per Space $861.21

Protein Vit Minerals $0.2025 $0.2025 / lb DM DDGS $0.0945 $0.0945 / lb DM High Moisture Corn $0.105 $0.105 / lb DM Corn Silage $0.075 / lb DM

Cost per lb. of Feed $0.1017

(Feed Use/ lb of Gain) * (Cost per lb of Feed) Feed Use/ lb of Gain is 7.25 Cost per lb of Feed is $0.1017 Feed Cost per lb / Gain $0.737

(Total Cost Per Space excluding interest) * (Capacity) Total Cost Per Space excluding interest is $861.21 Capacity is 1,000 Total Cash Expense $861,214.81

The farm enterprise should reject the proposed expansion because the cumulative discounted net cash flow projections register a negative NPV at the end of the projects useful life. There are a few caveats we have which could change our decision.

Changes that will affect NPV A lessening of beef price volatilityA lessening of beef price volatility Increase in the price of outputsIncrease in the price of outputs A removal of risk concerning the JBS Processing Plant which is in danger of shutting downA removal of risk concerning the JBS Processing Plant which is in danger of shutting down Decrease in the price of inputsDecrease in the price of inputs

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