Introduction / Overview Financial Health Problem Statement
Discount Rate After Tax Cash Flows Recommendations &
Summary
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Patrick Vincent Kelly Grandt Larry Jacques
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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
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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
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The objective of this project is to project discounted cash
flows for a cattle feedlot expansion utilizing an appropriate
discount rate for 30 years.
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
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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
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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
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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%
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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
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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
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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
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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
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Current RatioCurrent Ratio Term-Debt RatioTerm-Debt Ratio
focuses on solvency and liquidityfocuses on solvency and
liquidity
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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
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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
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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.
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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
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Nature of CapitalNature of Capital Budgeting Problem S.W.O.T
AnalysisS.W.O.T Analysis Risk AssessmentRisk Assessment
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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
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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
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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
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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
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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
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Internal Risk External Risk
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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)
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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
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WACCWACC Dividend Capitalization ModelDividend Capitalization
Model Capital Asset Pricing ModelCapital Asset Pricing Model The
Discount rateThe Discount rate
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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
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Dividends per Share Cost of (for next year) Growth Rate Equity
of Dividends Current Market Value of Stock = +
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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)
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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%
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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
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Upper Right Lower Right Lower Left Upper Left
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IRR : 12.5% Assumption: to continue having similar returns
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The IRR is 8.6235%.The IRR is 8.6235%. A discount rate this
lowA discount rate this low VolatilityVolatility RiskRisk
UncertaintyUncertainty
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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
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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)
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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
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(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
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(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
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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
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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
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(Sum of Interest Expense per Turn) * (Annual Turnover)
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Total Interest Expense per Turn $45.56 Feeder $34.51 Non
Feeding Operating $1.83 Feed $9.22
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$45.56 * 1.95 Operating Interest per Space $88.69
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(Capacity) * (Operating Interest per Space) Capacity is 1,000
Operating Interest per Space is $88.69 Approx. Interest on
Operating Expense $88,690.33
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(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
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(Feed Cost/head) * (Annual Turnover) Feed Cost per Head is
$442.40 Annual Turnover is 1.95 Total Cost per Space $861.21
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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
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Cost per lb. of Feed $0.1017
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(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
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(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
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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.
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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