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Pro Forma Analysis
Topic Coverage
1. Definition of Pro forma analysis.
2. Alternative approaches to
projecting net benefits from
production and investment
opportunities.
3. Input to capital budgeting and
valuation decisions.
PRESENT
PAST
FUTURE
 Historical analysis
Comparative analysis
Historical price and
yield trends
 Pro forma analysis
Forming expectations
about future prices, costs
and productivity
Ad hoc extrapolations
Projections based upon
available outlook data
Projections based upon
econometric analysis
Point Forecast Assumptions
Farm
program
policies
Weather
and
disease
One
scenario
examined
Macroeconomic
policies
Foreign
trade
policies
Global
market
events
Baseline
Scenario
Assumes perfect
knowledge of
outcomes in all 5
areas!!!!
What does this mean for:
Crop and livestock
prices?
PE
Unit input costs and farmland prices?
Debt repayment capacity and credit risk?
Asset valuation and collateral risk?
QE
Structural Pro Forma Analysis
Farm
program
policies
Weather
and
disease
Macroeconomic
policies
Foreign
trade
policies
Global
market
events
Multiple
scenarios
examined
Scenario
#1
Scenario
#2
Scenario
#3
Scenario
#5
Scenario
#4
D
Scenario
#6
Scenario
#7
Scenario
#8
Scenario
#9
S
Supply-side risk for a
given price…
PEP
QLQ
QEQH
Structural Pro Forma Analysis
Farm
program
policies
Weather
and
disease
Macroeconomic
policies
Foreign
trade
policies
Global
market
events
Multiple
scenarios
examined
Scenario
#1
Scenario
#2
Scenario
#3
Scenario
#5
Scenario
#4
D
Scenario
#6
Scenario
#7
Scenario
#8
Scenario
#9
S
Demand and supplyside risk and potential
price variability…
PH
PEP
PL
QLQ
QEQH
Ad Hoc Modeling Approaches
 Naïve model – using
?
last year’s prices, costs
and yields
 Simple linear trend
extrapolation of
historical prices, costs
and yields
 Using assumptions
made by others
Econometric Model Approach
 Capturing future
?
supply/demand impacts
on prices and unit costs
 Linkages to commodity
policy
 Linkages to domestic
economy
 Linkages to the global
economy
Historical Data on Fixed Input Sales to Producers
Timeline Required for
Capital Budgeting…
Assume it is the year 2000 and John Deere wants
to project farm machinery and equipment sales
over the next six years to determine if plant
expansion is necessary.
2000
2001
2002
2003
2004
2005
2006
Timeline Required for
Capital Budgeting…
Assume it is the year 2000 and John Deere wants
to project farm machinery and equipment sales
over the next six years to determine if plant
expansion is necessary.
2000
2001
2002
2003
2004
2005
2006
Capital budgeting models of investment decisions
require projections of the annual farm revenue and cost
values over the entire 2001 to 2006 time period.
Econometric Analysis Based on Time Trend Extrapolation
IT = f(YearT)
A linear time trend projection of future farm
machinery and equipment sales therefore does a poor
job of predicting future sales activity.
Econometric Analysis Based on Investment Theory
IT = f{[E(PT)×E(QT)]/E(cT)}
An econometric model based on investment theory
does a much better job of predicting future sales
activity.
Crop Market Model
Demand equation:
Qd = a0 - a1(Price) +  ai (demand shifters)
Supply equation:
Qs = b0 +b1(price) +  bi (supply shifters)
Market equilibrium:
Qd = Qs
Crop Market Equilibrium
Price
S
D
Supply consists of:
-Beginning stocks
-Production
-Imports
Pe
Demand consists
of:
-Food use
-Feed use
-Exports
-Ending stocks
Qe
Quantity
Histogram for Wheat Prices
3.345 3.145 3.945
- .80
+.80
Wheat Projections Made in 1997
Actual
$5.00
Forecast
$4.50
$4.00
$3.50
$3.00
$2.50
Actual/Baseline
Prolonged Asian Crisis
USDA
2006
2005
2004
2003
2002
2001
2000
1999
1998
1997
1996
1995
1994
1993
1992
1991
1990
$2.00
Estimating the Annual
Supply and Use of Wheat
Econometric Analysis – Food Use
Own price elasticity
Income elasticity
Cross price elasticity
Observed and Predicted Values
For Wheat Food Use
Remaining Steps to Forecasting
the Price of Wheat
Develop similar econometric equations for
feed use, exports and ending stock
demand.
Develop econometric equations for
production and import supply.
Substitute the estimated equations into
the market equilibrium definition (QD=QS)
and solve for the price where excess
demand equals zero.
Crop Market Model
Demand equation:
Qd = a0 - a1(Price) +  ai (demand shifters)
Supply equation:
Qs = b0 +b1(price) +  bi (supply shifters)
Market equilibrium:
Qd = Qs
Conclusions
Econometric models are preferred over
naïve models and linear time trend
models.
Much more accurate.
Provide much more information (e.g.,
elasticities).
Allow for sensitivity analysis with
independent (exogenous) variables when
evaluating potential variability about
expected trends.