Download Niskanen Accounting for risk in dairy farms

Accounting risk in farm
investment calculations:
application to dairy farm
investment
Olli Niskanen
Anna-Maija Heikkilä
Sami Myyrä
© Natural
Natural Resources
Resources Institute
Institute Finland
Finland
©
Outline
•
•
•
•
•
Introduction to the topic
CAP investment support schemes
Few words about investment calculations
Proposed risk-accounting investment calculation method
Application to a dairy farm investment
– Insurance perspective
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Introduction
• Continuous investments are needed in agriculture
– To improve productivity
– Retain the viability of production
– To improve animal welfare
• Agricultural investments require a lot of capital
– Interest on capital is low
• Investors face multiple risks
– Output prices
– Input prices
– Yield
– etc.
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CAP investment support schemes
• Are based on a one-time grant financing a share of the
investment and/or on subsidised interest rates
– Relaxing budget constraints
– Reducing the downside risk by reducing the actual
investment cost
• RD investment support promotes investments that otherwise
would not have been undertaken (the principle of additionally),
because the cost is too high and/or the farmer has limited
access to credit.
• However, uncertain returns on investment are often a greater
obstacle to investment than the lack of financial resources
(Lefebvre et al., 2014)
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Current CAP investment support schemes
• In the 2014–2020 RD programme, most of the investment
support is allocated to “Investments in physical assets” (Article
17) with following targets:
– Total investments (private and public) in agricultural
physical assets is EUR 16.8 billion in 2014–2020
– Number of farm holdings supported by Investments in
physical assets in agriculture programme is 334,400 farms
(European Commission, 2016)
– The value of eligible investments varies widely between
types of investments and countries
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Problems related to direct support
• It is well recognized that area-based subsidies (direct payments)
partly capitalize into land values and rents (Feichtinger and Salhofer,
2011)
• It is possible that the same phenomenon follows with subsidised
agricultural investments (but not studied)
160
Index, 2000 = 100
150
140
130
120
Consumer price index
110
Building cost index
100
Agricultural building cost index
90
80
6
Source: Statistics Finland
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Investment calculations
• Problem: Lack of simple, understandable risk accounting
calculations
– Net present value methods ignore risk
– Often sensitivity analysis is made with different price
assumptions, but a real risk assessment is missing
• Use of real options theory is not widespread among farm
investments
• Deviations are basically understood, but their determination
may sound gibberish in practical use
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Proposed risk-accounting investment calculation
method
• The three values (min, median, max) are used to construct a
PERT (Program Evaluation and Review Technique)
distribution, which is a special form of Beta probability
distribution
– The PERT distribution was originally developed for the US
Navy Special Projects Office in 1957 to support the US
Navy's Polaris nuclear submarine project (Malcolm et al.,
1959)
– In this complex project, the details and durations of all
activities were not known, but the project management
required an estimate of the project finishing time.
– For each subproject, the most optimistic, most likely and
most pessimistic time required to accomplish each activity
were estimated. Timing deviations of the subprojects
formed the probability for the entire duration of the project.
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Application to a dairy farm investment
• In the method, three descriptive values form the distributions of input
and output variables of the net present value calculation
– Pessimistic value, median and optimistic value
• The values may be based on historical data or expectations
Variable
Average milk yield of the herd, kg
Milk price, €/kg
Grass silage price, €/kg
Barley price, €/kg
Rapeseed meal price, €/kg
Correlations matrix
Milk
Grass silage
Feed barley
Rapeseed meal
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Milk
1.00
0.65
0.82
0.86
Minimum
8,009
0.346
0.105
0.096
0.180
Median
8,837
0.395
0.141
0.136
0.320
Grass silage
1.00
0.59
0.61
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Maximum
9,591
0.459
0.155
0.187
0.423
Feed barley Rapeseed meal
1.00
0.90
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1.00
0,11
0,11
0,11
0,12
0,12
0,13
0,13
0,13
0,14
0,14
0,15
0,15
0,15
0,35
0,36
0,36
0,37
0,38
0,39
0,40
0,41
0,42
0,43
0,44
0,45
0,46
20
15
10
5
0
0,18
0,20
0,22
0,24
0,26
0,28
0,30
0,32
0,34
0,36
0,38
0,40
0,42
8009
8138
8267
8396
8526
8655
8784
8913
9042
9171
9300
9430
9559
0,001
0,0005
10
0,10
0,10
0,11
0,12
0,13
0,13
0,14
0,15
0,16
0,16
0,17
0,18
0,19
Distributions of input and output variables
• In this case, other factors are fixed
Feed grain
Average production
0,0015
30
20
10
0
0
Rape seed meal
10
Milk price
5
0
Grass silage
60
40
20
0
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Simulation results
• Net present value of an animal facility per cow
• Interest rate of 2% and duration of 15 years were used while
deriving the net present value
• Monte Carlo simulation with 10,000 draws
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18000
16000
14000
12000
10000
8000
6000
2,0
1,8
1,6
1,4
1,2
1,0
0,8
0,6
0,4
0,2
0,0
4000
Values x 10^-4
Net present value
Probability distribution of the NPV
1400
1200
Without investment subsidy, there is
23% probability of archieving NPV target
1000
Profitability limit (€12,000
investment) without support
800
Profitability limit (€12,000
investment) with support
600
400
Margin
200
0
With investment subsidy, there is 94%
probability of archieving NPV target
0,00
0,06
0,13
0,19
0,25
0,32
0,38
0,44
0,51
0,57
0,63
0,69
0,76
0,82
0,88
0,95
Margin per animal (EUR per year)
• In the case of a median investment cost of €12,000 and the typical
subsidy rate of 40%, the subsidy for the investment is €4,800
Probability of margin equal or higher
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Investment insurance?
1400
1200
1000
Profitability limit (€12,000
investment) without support
800
Profitability limit (€12,000
investment) with support
600
400
Margin
200
0
0,00
0,06
0,13
0,19
0,25
0,32
0,38
0,44
0,51
0,57
0,63
0,69
0,76
0,82
0,88
0,95
Margin per animal (EUR per year)
• Expected annual indemnity up to the subsidised level is €146 per year
• The present value of the subsidy being €374 per year
Probability of margin equal or higher
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Comparison of one-time and insurance based
investment support
• The price difference comes with the possible investment
revenues: Direct, single investment aid does not affect the
future margins faced by the farmer
– Margins above the lower line are revenues for farmer
• In other words, the revenue possibilities are higher as less of
the revenue is spent on the interest cost
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Conclusions
• The key advantage of hypothetical decoupled investment
support increases motivation to cost-efficient construction
because the subsidy is not dependent on investment cost
• Margin insurance as an investment subsidy tool could reduce
investment risk, but would also require long-term
commitments which might be expensive and troublesome to
administer
– Less attractive investments, because of revenue
possibilities would be reduced
• Administrative burden or costs faced by farmers should not be
increased
– Therefore, the idea presented in this paper is a simplified
discussion opener rather than actual proposal
– However, margin insurance could reduce risk, as long as
the risks are properly determined!
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Thank you!
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Support to farm investments in RD Policy 2007–2013
• Farm investment support is an essential component of the productivity
and sustainability enhancing strategy within EU Rural Development
scheme
Modernization of
agricultural
holdings (measure
121)
Programmed total public expenditure, billion €
EAFRD budgeted contribution, billion €
Percentage of EU Rural Development budget
(EAFRD contribution)
Actual declared expenditure (Q4 2006 to Q3
2014), billion €
18.4
11.9
Support for adding
value to agricultural
and forestry
products (measure
123)
8.7
5.3
12.4%
5.5%
9.6
3.5
Source: European Commission
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