This presentation helps farmers learn how to make better capital investment decisions by taking into account the time value of money. It explains how to calculate the Net Present Value (NPV) of a stream of cash flows over time, and how to determine the Internal Rate of Return (IRR) from a given investment. If we know the cash required upfront, an estimate of the annual cash flow resulting from the investment, and the remaining value of the investment at a given time in the future, we can calculate the IRR. The presentation includes several "real world" farm examples.

1. Farm Investment Analysis
Paul Dietmann
Senior Lending Officer – Mission Financing
Paul.Dietmann@compeer.com

2. 2
RESOURCES
• Three resources provided to us for free: sunshine; wind; and
precipitation
• Three resources we have available to invest: our labor; our time; and
our wealth
• Everything else can be borrowed, bought, or rented
• Approximately 40 productive years

3. 3
THE BIG QUESTION: How do we make the wisest
use of all of the resources at our disposal?

4. 4
If we can develop cash flow projections for our investment
options, we can use Net Present Value (NPV) to analyze each
option, and Internal Rate of Return (IRR) to compare one to
another.

5. 5
Investment forces us to think about how the
value of money changes over time
• Money has a time value
• The sooner you receive a payment, the better off you are
• Money you get today can be invested or used to stop interest from accruing
• Inflation causes money to lose buying power over time
• Benefit of investments are in the future
• We need to adjust the value a payment to reflect the cost of waiting for it
• The longer you have to wait to get it, the bigger the payment should be
• The longer you wait, the greater the risk that you won’t get paid back

6. 6
6
Source: investopedia.com, Understanding the Time Value of Money
In Option A, we are “compounding.” We apply a compound interest rate.
In Option B, we are “discounting.” We apply a discount rate.

7. 7
AT 3%...
7
Adapted from source: investopedia.com, Understanding the Time Value of Money
$10,000 + $927 = $10,927
$10,000 - $849 = $9,151

8. 8
How do we establish a “discount rate?”
• We could use the interest rate we would have to pay to get a loan for
the investment
• We could use the prime lending rate and add to it the rate of inflation
• We could establish a personal “hurdle rate”
• Whichever method we use, we need to adjust for the riskiness of the
investment. The more risky it is, the greater the discount factor.
8

9. 9
NET PRESENT VALUE (NPV)
• Tells us what a future cash payment is worth in today’s dollars
• Converts a stream of future cash flows into a single current value
• Can tell us if an opportunity is a good investment
• It won’t tell us if it’s our best investment of dollars

10. 1 0
NPV FOR $10,000 INVESTMENT, $1,000
ANNUAL CASH FLOW, $7,000 SALVAGE VALUE
Year Annual Net Cash Flow
Factor @ 5%
discount rate
Present Value of
Annual Net Cash Flow
0 ($10,000)
1 $1,000 .9523 $952
2 $1,000 .9070 $907
3 $1,000 .8638 $864
4 $1,000 .8227 $823
5 $1,000 + $7,000 = $8,000 .7835 $6268
Net Present Value of the cash flows $9,814
Since the initial cash outlay was $10,000, this investment would give us less
than a 5% rate of return.

11. 1 1
INTERNAL RATE OF RETURN (IRR)
• A method of trying a series of discount rates until we finds the one
that gives us a NPV equal to our initial investment
• Allows us to compare investments of different dollar amounts and
different lifespans

12. 1 2
What does any of this have to do with farming?!
We can calculate the IRR on any farm investment if we know:
1) the cash investment required upfront
2) the estimated annual cash flows
3) remaining value of the investment at a given point in its lifespan

13. 1 3
SCENARIO: SUNSEED FARM’S D-10T POTATO DIGGER
Sunseed farm bought a new potato digger in 2015 for $10,709. With a 20% down
payment and financing the balance at 5% for 7 years, the payment on the digger is
approximately $1500/year. Net operating cash flow of growing potatoes increased
by $487/acre/year with the digger (some additional operating expenses but much
lower labor cost).
Without the digger, they were able to grow one acre of potatoes digging them by
hand. With the digger, they grew two acres in 2015, planned to grow 4.5 acres in
2016, and at least 5 acres in future years. They intend to use the digger for at least
ten seasons. It should be worth at least $3,000 at the end of the tenth season.

14. 1 4
IT IS TEMPTING TO DO THIS REALLY SIMPLE CALCULATION:
One year x $487 x 2 acres = $974
one year x $487 x 4.5 acres = $2,192
eight years x $487 x 5 acres = $19,480
salvage value at the end of 10 yrs $3,000
$25,646 $25,646
minus the initial 20% down payment ($2,142)
minus 7 years of loan payments ($10,500) -$12,642
=net cash flow for 10 years $13,004
This suggests you’d get a 607% return on your initial cash investment ($13,004/$2,142 =
607%), which is NOT TRUE.
This calculation doesn’t consider the time value of money. To consider the time
value of money, we need to apply a discount rate.
14

15. 1 5
How good is the investment in the potato
digger?

16. 1 6
What about making a bigger investment…like
buying a farm?
16

17. 1 7
ANOTHER SCENARIO: You have been renting a farm for $12,000/year, saving up
for a down payment, and hoping for an opportunity to buy it.
The day has come; you can buy the farm for $250,000. You will need to put down
$75,000 and finance $175,000 on a 20-year note at 5% interest = $14,042/year loan
payment.
You’ve developed a cash flow projection. With loan payments, property taxes, and
annual building repairs & improvements, your cash outlay will be $10,000 more each
year when you own the farm compared to just renting it. However, you will be
building equity and expect the farm’s market value to increase by 4% each year.
You really want to buy this farm BUT is it a good investment? 17

18. 1 8
FACTORS TO CONSIDER
• Cash outlay is $75,000
• Net annual cash flow is estimated to be ($10,000) compared to continuing
to rent the farm
• Farm should be worth approximately $304,000 in five years
• Mortgage balance in five years will be approximately $145,000
• Owner’s equity in five years will be $159,000 minus “contingent liabilities,”
an estimate of sales costs that would have to be paid if the farm was sold
• $304,000 x 8% = $24,000
• $159,000 - $24,000 = $135,000 estimated owner’s equity
18

19. 1 9
Does it make financial sense to buy the farm?
We can use our net present value and internal rate of return tools to
analyze the investment
19

20. 2 0
NPV OF CASH FLOWS FOR THE FARM
20
Year Annual Net Cash Flow
Discount Factor
@ 5%
Present Value of
Annual Net Cash Flow
1 ($10,000) .9524 ($9524)
2 ($10,000) .9070 ($9070)
3 ($10,000) .8638 ($8638)
4 ($10,000) .8227 ($8227)
5 ($10,000) + $135,000 .7835 $97,938
Net Present Value of the cash flows $62,479
Since the initial cash outlay was $75,000 and NPV of the cash flow is $62,479, we
know the Internal Rate of Return is less than 5%

21. 2 1
What is the IRR on the investment?
21

22. 2 2
WHAT IF: Instead of buying the farm, we extend the lease five years
and invest $50,000 in improvements that add $15,000/year in net cash
flow. Zero value at the end of the five-year lease.

23. 2 3
WHAT IF: Instead of using the entire $50,000 of our cash on the
improvements, we put 20% down ($10,000) and finance $40,000 for
five years at an interest rate of 6%? The annual loan payment is $9,496,
which reduces the annual net cash flow to $5,504.

24. 2 4
SOME CAUTIONS
• This is only the beginning, not the whole story
• There can be good reasons to make a capital investment even if the NPV/IRR calculation
doesn’t support it
• Don’t substitute enterprise budgeting or investment analysis for whole farm financial
planning
• Month-by-month cash flow projections are extremely important if you are relying on
income from your farm to support family living costs
• People become farmers for many different reasons; high profitability is not usually #1.
And that’s okay…as long as you have adequate cash flow!
24