Forest Finance PDF

Introduction: Definition and Scope of Forest Finance Canesio D. Predo, PhD Professor Institute of Renewable Natural Resources Definition and Scope deals with tools and analyses on a wide range of issues affecting the susta...

Introduction: Definition and Scope of Forest Finance Canesio D. Predo, PhD Professor Institute of Renewable Natural Resources Definition and Scope deals with tools and analyses on a wide range of issues affecting the sustainable management of forest resources including both market and non-market goods and services deals with effective use of financial analyses to support forest management decisions reviews the elements of financial analysis for forest management investments. 2 Forest Finance Issues National level Local level financing mechanisms development of innovative forest valuation financing instruments economic analysis of forest cost-benefit analysis of policies forestry projects and policies trends in costs and prices valuation of non-market goods and services from forest revenue systems forests 3  Why is forest finance important? many of the world's forests are still managed primarily for the commercial production of goods and services increased awareness, international conventions and globalization of markets highlighting the importance of sustainable forest management to achieve broader development goals 4 Sources and classification of forest values Direct use values associated with: Consumptive uses commercial and industrial market goods (fuelwood, timber, pulpwood, poles, fruits, animals, fodder, medicines, commercial non-wood products such as rattan) domestic non-market goods and services (fuelwood, non-commercial non-wood products, animals, skins, poles, fruits, medicinal plants) Non-consumptive uses Recreation (jungle cruises, wildlife photography, trekking) Science and education (forest studies) 5  Indirect use values are associated with: Environmental protection Watershed protection, nutrient recycling and soil fertility, agricultural productivity enhancement gas (e.g. carbon dioxide/oxygen) exchanges, contribution to climate stabilization and carbon storage habitat and protection of biological diversity aesthetic, cultural and spiritual values 6  Option values People may value the option to use a forest in the future Although such values are difficult to measure in economic terms, they should be recognized in valuing the contributions of forests to human welfare This concern can contribute to the conservation and preservation of forests 7  Existence values People may value a forest or resource complex purely for its existence, without any intention of using it directly in the future. This includes intrinsic value Bequest values People may value a forest as a bequest to their children. 8  Relationship of forest finance with other branches of forestry Dendrology (identification of economically useful tree species) Forest ecology (patterns and processes of a forest ecosystem) Silviculture (art and science of controlling the establishment, growth, composition, health, and quality of forests to meet specific objectives) Forest management (comprises of the overall administrative, economic, legal, and social aspects of forest regulation) Ecoforestry – emphasizes practices which strive to protect and restore ecosystems rather than maximize economic productivity 9  Sustainable forest management -- emphasizes practices that maintain forest biodiversity, productivity, regeneration capacity, and vitality, while continuing to fulfill relevant ecological, economic and social functions Forest hydrology (embodies the effects of changes in forest land use on the movement, distribution, and quality of water in the ecosystem Forest mensuration (incorporates quantitative measurements of the forest stand to determine stand timber volume and productivity/health, and provides a basis of which management decisions can be made Urban forestry (care and management of urban tree populations for the purpose of improving the urban environment) Energy forestry (managing for the production of energy from biomass or biofuel derived from a fast-growing species of tree or woody shrub) 10  While forest finance is a science which is based in mathematics, it takes its facts from both economics and the physical laws of forest production The subjects to which forest finance is related can be classified as: Foundation subjects Applied subjects 11  Foundation subjects: Economics allocation of scarce resources for the production of goods and services to satisfy human wants Determine the present prices and value of the forest crop Future trend of demand and prices and the indicated objectives towards which crop production should be guided Silvics physical factors of site and the behavior of the different species on these sites, we arrive at the choice of species to plant and its probable productiveness Mensuration Obtain the measures and prediction of the species 12  Accounting – able to deal with the physical and economic data in a manner conforming to sound principles, accounting methods similar to those employed by any business but suited to the specific conditions and problems arising in forestry. Applied subjects: Forestry policy – forest finance findings/conclusions may influence public forest policy indicating the financial position of the private owner and the moderation necessary in attempting to enforce public regulation Silviculture – owner can be guided in the determination of the character and extent of operation permissible in the forest. Forest management – forest finance can guide mgt in building forestry enterprise, which seeks to attain success gauged by efficiency, a margin for profit, and the highest possible returns for the required expenditure. 13 Financing of Forestry and Forest Ecosystem Services Canesio D. Predo, PhD Professor Institute of Renewable Natural Resources  Financing of Forestry & Forest-based Enterprises Lecture Goals: 1. Identify main objective of forestry financing, the challenge and the opportunity 1. Identify and classify financing mechanisms for private and public forestry. 2. Find out and discuss public financial assistance to private forestry 3. Define and classify forest ecosystem services & how they can be financed. 2 Purpose of forest financing sustainable forest management –many countries now want to manage their forests more sustainably than they have in the past. Challenge of forest financing progress is hindered by a lack of suitable financing Current practice: – take an ad-hoc approach to financing, using a small number of mechanisms such as grants and subsidies, that often cover only a few activities – reliance on government budgets and overseas development assistance as funding sources remains high. 3 To address this challenge: it is necessary to examine how to expand and diversify financing mechanisms and sources of finance. contributions of forests to economic development, human well-being and the environment are increasingly recognised as important. – experimenting with innovative financing mechanisms that may generate new sources of revenue and help to make investments in sustainable forest management more attractive and feasible. 4 Constraints to implementation many of the benefits of sustainable forest management do not generate revenue for forest owners and managers. – they have no incentive to produce the full range of benefits from forests and continue to focus on production of timber and a few other marketed products. – complexity and generally higher costs and perceived risks of sustainable forest management compared to other land uses, including unsustainable forest practices (economic constraints). often compounded by policy, legal and institutional constraints such as: – weak institutions, a lack of policy co-ordination across sectors; – unresolved land tenure issues; and – weak governance, as well as a lack of technical capacity in countries. 5 Constraints to investment in small-scale forestry Forest management is capital intensive and a long-term investment. This is particularly true in the case of tree planting. Incentives for tree planting are available in some countries, but access to finance from the private-sector is often constrained for the following reasons: – forests are often not acceptable collateral for a loan (exceptions include Colombia and Uruguay); – land cannot be used as collateral without clear land tenure; – lending policies favour short-term loans with low risks, but a lack of information contributes to an inflated perception of risk in forestry; and – interest rates are often higher than growth in the value of forests when timber is the only marketed output. Constraints such as these often affect small-scale forest owners and community-based forest enterprises. In addition, administration costs are similar for large and small loans and this discourages lending to small enterprises. 6  Importance of Financing Financing is very important aspect of business – Lack of financing may not materialize even most promising business propositions – New enterprises fail to progress or even die out from business before it can start to recover part of its initial investment due to insufficient funds to continue the operations 7  Forestry or forest-based enterprise or any kind of business requires a considerable amount of money For private forestry enterprise money is needed to: – Purchase or lease the land which will be used for the enterprise – Develop the area ready for planting of tree crops, establishing the plantation, maintaining and protecting the plantation and later harvesting the mature crop 8  Source of Financing Small enterprises – savings Large enterprises – savings and borrowed funds or loans – Amount borrowed and repayment time depend on the size and nature of enteprises 9  Types of Private Forestry Classification by objectives and type of ownership: Tree Farms – small area of forest land or tract of land which is purposely planted to tree crops Plantations developed by the Timber License Agreement (TLA) holders in fulfilment of their reforestation obligations Industrial forest plantations – developed by individual or firms to serve as a continuous source of raw materials for its processing firm Agroforestry farms – farms which practice a land mgt that combines agricultural crops and forest plants and/or animals simultaneously or sequentially and applied mgt practices which are compatible with the cultural patterns of the local population Forestry as an independent business enterprise – individuals, families and firms which are engaged in growing tree crops for sale in the open market – growing mahogany instead of devoting the land for agricultural production 10  Financing of Private Forestry Financing of true forestry is a long term nature, and much longer than forest-based enterprises Financing depends on the area devoted to the venture and the rotation of the species planted in the area – Tree farms require small areas and little amount of financing – Industrial forest plantation need large area of land to be developed to provide a continuous stock of harvestable timber – requires large and long term financing – Forestry enterprises would need a long-term loan since the business will obtain its revenue only at the time of intermediate harvest and at the final harvest – Wood-based enterprises would require short-term loan; long-term loan in some cases, if necessary 11  Financing of Public Forestry DENR which is mandated to manage the public forest do not harvest nor process the timber produced from the forest TLA holders are the ones logging the natural forest – Pay the government forest charges which is collected based on the volume of timber harvested from the forest. – Forest charges represent the price of the timber at the stump Government appropriation is the most common source of funds in public forestry Loans from financing institutions like the World Bank are also used for projects aimed at hastening the development of the public forest. 12  Financing of Wood-Based Enterprises Wood-based enterprises are those which makes use of wood as raw material to produce other products Classified into: – Small industries – use inexpensive equipment and have low capacity. Example: mini-sawmills and rural woodworking establishments in small towns and barangays Daily rated capacity: 23.5 cu m per day Owner have other financial activities aside from the enterprise Financed by short-term bank loans to meet payrolls and current expenses; secure credit in the form of advanced payments from wholesaler and other purchasers If condition permit, they secure a sort of involuntary credit by deferring payment of labor and bills 13 – Medium industries Regular sawmills Daily rate capacity greater than the mini-sawmill: >23.5 cu m per day Financing could be on a long-term basis; often obtain funds by organizing a company and by selling stocks or bonds – Large industries enterprises Large sawmills, pulp mills, and plywood mills Require million of pesos just to start a business Source of borrowed funds – big financial institutions 14  Assistance of Govt to Private Forestry and Wood-based Enterprises Govt involve the private sector in rehabilitating the denuded areas of our country – Extend both direct and indirect assistance to private enterprises – Forms of assistance include: reduction in taxes facilitating loans at low interest rate price subsidies of inputs like seedlings and fertilizers and other inputs (chemicals, glue, etc, in the wood-based industries) use of general police power for the protection of life and property imposition of import duties or tariffs to prevent or discourage importation of competing foreign goods that might reduce the market for domestic products 15 Value, Cost, Prices and Profit Canesio D. Predo, PhD Associate Professor Institute of Renewable Natural Resources College of Forestry and Natural Resources University of the Philippines Los Banos  Kinds of Values in Forestry A. Intangible value Sentimental values Artistic or aesthetic values Scenic or landscape Recreation values Scientific values Inherent value of a material nature which are difficult to define such as watershed protection 2  Kinds of Values in Forestry B. Tangible Values ❑ Those referring to kind or quality of value; does not require expression in monetary terms 1. Use or utility value – use is the basis of most tangible values, which are measured by the relative profitableness or different ways of using an article or piece of land 2. Scarcity value – man likes to attach importance to things which are rare apart from their usefulness. When they are both rare and useful, they have high scarcity value 3  Kinds of Values in Forestry 3. Monopoly value – an artificial scarcity value created by human control of a product or property 4. Luxury value – pertains to expensive or rare articles irrespective of their utility, for human beings enjoy processing such objects and will pay more for them than their use value Example: A table made of narra is as useful as one made of gmelina, but its prices is greater  Kinds of Values in Forestry 5. Nuisance value – a piece of property must be used in such a way as to cause inconvenience or loss to another person. Example: Small private holdings surrounded by land where forestry is being practiced, often have nuisance value bec they create fire and other special hazards.  Kinds of Values in Forestry ❑ Those defining the method used to determine it or the purpose to which it is determined. 1. Speculative value – a property that is expected to increase in value by an unknown amount is said to have a speculative value equal to the amount the purchaser expects to receive when he sells 2. Liquidation value – obtained from a property by exhausting all or most of its productivity. Example: the liquidation value of forest is the value of all timber removed (when clear cut) 6  Kinds of Values in Forestry 1. Salvage, wrecking or residual value – remaining value of a property after its usefulness for its original purpose is gone. 2. Appraisal value – evaluation in monetary terms the exact amount of all types possessed by a piece of property. This must be always in terms of stated values bec a property may have different uses and hence different values 3. Assessed value – set upon on property by public official for taxation purposes based on sale value of the asset; 7  Kinds of Values in Forestry 4. Cost value – present monetary value of a piece of property as determined by the sum of all its past cost to the owner, to which compound interest at a given rate on the sums invested is added. a) Probable cost value – set upon on property at a given date in the future by adding expected expenses plus compound interest on them to cost value at present b) Present cost value – serves the owner as a basis for determining the rate of profit from ownership or the selling price if he wishes to sell c) Estimated future cost value – a basis for calculation of pure profit 8  Kinds of Values in Forestry 5. Capital value – a mathematical determination of use value obtained by capitalizing present earning on the assumption that they will be perpetuated or will continue for a given time ▪ If the earnings will only be realized in the future, by discounting them to the present. ▪ Often called discount value since this value is determined by discounting procedures ▪ Also called present value since it applies only to the present ▪ Also called expectation value since it is based on an expectation of future earnings ▪ Also called soil expectation value if used for the purposed of determining the value of forest soils for 9 growing trees  Kinds of Values in Forestry 6. Realization value – raw materials are less valuable than the finished products into which they are made. The difference between these values is known as realization or conversion value 7. Replacement value – cost of replacing an article or structure that has been destroyed. ▪ In forestry, it is the value of forest based on what it would cost plus interest at a given rate to produce an equivalent stand in kind and volume ▪ If the prices prevail at the time of destruction, it is equivalent to cost value. Since this is never possible, prices prevailing at the time of destruction are used ▪ A modified form of cost value – one of bases for appraising damages to forests 10  Kinds of Values in Forestry 8. Market or sale value – for ordinary commodities standard values or prices have been arrived at known as market or sale value. ▪ If there is no such standard value when the property is sold, the buyer and seller must mutually agree upon its price, after each has appraised it on the basis of the values it contains for him ▪ In general, the seller usually sets a maximum price he hopes to get and a minimum, below which he will not sell. The buyer sets a minimum for which he hopes to buy and a maximum beyond which he will not go. Inside these limits, a price must be agreed upon that is the resultant of the seller’s desire to sell and the buyer’s desire to buy the product. ▪ Except for a forced sale, the price paid is assumed 11 to represent the value of the property  Costs Review of the production function Derive the cost curve – Total cost Fixed cost Variable cost – Marginal cost – Average cost  Input-Output Relationship Production Function – Relationship between the amount of variable inputs used and the output produced – Also called factor-product or input- output relationship – Can be expressed as: Y = f(Xi;X2,…,Xn) This indicates that the amount of product y is function of the amount of the variable input Xi and the level of fixed inputs X2, through Xn. The number of factors that are fixed and variable depends in the length of the planning horizon 13 (short-run or long-run).  Typical Neoclassical Production Function Output 8 7 6 (Y) 5 4 3 2 1 0 1 2 3 4 5 6 7 8 Input (X) 14  Forms of Production Functions 1. Constant Productivity Yield (kg) 3,000 2,000 1,000 0 10 20 30 40 Amt of fertilizer (kg) 15  2. Diminishing Productivity Yield (kg) 3,000 2,000 1,000 10 20 30 Amt of fertilizer (kg) 16  3. Increasing Productivity Yield (kg) 4,000 3,000 2,000 1,000 0 10 20 30 40 Amt of irrigation water (liter) 17  Note: – The three production forms consider only one variable input and an output – Other technical relationships: MPP (Marginal Physical Product) APP (Average Physical Product) 18 The marginal physical product (MPP) of the ith input is equal to the change in the amount of product (Y) produced over the change in the amount of the variable input Xi Y MPPXi = X i The average physical product (APP) of the ith input is equal to the average output per unit of variable input and is calculated as the total product divided by the amount of variable input used. Y APPXi = Xi 19 Stages of Production Function Y I Y II III 40 35 30 25 20 15 10 5 0 0 1 2 3 4 5 6 7 8 9 10 APP MPP 10 8 6 4 2 0 1 2 3 4 5 6 7 8 9 10 11 -2 20  Max Level of Input MVP = MIC (or MFC) MVP – additional or marginal income received from using an additional unit of input Total Value Product (TVP) MVP = Input Level TVP = TPP * Py MVP = MPP * Py 21  MIC – change in total input cost or the addition to total input cost due to an additional unit of input  Total Input Cost (TIC) MIC =  Input Level TIC = X * Px MIC = Px 22  Profit Maximizing Level of Input MVP = MIC Example: MVP = MIC If MVP > MIC, addl profit can be made by using more input 23  Time and Other Special Cost Units The efficiency of operations maybe compared by a record of the time necessary to perform them. For such comparison, man-time units are used, the time varying from an hour to a year. If an average man working under average conditions can plant a hectare of ipil-ipil seedlings in 12 hrs, we may say 12 man-hr or a 1.5 man-day job, assuming an 8-hr day.  Uses of Time Unit Man-time units are partially valuable in comparing the efficiency of work under different wage scales Since wage rate vary with time and place, time-units offer about the only possible measure for real efficiency of certain classes of operations Time units are also used for animal and power transport. E.g., truck-hours, kw-hr Cost Distribution and Reduction Cost of making the same type of product varies widely. This varies according to: – Time – Type of plant – Place – Labor rates – Quality of raw materials – Distance of plant from raw material and from market, and many other factors  Sometimes, as between competitive plants, cost may not differ much in total but greatly in detail, sometimes, it is the reverse. There are several ways of reducing costs so as to increase profits – Mechanization – Wage reduction – Substitution of less expensive raw materials  Limitations on Cost Reduction Strategies The limits of mechanization are set by the progress and invention and the law of diminishing returns in the use of capital Wages can be reduced only so far, beyond which, worker will refuse to work or will work so badly that labor cost again increases  Competition and other factors fix prices of raw materials Substitution of cheaper raw materials carried too far reduces the selling price of the final product More complete utilization of materials may increase cost bec of greater input of labor and mechanical power necessary Fixed cost, involving interest payments on borrowed capital are reducible only when operations are profitable enough to pay off indebtedness, or are reducible by financing at lower interest rates – which are usually difficult to accomplish  Prices Kinds of Prices – Commodities usually have these prices Mill or factory Wholesale Retail Note: prices quoted in statistics are usually wholesale or mill prices  Price Variations Prices vary according to whether they are: a) short-term variation Ex: prices of lumber maybe low during slack in building construction activities b) long-term variation Ex: prices of lumber is going upward due to increasing scarcity of stumpage Long term prices change greatly affects the fortunes of business  Real and Monetary Prices ✓Monetary price - expressed in cash ✓Real price – expressed in terms of purchasing power or gold Since the value of money is constantly changing, it is desirable to change monetary prices to real or adjusted ones  Comparing Prices Prices can be compared by: monetary prices and real prices index or relative prices – turn prices into percentages of a given price or the price at a given time – makes possible between price movements or different commodities measured in different units – sometimes both systems are used by making indices to real prices  Monetary prices maybe converted to real prices by coordinating them either with: – Shifts in value of gold or other metallic unit in which currency is based – Purchasing power as determined from an all-commodity index generally more useful and consists in either: – the use of purchasing power index which is a reciprocal of all commodity index – the use of the commodity index itself Use of Purchasing Power Index Divide the price by the purchasing power index Use of Commodity Index Multiply the price to be converted by the index Index Prices usually published by a govt agency that is given the task to determine such prices weighted or unweighted; has always a base year Using index price on the same base, we can compare the price movements of commodities Price and Production Cost A lumber dealer with a year full of stock facing a sudden decline in building operations in his community maybe force to sell his stock below what he paid for it and incurred loss in order to pay his current bill In the face of an increase in building activity, price goes up even though previous price was well above his cost Private industry – goods cannot be sold continuously at less than cost. The higher the cost of production, the less product is being sold. If costs rise but selling prices remain stationary, profits would disappear. In the long-run prices tend to rise with increasing production cost and to decline with decreasing ones. Short-time prices are often unaffected by production cost  Competition Between Producers of Similar Products Under Imperfect Market A producer whose costs are lower can undersell his competitors and still make a profit Between two or more producers at the same costs and one producer is satisfied with a lower profit, he also can undersell his competitors Prices could be set by the producers who operate at the lowest margin of profit – happens only if these producers can meet the demand bec the lowest-cost manufacturers are few in number and may not be able to sell at such levels  In time of lowest demand – Prices are set by the lowest-cost producers provided prices are fixed by cost of production In normal times – Prices are set by the average-cost producers In time of great demand – Prices are set by the highest-cost operators In each case, the producers whose costs are out of line with the prevailing prices stand to gain or loss according to the relationship of their costs to prevailing prices Effects of Abundance of Raw Materials on Prices of Finished Products Prices of raw materials vary according to supply and demand situations Prices relationships: – An increase in raw material cost leads to increase the prices of finished products so long as they cannot be compensated by decreased cost elsewhere in the production process – Increasing scarcity or inaccessibility of raw materials tend to encourage the use of substitute that finally may decrease the use of original products and be important factor in setting its prices – Under competitive conditions, the total supply of raw materials often has nothing to do with current prices of finished products  Effects of Business Cycles on Prices Under stable economic conditions, prices remain reasonably fixed but economic conditions not long remain stable In time of prosperity – Prices are generally increasing – Purchasing power of money is lessened, credit inflation and wild speculation accompany period of prosperity – Paper values are destroyed, employment decreased, demand for goods is further reduced since high prices already reduced the demand for these good. – Prices then would slump to low levels and finally to a point where price structure would break down  In time of depression – Price structure must be painfully built up again during depression periods. – Both costs and selling prices generally tend to rise and fall in unison with fluctuations of the business cycle, but this does not follow for all items of costs, so that some prices may be thrown out of alignment with costs and others may not be particularly affected  Public Price Control Govt has many powers of price control In time of war, emergency, or in other exceptional circumstances, it may fix or at least state a max price and above that it may not go Example: ceiling price and floor price of selected commodities Agricultural commodities – govt attempts to raise prices in the interest of a class of the population supposed to be in need of financial assistance Govt, as large buyer and seller of goods and services, influences prices in the same manner as other large producers and consumers In regulating some prices, govt affects others, and thus affects the general price structure. Tend to keep price down at the benefit of the consumers rather than producers, and in general to equalize the extremes of the business cycle.  Profit Profit = Total Revenue – Total Cost Operating Profit – A business is making profit over and above its operating cost – A business may make an operating profit but net profit of it has a heavy debt load – Usually figured in terms of yearly operations, sometimes for longer or shorter periods, and sometimes for the life of a specific operation – Total profit in a lumber operation cannot be determined until it is concluded, perhaps 25 yrs after it is started  Common Strategies to Maximize Profit 1. Business may restrict expansion of production in order to keep up prices and make a high profit on a small output 2. Business may increase its production and try to market a larger volume by reducing prices Strategy #2 demands greater capital investment, greater managerial skill and greater business risk. Competition becomes keen and will force them down If the largest number of businesses takes strategy #1, prices will be maintained at high levels  Social Significance of Prices and Profits Assume that all lumber mills decide on high-production low unit profit basis – Price would fall -> price of housing also decline - > many people could own their homes and rent would be cheaper – Many people able to build houses that could not afford to maintain them – Many houses ordinarily rented remain idle – In the long-run, such policy would lead to deforestation, soil erosion, and later to extremes high prices for inferior lumber  Social Significance of Prices (Cont’d) It is difficult to see any ultimate social advantage in unrestricted competition on a high production Forest Valuation and Appraisal Canesio D. Predo, PhD Associate Professor Institute of Renewable Natural Resources Valuation Calculating the value an “investor” places on “property”, − NPV − WPL (SEV) of buyer − Reservation price of seller − “Instinctive” value Uses of valuations − Offering price − Asking price Appraisal Process of estimating “market value” − Average expected selling price for similar property − Goal is to obtain the “fair market value” → Def. – Price at which a willing seller and a willing buyer will trade, neither being under compulsion to trade, and both having access to all knowledge relevant to the transaction Appraisal Uses 1. Taxes ▪ Assessment for property tax levy ▪ Basis of property 2. Amount of loan collateral 3. Estimate damages for insurance or law suites Stumpage Valuation What buyers pay for standing timber ready for harvest ▪ Possible buyers 1. Logger 2. Saw or veneer mill timber buyer 3. Broker of logs or standing timber → Broker – buy for resale » accumulate specific products for buyers » broker knows her/his customers Stumpage Valuation → from buyer’s perspective Stumpage is a residual, or conversion return » Value of veneer or lumber − Less milling cost − Less overhead for procurement and working capital » Delivered log price − Less cost of logging and hauling − Less overhead for procurement and working capital, equals » Stumpage value − Might be called “willingness to pay” for stumpage, WPS Valuation Factors Price of lumber, veneer, or pulp Efficiency of processing plant Proximity of stand to mills or brokers’ yards Price expectations of buyers Season of the year How can a log have a negative conversion return? Stumpage Valuation → from seller’s perspective Reservation price −Price below which an owner won’t sell stumpage Why aren’t conversion return and reservation price always the same? − Unrealistic perception of timber values − Non-consumptive value given to timber in-situ Measures of Value WPL (bare land) ▪ Even-aged management (equation 9-7) ▪ Uneven-aged management (equation 8-5) ▪ Holding value of immature even-aged timber (equation 7-14) ▪ NPV of uneven-aged forest (equatiom 8-6) WPL is an investor’s maximum willingness to pay for an income-producing asset, but it’s not necessarily the market value  Loblolly Pine Pulpwood Forest Values $2,000 $1,800 $1,600 $1,400 $1,200 Land value $/A $1,000 Liquidation value $800 Holding value $600 $400 $200 $0 0 5 10 15 20 25 30 Year Valuation of Large “Tracts” of Timber Old growth Young timber Impacts of loans Old-Growth Timber Valuation Consider timber only, not land Formula: Volume too large to harvest in NPV of future timber harvests one year Current stumpage value of entire volume Timber value in year zero is less than sum of future harvest values, as determined by “timber valuation factor” which equals,  Old Growth Valuation Factors RHVG – 6%, Inc. Tax – 38%, Infla. – 5%, Mgt. cost – 2% of harvest value Real Interest Rate Depletion period, yr. 3 6 9 12 15 2 0.947 0.888 0.835 0.788 0.746 5 0.938 0.832 0.744 0.671 0.609 8 0.939 0.791 0.677 0.587 0.515 11 0.948 0.761 0.625 0.523 0.445 14 0.963 0.738 0.583 0.472 0.391 17 0.983 0.719 0.547 0.430 0.348 Young Timber Collection of various aged thrifty young growth stands to be cut at different times → Timber’s NPV will likely exceed stumpage value − Not true if real interest rates are high and buyers are pessimistic about future stumpage prices Impact of Loan on Property Valuation Leverage – use of existing equity to borrow funds to purchase additional business assets Loans are denominated in current dollars » Payments not adjusted for inflation » Loan rate is adjusted by lender for expected inflation rate and risk Impact of Loan on Property Valuation Example: 5% real rate (3% risk-free plus 2% risk), and inflation rate is expected to be 6%, nominal rate should be 91.05 x 1.06) – 1 = 0.113, or 11.3% Borrow $100,000 at 11.3% for 10 years Annual payment → 100,000 (0.113/(1-1.113-10)) = $17,194.31 using capital recovery multiplier Impact of Loan on Property Valuation Impact of loan on NPV NPV loan = principal less PV of − Principal enters as a revenue payments − Payments enter as costs = $100,000 – $17,194.31 (1-(1.0918)-10 / 0.0918) Payments are discounted with risk free interest rate since payments are = $100,000 – $109,478.28 legal obligations = -$9,478.28 » Continuing with example above, discount rate for loan payments would be: (1.03 x 1.06) – 1 = 0.0918, 9.18% Impact of Loan on Property Valuation If investor had used a higher discount rate, say 14%, the PV of loan would have been $10,312.49 This would overstate the PV of the loan by $19,790.77, which is = $10,312.49 – (- $9,478.28) Result would be overbidding for properties Impact reduced on after basis because interest payments usually tax deductible Appraising Market Value Appraisal methods 1. Comparable sales 2. Capitalized income 3. Replacement cost Goal of appraisal is estimation of most-likely selling price, not an average price Appraisal by Comparable Sales Use depends on availability of sales data −Data base is a valuable business asset Factors to consider in making comparisons: ▪ Species mix ▪ Road building and logging costs ▪ Quality ▪ Log scale used ▪ Average diameter ▪ Type of harvest ▪ Size of sale ▪ Product mix ▪ Terms of sale – cash at closing, pay-as-cut, ▪ Terrain installments ▪ Date of sale ▪ Liability for severance or other harvest tax ▪ Distance from mills Adjusting Sales to Make Them Comparable Regression analysis − Unit price made a function of sale characteristics − Requires sales data for a relatively short time period » Or, use trend line as independent variable − The larger the number of factors (independent variables), the larger the data base required Adjustment factors, non-statistical method − Experienced appraisers make adjustments based on » Knowledge of market, or » Published factors Appraisal by Capitalized Income Referred to as income appraisal or income approach It’s simply a NPV calculation, but based on most likely conditions, not the conditions for a specific person Used of necessity when no comparable sales are available Not useful if non-income benefits are the major output of a property Appraisal by Capitalized Income Assumptions: Use regional average yields Project prices with trend-lines for real prices Proper discount rate to use is difficult to estimate − Derived capitalization rate – discount rate used by average buyer in computing price paid for a property Estimate like IRR for sample properties by assuming cash flows and finding r that results in observed sales price Appraisal by Replacement Cost Useful if − Trees were planted within the last “few” (less than 6) years − Land with timber recently purchased Assumption is that market price reflects the initial costs, but the further out in time the valuation date is, the less likely it is that past costs affect market price. − SUNK COSTS DON’T MATTER!  Appraisal by Replacement Cost Calculate “Forest NPV” Ht + Lt 1-(1+r) -(t-y) + (a-c) (1+r)t-y r Then, compound Forest NPV forward to valuation year, y, and add annual cost, Forest NPV (1+r)y + c ((1+r)y -1)/r This is more like the seller’s asking price based on her costs Appraisal by Replacement Cost Guideline for income approach − When discounting, enter incomes as positives and costs as negatives Guideline for replacement cost approach − When compounding historical costs, enter costs as positives and revenues as negatives Depreciation Canesio D. Predo, PhD Associate Professor Institute of Renewable Natural Resources  Process of allocating the cost of a plant asset to expense in the DEPRECIATION accounting periods that benefit (revenue) from its use Purpose? Matching Balance Sheet Income Statement Acquisition Cost Expense Cost Allocation (Unused) (Used) Often called ‘write-off’ of cost  Comparing Depreciation Methods Straight line Declining Balance Units of Production $20,000 $16,000 $9,000 Annual Production $8,000 $14,000 Depreciation Depreciation Annual DDB Depreciation Annual SL $7,000 $15,000 $12,000 $6,000 $10,000 $5,000 $10,000 $8,000 $4,000 $3,000 $6,000 $2,000 $5,000 $4,000 $1,000 $2,000 $0 1 2 3 4 5 $0 $0 1 2 3 4 5 1 2 3 4 5 Life in Years Life in Years Life in Years Straight-Line Method Allocates cost evenly over its useful life Assumes the decline in usefulness occurs evenly over time Easiest method to apply Most utilized method A time-based method Depreciation Cost - Salvage Value = Expense for Period Useful life in periods  Straight-Line Method On January 1, 2004, equipment was purchased for $50,000 cash. The equipment has an estimated useful life of 5 years and an estimated residual value of $5,000. Depreciation $50,000 - $5,000 = = $9,000 Expense per Year 5 years Dec. 31 Depreciation Expense 9,000 Accumulated Depreciation - Equipment 9,000 To record annual depreciation  Straight-Line Method Depreciation Accumulated Expense Depreciation Accumulated Book Year (debit) (credit) Depreciation Value $ 50,000 2004 $ 9,000 $ 9,000 $ 9,000 41,000 2005 9,000 9,000 18,000 32,000 2006 9,000 9,000 27,000 23,000 2007 9,000 9,000 36,000 14,000 2008 9,000 9,000 45,000 5,000 $ 45,000 $ 45,000 Salvage Value Depreciation Rate = (100% ÷ 5 years) = 20% per year * At end of useful life, book value = salvage value Straight-Line Method Depreciation Expense Book Value reported on reported on the Income Statement. the Balance Sheet $9,000 $45,000 $40,000 $41,000 $7,000 $35,000 Depreciation $32,000 Book Value $30,000 Expense $5,000 $25,000 $23,000 $20,000 $3,000 $15,000 $14,000 $1,000 $10,000 $0 $5,000 $5,000 2004 2005 2006 2007 2008 $- 2004 2005 2006 2007 2008 For the year ended December 31 For the year ended December 31 Units-of-Production Method Allocate asset cost based on number of units to be produced over its life A usage-based method  Units-of-Production Method Step 1 Depreciation = Cost - Salvage Value Per Unit Total Units of Production Step 2 Number of Depreciation Depreciation = × Units Produced Expense Per Unit in the Period  Units-of-Production Method On December 31, 2004, equipment was purchased for $50,000 cash. The equipment is expected to produce 100,000 units during its useful life and has an estimated salvage value of $5,000. If 22,000 units were produced in 2004, how much is depreciation expense? Step 1 Depreciation = $50,000 - $5,000 = $.45 per unit Per Unit 100,000 units Step 2 Depreciation = $.45 per unit × 22,000 units = $9,900 Expense  Units-of-Production Method Depreciation Accumulated Book Year Units Expense Depreciation Value $ 50,000 2004 22,000 $ 9,900 $ 9,900 40,100 2005 28,000 12,600 22,500 27,500 2006 - - 22,500 27,500 2007 32,000 14,400 36,900 13,100 2008 18,000 8,100 45,000 5,000 100,000 $ 45,000 Salvage Value Declining-Balance Method Accelerated method More depreciation in early years Less depreciation in latter years of life Double-declining balance → Double the straight-line rate A time-based method Straight-line rate X 200% = DDB rate 12 Declining-Balance Method Why use Depreciation Repair accelerated? − Some assets are Expense Expense more efficient in Early Years High Low early years − Most assets have Later Years Low High less related maintenance cost in early years Early years’ total expense approximates later years’ total expense.  Double-Declining-Balance Method Step 1 Straight-line = 100 % ÷ Useful life = 100% ÷ 5 = 20% Step 2 rate Double-declining- = 2 × Straight-line rate = 2 × 20% = 40% balance rate Multiply rate times beginning book value Depreciation = Double-declining- × Beginning period expense Step 3 balance rate book value 2004 expense = 40% × $50,000 = $20,000 2005 expense = 40% × ($50,000 - $20,000) = $12,000  Last Year DDB Dilemma Depreciation Accumulated Book Year Expense Depreciation Value $ 50,000 2004 $ 20,000 $ 20,000 30,000 2005 12,000 32,000 18,000 2006 7,200 39,200 10,800 2007 4,320 43,520 6,480 2008 2,592 46,112 3,888 $ 46,112 Below is not equal to salvage value So how do we fix this? Fixing the DDB Last Year Dilemma Depreciation Accumulated Book Year Expense Depreciation Value $ 50,000 2004 $ 20,000 $ 20,000 30,000 2005 12,000 32,000 18,000 2006 7,200 39,200 10,800 2007 4,320 43,520 6,480 2008 1,480 45,000 5,000 $ 45,000 We usually must force depreciation expense in the last year so that book value equals salvage value.  Partial-Year Depreciation Required when a plant asset is acquired during the year, depreciation is calculated for the fraction of the year the asset is owned. Most companies allocate to closest full month  Partial-Year Depreciation (Example) Equipment purchased on July 31, 2004. The equipment cost $65,000, has a useful life of 10 years and an estimated salvage value of $5,000. Calculate financial statement amounts at December 31, 2005. Depreciation = ($65,000 - $5,000) ÷ 10 = $6,000 per year 2004 expense = $6,000 × 7/12 = $3,500 2005 expense = $6,000 Accumulated depreciation 12-31-05 = $9,500 Book value at 12-31-05 = $65,000 - $9,500 = $55,500  Reporting Depreciation Property, plant, and equipment: Land and buildings $ 150,000 Machinery and equipment 200,000 Office furniture and equipment 175,000 Land improvements 50,000 Total $ 575,000 Less Accumulated depreciation (122,000) Net property, plant, and equipment $ 453,000 Principles of Forest Valuation Canesio D. Predo, PhD Associate Professor Institute of Renewable Natural Resources Valuation of Forest Land and Timber Stand Land and timber stand are basic capital of any forest enterprise Valuation of land and timber is a large concern − Investments are heavy, relatively permanent, and entail in full the many responsibilities of land ownership The long-range nature of timberland investments makes careful and searching application of appraisal techniques particularly important Valuation of Forest Land and Timber Stand Timberland market values (e.g. US) − based almost entirely on the conversion value of the timber stand currently in existence upon the land − with little or no regard for the possibilities of continued production of forest crops As forest areas are placed on a permanent timber-growing basis − Timberland increasingly will be valued, bought and sold on the basis of their productive capacity rather than on the value of currently standing timber as stumpage for conversion − Application of sound valuation methods based on land productivity is important for establishment of market prices for sound forest investment Valuation of Forest Land Land is one enduring resource of a permanent forest business Value of land for forest uses is derived from the forest crops or other services it can produce Factors Determining Forest Land Value Forest land takes its value from the crops it produces; estimation of this value necessarily requires measurements of these crops. The problem is to determine expectation value or contribution of the land itself Controlling Factors 1. Site quality 2. Kind and intensity of management practiced including its costs 3. Value of the product 4. Effect of time interval involved as measured by the rate of interest employed 1. Site Quality − inherent vigor of the site that measures the potential productivity of the forest − remains approximately constant irrespective of the character, condition, or quality of the timber stand currently occupying the area, except when land use practices have caused soil erosion, impoverishment or development of undesirable soil texture or structure 2. Kind and Intensity of Management Practices − Volume and quality of timber actually produced is influenced by the kind and intensity of management practices − Degree of promptness of regeneration, species composition, stocking and growth can be largely controlled by the silviculture practices applied − A given site may produce crops ranging from practically none to all of those approaching its biological potential − The cost of forest practices must be considered in relation to their efficacy 3. Value of the Product − Entails not only an estimate of what the products will bring in the market but also the cost of getting the products off the market − Accessibility factors are often of controlling importance in determining the value of the timber crop as it stands in the forest 4. Effect of time interval involved − Growing of timber takes time and usually a lot of time in relation to the length of most productive processes within the range of business experience − what rate of interest should be employed in bringing the various costs and income elements, incurred and received at widely differing times to a common point in time → Time preference of individuals or group is one factor involved: public owners have a relatively low time preference, indicating the use of a fairly low interest rate in considering public undertakings Individual owners who must operate in full exposure to competitive business pressures, have a higher time preference and can be expected to apply a rate at least as high as the ‘going’ rate for alternative investments Estimation of Forest Land Value for Even-aged Forest Direct estimate is to start with a price of bare land, and visualize establishment of a forest stand upon it A stand is grown to maturity, harvested, and the process started over again with no termination date to the series of income A particular plot soil yields a crop at periodic intervals only  Capital value of a series of permanent periodic income (Vo) a Vo = (1+i) − 1 n where: n = interval between incomes in the rotation assuming that all incomes are measured at or equated to their age (or rotation age) a = net income received at rotation age yielded i = interest rate Vo = capital value of permanent periodic income yielded from the soil; indicates the land value, which is also Se or expectation value  If all incomes were net and received at rotation age only − Se value could be determined by a simple capitalization process indicated by the above formula, provided net income and suitable rate of interest were equitably determined Incomes are seldom received all at one time however, and they are not net Expenses are also incurred at various times The various elements of cost and income pertinent to a particular plan of mgt must all be brought to a common point in time (rotation age) so that net income can be determined and capitalized Example: Cost and returns per acre for Southern pine managed on an even-aged basis for pulpwood on a rotation of 30 years and 5% interest rate Income or Cost and Value ($/acre) Formula for Accumulation Value of Interest Factor ($) Value of Income or Cost at Assumptions of Interest Rotation ($) INCOME Harvest yield at age 30 240.50 240.50 37.0 cords @ $6.50/cord Thinning at age 15 6.00 (1.05)15 2.0789 12.47 2 cords @ $3/cord Thinning at age 20 22.80 3.5 cords @ $4/cord 14.00 (1.05)10 1.6289 Thinning at age 25 44.67 7 cords @ $5/cord 35.00 (1.05)5 1.2763 Total Income 320.44 at Rotation Age COST Establishment in year 1 30.00 (1.05)29 4.1161 123.48 Annual protection, tax and (1.05)30 − 1 1.75 66.4388 116.27 administrative cost 0.05 Total Cost at Rotation Age 239.75 Net Income at Rotation 80.69 Age  Value of rotation age = 80.69 per acre Soil expectation value (Se) = capitalization of this value received once every 30 years: 80.60 Se = = 24.29 per acre (1.05) − 1 30 The general formula of this type of calculation can be written as: r −a r −b  (1 + i ) r − 1  r −a  (1 + i) r − 1  Yr + Ta (1 + i ) +Tb (1 + i ) + AR   − C (1 + i ) − S (1 + i ) − e  r   i   i  Se = (1 + i ) r − 1 where: Yr = yield at rotation age Ta, Tb, etc.= net value of thinning and other cuttings made at age a, b, etc. AR = annual incomes received from sale of grazing and hunting privileges C = cost of stand establishment Sa, Sb, etc. = net cost of stand improvement cuttings made at age a, b,, etc. e = annual expenses such as taxes, fire protection, administration, etc. r = length of rotation, years i = rate of interest expressed in decimal  Another formulation of soil expectation value: Se =  R(1 + i) r −t −  C (1 + i) r −t (1 + i) r − 1 The numerator represents the net income estimated at the rotation age If this value is divided by (1+i)r-1, the results indicates the capital of an indefinite number of such income, each received r years apart. If the income is received for only one rotation period, the denominator would be (1+i)r only, following the usual procedure for discounting the value of a single permanent due r years in the future The -1 makes all the difference between a single and permanent period income  Using the earlier example, the present value of the single net income of $80.69 due 30 years is: 80.69 80.69 Vo = 30 = = 18.67 (1.05) 4.3219 The value of a permanent periodic income or the Se value was determined as $24.29, or $5.62 more. The difference seems small but checks with the practical observation that promise to pay something every 30 years is not worth much more than a promise to pay it once Theoretically, this amount could be put at interest for 30 years at which time it would accumulate to $5.62(1.05)30 or $24.49. The $18.67 periodic income could be paid out of this fund leaving $5.62 and the process could start all over again Significance of Forest Land Values Se estimation includes all the factors affecting land values: 1. Site quality – integrated in the physical level of productivity estimated 2. Cost of management – embodied in the cost assumed 3. Market and accessibility factors – enters into stumpage prices used 4. Time element – represented by the rate of interest used Practical Implications for Se Se values are extremely sensitive in the rate of interest employed. − Example: for 100 years rotations every fraction of a percent makes a sizable difference both in cost accumulation and in capitalizing net income − If Se values is used as a measure of rotations, the nature of the capitalization process inflates capitalized value when the rate is low or vice versa Se calculation focuses attention on the costs and return of building up of a forest on bare land − guide to forest land value indicating ceiling prices that could be paid on sound investment basis  Se values give a useful guide to the desirable length of the rotation − At reasonable rates, they gives a good indication of the most profitable rotation − Rotation of highest Se values fall somewhere in between that indicated by the culmination of the mean annual increment & by max mean annual forest rent The ground level of Se values in a forest area is of broad regional significance − Brings out clearly whether a forest once destroyed can be rebuilt on anything approaching a private business basis Valuation of Timber Stand Value of timber stand is subject to current change as the stand grows; in contrast to land value since land does not grow As the timber approaches maturity, its value is increasingly represented by: a. Market value of the standing timber for immediate conversion, plus b. Whatever residual land value General Approaches to Valuation of Timber Stand Current market value – based on comparable timber stand. In places where forest production is done by private individuals, there are areas where market prices are fairly established Cost value – the determination of cost value of a stand at a given age is a matter of looking backward to answer what has been harvested. This is a natural approach for the following reasons: − it measures the degree of success or failure of the investment made − it is an important basis in the event of damage when question of loss incurred is faced Income values – estimation of future returns; estimating present net worth of all future incomes (less costs) that reasonably maybe expected Estimation of Cost and Income for an Even-aged Stand Determination of cost and income values for even-aged stands following logically from those used in land value determination except that the focus is on the stand, and either actual or assumed land values are used A. Cost value ▪ Estimate for a stand of given age, the net present worth; at some assumed rate of interest of all past expenditures ▪ Income during the period be naturally deducted ▪ Land value need to be included and logically it should be what the land actually cost ▪ In calculating cost value only, the Se value cannot be determined separately since we have excluded future income in the determination of cost value. Se value determination requires that all cost and revenues within the rotation period be considered.  Cost Value per Acre of an Even-Aged Southern Pine Stand at Age 15 (Interest at 5 percent) Receipt or expenditure Value per acre Formula for Value of interest Value at item accumulation factor age 15 Expenditures: Purchase cost of land $ 20.00 (1.05)15 2.0789 $41.58 Site preparation and 30.00 (1.05)14a 1.9789 59.40 planting Annual costs 1.75 (1.05)15-1 21.5786 37.76 0.05 Total expenditures $138.74 Thinning at age 15 6.00 6.00 Next value at age 15 $132.74 B. Income Value ▪ Determined according to the same general procedure except that the viewpoint is forwarded and only future incomes and expected costs are included instead of past cost and income ▪ Arbitrary land value at the end of the rotation is assumed ▪ The income value is a discounted value 26  Income Value Per Acre of an Even-Aged Southern Pine Stand at Age 15, Rotation 30 years (Interest at 5 percent) Receipt or expenditure item Value per acre Formula for discount Value of interest Value at factor age 15 Receipts: Estimated land value at $ 30.00 1/(1.05)^15 0.4810 $14.43 rotation age Major harvest cut at 240.50 1/(1.05)^10 0.4810 115.68 rotation age Thinning at age 20 14.00 1 /(1.05)^5 0.7835 10.97 Thinning at age 25 35.00 1/(1.05)^10 0.6139 21.49 Total receipts $162.57 Expenditures: (1.05)15-1 Annual costs 1.75 10.3797 18.16 0.05 (1.05)15 Net value at age 15 $144.41 Source: Davis p. 368 27 Alternative: Each item could have been individually discounted instead of carrying them all to the end of the rotation Land value can logically be estimated separately from the timber value, since such a value would reappear at the end of the rotation when the major crop is harvested. The bare land could presumably be sold as such and becomes an element of future value to consider in exactly the same way as an expected future timber value Cost and expectation values are determined by: » Cost considers what has happened » Expectation value considers what is expected to happen Relationship between cost and income value Land value – one element common to both In the illustration, exactly the same assumptions were employed as were used in the determination of a land or Se value except that estimated actual cost or market values for the land were assumed. If the calculated Se value have been used as the land value in both cases, cost and income values would have been identical 29 Cost and Income Values per acre of an even-aged southern pine stand at age 15 when rotation is 30 years (interest at 5 percent) Receipt or Value Formula for accumulation Value of Interest Value at age 15 expenditure item per acre or discount factor Cost value Expenditures: Land value (Le) $24.29 (1.05)15 2.0789 $50.50 Site preparation and 30.00 (1.05)15 1.9799 59.40 planting 1.05 15 − 1 Annual costs 1.75 21.5786 37.76 0.05 Total expenditures 147.66 Receipts: Thinning at age 15 6.00 6.00 Net value at age 15 141.66 Income value Receipts: Land value at rotation $24.29 1 0.4810 11.68 1.05 15 age Major harvest cut at 240.50 1 0.4810 115.68 1.05 15 rotation age Thinning at age 20 14.00 1 0.7835 10.97 1.05 15 Thinning at age 35 35.00 1 0.6139 21.49 1.05 15 Total receipts $159.82 Expenditures: 1.05 15 − 1 Annual costs 1.75 10.3797 18.16 0.05 1.05 15 Net value at age 15 $141.66  Cost or income value – for a timber stand can only be calculated when there is a timber stand on the ground. Income values for uneven-aged stands 1. Cost value cannot be determined in uneven-aged stand since the stand is never developed directly on bare land. 2. Land value never exists separately from timber value unless the forest is destroyed. Valuation of the regulated forest (even-aged management) Common forestry business situation – is a forest organized for sustained yield. Income in more or less equal amounts are received each year and expenses are currently paid. The difference represents the yearly operating proft or loss as the case may be. 32 c. Valuation of stumpage Stumpage – timber in unprocessed form as it is found in the woods, most frequently, standing timber whether live or dead. It can also be applied to timber wind-thrown in connection with right-of-way clearing as long as it is not cut up into logs and other merchantable unit. Importance of stumpage valuation Valuation of stumpage – is of direct and immediate concern to almost anyone concerned with a timber business. It is the raw material of the forest from which all woods are derived. 33  Stumpage Valuation Canesio D. Predo, PhD Institute of Renewable Natural Resources Stumpage valuation Stumpage – standing merchantable timber Stumpage value – the value of the standing merchantable tree Formula: SV = S – C – M Where S = selling price/m3 of the product derived from stumpage C = production cost /m3 M = margin for profit and risk (%); in overturn method, *M is expressed as a % age of direct production cost Income valuation Based on the present value of all future net incomes of a resource Need to discount future net incomes to the time when valuation is adone Can be used to value existing timber stand grown under even- aged or uneven-aged management Income valuation: Even-aged Stands Assume termination date for the stand, which is the end of the rotation Can be done at any age of the rotation Assume arbitrary land value at the end of rotation, considered as future income Income valuation: Even-aged Stands Formula: 𝑅𝑛 𝐶𝑛 Income Value = ∑ −∑ 1+𝑖 𝑛−𝑡 1+𝑖 𝑛−𝑡 Where: t = the age when we value the stand n = any year within the rotation Rn = revenue that will be received in any year between t and the rotation Cn = cost that will be incurred in any year between t and the rotation i = discount rate Income valuation: Uneven-aged Stands If there are annual cuts, formula Formula: becomes: 𝑅𝐶 𝑎 Income Value = − 𝐸 Income Value = 𝑐 1+𝑖 −1 𝑖 Where: c = number of years in the cutting cycle Where a = net annual income Rc = stumpage value per cutting cycle i = discount rate E = capitalized value of annual expenses, or e/i e = annual expenses i = discount rate Cost valuation Can be applied to even-aged stands, including fruit tree plantations Compound all costs incurred prior to time of valuation Net cost/year = cost/year – receipt/year → Also consider cost of land, whether purchased (beginning- of-period) or rented (annual cost) Cost valuation Formula: 𝑡 ෍ 𝐶𝑛 1 + ⅈ 𝑡−𝑛 Income Value = 𝑛=0 Where: t = age when stand is valued n = any year prior to t Cn= net cost at year n i = discount rate Valuation of Ecosystem Services: Methods and Tools Canesio D. Predo, PhD Associate Professor Institute of Renewable Natural Resources Note: Most of the slides are from Luke Brander’s presentation at EEPSEA training Economic Value Economic value is defined in terms of a trade-off. If 1X = 100Y for some individuals, this means that no more and no less than the individual would be willing to exchange X for 100 units of Y. Question: Does the market price of a “good” measure its economic value?  Modern Definition of Economic Value Dupuit(1844) – The “maximum sacrifice expressed in money which each consumer would be willing to make in order to acquire an object” provides “the measure of the object’s utility.” Marshall (1879) – The “economic measure” of a satisfaction is“ that which a person would be just willing to pay for any satisfaction rather than go without it.”  Two ways to define trade-off between x & y 1. The maximum amount of Y the person would give to obtain X (the willingness to pay or WTP measure) 2. The minimum amount of Y the person would be willing to accept as compensation to forego X (the willingness to accept or WTA measure) Cost – measured in terms of foregone resources (opportunity cost) Value confused with cost. These are two entirely different concepts. Price measures cost, not the former. Valuation refers to estimation of economic value. Sometimes —people would use cost as a measure of value—but this is not correct, even if this is easier. Externality The emission of greenhouse gases imposes costs on others that are not borne by the emitter. The costs will be felt over a long time period and over the entire world. But, the exact nature of costs is uncertain: they will be shaped by policies, market mechanisms, & other events Private costs vs social costs Why Do Valuations? Benefit Cost Analysis / Resource Allocation Decision −Efficient choice in the use of scarce resources −Compare the worth of various options −Economic valuation is about being able to judge the relative value of alternatives Resource Pricing: Natural Resources Damage Assessment Natural Resources Accounting Designs of economic instruments (PES and other market-based instruments) Awareness raising (losses/opportunities)—behavioral change Measure opportunities from the environment change Distribution impacts (gainers and lossers) Awareness raising (losses/opportunities) – behavioral change  Total Economic Value Use Value Non-use Value Direct Indirect Option Existence Others Secondary Future Direct Goods and No Consumption Consumption of Consumption of Services, of Goods and Bequest values Goods and Primary Goods Including Services Services Ecological Timber, Fruits, Scenery, nut, herbs, latex, Biodiversity, Recreation, Wildlife, Biodiversity, guma arabic, Community litter, Fuelwood, Community Scenery, integrity, Wildlife, Biodiversity, Recreation, Forage and Climate mitigation, Integrity, Scenery Scenery, Wildlife Wildlife, Air, soil fodder, Developed Air quality, Soil recreation, Air, recreation and quality, Water soil and water and water quality hunting cycle, Biodiveristy quality  1. Physical / production linkages a. Market prices b. Replacement costs c. Damage costs d. Net factor income e. Production function approach Valuation methods 2. Behavioural linkages / revealed preferences a. Hedonic pricing method b. Travel cost method 3. Behavioural linkages / stated preferences a. Contingent valuation method b. Choice modelling 4. Value transfer  Market Valuation Non-market Valuation Techniques Techniques Physical Linkages Behavioural Linkages Dose-response Revealed Stated Functions Preference Preference Market prices Hedonic Pricing Contingent Valuation Method Replacement cost Travel Cost Method Choice Experiment Avoidance cost Method Production function Cost estimates Use values Use and non-use values Value Transfer 1. Physical / production linkages By observing the quantity of an environmental service or good and multiplying it by its market price, the value can be determined However, most environmental goods and services are not traded on a market a. Market prices - Straightforward and inexpensive, but rarely sufficient as a stand- alone valuation technique and ignores costs of other inputs b. Replacement cost Not a “correct” measure of economic value, as it is not based on people’s preferences for the goods and services valued. Difficult to find “exact” replacements of the goods and services valued. Replacement cost: step-by-step 1. Identify services provided by ecosystem. e.g. water storage by natural lake 2. Assess the extent to which services are used. e.g. quantity of water piped for use 3. Identify man-made replacements to provide equivalent level of service. e.g. dam and reservoir 4. Estimate costs of replacement (secondary sources, expert consultation) e.g. cost of constructing dam c. Damage cost avoided Useful for valuing ecosystems that provide some form of natural protection. Most cases of avoided damage remain hypothetical. Damage cost avoided: step-by-step 1. Identify protective services provided by ecosystem. e.g. protection of houses by mangrove 2. Assess the extent to which protection would decline with ecosystem loss. e.g. increase probability of flooding given degradation 3. Identify the infrastructure, property etc. that is affected by the change in protection. e.g. number of houses at risk of flooding 4. Estimate the cost of damage.a e.g. cost of repairing and rebuilding Cost-based approaches Pros: Data sometimes easy to obtain Straightforward, “easy” implementation and analysis Cons: Limited to cases where market/shadow prices are available Benefit is not equal to cost – second best approach Is the restored/replaced environment equivalent? Is the value lower because it is no longer authentic? Avoidance cost: damage is often hypothetical d. Net factor income Values ecosystem services as an input in the production of a marketed good. Value of output minus cost of other inputs. e.g: Wetland value = Fish catch*Price - (Boats*Price + Labour*Wage) Only a rough approximation of value. Suggests that all producer surplus is due to ecosystem input. e. Production function approach − Environmental resource services are inputs in production (often unpaid for) − Production function method values ecosystem services as inputs in production of commercially marketed goods  Step-by-step: Production function method Steps Example 1. Identify ecosystem service Role of bees in pollination 2. Identify related production process Production of coffee 3. Determine statistical relationship Output [coffee sale] = Inputs ƒ [labour, between inputs and output land, climate, fertilizer, pesticides, bee density]4r Step-by-step: Production function method (cont.) Steps Example 4. Estimate net revenues using With an estimated bee density of 1000 above production function “with per hectare, the net-revenue of coffee conservation” is estimated at $10,000 per hectare 5. Estimate net revenues using With a bee density of 500 per hectare, above production function “without the net-revenue of coffee is estimated conservation” at $4,000 per hectare 6. Calculate the change in net Pollination value has declined by revenues $6000 per hectare Production function approaches Pros: Reveals actual environment – economy linkages Cons: Only useful for valuation of ecosystem services that are inputs in production of marketed goods (not for non-use values) Method can become complicated – dose- response relationship can be complex Price of marketed goods depends on many other factors  Which goods/services provided by a tropical forest could we value using the production function approach? Lumber Tourism Water supply regulation Fire prevention Biodiversity Existence value Flood/landslide prevention Carbon sequestration 2. Revealed preference valuation methods Looks at decisions people make in reaction to changes in environmental quality – in markets Indirect approach Measures direct use values a. Hedonic Pricing The monetary value of environmental attributes can be valued by comparing house prices with different surroundings  Step-by-step: Hedonic pricing method Steps Example 1. Identify ecosystem service City park providing recreation opportunities and views 2. Collect data on sales and House sales, location, structural, characteristics of associated good neighbourhood, environmental characteristics 3. Estimate hedonic price function Estimate how much more people pay relating price with characteristics for houses close to the park Applications of hedonic pricing: Property (houses) −Differences in house prices reveal willingness to pay for environmental amenities or to avoid disamenities. −E.g. proximity to parks, lakes and beaches, air quality, proximity to hazardous waste sites, flood risk. Wages −Differences in wages reveal willingness to accept. −What environmental impacts does this value? Hedonic Pricing Pros: Looks at actual behaviour Prices for houses often readily available – costly to obtain!!! Cons: Can only value environmental services that affect prices of marketed goods. Captures perceived differences in environmental attributes. Requires high level statistical expertise. b. Travel cost method − For valuing recreational sites, e.g. parks, forests, coral reefs − Travel cost to a site can be regarded as the price of access to the site (indirect method).  Step-by-step: Travel cost method Steps Example 1. Identify ecosystem service Aesthetic aspects of coral reefs generating recreational value 2. Define set of distance zones around geographic divisions of visitors to the the recreational site coral reef 3. Collect visitor information for each cost incurred, motives, frequency, site zone attributes, socio-economic variables  Step-by-step: Travel cost method (cont.) Steps Example 4. Calculate average travel cost /time per $500 / 5 hours from California to Hawaii; zone $1500 / 24 hours from Europe to Hawaii 5. Estimate statistical demand function The higher the cost, the less likely will be a visit, thereby reducing visitation rate from the far zones. 6. Collect (secondary) information from Number of visits to Hawaii each zone about visits 7. Estimate total benefit by calculating the area under the demand curve at the the consumer surplus current number of visitors Travel cost example: Recreational value Hawaiian reefs Source: van Beukering et al. 2001  TCM Example: Coral reefs in Hawaii Number of Reef associated Total travel Visitation rate Zone # Zone name active marine consumer surplus per costs