A report assessing viability of an olive

farm investment project

Prepared for Dan Franchi

Submitted for Review December 9,

2018

Olives In Your
Backyard

Joshua Castle and Matt Steensma

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Table of Contents
LIST OF TABLES AND FIGURES II

EXECUTIVE SUMMARY III

ABSTRACT 1

ASSUMPTIONS 1
VARIABLES WITH SIGNIFICANT UNCERTAINTIES 2

ENGINEERING ECONOMICS JUSTIFICATION 2

ASSESSMENT OF UNCERTAINTIES, SENSITIVITIES AND RISKS 4

CONCLUSION 5

WORK CITED 5

APPENDIX 6

List of Tables and Figures

Table I. Olive Farm Assets and Corresponding Value.................................................................... 1
Figure 1: Initial Costs Pie Chart.................................................................................................... 3
Figure 2: Annual Expenses Pie Chart ............................................................................................. 3
Figure 3: IRR Sensitivity Plot.......................................................................................................... 4
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Executive Summary

The following report analyzes an investment towards an olive farm. The options for this
investment are to either make the investment or to do nothing. The investment has been mostly
characterized; the projected investments, costs, and revenue have been researched and are
defined in a written document with upper and lower bounds on some of the more critical
values. Of those values, the initial investment is a 415,000 USD payment that is followed by
smaller secondary investments throughout the first three years of the project. The revenues and
expenses start with a three-year ramp up, and by the end of the third year, the values are
projected to reach year-to-year consistency with a positive difference. At the end of year ten, the
farm can be sold for 800,000 USD. The specific values for each of the required items are further
defined in the report. Ultimately, the farm’s goal is to produce olives, as olive oil is a profitable
export.

The olive farm is expected to be profitable, as the internal rate of return after the ten-year period
is 17.2%, which is above the MARR of 12%. In addition, the olive farm pays itself back in a
little less than seven years, meaning the investment will not be at a net loss to the investor. After
looking at sensitivity and any external risks, we determined that the farm should be a fruitful
investment so long as the production of olives stays above 79% of the projected production
value: or the farm must make at least 59.3 tons of oils every year after the third year. After
researching California’s environment and the ideal growing conditions for oil trees, we
determined that the farm should be able to meet the yearly production value, even with the
drought, because these already mature trees can withstand severe drought conditions. The
salvage value is a somewhat critical feature in meeting an IRR above the MARR at 12%. The
investor would need to meet a salvage value of at least 300,000 USD in order to stay above the
MARR. Since the land was purchased for 415,000 USD, we are confident that the investor will
be able to make back at least 300,000 USD. In fact, with the value of land continuous growing in
the state, the probability of the land itself decreasing in value is unlikely. Even if there was a
wildfire that burned most of the land’s assets, the land itself still holds a fair amount of value.
While it is important to note the effect of the salvage value, for this case we do not find the
salvage value to be a major risk. We recommend investing in the olive farm.
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Abstract

An individual is interested in purchasing an olive farm as a long-term investment. They are

prepared to initially lose money in the first couple years of development in order to save money
on taxes by utilizing another investment. The cost for this orchard is 415,000 USD but the
expected salvage value is 8000,000 USD at the end of a ten-year
investment period. The minimum attractive rate of return is 12% over this investment period.

The 40-acre orchard will have olive trees are planted on 15 acres. The purchase price includes
the assets listed in the table below:

Asset Value
3000 Olive Trees 50 USD per tree
2 Wells 10,000 USD per well
1 Solar Powered Pumping System 6,000 USD
1 Large Barn and 1 Small Building 40,000 USD
3 miles of Fencing 4.50 USD per foot
2 miles of Dirt Roads 10,000 USD
5 Gates 1,200 USD each
20,000 feet of Irrigation .40 USD per foot
15 acres Worth of Underground Piping 12,000 USD
1 Storage Tank 5,000 USD
Table I. Olive Farm Assets and Corresponding Value

Assumptions

We implemented the following assumptions in our investment calculations:

• Olive trees are seven-year MACRS while all other assets are five-year MACRS
• The value of the raw land, net after subtracting the value of the above assets, is not
depreciable
• Well repairs of 1,000 USD will be necessary each year
• Expected output is 5 tons of olives per acre that will ramp up from 30% output the first
year to 60% in year two and 100% in year three
• Olives will be pressed into oil and the pressing process will yield 50 gallons of extra
virgin olive oil per ton of olives
• Extra virgin olive oil can be sold for 40 USD a gallon with expenses of 6 USD per bottle
• 20% of the olive oil could be sold retail for 18 USD per half-quart with expenses of
4 USD a bottle plus olive oil
• Picking costs are 450 USD per ton of olives
• Transportation costs to oil press is 80 USD per ton of olives
• Using the press costs 210 USD per hour and press is capable of handling .5 tons per hour
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Variables with Significant Uncertainties

• Production of olives can vary from 50% to 125% of expected value based on rainfall
• Selling price of a gallon of olive oil ranged from 30 to 50 USD in the last year depending
on demand.
• Annual operating and maintenance expenses are 18,000 USD but can vary by up to 25%
in each direction

Engineering Economics Justification

The olive farm is projected to ramp up production over the first three years, as the trees
themselves and the production processes will be refined with time. Over the first three
years, production of olives is expected to increase from 30 percent in year one to 60 percent in
year two, until the olive farm is operating at full production in the third year. It is important to
note that other investments, such as the purchase of a tractor and storage bins, define the time
period for ramp up. If the olive farmer had invested in these items before year one, production
rate for year one would have started high and reached full production sooner
than three years. This would also influence the taxes, as these items would have
increased the negative taxes for the first couple of years. However, looking past the first few
years at the current financial plan, the annual return will remain relatively constant from the end
of year three until the end of year ten, because all the investments are taken care of and the
revenue and expenses both decrease their year-to-year variability.

The total initial investment of 415,000 USD is comprised of two categories: the land has a
projected value of 86,720 USD and the total investments necessary to begin olive production
total to a value of 328,280 USD. As mentioned above, five other investments are made over the
course of three years to increase production, and these investments add to a total value of 58,600
USD. After year three, no additional investments are required for the ten years. The percentage
that each investment contributes to the olive farm can be seen below in figure 1.
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Figure 1: Initial Costs Pie Chart

Expenses will increase with the amount of olives produced, as a decent amount of the expenses
are based on olive production. Once the olives are produced on the tree, they must be picked,
moved, pressed, and bottled. In addition, the olive farm itself has constant operating cost that is
expected to stay within ± 4500 USD of 18,000 USD. If the projected annual output of olives
remains constant, it is expected that expenses will total an approximate value of 135,000 USD. A
breakdown of the annual expenses can be found below in figure 2.

Figure 2: Annual Expenses Pie Chart

The annual revenue is proportional to the amount of olives produced, as the olive farm’s only
export is olive oil. The success of the oil farm is contingent on the success of the olives, which is
why most of the expenses are focused on olive production instead of other farming expenses.
Once the expected output of olives reaches a constant rate of full production, the annual revenue
is expected to be about 228,000 USD. Of course, it would benefit the farmer if they were able to
sell more oil olive at retail. Comparing the annual wholesale revenue to the annual retail revenue
after year three, there is only a 12,000 USD difference; however, 80% of the olives are allocated
to wholesale production while only 20% of the olives are allocated to retail production. We are
assuming the market for retail olive oil is not as consistent, otherwise it would behoove the
farmer to focus more on the retail market.

After ten years, the olive farm is projected to acquire a net present value of 205,934 USD before
taxes and a net present value of 163,231 USD after taxes. Other metrics considered in calculating
the investments potential payoff were the internal rate of return (IRR) and payback period. The
projected IRR is 17.2%, which compared to the minimum annual rate of return at 12% shows the
investment to be favorable. In addition, the payback period for this olive farm is a little less than
seven years. With no additional investments needed and the revenue and expense values coming
to a consistent net positive value, the payback period is reasonable. Overall, judging this olive
farm without external factors makes this a solid investment; we would recommend.
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Assessment of Uncertainties, Sensitivities and Risks

Three variables are expected to have significant variance over the duration of the investment:
• The production of olives can vary between 50% and 125% of the expected annual
production
• The price of the olive oil can range between 75% and 125% of the expected price of
40 USD
• Maintenance expenses are expected to range between 75% and 125% of the expected
annual cost of 18,000 USD

Some of the effects of sensitivity changes have been mentioned above, but their effect on
the olive farm’s overall IRR can be visualized in the sensitivity plot in figure 3.

Figure 3: IRR Sensitivity Plot

This figure reveals that the production of olives has the greatest effect on the value of the
investment. This is a cause for some concern; if the worst-case scenario of expected
production occurs and the output of olives drops to 50%, then the IRR decreases to 5.1%. If all
other factors remain constant, a minimum of 79% of expected production is necessary to meet
the MARR of 12% over the ten-year period.

Figure 3 also shows that price olive oil can be sold at influences the appeal of the investment.
The project’s IRR remains greater than the MARR unless the price of olives sold drops below
60% of the expected value. Since the worst-case scenario of selling olive oil is projected at 75%,
we are confident that if other factors maintain their expected values, the investment will not drop
below the MARR as a result of decreased olive oil prices.

The salvage value is a somewhat critical feature in meeting an IRR above the MARR at 12%.
The investor would need to meet a salvage value of at least 300,000 USD in order to stay above
the MARR. Since the land was purchased for 415,000 USD, we are confident that the investor
will be able to make back at least 300,000 USD. In fact, with the value of land continuous
growing in the state, the probability of the land itself decreasing in value is unlikely. Even
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if there was a wildfire that burned most of the land’s assets, the land itself still holds a fair
amount of value. While it is important to note the effect of the salvage value, for this case we do
not find the salvage value to be a major risk.

Conclusion

Since the production of olive trees is the most vital component of this operation, an
understanding of external impacts is important before making the initial investment. California
has been in a drought since the early 2000s, and the livelihood of these trees is what will yield
the olives. A resource endorsed by the Florida Department of Agriculture and Consumer
Services informs us that, “Once established, olive trees are among the most drought-resistant
trees in the world, but porous soils such as Florida sand are very inefficient at retaining moisture;
olive trees in sandy soils must be watered often. You will have to water sufficiently to get your
tree established and thereafter as necessary during dry periods. No one can give you a formula
for that; you will have to observe and evaluate. Low volume spray irrigation can be used
effectively, but drip irrigation is of little or no use in sandy soils” (The Care and Feeding of
Olive Trees).

While California is in a drought, these trees are already four years old, meaning they are
somewhat established. Furthermore, California is known for having some of the best soil in the
world. Initially, the farm may experience some issues with trees not taking root, but if the trees
take root, they should be able to withstand the drought conditions and yield olives for
production. While environmental concerns are not the only factor – plant diseases
and wildfires are prevalent in California – you could argue that any land asset in the state is at
equal risk to these conditions. If we are evaluating this investment from a position of farming
one type of product compared to another, olive trees seem to be a strong choice, as the return on
investment after the ten period is impressive.

Work Cited

[1] “The Care and Feeding of Olive Trees.” Olive Tree Growers - Frequently Asked Questions
About Olive Trees, 9 Feb. 2015, olivetreegrowers.com/blog.php?view=detail&id=19.
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Appendix