Term Paper on Forest Resource Economics and Project Analysis

Topic: A Hypothetical Forestry Project with All Possible Cost and Benefit Streams with the
Calculation of Cost Benefit Ratio (B/C Ratio), Net Present Value (NPV), Internal Rate of
Return (IRR) and Land Expectation Value (LEV) in order to Fix the Financial Rotation
Age of the Forest

Submitted By
Md. Shaidul Islam
ID- 16208011
MS Forestry
Session: 2019-2020
Course No. FOR 502
A Hypothetical Forestry Project with All Possible Cost and Benefit
Streams with the Calculation of Cost Benefit Ratio (B/C Ratio), Net
Present Value (NPV), Internal Rate of Return (IRR) and Land
Expectation Value (LEV) in order to Fix the Financial Rotation Age
of the Forest
Introduction:
Benefit-cost ratio (BCR), net present value (NPV), internal rate of return (IRR) and land
expectation value (LEV) are all important financial metrics used in decision-making processes.
Rotation is guided by the management objectives.
Information and Records Needed to evaluate Forestry Investment
When making forest-management and investment decisions, need good information. This section
covers some basic terminology you need to know and information you need to collect and maintain
to help you analyze forestry investments.
a) Investment period: A timberland investment, like any other investment, has a certain
investment period, or timeframe that must be taken into account. This timeframe is called
the rotation. The rotation age is the time it takes for a tree to grow from a seedling to a
merchantable size. Rotation varies from species to species.
b) Site Index: To know how much forest investment will be worth in the future, one must
know what kind and how much timber will be growing in your forest at any given time.
The rate at which timber will grow depends on the tree species and the capability of the
land to grow trees. This ability is referred to as the site index.
c) Growth and Yield: Another factor to consider when estimating forest values is how trees
will grow. Forest stand growth can be projected through the use of a growth and yield
model or a stand table projection. These models will project the volume of wood produced
throughout the rotation and may include management variables such as thinning, herbicide,
and fertilization treatments
d) Discount Rate: The discount rate is a key component in any investment. The discount rate
may be the interest rate associated with borrowing money to complete forestry activities.
If a loan is not needed, the landowner may have forgone other investment opportunities to
complete those activities. In this case, the discount rate would be the rate the timberland
investment would need to exceed to be viable. Nonindustrial, private landowners should
consider how much money they could make on other investments when determining if
investing in timberland is a good option for them
e) Costs: Costs associated with a piece of timberland may include the purchase price of the
land, site preparation, seedlings, planting, herbicide treatments, fire line and road
construction, pre-commercial thinning, and annual taxes, although not every landowner
will have all of these expenses. Costs should be tracked and documented because they are
truly investments in the future of your forests. For information on current costs of forest-
 management practices, contact your county Cooperative Extension System office or a
registered forester or land manager.
f) Revenue: Revenue from forestland may occur on a regular basis, such as income from
hunting permits or pine-straw raking, or it may occur periodically from timber harvests.
Revenues from timber sales will differ based on the area, time of year, weather patterns,
and general market behavior.
g) Cost-Share Programs: Landowners can apply for cost-share programs to help offset some
of the costs associated with forest management, such as planting and forest-stand
establishment. These plans change from time to time and often have set times established
for when a landowner may apply. While these programs can be of great help to landowners,
they may have limitations as well. Be sure to understand all requirements and expectations
before signing up for any assistance program.
h) Taxes: Beyond basic land taxes, this can be a very complicated topic and often requires
the assistance of a certified public accountant or tax attorney.
i) Net Present Value: NPV is a good way to evaluate long-term investments such as those
related to forestry because it provides a dollar amount of how much your investment will
return, at a given rotation length, with relation to the given discount rate. NPV is defined
as the difference between the present value of all future income and the present value of all
costs, at a given discount rate. In other words, it will tell you how much your forestry
investment will return. A positive NPV tells you that your investment will return more
money than another investment at the interest rate you choose for discounting. NPVs are
sometimes negative, which means that the investment is not financially practical. For
example, a negative $5,000.00 NPV means that the forestry investment would need
$5,000.00 more in revenue in today’s dollars to make a return
j) Benefit-Cost Ratio: B/C is used to analyze many investments, including timberland. This
ratio is used to determine if the revenues outweigh the costs. As an estimate of a project’s
return per dollar of investment, the value given by this ratio should always be greater than
or equal to one to be realistic. If the B/C of an investment is greater than one, the present
value of the revenues is equal to or greater than the present value of the costs associated
with a project.
k) Land Expectation Value: LEV is used to analyze the value of the timberland into
perpetuity. LEV uses the present value of all revenues and expenses to estimate how much
money can be produced in a timberland investment that will be managed as forestland
forever. You may also hear LEV referred to as soil expectation value, the Faustmann’s
formula, or bare land value. This measure is most commonly used to value even-aged forest
stands, although it can also be used to value uneven-aged stands. It is important to
remember that in analyzing investments using LEV, practices will continue in the same
manner endlessly. LEV is typically used for defining the best management practice and the
optimal rotation age for forest stands. NPV and LEV financial criteria are affected by site
quality, costs, prices, and interest rates. The site quality will affect the timber volume yield
and, therefore, the revenues gained. Variability in costs and prices will also affect these
two financial criteria. Interest rates, or discount rates, will affect these criteria also. When
 evaluating options, you must remember that present value should be greater than zero for
any investment to be feasible.
l) Internal Rate of Return: The Rate of Return (IRR) on an investment is the rate of
compound interest that’s “earned” by the funds invested. IRR is the average rate of capital
appreciation during the life of an investment.

Calculation of B/C Ratio, NPV, IRR: and LEV:

BCR: The BCR is a ratio that compares the present value of expected benefits to the present value
of expected costs over a period of time. It is used to determine whether an investment or project is
worth pursuing. A BCR greater than 1 indicates that the benefits outweigh the costs.
𝐏𝐫𝐞𝐬𝐞𝐧𝐭 𝐕𝐚𝐥𝐮𝐞 𝐨𝐟 𝐛𝐞𝐧𝐞𝐟𝐢𝐭𝐬
B/C ratio = 𝐏𝐫𝐞𝐬𝐞𝐧𝐭 𝐕𝐚𝐥𝐮𝐞 𝐨𝐟 𝐜𝐨𝐬𝐭𝐬

IRR: The IRR is the discount rate that makes the net present value of an investment equal to zero.
It is used to determine whether an investment or project will be profitable. An IRR greater than
the required rate of return indicates that the investment will be profitable. The following figure
gives an idea about how to calculate IRR. IRR can be calculated from the linear interpolation
which is given as follows:

NPVLR −0
LR + (HR – LR) (NPV )
LR − NPVHR

Where; LR = Lower rate and HR = higher rate

Figure 1: Calculation IRR from NPV.

NPV:
i. Future Value, FV = (PV) (1 + i)n
 ii. Present Value, PV = FV /(1 + i) n
iii. Interest Rate, i = [FV/ PV] 1 / n-1
iv. Number of periods, n = ln (FV / PV)/ ln (1 + i)
LEV: For a specific project with more than two values on the cash-flow diagram, IRR can be
estimated using a systematic process to find the “i” that makes the present value of the revenues
and the present value of the costs equal. and LEV: Land Expectation Value (LEV) is an estimate
of the value of a tract of land for growing timber. It is the Net Present Value of all revenues and
costs associated with growing timber on the land (not just those associated with one rotation or
other time period). LEV is thus a special case of NPV – it’s NPV where all present and future
revenues and costs expected from a tract of land are considered. LEV can be interpreted as the
maximum price you can pay for a tract of land for growing timber, if you expect to earn a rate of
return greater than or equal to the discount rate used to calculate LEV.
LEV = Net Value in Year n/ (1 + i)n-1
Hypothetical investment information: (Benefits
((Tk/ha)

PV (Net

FV (Net
Return)

Return)
(Tk/ha)

(Tk/ha)
Return

Return

(Cost)
Gross

Ratio
Total

NPV

LEV
Cost

IRR
Age

)B/C
)Net

PV

PV

4593814
-101500

-101500

-101500
101500

101500
0

-
5204814
-126500

-115000

-216500
25000

22727
1

-
6601867
-176500

-145868

-362368
50000

41322
2

-
6783788
-199500

-149887

-512255
23000

17280
3

-
4482339
-159500

-611292
-99037
10000

50000

31046
6209
5

-
2085204
-119500

-657364
100000

-46072
10000

38554
3855
9

-
42 40 35 33 30 25 23 20 18 15 10

50000 20000 10000 10000 12000 7000 14500 5000 10000 20000 20000

1876024 1876028 1866695 1848212 1478570 1344155 1120129 829725 638250 555000 200000

1478024 1528028 1538695 1530212 1170570 1048155 831129 555225 368750 295500 -39500

913 442 356 431 688 587 1619 743 1799 4788 6373

34257 41451 66425 79578 84735 112782 125094 123333 114795 132863 63726

0 0 0 0 0 1 1 1 1 1 0

26989 33762 54753 65886 67084 87946 92819 82531 66323 70740 -12586

-21118 -48107 -81869 -136622 -202508 -269592 -357537 -450356 -532887 -599210 -669950

1221508 1528028 2478083 2981951 3036157 3980365 4200916 3735276 3001726 3201656 -569629

22720 34524 91434 134170 184576 364563 528131 652165 658285 1007682 -266378

29% 28% 27% 25% 23% 19% 14% 5% -7% -26%

 1853512

1385512

860294
70000

25429

19008

11967
-2110

29%
960
43

0
1838684

1345684

627771
25000

18952

13871

11761

6538

30%
258
44

0
1562881

1049881

404775
20000

13313

20704
8943

3478

30%
170
45

0
Table1: The hypothetical data for forest-management and investment decision
The analyses shows that maximum BCR is 1 and LEV is 1007682 at the year 15th. But NPV and
IRR worth for investment reveals that year 45th will yield the maximum timber.
Conclusion: The forestry sector is viewed as part of the solution to balance economic growth with
conservation and ensure sustainable development. Forest economics addresses the economic
problems involving in buying, selling and management of forest land used for water resources,
wildlife and some other produce. Rotation is an important factor in the regulation of yield and
proper management of the forest as a whole. Management objectives determine the fixation of
rotation. Therefore, rotation should be fixed carefully.
References:
Bullard, Steven H. & Straka, Thomas J. (2011). "Basic Concepts in Forest Valuation and
Investment Analysis: Edition 3.0". Faculty Publications. 460.
https://scholarworks.sfasu.edu/forestry/460
Barlow, B.; Bowen, T., Bowen, J., & Cooke, J. A. (2014). Guide to Analyze Forestry Potential.
Alabama Cooperative Extension System (Alabama A&M University and Auburn University),
32pp.