The performance of forestry investments is usually evaluated by measures of net
present worth and internal rate of return. These measures for your property are presented in the per acre profitability report at the end of your inventory, growth, and treatment data by YIELD-MS, the
growth and treatment program of INFORM, an integrated system of forestry software programs. The following will explain the meaning of these measures and what went into calculating the results for your
NET PRESENT WORTH
Net present worth is the present value of future returns minus the present value of future costs. It's possible to calculate the present value of a
future return or cost by a technique called discounting. Discounting is essentially the reverse of compounding. To illustrate, if you estimate that you will need $1,000 in 10 years, how much
money would you have to invest now at 6% compound interest to produce that $1,000? The amount would be the present value of the $1,000 discounted at 6% compound interest.
discount rate for returns in the 10 to 20 year time frame are generally pegged to returns on treasury bonds of the same maturity. At present, these rates are 6-8%. But these rates include the
anticipated rate of inflation for the time frame. The real interest or discount rate
for treasury bonds would be lower by the rate of inflation which is currently 3-4%. This means a 3-4% real interest or discount rate.
Your simulations are done in real, or net-of-inflation
terms. Inflation is not included in the simulations because it is so hard to predict. I normally use a real discount rate of 6% in creating profitability reports because forestry investments are less liquid and less secure than treasury bonds.
If the rate of return earned by the investment is greater than the discount rate, the net present worth will be greater than zero. If not, it will be less than zero. Most owners are satisfied
if their forest investments can grow faster than the discount rate. This rate is easily achieved by most forest stands.
INTERNAL RATE OF RETURN
Internal rate of return is the rate of interest at which discounted returns equal discounted costs. Returns are from sales of timber and land, although there may also be lease
fees, tax savings, etc. Costs include land and timber purchases, taxes, forester's fees, timber stand improvement, etc. The internal rate of return assumes that the returns from sales of timber
during the management period will be re-invested in the project. This may be an unrealistic assumption where internal rates of return of the project are higher than those obtained from other
COMPOSITE RATE OF RETURN
The composite rate of return assumes that returns from sales will be invested at the discount rate
rather than the internal rate. It is therefore a more realistic rate of return. The composite rate of return is nearly always lower than the internal rate.
ANNUAL EQUIVALENT VALUE
Annual equivalent value is the net present value expressed as an annuity
over the time period of the simulation. It can be viewed as an annual bonus earned above the discount rate. It is a useful measure for comparing investments of unequal length. For instance, it might be useful in comparing the periodic returns of forestry investments with the annual returns of agricultural investments.
Your report also includes discounted benefit/cost ratio and soil expectation value. The former is another measure of profitability for the time period analyzed. The
latter is the discounted value of presumed future returns on the same frequency--15 years in this case. This measure is of course irrelevent to your simulation because the theoretical cleacut would
remove all the timber and growing stock.
UNDERLYING ASSUMPTIONS AND METHODS
Your financial analysis assumes that the present inventory value of timber and growing stock is the
starting point or basis of the investment. This is done in order to calculate the performance of the timber investment, even though you may not actually have that much invested in the
trees--particularly if you've owned the land for some period of time.
If the total initial investment in a forest property is divided among catagories of timber and growing stock, bare land,
houselots and buildings, the actual investment in the timber is usually less than its full inventory value. In any case, the latter value is the one used for your investment analysis. This
investment basis is depleted by the value of any initial thinnings or harvests and the balance is carried to the end of the simulation period as the adjusted cost basis.
Chapter 61 taxes and
forester's fees are added to the cost basis over the simulation time period. Chapter 61 land taxes are added on an annual basis. Chapter 61 stumpage taxes are added to the expenses of sales as
percentages. Fees may be for management planning, boundary work, timber marking and sales, etc.
At the end of the simulation period the stand or forest is theoretically clearcut to make the program
perform its financial analysis. The program divides the final net value by the adjusted cost basis to determine the present net worth, internal rate of return, and the other measures of
profitiabiliy. In reality, your forest stands will be partially cut again towards the end of the simulation period.
I separate the investment in land from the investment in
timber because land values grow according to different and less predictable criteria. For example, during the 1970's land values increased dramatically. This was during a period of
when other investments were less attractive. Many investors bought land and other real property. Increased demand forced land values up. As inflation fell in the 1980's, investors took their money out of land and put it into stocks and bonds. As a result, the value of land went down to the point where now in real (uninflated) terms it's at a 20 year low.
A future increase in inflation would probably cause land values to rise again. But absent such an increase, they should stabilize or increase slightly from their current low levels. Houselot values
are of course a different subject because there is much less land suitable for development. The prices of houselots have continued to rise in real terms through the 1980's and early 1990's.
VOLUME INCREASE RATES
As trees grow in diameter and height, their volumes increase. The 15 year simulation shown in your growth report is for the residual stand after the first cut.
It depicts how your forest will grow in basal area, Mbf, and cords per acre. It also shows how the forest will grow in value (exclusive of market value increases--see below).
rates are influenced by species composition, stand age and site quality. The inventory determines species composition. Increment borings determine age and soil maps determine site quality.
The program adds ingrowth from trees too small to appear in the inventory. It also deletes trees from the inventory according to predetermined mortality rates for different species. Net total
volume increase rates will generally range between 3 and 5% per year.
GRADE VALUE INCREASE RATES
After an initial thinning, improvement harvest, or shelterwood cut, most residual trees will grow
about one inch in diameter every 5 years. In my grading system, tree grades are based on 2 inch diameter classes and clearness of the butt log. Therefore residual trees without serious defects
will increase by at least one grade during a 15 year simulation.
Grades were assigned to all the trees in your inventory according to my specifications. As YIELD-MS grows your inventory, it
increases grade and value of predetermined proportions of the inventory as they meet the diameter requirements for the next tree grade.
Since the unit value (per Mbf value) of high grade species increases
by 50-100% with each increase in grade, the residual trees representing most of the value in a stand will nearly double in grade (unit) value every 15 years. This usually translates to a
3-4% real grade value increase rate. Lower value species will show lower rates of grade value increase.
MARKET VALUE INCREASE RATES
Different species have shown dramatically different
rates of market value increase in recent years, including some very high rates for the more valuable species. However, projecting these rates into the future may be overly optimistic. A
conservative estimate would put real market value increase rates in the range of 0-5%, depending on the species and grade, for the term of your simulation.