At the interest used of 6 percent.

Of interest here is the huge discrepancy between our calculated bare land value of
$3.816.68 and the $100 value of land used in the analysis. If land was really worth this much
in terms of income produced and could be bought for $100, then we would expect all kinds of
the people to be buying land at $100 and growing Chirstmas trees. This would surely bid up
the prince of land above the $100 level. If this is such a good deal, why doesn’t everyone do
it? It is possible that the first people to plant trees make these returns, but as others come in
and increase supply, tree prices and earnings surely will fall.

By including land as a cost in the analysis. Rudolph was saying that all profit or
income was being attributed to the owner’s or maneger’s skill rather than to the land as a
capital asset. While it is always a debatable question how to split returns between
entrepreneurial skill and capital assets, most theorists assume you can hire managers at a cost
and thus attribute all net returns to capital (land).

An equivalent SEV for a fully regulated uneven-aged forest system with equal
harvests every cutting cycle can be calculated by the SEV equation (7-17) as

Where a = the net return each cutting cycle

w = the lenght of the cutting cycle in tears

Normalizing projects

Where two or more projects are being compared for porposes of choosing which one to
implement, the projects have to be comparable. To be completely comparable, projects need
to have the same number of years of project life, have a similar timing of cash flows, and be
of the same size in terms of invesment cost. Rearly are all these condition met.
Comparingsons of fertilization to precommercial thinning to site preparation to planting
projects, for example, involve different lengths and characteristic cash flow schedules.

To compare project fairly, the project need to be normalized to a common basis by

making a series of explicit assumptions and calculations. The general approach is to adjust all
projects to the lifetime of the longest project, to make explicit assumptions about how
intermediate revenues are reinvested, and to make explicit assumptions about the inflation
rate. We have already considered the issue of inflation, so here we consider adjustment for
project life and renivesment of intermediate revenues.

Different Project Leghts And The Reinvesment Rate

Consider two investment projects. The investor with 10,000 could either (1) buy 6- month
money market certificates and earn an 18 percent rate of return, or (2) purchase a 5-year
corporate bond that pays a 14 percent rate of return.

A simple comparison might suggest the money market certificate as preferable because of the
higher earning rate. But in making such a comparison, we take the 18 percent of the 6 month
note as its indicator of value relative to the bond. Thus we have implicitly assumed that every
6 months the investor will cash in the note and reinvest all the proceeds into another 6 month
certificate that earns exactly 18 percent. In fact, a total of 10 sequential but independent
invesments are needed over the 5 year life of the corporate bond. Is this likely? Will the
earning rate stay at 18 percent? Is there a cost in reinvesting every 6 months? These are some
of the question we should consider. The relevant comprasion is the future value, after 5 years,
of $10,000 invested today in each alternative. It may be that the longer term but lower yield
bond will perform better over the entire period.

To adjust, the analyst must first decide on the time period for project comparison. This can be
either a predetermined planning horizon or the length of the longest project. Secound, an
explicit earning rate for the reinvesment of project incoomes into new projects is needed.
Three assumptions about this reinvesment rate are possible.

1. New projects with exactly the same cash flows and thus earning rate as the initial
project can be found. If the initial project were, say, precommercial thinning of red
pine on site II lands, then this assumption requires that ample acreage of the same
type of project opportunity be available.
2. The proceeds of the initial project will be reinvested at the guiding interest rate.
3. The proceeds will be reinvested in some other kind of specified projects with known
earning rates that differ from the initial project and the guiding rate. This assumption
requires that the analyst have detailed knowledge about other future project.

To illustrate the dual adjusment for project length and reinvestment rate consider the
following pair of timber management invesments, one for 20 years and one for 60 years.

1. Project A- precommercial thinning of pine

Cost 100 per acre

Project length 20 years
Incrased value of haervest 1,374

Calculated project earning rate using

Guiding rate
2. Project B – planting cutover land to pine
Cost

To adjust and compare these project we must decide how the 1,374 received from
project A at year 20 is reinvested for the next 40 years. Consider three assumptions:
1. The 1,374 is reinvested at the project earning rate 14 percent
2. The
3. The

These
When prjoect b is compared to project A on the basis of worth, it obviously makes a
difference what reinvesment rate is assumed. The assuption of reinvesment opportunities in
similar projects does make project A superior. However, the other two reinvesment
assumption show project B preferable. Remember, reinvesment opportunities at the project
earning rate is the implied assumption made whenever projects of different lengths are
compared by the unnormarlized project earning rates. Seldom is this a good assumption and
comparisons on the basis of the project earning rates tend to be in error when differences in
project lengths are substantial. Since the analyst in many problems is looking 5 or more years
into the future before reinvesment tajes place, futurebeforte reinvesment takes place, future
opportunities are rather uncertain, and often the guiding rate ts the assumption that can be
made.

These adjustments to normalize projects are rather critical in longer term forestry projects and
need to be made carefully and explicitly in the specific of the decision maker and problem in
question.

The Realizable Rate return (RRR)

Because many people prefer to compare projects on the basis of earnings rates, an earning
rate of a project can be calculated thats is the weighted average return on the project,
considering the return on the initial invesment and the return on any reinvesments. This
earning rate is called the realizable rate return (RRR) and is calculated by finding the earning
rate that equates (1) the future value of earning at the end of the normalized project life using
specifed reinvesment assumptions for intermediate revenues to (2) the present value of all
costs, with intermediate costs discounted to the present at the same reinvesment rate as taht
for the intermediate revenues.

This formula will make both the adjusment for different project lengths and an adjusment for
intermediete costs and returns of any project. To illustrate calculation, the data from the
earlier comparison of project A (precommercial thinning) and project B (planting) can be
used. The intermediate revenue in this case is 1,374 form project A received at year 20.

To lisutrate, the RRR for the 8 percent reinvesment assummption was calculated using Eq.
(7-19) as
The comparison of the project based on RRR is consistent with the earlier comparison based
on normalized PNW. A detailed presentation of the RRR concept is presented by Schallau
and wirth (1980), followed by a spirited discussion by Klemperer (1981). We support the
recomendation of these authors to use the RRR as the correct general criterion to characterize
a project in term of an earning rate. It encompasses the traditonal internal Rate of Return
(IRR) criterion presented in Chap. 8 as well as the cases when the reinvesment rate is
different from the earning rate of the subject project.

QUESTIONS

7-1 Site preparation and planting a spruce-fir site to Douglas-fir costs 5250 per acre. When
mature at 100 years, the stand is expected to have 40,000 bd ft of sawlogs per acre. At future
stumpage prince of 100, 200, 300, and 400 per tousand. What is the earning rate of the
planting invesment at each price?

7-2 A loblolly pine stand is planted at a cost of 580 per acre is expected to have a total
stumpage value of 5,000 per acre when harvested in 60 years.

(a) At interest rates of 3, 6, and 9 percent, what is present value of the harvest?
(b) What is the present net worth (PNW) of the invesment at each guiding rate?

7-3 A ponderosa pine platation is expected to grow according to the following yield schedule
:

Planting cost are 100 per acre. Stumpage is expected to sell for 200 per M bd ft.

(a) What is the rotation age that maximizes the present net worth over one rotation at 4
and 8 percent guiding rates.
(b) Whats is the rotarion that maximizes the soil expection value (SEV) at 4 and 8 percent
guiding rates?
(c) Does the present net worth over one rotation give the same decision guidance as
SEV? Explain.

7-4 A genetic research program has discovered a new strain of ponderosa pine which
produces a 30 percent increase in harvest yield over in Question 7-3. The increased cost for
this seed runs $50 per planted acre.

(a) For rotations of 30, 50, and 90 years. What is the increase in harvest value of the stand
at rotation age?
(b) For each rotation calculate the present net worth of investing in the improved seed for
one 30-, 50-, and 90 years rotation at 4 percent and 8 percent. Under which condition
would it pay to buy the better seed?

7-5 An investment in precommercial thinning (PCT) of lodgepole pine costs $75 per acre.
The growth increase, when harvested 40 years after treatment, is an additional 5 M bd ft of
sawlogs and 10 cords of firewood. Stumpage prices are $100 per M bd ft for sawtimber and
$10 per cord for firewood, now and in the future.

(a) Calculate the earning rate on this future.

(b) What is the present net worth of the invesment at an interest rate of 10 percent?
(c) Would you recommend the treatment if the guiding interest rate were 10 percent?
(d) What is the maximum amount you could spend per acre for the treatment and realized
a 10 percent return on the invesment?

7-6 Jane Hawley inherited a wooded farm on Virginia’s Eastern Shore in late December of
1985. The farm had long been used for goose and deer hunting by a club that held a valid
lease signed by her father with 25 years yet to run. The lease required a payment of $15,000
to be made every years. The next payment is due in December 1986 and every 3 years
thereafter until the last payment in December 2010. Jane’s guiding rate is 10 percent.

(a) Calculate the present value of the hunting club lease as of December 1985 for purposes
of estimating inheritance taxes. (Use the periodic series equations.)
(b) If Jane put all the proceeds from the lease in a trust fund earning 8 percent, would there
be enough to send her twin sons to Harvard graduate school in 2010 for MBA’s when the
tuition is then expected to be $100,000 per student?

7-7 The average annual timer yield for a 2.500-acre management area was reduced from $30
per acre to $20 per acre by a prescription to enhance wildlife and domestic forage production.
If the increase in forage is valued at 51.50 per acre per year, what is the present value of
increased wildlife benefits for the whole management area needed to equal the net reduction
in commercial values? Assume a planning horizon of 50 years and a guiding interest rate of 7
percent. Is your answer an estimate of (1) the opportunity cost of the activities to enhance
wildlife, or (2) the value of the increased wildlife benefits?

7-8 A revenue 0f $3,000 per acre is expected in 20 years from harvesting a timber stand and
selling it at the market princes prevailing at that time. The owner expects inflation to average
5 percent over the next 20 years and she also .... return of 7 percent on her timberland
invesments. Whats is the present value of the future harvest revenue in today’s current dollars
after adjusting for inflation and discounting by the real guiding rate?

7-9 A plantation that is established today at a cost of $100 is expected to provide a thining
yield of 20 cords of pulpwood at age 20 and, when regeneration harvested at age 30, a
pulpwood yield of 10 cords plus a sawtimber yield of 20 M bd ft. Current stumpage prices
index is $15 per cord for pulpwood and $150 per M bd ft for sawtimber. The wholesale
prince index is forecast to inflate at a rate of 5 percent, pulpwood prices to inflate at 3
percent, and sawtimber princes to inflate at 9 percent over the next 30 years. The owner
expects a real rate of return of 4 percent on timberland invesments. What is the present value
of all revenues for one rotation?

7-10 A minimum-level two intensive management prescriptions for managing Virginia pin
for pulpwood need to be evaluated. These prescriptions are :
 1. Plant, then harvest at age 30 (minimum intensity)
2. Plant, precommercial thinning at age 10, harvest at age 30
3. Plant, precommercial thinning at age 10, fertilize at ages 10 and 20, harvest at age 30

Per acre costs planting $100, precommercial thinning $50, and fertilizer $30 per application.
The per-acre cash flows associated with these three prescriptions are as follows :

Using a guiding rate of 5 percent and assuming no inflation :

(a) Calculate the present net worth of each prescription, treated separately.
(b) If the minimum prescription (1) is required by law, calculate separately the
incremented present net worths of returns to the two intensification trearments of
thinning only (prescription 2) and thinning plus fertilization (prescription 3) to
determine which is the most worthwhile.
(c) Calculate the soil expection value (SEV) for each of the three prescription options at
guiding rates of 3, 5, and 7 percent.

7-11 An uneven-aged hardwood forest currently has an inventory of 17 M bd ft of

growing stock. This timber sells for $250 per M bd ft now and in the future. The owner
has a guiding rate of 6 percent. The forester has determined that the ideal, sustainable
reserve growing stock level is 12 M bd ft and two options fot initiating management need
financial evaluation :

Option 1 : immediately harvest 5 M bd ft and reduce the stand to the reserve growing
stock of 12 M bd ft and subequently harvest 10 M bd ft every 20 years forever.

Option 2 : Wait 10 years when the stand will have an inventory of 26 bd ft, harvest 14 M
bd ft reducing the inventory to 12 M bd ft and subsequently harvest 10 M bd ft every 20
years forever.

(a) Calculate the present net worth (PNW) of both options :

(b) Calculate the PNW of both options if a 7 percent rate of price increase for hardwood
stumpage and a 4 percent rise in the wholesale price index is expected forever. The
owner expects a real rate of return of 5 percent.