Case Study in Financial Modeling and Simulation of a Forestry Investment potx

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Chapter 10: Case Study
in Financial Modeling
and Simulation of a
Forestry Investment
Investment in forestry as an
example of capital budgeting
techniques applied to long
term projects.
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Introduction

Forestry provides two types of long
term benefits:-

Wood benefits;
timber, poles, thinnings

Non-Wood benefits;
environmental protection,
wildlife habitat,
land restoration,
recreational environment.

Both these benefits can span a lifetime
of over 50 years.
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Cash Flow Structure
General for Projects Particular to Forestry
initial cash outlay long term maintenance
inflows from sale of product timed on-going outlays:-

thinnings, maintenance,
income- poles or timber?
income – time of harvest?
Cash Flow Forecasting
Cash flow prediction over a long horizon is difficult.
Investment Evaluation Criteria
The Land Expectation Value(LEV) model is applied
in preference to the NPV model.
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Key Parameters in
Forestry Models

Establishment:- land, land preparation,
plant stock, planting, watering.

Maintenance:- weed control, fertilizing,
pruning and thinning, fire and pest
protection.

Inflows:-
wood; commercial thinning, final harvest
non-wood; flora gathering, recreation,
land renewal.

Required rate of return.
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Forest Yield Factors

Wood growth is measured by the
MAI: Mean Annual Increment;

‘the annual increase in cubic meters of
harvestable timber per hectare’.

The MAI is influenced by-
relevant rainfall, soil fertility,
species mixture, planting régime,
crop protection.

Final monetary payoff is influenced by-
harvest age, species type, timber price.
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Forestry Risks 1

Establishment:
drought, weeds

Production:
storm, fire,
pests and diseases,
unsuitable species,
collateral damage at harvest.
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Forestry Risks 2

Timber return: inappropriate
pruning and thinning, poor growth,
timber usage and fashion changes.

Sovereign risk: regulatory changes,
taxation changes, uncertain harvest

rights.
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Predicting Cash Flows 1
The key growth indicator is the
Mean Annual Increment.

0 20 50+
Years of growth
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Predicting Cash Flows 2
The Delphi method may be used to
forecast the MAI, costs, and sales
incomes.
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Predicting Cash Flows 3
Particular long-term data for native
species is difficult to estimate.
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Solving the Model

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Solving the Model
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Solving the Model
Define and predict the long
term benefits
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Solving the Model
Define and predict the long
term benefits

Asses the risks
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Solving the Model
Define and predict the long
term benefits
Asses the risks
Estimate
the cash
flows
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Solving the Model
Define and predict the long
term benefits
Asses the risks
Estimate
the cash
flows
NPV
LEV
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
Sensitivity Analysis

Variables:
stumpage price
yield - thinning
yield - poles
yield - timber
weed control
pruning.


Scenario Analysis

Harvest at Yr 34,
or Yr 60

Monte Carlo
Analysis of
sensitive
variables.
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Forestry Modeling

Forestry projects are long term.

Costs and benefits are difficult to
predict.

Growth risks and product types are
particular to forestry.

Modeling helps to analyze the
forecast values.