Final Flashcards
1
Q
What is Present Value (PV)?
A
Money available or invested currently OR current value for amount received in future
2
Q
What is Future Value (FV)?
A
Amount of money received in future OR amount a PV will be worth at a future date
3
Q
What is Payment (PMT)?
A
Number of dollars to be paid or received at end of each time period in a series
4
Q
What is interest rate (i)?
A
Rate used to find present and future values, sometimes called discount rate; often equal to opportunity cost of capital.
5
Q
What are Time Periods (n)?
A
Number of time periods used for calculating PV and FV; often 1 yr in length; annual interest rate (i) need to be adjusted to number of periods in year
6
Q
What is annuity (A)?
A
Series of equal, periodic payments (made at end of yr)
7
Q
What is compounding?
A
Procedure to determine future values when interest earned in a time period is reinvested and earns interest in later time periods - both capital and interest earn interest
8
Q
What is discounting?
A
Procedure to reduce value of future sum by amount of interest that would be accumulated from it at that point in time. (Opposite of compounding)
9
Q
Is paying tax a good thing?
A
Yes, it means you are making money; you just want to pay it at the lowest rate possible.
10
Q
What are the two kinds of tax rates?
A
Federal rates and Provincial rates.
11
Q
Which province has the lowest tax rates?
A
Alberta.
Saskatchewan has the second lowest and tax rates get higher in the East.
12
Q
What is Registered Retirement Savings Plan (RRSP)?
A
RRSP is a deduction that reduces your income, so you pay less on taxes.
You can save your RRSP for future use when you are making more money to have a bigger deduction on taxes.
13
Q
What is different about cash accounting and accrual accounting?
A
At the end they will end up the same, the only difference is timing.
14
Q
What is a deduction?
A
Deduction is something that reduces income
* RRSP contribution, interest on an investment or land
* Expenses PAID by a farm or business
15
Q
What is credit?
A
Credit is something that reduces tax worth 26% of face value
* Credits are things like the “Basic personal amount” ($16,615)
* Tuition
* CPP & EI paid by employee
* Medial
* Donations (political and charitable) – are exceptions to the 26%
16
Q
What is Capital Gain (CG)?
A
Capital Gains are most preferable form of income regardless of
entity
* Taxed at half the rate of most other forms of income
Capital gain is the amount by which the proceeds exceed the
Adjusted Cost Base (ACB)
* Capital property covers many types of assets, but we will focus on Farmland,
Shares of a corporation, & Partnership Interest
Only 50% of the Capital Gain is taxable
* Inclusion rate is the amount of the gain that is taxable
Personally, the taxable portion is taxed at personal marginal rate
* Accountants are constantly looking for ways to create capital gains and as
result the CRA has provisions in the act that turn what would appear to be a
capital gain into dividends
Corporately capital gains also are only 50% taxable corporately BUT
do not qualify as Active Income
* Active income is income that is able to be taxed at the 11% rate (SK)
* The taxable portion of the gain is taxed at 50.67%
* 30.67% of the 50.67% is refundable ($100 Dividends recovers $38 tax)
* Refundable Dividend Tax on Hand (RDTOH)
* The other 20% of the 50.67% is permanent
17
Q
Business Vs. Company
A
May people refer to their business as a company, but it is not
Company is a separate entity in which a business can operate
* Business can be carried on in a company, partnership, trust or as an individual (The proprietorship on prior slide)
* All thumbs are finger but not all fingers are thumbs
18
Q
What is proprietorship?
A
*This is an individual who reports his business or farming activity on
his/her personal tax return
*Subject to personal rates of taxation - generally not optimal
* Very simple structure
* File on farm statement on personal tax return
* T2042 for basic filings – does not generate/file AgriInvest
* T1163 Statement A – files AgriInvest information
* No creditor protection and personal tax rates are high
19
Q
What is a corporation?
A
- Income tax rates for an ACTIVE corporation is far lower than personal
rates - On amounts up to $500,00
- 9% in SK
- Leaves more after-tax money to re-invest in business
- If you are taking out your all your profits, a company will give NO
tax savings - Savings offered with a corporation is only a deferral UNTIL money
taken out personally the personal level of tax makes it equal to if it
was earned personally (in theory, not quite perfect BUT very close to) - This is referred to as integration
- Passive (non-active) income is taxed at 50.67% (20% permanent +
30.67% refundable) (in SK) (2015 and prior was 46.67% + 26.67%) - Passive income is income from investments and rental or interest from arms
length parties (non-arms length rental and interest is generally still active) - Capital gain income is passive and the taxable portion is taxed at ~51%
20
Q
What are a Farmers 3 biggest tax benefits?
A
- Cash basis of accounting (can be a drawback if not planned properly
however) - Extra Capital Gain Exemption ($1,000,000 VS ~$910,000)
- Qualified Farm Property – allows for intergenerational transfer
without triggering tax – No other industry gets this
21
Q
What is Capital investment analysis and what is another name for it?
A
Another name is Capital budgeting, and it is used to determine profitability of a
capital investment.
you use the noncurrent assets from balance sheet.
22
Q
What are the 5 types of capital investment analysis and which ones consider time value of money?
A
▪ Payback Period
▪ Simple Return
▪ Net Present Value*
▪ Annual Equivalent & Capital Recovery*
▪ Internal Rate of Return*
- Consider time value of money
23
Q
What information do you need for a capital investment analysis?
A
▪ Initial Cost of the investment (total cost, installation, transport, taxes etc.)
▪ Terminal value (salvage value)
▪ Net cash revenues – Cash receipts minus cash expenses, (money going in + money going out)
a) There is no depreciation (non-cash,
acctd for in initial cost & terminal value)
b) There are no loan payments.
▪ Discount rate
* Cost of capital, min rate of return required to justify investment
* If $ to be borrowed, discount rate can = lender’s %
* If combining borrowed and equity capital, use weighted average cost
of capital
* Risk, taxes, inflation later
Investment analysis determines profitability of investment w/o
considering method of finance.
24
Q
What is payback period?
A
▪ Does not measure investment’s total profitability, measures how
quickly investment adds to liquidity.
▪ Easy and quick
▪ No time value of $
▪ Estimate years required for investment to pay for itself
▪ Shortest payback period most favored
25
What is the payback period formula when cashflows are equal?
Payback period = Cost of investment / Annual cash revenue expected
26
What do you do when payback period cashflows are not equal?
Add up revenues year by year to determine by which year the investment value is recovered.
27
When would you accept the investment using payback period?
If payback period < than your required
payback period
28
What are advantages of payback period?
▪ Useful when quick cash recovery important
▪ Best for investments with similar lengths
29
What are disadvantages of payback period?
▪ Disregards earnings after payback date
▪ Ignores timing of cashflows
30
What is another name for simple rate of return?
Accounting rate of return
Unadjusted rate of return
Financial statement rate of return
31
What is simple rate of return and what is the equation?
Simple rate of return is a quick way to compare and rank investment
opportunities.
Incremental (over and above investment cost) average annual net revenue as percent of original investment.
Rate of return = ((Total net cash revenue - Initial cost) / Years) / Initial cost
32
When would you accept the investment using simple rate of return?
If simple rate of return ≥ your required rate of return
33
What are advantages of simple rate of return?
Investment’s earnings over its life → better picture of profitability than
Payback Period
34
What are disadvantages of simple rate of return?
“Incremental average annual net revenue”, no size and timing of cashflows.
Ignores time value $ - no discounting, overstates rate of return for future income.
35
What is another name for Net Present Value (NPV)?
Discounted cash flow
36
What is Net Present Value?
▪ Projected net cashflows discounted to present value
▪ Each projected cash flow can be positive or negative
▪ Sum values together, then subtract investment cost to get NPV of investment
▪ Preferred method of evaluation of profitability
37
What is the equation for Net Present Value?
NPV of investment is sum of the present values for each year’s net cash flow minus initial investment cost.
NPV = (P1/ (1+i)^1) + (P2/ (1+i) ^2) + ... + (PN/ (1+i)^N) + (VN/ (1+i)^N) - Cost
Cost = the initial investment
PN = the net cash flows from the investment
VN = the salvage value of the investment
N = the length of planning horizon
i = the discount rate or required rate of return
38
Present value Vs. Net present value
▪ Both involve discounting future cash flows
▪ Present value applies to payments to be received (or paid out)
▪ Net present value applies to net cash flows from an investment, minus the amount paid for the initial investment.
▪ NPV analyzes profitability
39
When would you accept the investment using Net Present Value?
If NPV exceeds zero → accept the investment
40
What does a positive Net Present Value mean?
Actual rate of return on investment is bigger than the discount rate used.
41
Does a negative Net Present Value mean you have lost money?
Negative NPV means you are making less money on that investment then what you put in for your discount rate, so it does not mean you are losing money.
42
What is Net Present Value limits?
▪ Does not consider scale of project.
▪ Assumes intermediate cash flows re-invested at discount rate
43
What is Annual Equivalent and what is the equation?
▪ NPV can be converted to annual equivalent
▪ Instead of simply dividing NPV of investment’s lifetime net return by number of years of life, use discounting
to calculate an annual cash flow (annuity) with same NPV.
▪ Can then compare investments with different lives
A=PV x i / (1- (1/ (1+i)^n))
44
What is Capital recovery and loan repayment schedule?
Capital recovery
▪ Can use the Annual Equivalent technique to convert initial investment cost of capital asset to annual cost.
▪ Alternative - interest charge and depreciation ownership costs.
▪ Annual amount to recover initial cost w/ interest of asset over its life, including interest on salvage value
Loan repayment schedule - Loan payments Same calculation as Annual Equivalent.
45
When and how is Internal rate of return (IRR) used?
When investment’s NPV >0, earnings are greater than discount rate used in analysis.
You don't know what the actual rate of return is, however, you can calculate this rate of return by setting the equation to 0 and solving for i (use NPV equation).
46
How is Internal rate of return different from simple rate of return?
It is different because it includes time value of money and actual returns, not average annual returns.
47
When would you accept the investment using Internal rate of return?
IRR ≥ your required rate of return.
Investment with IRR > discount rate would be a profitable investment
i.e., NPV would be positive.
48
What are some disadvantages of Internal rate of return?
▪ IRR rate may overestimate (assumes intermediate cash flows re-invested at IRR)
▪ IRR scaled, small investment may have high IRR, but small NPV
49
What is financial feasibility?
Are you doing to be able to generate cash flows to pay off the loan at the right time?
50
What do you do if you have negative cash flows?
▪ Reduce size of loan
▪ Increase the years to pay off loan
▪ Interest-only payments until cashflows increase
▪ Do you have more equity capital that you can out into it
▪ Change the type of loan you have
51
What rate do you use for discount rate?
▪ If borrowed capital, set equal to cost (interest rate)
▪ If using equity and borrowed $, use weighted average cost of capital
▪ Your required rate of return – your criteria
▪ Return that could be earned on an alternative investment
▪ Need to also adjust rate for risk, inflation, taxes
52
what do you adjust for investment returns for income tax and what is the equation?
▪ Adjusting net cash flows
▪ Income taxes change net cash revenues
▪ Cash inflows - taxable income
▪ Cash outflows - tax-deductible expenses
▪ Depreciation NOT in net cash revenue because it is not cash, but is tax-deductible, reducing taxable income and income taxes.
▪ Should add this tax savings into investment net cash revenues for
investment analysis.
After tax discount rate (r) = i x (1-t)
53
Why do you incorporate inflation in investment analysis?
▪ Inflation impacts net cash revenues, salvage value, discount rate
▪ Net cash revenues and salvage value and discount rate are adjusted for inflation.
▪ Inflation-adjusted discount rate called “nominal discount rate”
▪ Real discount rate (5%) + Expected inflation rate (2%) = Nominal
discount rate (7%)
▪ Otherwise, do estimates at current prices and use real discount rate
54
Why do you incorporate risk in investment analysis?
▪ Estimates of production, prices and costs to estimate cash flows, including salvage value
▪ Investment life increases → risk increases → required rate of return should increase
▪ Add risk premium to discount rate
55
Why should you do a sensitivity analysis?
▪ Estimates may be inaccurate
▪ Sensitivity analysis asks questions of the estimates and values used
▪ Values lower/higher, analysis recalculated
▪ How ‘sensitive’ is the investment to changes?
56
Increasing the discount rate will cause the present value of a future payment to...
A) Increase
B) Decrease
C) stay the same
B) Decrease
57
The future value of a $10,000 investment in a savings account will depend on...
A) the interest rate
B) the time it is left in the account
C) both the time and the interest rate
D) the discount rate
C) both the time and the interest rate
58
The present value of a future 5-year series of annuity payments of $5,000 using a 4% discount rate...
A) equals the sum of the payments
B) is greater than the sum of the payments
C) is less than the sum of the payments
D) cannot be determined with this information
C) is less than the sum of the payments
59
How has SK farmland ownership regulations changed over the years?
▪ 1974 – 2003 Only SK residents >10 acres
▪ 2003 - Only Canadian individual and companies
▪ 2014 – Controversies
*114,000 acres sold to Canada Pension Plan Board by Regina investment
company
* Skyline Ag deal rejected by Farmland Security Board
▪ 2015 – Legislation to prohibit pension plans, large trusts to acquire
farmland, but no restrictions on private investors
60
What does nonfarm investment in farmland affect?
▪ Community dynamics
▪ Land stewardship
▪ Heirs of farmland with no land connection, little understanding of ag
pricing
▪ Can affect land values, especially in RM with significant purchases
▪ Benefits & risks of high land prices unequally distributed among
farmers
61
What affects farmland values?
▪ Potential profit/acre
▪ Interest rates - With low rates you are more likely to invest in farmland or other things
▪ Returns on other investments
▪ Urbanization
62
What are land characteristics affecting economics?
▪ Permanent resource - No depreciation on farmland as long as it is properly managed
▪ Immobile
▪ Unique (soil characteristics, drainage, etc.)
▪ Supply fixed
▪ Environment
63
How much land should you control?
Need the right amount to match your resources
Too little land, your business will be limited
Too much land, your management might not be able to handle it.
64
How do you get land?
Buy it, rent it or both
65
What are advantages of owning land?
▪ Security - Don't have to worry about losing a lease
▪ Loan collateral - As you accumulate equity, you can borrow against that equity of the land value (able to get bigger loan)
▪ Independence - If it is your own land, you can make your own decisions
▪ Inflation hedge - Land is always at or above inflation hedge
▪ Pride
66
What are disadvantages of owning land?
▪ Cash flow - lots of money tied up in land
▪ Lower return - you would get a higher return in equipment, feed, livestock, fertilizer.
▪ Less working capital - debt payments can eat away at your working capital and that can limit how much you can do for your inputs and limits your level of production and profit
▪ Size limits
67
What are advantages of leasing land?
▪ More working capital - control more land with less money tied up
▪ Management experience
▪ More flexible size - short term agreements so you can easily increase or decrease the amount of land
▪ More flexible financial obligations - not tied down to 25 years of payments
68
What are disadvantages of leasing land?
▪ Uncertainty - agreement might not be renewed. you can be over capitalized, too much machinery and you don't have the land to spread those costs over
▪ Quality of facilities
▪ Slow equity accumulation
▪ Power and Control - your landlord might tell you what you can and can't do
69
What are the 2 ways of establishing the value of land and why do you want to know the value of land?
▪ Economic Value of Land - using income capitalization (productive value of the land)
▪ Market Value of Land
You want to make sure that the price you are paying for is reasonable.
70
How to calculate the economic value of land and what costs are included?
Productive Value of Land - PV of land’s stream of net after-tax returns from ag production
It is like the enterprise budget except land part is different
You have cash and non-cash costs, fixed and variable costs, input costs, depreciation, interest on your investments. you won't have any cost to the land except for land taxes.
1. Estimate gross income of land
2. Estimate your costs of production
3. ‘Return to Land’ “R”
4. Divide return to land by capitalization rate V = R/d
V = value of the land
R = return to the land
d = discount rate
Capitalization rate: Rate of return you could get from other investments
Adjust capitalization rate for annual inflation rate of the land
71
How do expectations of rate of increase in land value affect
calculated economic value of the land?
It increases the value
72
What is the effect of loan rate on value of land?
With a higher loan rate, the land is worth less
73
What are advantages of Calculating Economic Value of Land?
Based on economics
Land value will increase overtime as a general trend
74
What are disadvantages of Calculating Economic Value of Land?
Pinning down numbers for your return for the land is hard
It is sensitive to discount rates
75
What are you looking at to figure out the market value of land?
Location
Land quality
Purchaser
Arms-length sales
Improvements
Time of sale
Ratios to compare
Financing
Accredited appraiser
76
What is financial feasibility analysis?
Will there be sufficient cash flow to cover annual operating expenses and interest and principal payments of land purchase?
Only look at cash flow
No depreciation
No opportunity costs of labour
Can assume come inflation in both your expenses and returns
Include family living expenses
77
Land value- Estimated income (enterprise budget) includes mostly all costs. What does it not include?
Land investment costs (land purchased, loan payments, interest, principal)
78
Does cash flow include all cash expenses and only cash?
Yes
79
What does the results of financial feasibility analysis mean?
▪ Negative cash flows from debt-financed land purchase at the beginning and overtime will become positive
▪ Land prices include expectations of appreciation in value, but expectations do not increase cash returns
▪ Need cash flow analysis of entire business (off farm sources)
80
What are two other names for Future Value of Single Payment?
Future Value of Present Value
Compound Interest
81
What is the equation for Future Value of Single Payment?
FV = PV x (1+ i)^n
n = years
82
FCC reported land prices increased 14.9% in Saskatchewan between July 2021 to June 2022. How much would an acre of land currently worth $2,000 (PV) be worth (FV) in 5 years if this rate continue?
FV= PV x (1+ i)^n
FV = $2,000 x (1 + 0.149)^5
FV = $4005
83
Local bank offering savings account with 6% annual interest compounded quarterly (every 3 mos or 4x/yr). Investing $1,000 for 1 year. What would FV be?
FV = PV x (1 + i)^n
FV = 1,000 x (1 + (0.06/4))^(4 x 1) = $1,061.40
*when given annual interest rate (payments are semi annual, quarterly, monthly, daily), you must convert annual rate to a rate per conversion period. (semi-annual = 2, quarterly = 4 ...)
84
What is Future Value of a Series (Annuity)?
How much will a series of $X now at interest rate i, be worth in year Y.
Same amount invested each year - annuity or uniform series
85
What is the equation for Future Value of an Annuity?
FV = A x ((1 + i)^n - 1) / i
86
$1,000 deposited at end of each year in a savings account that pays 8% annual interest. What is the value of this investment at the end of 3 years?
FV = A x ((1 + i)^n - 1) / i
1000 x (1 + 0.08)^2 = $1,166.40
1000 x (1 + 0.08)^1 = $1,080.00
1000 x (1 + 0.08)^0 = $1,000.00
Total= $3,245.40
FV = 1000 x ((1.08)^3 - 1) / 0.08 = $1,166.40
87
What is Sinking Fund Deposit?
How many $ will be needed to be put in a series of deposits at interest rate i to end up with $X in year Y
88
Calculate the payment (annuity) needed to have a known amount of money in the future (FV). How much money would you need to deposit in a retirement savings account at end of each year to have $1,000,000 at end of 30 years if the annual interest rate is 5%
A = $1,000,000 x (0.05 / ((1.05)^30 - 1) = $15,051
Power of compound interest and early savings ($15,051 x 30 = $451,530)
89
What is Present Value of a Future Single Payment?
How much is $X in future year Y worth now considering an interest rate of i?
90
What is the equation for Present Value of a Future Single Payment?
PV = FV x 1/(1 + i)^n
91
Discounting the future $ amount by an expected interest rate and known number of years gives __________
present value
92
What is the worth to you now (present value) of a $5,000 payment available 3 years in the future if the annual interest rate is 5%?
PV = FV x 1/(1 + i)^n
PV = $5000 x 1/(1.05)^3
PV = $5000 x 0.8638 = $4319
93
What happens as n or i get larger in Present Value of a Future Single Payment equation?
As the number in denominator gets larger, the factor gets smaller.
The higher expected i is or the higher the number of years, the less it will be worth.
94
Ex. 1. $1,000 received 10 yr from today, 5% interest per year. What is the Present Value?
Ex. 2. (higher i) $1,000 received 10 yr from today, 10% interest per year. What is the Present Value?
Ex. 3. (higher n) $1,000 received 20 yr from today, 5% interest per year. What is the Present Value?
Ex. 1 PV = $1,000 x 1/(1 + 0.05)^10
PV = $613.91
Ex. 2 PV = $1,000 x 1/(1 + 0.10)^10
PV = $385.54
Ex. 3PV = $1,000 x 1/(1 + 0.05)^20
PV = $376.89
95
What is the Present Value of a Future Series of Unequal Payments?
Payments differ in timing and amount
Discount each future payment to a present value - sum together
Useful for capital investment analysis - cashflows differ each year
96
What is the equation for Present Value of a Future Series of Unequal Payments?
PV = (P1/(1 + i)^1) + (P2/(1 + i)^2) + (P3/(1 + i)^3)... + (Pn/(1 + i)^n)
97
Find the present value of an oil royalty expected to pay $3,000 at end of Year 1; $4,000 in year 2; $5,000 in year 3; $6,000 in year 4. Use a discount rate of 6%. What do you notice happening?
PV = (3000/(1.06)^1) + (4000/(1.06)^2) + (5000/(1.06)^3) + (6000/(1.06)^4)
PV = $15,341
98
The present value pf the oilroyalty is $15,341, which is less than the summed value of the payments (3000 + 4000 + 5000 + 6000 = $18,000). $2,659 difference represents ________.
time value of money
99
What is Present Value of Future Uniform Series of Payments (Annuity)?
How much is a series of $X over future Y years worth at present considering an interest rate of i?
100
What is the equation for Present Value of Future Uniform Series (Annuity)?
PV = A x (1 - 1/(1 + i)^n) / i
A represents the annuity payment in each period
101
What is the present value for Alexander Ovechkin's new $47.5 contract of ($9.5 million average annual salary for 5 years), using a 6% discount rate?
PV = A x (1 - 1/(1 + i)^n) / i
PV = 9,500,000 x (1 - 1/(1.06)^5) / 0.06
PV = 9,500,000 x 4.2124
PV = $40,017,800
102
What happens to the present value of the annuity (A) as n increases and approaches infinity?
The present value of the annuity (A) increases at a decreasing rate (at some point PV of last payment (A) approaches zero.
103
What is Capital Recovery of Loan Payments?
How many $ are needed for each payment in a series at interest i to pay back $X in Y future years?
104
What is the equation for Capital Recovery of Loan Payments?
A = PV x i / (1 - 1/(1 + i)^n)
105
If you borrow $10,000 today to be repaid in equal instalments of principal and interest over 10 years at annual interest rate of 5%, what is the annual payment?
A = 10,000 x 0.05 / (1 - 1/(1.05)^10)
A = $1295.05
106
What are machinery cost calculators used for?
▪ Provide cost estimates for renting equip or custom farming operations farmer-to-farmer.
▪ Budgeting
▪ Investment Analysis
▪ Return to land
NOT used for commercial use
107
What is the equation for rental rate?
Rental rate = Ownership costs + 15% margin
How to calculate ownership costs (Fixed costs):
Ownership costs = Depreciation + Investment Cost + Insurance/Housing
108
What is the equation for a custom rate?
Custom rate = (Ownership costs + 15% margin) + (Operating costs + 15% margin)
How to calculate operating costs (variable costs):
Operating costs = Repair & Maintenance + Fuel + Labour
How to calculate ownership costs (Fixed costs):
Ownership costs = Depreciation + Investment Cost + Insurance/Housing
109
What are the machinery and equipment fixed (ownership) costs?
▪ Depreciation
▪ Interest
▪ Insurance
▪ Housing
▪ Lease payments
▪ Tax (not usually a consideration)
110
What is Straight Line Depreciation for machinery?
▪ Loss in value from age, wear, obsolescence
▪ Also, an accounting procedure to spread out $ outlay over ownership period, also a tax write-off
▪ Most (not all) depreciation due to age and obsolescence, so considered fixed
111
How do you calculate annual depreciation?
Annual depreciation = Total depreciation / Ownership life
Total depreciation = Initial cost - salvage value
*Total depreciation is always going to be the same no matter how you calculate it
112
Where is there interest on equity capital?
▪ Equity capital invested in the machine
▪ Loan interest cost
▪ Weighted average (if you have a loan and equity capital)
▪ Average annual interest cost = interest rate x Average value machine
▪ Average value = (cost + salvage value) / 2
113
What is Capital Recovery Charge (CRC) and what is the equation?
CRC amortizes the money tied up in machine over a given period & interest rate.
Annual “payment” to recover “loss” of depreciation value + interest and the salvage value + interest
Still uses depreciation and interest in its calculation, but incorporates Time Value of Money
CRC = (Total depreciation x Amortization factor) + Interest on salvage value
114
Is the value for Capital Recovery Charge Greater than or less than Straight Line Depreciation + Average Interest on Investment
Capital Recovery Charge is greater than Straight Line Depreciation + Average Interest on Investment
115
What values do you include for insurance and housing?
Together insurance & housing can be estimated at 0.5 -1.5% of purchase price (If you have actual values, use those)
If you have a capital lease, include these payments as well as insurance & housing
116
What are the Machinery & Equipment Variable (Operating) Costs?
▪ Repairs ( depends on how you treat equipment)
* % of new list price
▪ Fuel
* Estimated to be 75% (depends on how hard you push the machine)
* Engine horsepower and load
▪ Lube - 10 to 15% of fuel
▪ Labour is estimated to be around $27/hour in SK and MB
117
What are the costs of operating equipment?
▪ Fixed Costs (Ownership Costs)
* Depreciation
* Interest on Investment
* Insurance and Housing
▪ Variable Costs (Operating Costs)
* Fuel
* Repairs and Maintenance
* Labour
▪ Timeliness Costs
* Quality/Yield loss if field work not started/completed on time
118
What are the alternatives to owning equipment?
▪ Short-term rental
▪ Capital lease
▪ Custom hire
119
What thing do you consider when deciding to custom hire?
▪ Cost
▪ Skills
▪ How much work needed
▪ Availability, dependability
120
What is breakeven acres and how do you calculate it?
▪ Minimum area required to reduced ownership fixed costs to those of a custom operator
▪ Acreage size where it becomes cheaper to own the equipment rather than hire a custom operator
Breakeven acres = Total fixed costs per year / (Custom rate/ac - Variable costs/ac)
Can also use breakeven hours
Break even hours = Total annual fixed costs / (Custom rate/hour - variable costs/hour)
121
What does the Equipment Investment Ratio value mean and what is the equation?
▪ Low value --> may indicate machinery too old, too small for acres farmed which could lead to timeliness issues
▪ High value --> indicates investment may be excessive, risk of machinery debt or leasing costs causing financial troubles
Equipment Investment Ratio = Market value of equipment / Cultivated acres
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Why would you replace a piece of equipment?
▪ Current machine unreliable
▪ Size matters
▪ Income
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Where on financial statement(s) show business capital?
Short term assets, current assets and long term assets are on the balance sheet. Also is shown on statement of cash flows.
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What is credit and why is it important?
Credit is the ability to borrow money with the promise to pay back this money with the interest agreed upon. It is a temporary transfer of wealth.
Credit is important, because it helps you get the productive assets you need and pay for it later, so it raises the level of productivity.
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How much capital should be used according to economic theory and what should it be used for (allocation)?
The return you get from your investment gives you just enough revenue to pay for the extra added interest cost.
Allocation: Where you get the highest return
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What is outside equity?
Silent partners, lease items, share agreement, someone is putting in money in an indirect way towards your operation, custom farming
Obligation to share profits with outside source
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Define principal, interest rate, overnight rate, and prime rate.
Principal: the amount you borrow or the amount you still have to pay
Interest rate: expressed as the annual percentage rate
Overnight rate: lowest interest rate, what the banks charge each other
Prime rate: extra added on to overnight rate, banks best rate (they are usually all the same prime rate)
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What is annual percentage rate (APR) and annual effective rate?
APR: interest rate of charge each year on a loan
Annual effective rate: interest rate of how much compounding is involved
129
Two loans, both with 8% APR, Loan A has quarterly (4) payments and Loan B has monthly (12) payments. What is the effective rate of each loan?
Loan A: ie = (1 + 0.08 / 4)^4 - 1= 8.24% effective rate
Loan B: ie = (1 + 0.08 / 12)^12 - 1= 8.34% effective rate
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Ture or false: fixed rates are usually a little bit higher than variable rates
True, except it is currently flipped
131
Define down payment, collateral, loan-to-value, amortized (installment loan), and amortization schedule
Down Payment: The cash used towards purchase of asset
Collateral: Asset pledged as security of loan (if you don't pay, lender can take ownership of asset)
Loan-to-value: The amount of loan divided by value of asset, used to assess risk, do not want over 75%
Amortized (installment loan): loans where you have a schedule of payments
Amortization schedule: schedule of payments when you get loan
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How to classify loans?
- Length of repayment: short term loan (buy inputs to get through production, ex. fertilizer, fuel), intermediate term loans (to purchase equipment 1 to 10 years), long term loans (to buy land)
- Use
- Security
- Repayment plan
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What are the uses for ag loans?
- Real estate (land and buildings, so long term loans)
- Non-real estate (short and intermediate term loans)
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What makes a loan secured?
- Mortgage
- Lien
- Noncurrent loan (land, equipment) - usually secured by the assets being purchased
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What makes an unsecured loan?
- Good Credit history
- Interest rates higher
- Borrowing limit lower
- Shorter Repayment terms
- "Signature loan"
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How to know repayment period of loan?
- Loan will specify
- Can you pay more than required? Depends on the loan
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What is a line of credit? What are the advantages and disadvantages?
Agreement with lender on how much money you can use, you have maximum line of credit. You transfer in funds as you need them.
Advantages: if you suddenly need a big chunk of cash, you can get it. Only charged interest for the amount of time that you have money borrowed, no fixed interest
Disadvantages: Not everybody can get one, need proof you'll be able to pay it back, accurate records, reliable cash flow budget, need self discipline to only borrow what you need
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What is the interest on line of credit and what is the equation?
Interest only charge on outstanding loan balance (P)
L = P x I x T
Where,
l is interest to be paid on operating loan
P is amount outstanding
i is the interest rate
T is the proportion of year that loan (P) outstanding
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What is Constant Total Payment and Constant Principal Payment?
Constant Total Payment allows you to pay the exact same amount each period
Constant Principal Payment is when you pay a certain amount of the principal but the interest changes
140
What is Balloon Payment Loan?
Different type of Amortization schedule. Low periodic payments, big payment at the end. Usually refinance loan at the end. Used for if you think you’re going to get a big chunk of money coming in
141
What are examples of FCC Financial Products?
- Land and buildings loan
- Financing and leasing of equipment through dealer
- Line of credit
- Livestock loans through supplier
- Young Farmer Loan, Starter Loan
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What is the Canadian Agric Loans Act (CALA)?
You apply through local lender, not government.
Federal government guarantees up to 95%
You can purchase land, breeding livestock, intergenerational shares, irrigation
Cannot be used for repairing house, purchasing feed or livestock, or to buy quota
15 year loan
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What is the AAFC Advance Payments Program?
Administered by Growers associations (Canadian Canola Growers and others)
Up to $250,000 interest free up to 18 months to repay for commodities and 24 months for livestock
Have to apply every year
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What is the Cost of Borrowing?
- Annual percentage rate (APR) should be stated in loan agreement
- Fixed interest rate
- Variable interest rate
- Fees
- How to compare loans with different rates and payment schedules?
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What does loan PV mean?
- Loan with smallest PV is best choice
- Don’t forget cash flow
- When loan interest rate < your cost of money (discount rate), PV of loan < loaned amount. Loan is a bargain expense
- When loan interest rate > your cost of money (discount rate), PV of loan > loaned amount. Loan is a real expense
- If your cost of money (discount rate) is equal to loan interest rate, PV of loan = loaned amount
- Loan with least PV depends on loan terms and discount rate
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Assets are financed through a combination of _____
Equity and debt capital
The goal is to increase profit, you want assets to get as high as you can
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How is leverage supplementing equity capital with borrowing?
Debt equity ratio increase, leverage increases. Debt asset ratio is.5, half is borrowed, and half is from you
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What is the effect of leverage?
- Debt capital can either help and hinder equity growth
- In good years, ROA > COD
- Then, profits will increase, and equity will grow
- The greater the leverage, the greater the growth
- High leverage can increase financial risk when interest rates are high and ROA is low
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What is the maximum debt/asset ratio?
Max. Debt to Asset Ratio = ROA / COD
- This is the highest debt/asset ratio business can sustain
- This is the level where ROE will equal zero
- ROA is just enough to service your debt
150
What is Inflation and Capital Gains?
- When inflation high, want to hold inflation-proof assets that will increase in value, i.e. land
- When high investments in noncurrent assets, solvency and (market based) equity tied to changes in these assets’ value.
151
How does inflation and capital gains help liquidity or cash flow?
It only helps if you sell the assets, it does not help cash flow or liquidity.
152
What are the five points for a Financial Contingency Plan?
1. Reserves – maintaining savings in bank account, stored crop, sell off livestock, credit reserve (don’t want to be maxed out on credit)
2. Payments – in good years you should make extra payments towards loans
3. Off farm cut or increase – cut off-farm spending or increase off-farm income
4. Insurance – liability insurance
5. Sell – sell least productive things you have
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What is Capital Leasing?
- “Finance lease” – for big expensive thing, such as equipment. Alternative from a loan
- Length – most of item’s lifetime
- Buyout (purchase) option at end of lease – at end of lease you have the buyout option
- Cashflow
- Ownership – usually at end of lease transfers to lessee
- Advantages – getting something new, warranty, support if it breaks down, newest features
- Tax
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What is an Operating Lease?
- Length – not as long as capital leasing/life of asset (only part of item’s lifetime)
- Cashflow
- Ownership – always lessor (rental co.)
- Advantages – might not be renting something new. In theory someone is supposed to be responsible in fixing it, but that is not always the case.
- Tax – operating expense
- Availability
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Difference for tax deductions between lease and loan?
Loan – Capital Cost Allowance and Interest portion of lean payment
Lease – lease payment
156
What is a lease?
- Leasing is paying for the use (and control) of an asset
- Legal contract between landlord and tenant
- If the lease is over 3 years, it must be in writing to be legally enforceable
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What are the principles for a good lease? And other consideration for leases?
Principles
- Flexibility – fair adjustments on either side
- Adapted for individual situation
- Period – long enough for producer to use good land practices
Other considerations:
- Cyclical nature of agriculture – drought period would want to be renegotiated if on cash lease
- Liability protection
- Soil testing
- Pesticides
- Government payments
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What are the types of land leases?
- Cash Lease/ Cash Rent
- Crop Share Lease
- Flexible Cash Rent
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What is Cash Rent?
- Pre-negotiated cash payment(s)
- Landlord usually responsible for property taxes, insurance on buildings, major repairs
- Tenant (renter) supplies – labour, machinery, operating expenses, gets to keep all crop income
- Simplicity
- Managerial freedom – tenant can usually make their own decisions
- Risk – all on the tenant if crop fails that’s on them. Landlord has no risk
- Capital requirements – tenant has to put in all the inputs, landlord just has to pay property taxes
- Land use – short term goals, is the landlord going to keep up with land and fences if not renting
- Rigid terms
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What makes a fair cash rent?
- Land
- Crop – what kind of crops can you grow on this land
- Supply and demand – economics (is the price of supply tight in your area)
- Cost approach – investment cost, property taxes, buildings (the very minimum a land lord will accept)
- Market approach – what are other people renting their land for
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What is a Crop-Share Lease?
- Landlord receives a certain share of crops
- May be sharing certain operating expenses
- Landowner supplies
- Tenant supplies – most operating expenses
- Capital required 0 tenant doesn’t need cash up front to pay landowner, however, they need cash for operating expenses
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What makes a fair Crop-Share Lease?
- Establish and share variable expenses and fixed costs fairly
- Risk is shared
- Management – landowner has an interest in the yield, so might be particular on management
- Share rents tend to be higher than cash rents
163
What is custom farming?
- Operator provides all the machinery, labour, and field work (transport crop)
- Owner provides all the money for inputs, responsible for purchasing inputs, and gets all the income
164
What is a Livestock Share Lease?
- Two parties pool resources and share calf crop revenue
- Owner provides the cattle, other types of assets like land and buildings
- Operator is responsible for daily care of livestock, do some maintenance on the building, responsible for storing forage, may be responsible for marketing
- Cattle sales less shared costs are divided between parties according to arrangement
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Types of Livestock Share Leases?
- Cash lease – owner gets a fixed payment, operator has the risk
- Percentage of cost lease – share cost and revenue are the same percent
- Flexible lease – share cost first goes to operating costs, then goes to fixed costs. Divide the profit up depending on how much you contributed
- Fixed number of calves – owner of cows gets x number from those cows
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What are the advantages and disadvantages of Livestock Share Lease?
Advantages:
- Owner: keeps animal, still their herd, can focus on different parts of their business
- Operator: way to start out, not big investments of livestock, might be able to use someone else’s building, feed, pasture
Disadvantages:
- Owner: not a good operator, not good returns, not as much control over animals, if something happen with the agreement then you’re stuck
- Operator: owner might get involved and not be good, animals might not be in good shape, if mixing animals with own animals there’s a risk for biosecurity issues
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What is Custom Grazing?
- Livestock owner – come up with list of animals, maker sure they are branded or tagged
- Custom grazer – take care of feed, water, take care of animals, make sure fencing is good, keep owner informed
- Arrangement – daily charge for custom grazing, charge for pound of weight gain
- Rate – care and capacity of your pasture, look at neighbour’s charge rate
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What are the regulations as an employer for your employee?
- Mandatory payroll deductions
- SK Employment Act
- Occupational Health and Safety
- Workers Compensation
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What is listed in the HR guide for producers?
- Develop your farm or ranch’s image
- Write up a good job description
- Provide effective training and orientation
- Communication
- Motivation
- Manuals, SOP
