# Week 2 Bus 650

**Topics:**Net present value, Cash flow, Income statement

**Pages:**7 (1713 words)

**Published:**March 3, 2013

Clear-cutting is a controversial method of forest management. To obtain the necessary permits, Bunyan Lumber has agreed to contribute to a conservation fund every time it harvests the lumber. If the company harvested the forest today, the required contribution would be $300,000. The company has agreed that the required contribution will grow by 3.2 percent per year. When should the company harvest the forest?

The options that are available to harvest are years 40, 45, 50, and 55 year harvest cycles. This is because the forest was planted 20 years ago. Due to the inflation rate, and cash flow we will be looking at the real and nominal cash flow. Nominal cash flow and real cash refer to the same sources of cash to a business. However, different formulas are used for both. Real cash flow is basic measurement that takes basic measurement of cash flow into consideration, as well as present value. Nominal cash flow does not use inflation to determine cash flow. Nominal cash flow is more precise in forecasting future projects.

Real Cash flow is:

(1 + R) = (1 + r)(1 + h)

1.10= (1+r) (1.037)

r=.0608

r=6.08%

Conservation funds will grow at a slower rate than the inflation. The real return for the conservation fund can be determined by: (1 + R) = (1 + r)(1 + h)

1.10= (1 + r)(1.032)

r=.0659

r=6.59%

Cash flow from the thinning process also needs to be determined in order to have the accurate harvest schedule. The cash flow from the thinning process (CFT) is figured: CFT= Acres thinned ¡Á Cash flow per acre

CFT= 7,500(1200)

CFT=$9,000,000

The real cost of the conservation fund can be viewed above, however the after-tax cost needs to be figured. After-tax conservation= (1 C .35)(250,000)

After-tax conservation=$162,500

Revenue costs are

Revenue=(% of grade)(harvest per acre)(value of board grade)(acres harvested)(1 C defect rate) Tractor cost= (Cost MBF)(MBF per acre)(acres)

Road cost= (cost MBF)(MBF per acre)(acres)

Sale preparation and administration = (cost MBF)(MBF acre)(acres) Calculating the cash flow for each harvest schedule can now be done. Operating cash flow is equal to net income. Calculating the NPV can now be determined. 40-year harvest schedule:

Revenue $39,800,250

Tractor cost 7,200,000

Road 2,700,000

Sale preparation & admin 945,000

Excavator piling 1,200,000

Broadcast burning 2,287,500

Site preparation 1,162,500

Planting costs 1,800,000

EBIT $22,505,250

Taxes 7,876,838

Net income (OCF) $14,628,413

The PV of the first harvest in 20 years is:

First = $14,628,413/(1 + .0608) 20

PV First = $4,496,956

Thinning will also occur on a 40-year schedule, with the next thinning 40 years from today. The effective 40-year interest rate for the project is: 40-year project interest rate = [(1 + .0608)40] C 1

40-year project interest rate = 958.17%

We also need the 40-year interest rate for the conservation fund, which will be: 40-year conservation interest rate = [(1 + .0659)40] C 1

40-year conservation interest rate = 1,183.87%

Present value of future thinning can be determined by:

PV Thinning = $9,000,000/9.8517

PV Thinning = $939,286.45

The operating cash flow from each harvest on the 40-year schedule is $14,482,163, so the present value of the cash flows from the harvest are: PV Harvest = [($14,628,413/9.5817)] / (1 + .0608)20

PV Harvest = $469,325.52

Now we can find the present value of the conservation fund deposits, which will begin in 20 years. The value of these deposits in 20 years is: PV Conservation = C$162,500 ¨C$162,500/11.8387

PV Conservation = C$176.226.22

and the value of the conservation fund today is:

PV Conservation = C$176,226.22/(1+ .0659) 20

PV Conservation = C$49,182.52

so, the NPV of a 40-year harvest schedule is:

NPV = $4,496,956 + 939,286.45 + 469,325.52 C 49,182.52

NPV = $5,856,385.29

45-year harvest schedule:

Revenue $55,462,853

Tractor cost 9,840,000

Road 3,690,000...

Please join StudyMode to read the full document