I 70-20,450 DUVICK, Richard David, 1934ALTERNATIVE METHODS OF FINANCING GROWTH ON MICHIGAN DAIRY FARMS. Michigan State University, Ph.D., 1970 Economics, agricultural University Microfilms, A XEROXCom pany, Ann Arbor, Michigan ALTERNATIVE METHODS OF FINANCING GROWTH ON MICHIGAN DAIRY FARMS by Richard David Duvick A THESIS Submitted to Michigan State University in partial fulfillment of the requirements for the degree of DOCTOR OF PHILOSOPHY Department of Agricultural Economics 1970 ABSTRACT ALTERNATIVE METHODS OP FINANCING GROWTH ON MICHIGAN DAIRY FARMS by Richard David Euvick Increased size and specialization of farms has led to the Increased use of capital and credit by many fanners. In Michigan the trend on dairy farms is toward herds of 100 or more cows and many of these herds will be housed and handled in free-stall, milking parlor systems. How can farm operators finance the move from their present operations to these modem, larger-scale operations? What are some of the major factors that can aid the expansion process? And how do these factors affect other aspects of the f a m organization over time? This research used a synthetic approach to examine these questions with production relationships and costs corresponding to dairy farms in south central Michigan. A multiperiod linear programing model was developed for a 10—year period with primary emphasis on the financial aspects of the expansion process. After accounting for certain minimum establishment costs, the farm operation could expand through various means. The model allowed for land rental or purchase, grain sale or purchase, and the hiring of labor. Annual accounting was made of cash withdrawals for taxes and family living expenses. Borrowing was limited by Institutional restraints based on type of equity for different assets and by repayment capacity. The desired growth of the firm was assumed to consist of two primary, equally-weighted operator goals: (1) to maximize net worth, and (2) to maximize Income for family living Richard David Duvick expenses. The study examined the effects on the growth of a firm of differ­ ent (1) levels of beginning equity, (2) down payment requirements for both short and long term borrowing, and (3) repayment terms on long term debt. Also examined were the effects of alternative goals of the operator, appreciation of land values, investment credit, and lower milk prices. Larger amounts of beginning equity led to proportional increases in final net worth and less than proportional increases in consumption. In addition, the size of the farm operation was increased, both in year 1 and over time. In some situations the smaller equity levels resulted in unused capacity, as financing was insufficient for both the needed investments and current operating expenses. A minimum of $50,000 was needed to establish a farm operation under the normal down payment requirements assumed, and $35,000 under the smaller down payments. These amounts are more than most young or beginning farm operators would have, and they emphasize the need to know what factors may act as substitutes for csoltel and how they affect the growth process. Smaller down payments allow a greater expansion to occur for any given beginning equity. However, the expansion in size of the operation in terms of total assets or sales is much greater than is the increase in net worth and consumption. This Increased size is accompanied by a much larger outstanding debt and a higher debt/asset ratio, indicating a greater degree of risk for the operator. Alternative length of repayment plans on long term debt had almost no effect on growth in terms of net worth and consumption. They do provide flexibility in matching repayment capacity to desired Richard David EXivick investments and allow the operator to gain ownership control over a larger operation. In addition, deferred payment plans had little merit as an add to farm income. Alternative goals led to only small differences in results, but different strategies were pursued through time to achieve these re­ sults. Appreciation of land values led to increased purchases of land at earlier points in time and allowed a greater portion of the total debt load to be in the form of long teim debt. Repeal of investment credit would reduce the rate of growth of expanding operations, such as those examined, by about 4 percent per year. Other factors not explicitly examined, which seemed to have a major impact on the actual growth achieved are: family living expenses, the tax structure, land rental, purchase of nonfarm inputs, required initial investments, and management ability. It appears that results need to be interpreted not only in terms of the primary growth goals, but also in terms of the operator's view of other items such as outstanding debts and family consumption. ACKNOWLEDGMENTS The author wishes to express sincere appreciation to Dr. John Brake, Professor of Agricultural Economics for his help and guidance as major professor and thesis advisor. The author is also grateful for the helpful suggestions and ser­ vice given by Professors Larry Connor, Lester Manderscheid, and Ray Hoglund of the Agricultural Economics Department at Michigan State University. Also to Dr. Ronald Krenz and associates of the Economic Research Service, USDA, and especially to John Drew and Richard Benson. I am grateful for the support and encouragement given to me by the Department of Agricultural Economics and its chairman, Dr. L. L. Boger, and by the Economic Research Service, USDA. I would like to thank Mrs. Elaine Howery and Mrs. Barbara Gibson for their typing and cheerful cooperation. Finally, a special acknowledgment and thank you is given to my wife, Donna, and children, Sue, Tim, and Todd. Without their sacrifice and encouragement, completion of this endeavor would not have been possible. ii TABLE OF CONTENTS Section Chapter Title Page I .. . . Introduction................. 1 . 1.1 The Problem Situation......................................1 . 1.2 Objectives of the S t u d y .................................... 3 1.3 ......... General Approach .............................. . 1.4 Organization of the Thesis 4 ........................... 5 Chapter II . . . Previous Research............................... 7 Chapter III. . . Assumptions of the Research M o d e l ............... 12 3.1 .Physical Location....................................... 12 . 3.2 Production Technology..................................... 12 3.3 ...... Prices.............................................13 . 3.4 Goals of the Operator and Family.......................... 13 Chapter IV . . . The Linear Programming M o d el ....................15 . 4.1 A General Statement of the Linear Prograrrming M o d e l ............................. 15 4.2 ..The Basic M o d e l ........................................ 16 4.2.1 . .. .Definition of constraint r o w s ...................17 4.2.2 . .. .Definition of activity columns..................21 4.2.3 • .. .Resource levels................................ 36 4.2.4 . .. .Definition of objective functions............... 39 . 4.3 Variations on the Basic M o d e l ............................. 41 4.3.1 . • . . Goals of the farm operator......................42 4.3.2. . . . Equity requirements............................ 42 iii Iv Title . . . Length of repayment period......... 43 . . . Removal of Investment credit allowance 44 . . . Appreciation of land values ....... 45 . . . Lower milk prices ................. 46 . . . Presentation and Analysis of Model Results ..................... 47 . . . Results of the Basic Model ......... 47 . . . Results of the basic model with $70,000 beginning cash ....... . . . Cash flow of the basic model ....... 47 53 . . . Plans for presentation of other results ..................... 56 . . . Effect of Alternative Repayment Plans on Firm Expansion........... 58 . . . Alternative repayment plans with normal down payments......... 58 . . . Alternative repayment plans with liberal down payments ......... 61 . . . Summary of effects of alternative repayment terms ....... 63 . . . Effect of Alternative Levels of Beginning Cash on Firm Expansion and Minimum Equity Levels......... 64 . . . Alternative levels of beginning cash with normal down payments . . . . 64 Section Title 5.3.2 . . . . Alternative levels of beginning cash with liberal down payments . . . 5.3.3 . . . . Sunmary of effects of alternative beginning equity levels ........... 5.4 ......... Effect of Alternative Down Payment Requirements on Firm Expansion . . . . 5.4.1 . . . . Minimum equity situations for the N15&30 and L15&30 models ....... 5.5 ....... Relative Effects of the Alternative Repayment Plans, Beginning Equities, and Down Payment Requirements Examined 5.6 ......... Expected Consumption, Net Worth and Debt at the End of 10 Years by ilerd S i z e ....................... 5.7 ......... Sunmary of the Effects of Alternative Repayment Plans, Beginning Equities, and Down Payment Requirements on the Growth of the F i r m ................. Chapter VI . . . .Presentation and Analysis of Model Results for Other Selected Growth Variables....... 6.1 The Effects of Alternative Goals of the Farm Operator 6.1.1 . . . . The effects of maximizing only net w o r t h ......... vl Title . The effects of maximizing only consumption . ................. . The Effects of a Repeal of Investment Credit ............. . 94 . The Effects of Appreciation of Land Values ................. 96 . The effects of land appreciation and refinancing real estate loans .100 . The Effects of Lower Milk Prices . 100 . Normal down payment requirements and lower milk prices ......... 100 . Liberal down payment requirements and lower milk prices ......... 103 . Summary of the Effects of Other Selected Growth Variables . . . . 106 . Implications ................... 108 . Growth Factors Examined ....... 108 . Level of beginning equity . . . . 108 . Alternative repayment plans on long term debt ................. 110 . Smaller down payment requirements on short and long term loans . . . 111 . Goals of the operator ......... 112 . Appreciation of land values , . . 112 , Other Factors Important to Growth 112 , Growth Factors and Decision Making 115 vii Section Title Chapter VIII . . Sunmary and Conclusions................. Page .117 8.1 ......... Review of the Method and Underlying Assumptions........................ 117 8.2 ......... Sunmary of Primary Results..................... 118 8.3 ......... Suggestions for Further Research................122 Bibliography.................................................. 126 Appendix A . . . Procedure for Generating the Complete Ma trix...................... 129 A . l ......... Constructing the Full 10-Year Matrix of the Basic Model ................... 129 A.2 ......... Modifying the Basic M o d e l ...................... 13^ Appendix B . . . Basic Budgets for Matrix Activities............ 139 LIST OP TABLES Number Title Page 3.1 .. Prices assumed for products sold and Inputs purchased . . 14 4.1 .. Production activities for year 1 ....................... 23 4.2 .. Investment activities for year 1 ....................... 25 4.3 .. Purchase of dairy facilities, dairy cows, and additional roughage combined in the first 6 years of the 1BDFC activity...............................................28 4.4 .. Production resource acquisition and sale activities, year 1 ................................................ 30 4.5 .. Borrowing activities for year 1 ......................... 32 4.6 .. Taxes, consumption, and saving activities for year1 . . . 4.7 .. Allocation of fixed investments and minimum family 35 living expenses between iFCQST activities and x'uauui'ce uuritiLi'ctliiLs ...................... . . 3 7 4.8 .. Right-hand side values for basic m o d e l ................... 38 4.9 .. Nonzero entries for objective functions of the basic m o d e l ........................................ 40 5.1 .. Sunmary of production and financial data for basic model by years and 10-year totals, $70,000 beginning equity....................................... 48 5.2 .. Annual cash flow of basic model for $70,000 beginning equity ................................. 54 viii ix Nurriber Title Page 5.3 . • Model names and status of variable Items for the basic model and variations from the basic m o d e l .......... 57 5.4 . . Sunmary of results from the N15&30, N15&40, N10&20, and NDelay models to compare the effect of variations in repayment terms, $70,000 beginning equity.............59 5.5 • . Sunmary of results from the L15&30, L15&40, L10&20, and LDelay models to compare the effect of variations in repayment terns, $70,000 beginning equity.............62 5.6 . . Comparison of N15&30 results for three levels of beginning equity: $55,000, $70,000, and $95,000 ........ 65 5.7 . . Comparison of L15&30 results for three levels of beginning equity: $55,000, $70,000, and $95,000 ........ 68 5.8 . . Sunmary of results from the N15&30 and L15&30 models to compare the effect of different down payment requirements, $70,000 beginning equity .......... 72 5.9 • • Effect of initial equity position on final size of operation, total income, and final equity position for the N15&30 and L15&30 models .............. 75 5.10 . .Comparison of alternative solutions with basic model solutions for various measures of growth .......... 76 6.1 . . Sunmary of results from N15&30, N15&30CN, and N15&30CC models to compare effects of alternative operator goals, $70,000 beginning equity ................ 91 6.2 . . A comparison of results with and without investment credit, $70,000 beginning equity ....................... 95 X Number Title Page 6.3 . . Sunmary of results from the N15&30, NAPPR, and NAP&REF models to examine the effects of land appreciation and refinancing, $70,000 beginning equity..................................... 98 6.4 . . Comparison of basic model when milk prices are varied from $5.50 to $5*15 and $4.80 per cwt., $70,000 beginning equity ............................ 102 6.5 . . Comparison of liberal down payment requirement results with milk prices at $5.50, $5.15, and $4.80 per cwt., $70,000 beginning equity...............104 A.I. . Basic model (N15&30) for years 9 and 10 to illustrate construction of the model from the material presented in Chapter T V ...................... 130 A.2 . . Designation of activities by years included in the model and by presence or absence of year-toyear linkage......................................... 132 A.3 . . Borrowing activities for year 1 with 10-, 20-, and 40-year repayment periods and deferred payment for 4 years with 10- and 25-year repayment periods . . . 135 A.4 ..Coefficients for year 1 activities of the model to reflect minimum equity of 10 percent on chattel mortgages and 20 percent on real estate mortgages . . . 137 A.5 ••Modification of the 1LANC activity to reflect a 5 percent annual appreciation of land v alues...........138 B.l ..Labor requirements per acre for crops, acreage and labor required per cow plus replacement ......... 139 xi Number B.2 . Title Page .Cash expenditures per acre for crops, acreage and cash required annually per cow plus replacement . . . 1*40 B.3 • •Dairy production activity— 13,000# average production, mechanical feeding, herringbone parlor, c o m silage, haylage, and grain ration, tower silos and liquid manure system......................................... 1*41 B.*4 . .Investment credit allowable on purchases of Investment i t e m s ...................................... 1*42 B.5 • •Buy dairy facilities, excluding milking parlor, for 1BDFC activity.................................... 1*43 B.6 . .Estimated numbers of annual cattle purchases, sales, births, and deaths to initiate and maintain a *40-cow milking h e r d ......................... 1*4*4 B.7 . .Adjustments to short term credit when dairy cows are purchased........................ 1*45 B.8 . .Depreciation costs on purchased c o w s ................... 1*46 B.9 . .Adjustments to the 1TAXY row In the 1BDFC activity for capital gain or loss, depreciation, and sale of livestock when dairy cows are purchased............. 1*47 B.10 . . Adjustments to the 1ATAXY row in the 1BDFC activity for capital gain or loss, depreciation, and nontaxable Income when dairy cows are purchased................... 1*48 B.ll . . Adjustments to iNETWR of dairy animals for purchased cows in 1BDPC activities..................... 1*49 xii Number Title Page B.12 . . Cash expense In 1BDFC activity for additional roughage needed for the first five months when dairy cows are purchased.............................. 150 B.13 . • Investment cost of double-4 herringbone milking parlor and equipment, mllkhouse, milkhouse equipment, and bulk t a n k .............................. 151 LIST OP FIGURES Number 5.1 . Title Page . Relationship of herd size and outstanding debt at the end of 10 years, by beginning equity, repayment plan and down payment requirement.............83 5.2 . . Relationship of herd size and annual consumption in year 10, by beginning equity, repayment plan and down payment requirement........................... 84 5.3 . • Relationship of number of cows and net worth at the end of 10 years, by beginning equity, repayment plan and down payment requirement.............85 xiii Chapter I INTRODUCTION 1.1 The Problem Situation One characteristic of our changing agricultural sector in recent years has been the increasing amount of capital and credit necessary for a profitable farm operation yielding an adequate net farm income. Related to this is the continued outmigration of people from fanns, the increasing size of farms, and the decline in number of farms. Changes in the methods of obtaining capital, the acquisition of debt, and the terms of repayment of debt, can either retard or speed up such outmigration. In the future there will continue to be more individuals who desire to farm than there are farms available, and capital needs will Increase for the remaining farmers. Therefore, it is important that we gain further knowledge related to the establishment and expan­ sion of farm finis. In Michigan, dairying has long been the predominant agricultural enterprise. Ihe sale of dairy products has comprised more than one- fuui'Ui of tiie total cash receipts from farm marketings [2m ] .1/' Addi­ tional Income is received from the sale of dairy animals for milk, breeding purposes, and for slaughter. In the past, large numbers of producers with small herds produced the bulk of Michigan1s milk. In recent years large numbers of famers have quit dairying. But Many of those remaining in dairying have expanded their operations, and average herd size has Increased. 1/ Ihis larger herd size necessitates a much Bracketed numbers refer to items listed in the bibliography. 1 larger investment compared to former years. These larger investments have also led to increased use of credit for many f a m operators. For instance, in 1956 only 2,2 percent of all PCA loans made in the St. Paul District were above $10,000, while in 1966 21.3 percent exceeded this amount [14], This undoubtedly is also a reflection of the in­ creased annual production costs including substantial purchases of nonfarm inputs. The average total investment for specialized dairy farms in Michigan State University1s farm record project has increased from $86,179 in 1961 to $142,775 in 1967 [7]. The largest 79 of these 290 farms in 1967 had an average investment of $238,070 or nearly onequarter of a million dollars. These largest farms averaged 84.9 cows and had lower production costs per hundredweight of milk produced than the smaller fanns. Farms of this size and larger seem destined to be the primary sources of milk in the next decade and the farms with the greatest promise of returning a profit. Assuming tomorrow’s dairy farms will milk 80-100 cows with the associated investment in land, building, and equipment, how do fanners move from their present farm size situations to these m o d e m largescale operations? In the United States, fanning has traditionally been associated with the concept of family farm. Our values have held this to be a desirable form of control and much of our legislation and social custom have helped to promote this concept. In addition to f a m size being limited to a family operation, fanners have felt it best not only to control these resources, but also to have ownership of them. However, individual ownership of farms requires that each successive generation of farmers must accumulate the necessary capital to create their own firms. But If the capital base necessary for a dairy farmer to receive an adequate net Income continues to Increase, the question of how farmers are going to achieve this Increasingly larger task of capital accumulation becomes of greater Importance. Various proposals have been made for alleviating this problem of capital accumulation. Changes In the form of tenure, and primarily corporation farms, are currently a widely discussed change. Other proposals have referred to various forms of Integration where capital is furnished by a firm outside the farm production unit, generally In partial exchange for some measure of control of the farm operation. A third general area relates to changes In the Institutional means by which fanners gain access to credit. This Involves questions about the merit of such credit forms as low-equlty financing, permanent or semi-permanent debt, and insured low-equlty loans. This Is not an all-inclusive listing but Illustrates some proposals that are currently being examined to see If they may help to alleviate the problems asso­ ciated with capital accumulation by Individual farmers. X tC , WA W tI C U W W W IJ Various strategies are available to any particular Individual as he attempts to create a profitable farm organization. Individual background, motivation, ability, and resources controlled, In addition to outside forces such as general economic conditions can affect the success or failure of these strategies. Hence, the relative Importance of these and other variables needs to be assessed. Such analysis can provide Insight Into the desirability of Institutional changes affecting the availability and use of credit by farmers. This research will be oriented toward an examination of changes that could occur within those agencies whose primary function Is to extend credit to farmers. 1. Such focus has led to the following objectives: What Is the relative importance of different equity levels, down payment requirements, and terms of repayment on the growth of a firm? 2. What are the effects of other factors, such as operator goals or land appreciation on f i m growth? 3. How do these factors affect outstanding debt, taxes paid, value of assets controlled and other aspects of the farm business over time? 1.3 General Approach In a study of firms and how they expand over time it is necessary to have a model which will: (a) Incorporate the necessary production, marketing, consumption, and financing relationships; (b) allow adjust­ ments to occur and be recorded on a periodic basis to show adjustment paths through time; and (c) generate measurable output in terms relevant to the questions of growth. Tilex-e are a number of approaches that could be used to study firm growth with emphasis on capital accumulation by the farm firm. But In order to answer questions about future capital accumulation, and examine the usefulness of Institu­ tional practices not yet widely used, it is necessary to adopt a syn­ thetic approach such as a programming or simulation model. For this study a multiperiod linear programming model would seem to be most appropriate. Such a model cannot incorporate as much detail as a simulation model, but it can do a fairly complete job of detailing the Internal and external flow of funds and can provide conclusions relevant to the problem* The basic model Is developed for a dairy farm, with production relationships and costs corresponding to dairy fanns located In south central Michigan. Only one f a m type Is considered In the study, corresponding to the Increasing trend of specialization on today's farms. The model could readily be modified at a later time to examine effects on other fann types. Primary emphasis Is on financial aspects of the f a m operation. To keep the matrix size from becoming too large and unwieldy the pro­ duction and labor aspects of the f a m operation are limited. The bulk of the model Is devoted to capital and credit relationships. I.J| Organization of the Thesis The organization of the thesis will have a brief review of previous research In the area of capital accumulation and flrn growth in Chapter II. Chapter III will present the assumptions of the research model, while Chapter IV will describe the research model and define the r-eotrlotlorio ar*i activities of both the basic model and variations or. the basic model. The latter half of the thesis will present the results and impli­ cations of the research. In Chapter V the results of the primary fac­ tors examined— beginning equity, down payment requirements, and length of repayment terns— will be presented and a comparison made of their relative importance. Chapter VI will present the results of selected other factors affecting growth such sis goals of the operator and appreciation of land values. The implications of these results for 6 both farm operators and farm lenders will be presented In Chapter VII. A sunmary of the method and of the major conclusions of the research will be made In Chapter VIII. Chapter II PREVIOUS RESEARCH The problems associated with establishing and enlarging fann firms have bee one a major concern of agricultural economists in recent years. Of special significance has been the process by which the firm increases the amount of capital which it controls and/or owns. In 1957, Alvin Tostlebe’s book, Capital in Agriculture: Its Formation and Financing Since 1870 [32], presented a comprehensive look at long term trends in the accumulation of real capital and the means of financing capital additions and replacements for agriculture. Over this period, financing came largely from gross farm Income, with little use of external financing. However, this study was made on an aggregate basis, and what is internal to the agricultural sector is not necessarily internal to the individual farm units. Some farmers are borrowing money and adding to their debt while others are paying off previous debts. Only the difference appears as a debt from external sources, but the actual external financing is greater than _ 4-U4 OiLkO • In 1959, Edith Penrose's book, The Theory of the Growth of the Firm [28], focused attention on the problem of firm growth in a more general context. It also served to emphasize the dynamic nature of firm growth. Other studies have attempted to describe how individual firms acquired capital during their periods of growth. In 1964, Brake and Wirth [4] reported on a sanple of Michigan fanners. Data were col­ lected from the interviewers from the time of starting farming to 1961. Seme farmers started prior to 1930; others as recently as 7 8 the 1950's. This survey information provided an indication of the process of capital accunulation over time and indicated some of the problems and general relationships. In the report, f i m growth is viewed as occurring in three stages: establishment, expansion, and consolidation. As emphasized in the report, the expansion stage is the one of critical importance to firm growth. At this time, the operator is attempting to increase both his income and his net worth. This expansion stage is, perhaps, the stage most worthy of study. A 1965 report by Cumutt and Ferber [10] was a cross-sectional 3tudy of a sanple of central Illinois farmers surveyed in 1961 and 1962. This analysis examined the effects of various characteristics such as age, family size, years in farming, and acres operated on the value of f a m assets. Both of the above studies emphasize that younger farmers (who are generally the ones in the expansion stage) try to build f a m assets as rapidly as possible, while maintaining sufficient financial assets to meet emergency and family needs. Later years are devoted more to increasing the degree of ownership of assets. These studies give us insight into the problem of capital accumu­ lation by individual firms. However, they report what happened in the past, and we wish to deal with future needs and the means by which farmers can achieve future growth. In recent years several researchers have attempted to examine these questions using computer-oriented models.1/ The three basic approaches which have been used are: 1/ An excellent discussion of the various computer-oriented models which have been used in the area of f i m growth is the article by Irwin [21]. 9 multiperiod linear programming, recursive linear programming, and simulation. In 1959, Plaxico [29] outlined a theoretical approach to firm growth in a paper presented to the Great Plains Research Technical Cannittee GP-2. Martin [23] built upon this basic model to study capital accumulation and firm growth of Oklahoma and Texas farms in his 1966 Ph.D. thesis at Oklahoma State University. This analysis utilized a multiperiod linear programming model to examine the effect of hypothesized variables on firm growth at two starting equity situa­ tions to obtain specific growth rates over time. The effects on firm growth of land rental, a Keynesian consumption function, and capital rationing were studied. In this model profit maximization gave exactly the same results as four other objective functions. The model con­ sidered a 30-year planning horizon with perfect knowledge assumed for the period as a whole. Johnson [22] used a similar multiperiod linear programming model in his 1965 Ph.D. dissertation at Texas A & M University, but he also introduced probability distributions of crop yields as a source of variation to the farm flzm over time. These analyses were initiated at about the same time and examined basically the same hypotheses, but Johnson's analysis injects an element of uncertainty. Both Martin's and Johnson'3 analyses tend to confirm the intuitional ideas that more conservative Investment policies and more liberal consumption policies tend to restrict investment. However, neither study examined alterna­ tive credit policies for land purchase, nor did they include the pro­ gressive Income tax in the analysis. Another approach to examining the question of f i m growth and 10 capital accumulation is recursive progranming. Recursive programming solves for an optimum program in a single period, such as one year, subject to several flexibility constraints limiting the change of several variables to that consistent with past behavior. The output for one period then determines the resources available at the start of the next period. Heidhues [17] has used this technique in studying farm adjustment in northern Germany. The final approach to be discussed here is that of simulation. Simulation model is a tern which is not easily defined, since it refers not to a basic mathematical form of a model, but rather to a class of models utilizing the idea that, ". . . in a general way, simulation is some representation of reality " [29, p. 23]. In fact, each of the previous models is an attempt to "represent reality". But each of the prior models utilized some analytical optimizing procedure to determine the optimum solution. Simulation models vary in their formulation, but none guarantee that the solution given is an optimum solution. The simulation models generally have more flexibility in terms of accounting for various facets of any situation to be examined. bility is not costless. But this flexi­ The complexity of defining and validating detailed decision processes within a simulation model is very time consuming. In fact, due to the complexity and manpower requirements in building many of the simulation models, it is imperative that they be designed and utilized for several research projects, with successive projects building on earlier projects. The work of Eisgruber and others at Purdue University illustrates such a procedure. The initial simulation program was written by Eisgruber [13] to simulate a farm operation. The program was altered and expanded by Patrick [27] to 11 examine the effects of levels of management efficiency, Interest rates, and length of loans. Additional modifications have been and are being made to the simulation by other research personnel. Each of the above approaches has merit In the overall approach to studying capital accumulation by the farm firm. But in order to answer questions about future capital accumulation, and deal with Institutional practices that have not previously existed, it is necessary to adopt a synthetic approach such as the programming or simulation model. research utilizes a multiperiod linear progranming model. This Chapter III ASSUMPTIONS OF THE RESEARCH MODEL Research models must abstract from reality and emphasize those Items tfilch seem to be most crucial to the problem under study. In order to limit the problem to manageable size, many relatively Insig­ nificant Items are ignored, and certain conditions and parameters are hypothesized for Items which must be explicitly accounted for in the analysis. Any conclusions which are made from the analysis must be Interpreted In light of these basic assumptions. 3.1 Physical Location The study area Is assumed to be the general area of south central Michigan. This has been the area of greatest concentration of dairy farms In Michigan. At least in the short run, this area should con­ tinue as a primary dairy-producing area with its combination of natural resources suited to dairying and its proximity to a large metropolitan market. Future changes In milk marketing laws or the rapid acceptance of milk substitutes could alter the situation. It is also assumed that within this general area, dairy farming would primarily be found on a soil group designated S2 [see 8], These soils rank second In productivity in a four-part classification of Michigan soils. They are typically loam-clay-loam soils with Miami and Conover as representative soil types. The land is level to rolling and durable under cultivation except on the steeper slopes. 3.2 Production Technology It Is assumed that the managerial ability of the operator Is above average for both crop and livestock production. 12 Above average 13 management can be defined as the level of management (and corresponding technology) required to obtain yields Intermediate between present average yields, and the highest yields presently attained experimentally or by a few producers. Crop production is assumed to use four-plow power units and asso­ ciated machinery. The assumed per acre yields for each crop are: 85 bushels of corn for grain, 16 tons of c o m silage, 6.4 tons of haylage, 3.2 tons of hay, and 9 tons of oat silage. Dairy production assumed a herd averaging 13,000 pounds annual production. All replacement stock is assumed to be raised, but cows for expansion purposes are purchased. mineral is produced on the farm. All feed except supplement and Peed is stored in tower silos with unloaders and a mechanized feed handling system. Housing is assumed to be a cold-covered enclosed facility with free stalls and a liquid manure disposal system. A double-four herringbone milking parlor and milkhouse are part of this housing complex In which the cows are fed, housed, and milked. 3.3 Prices Prices assumed for products sold and major Input purchases are based on current and expected prices for these items (Table 3.1). 3.4 Goals of the Operator and Family Implicit in the model are several assumptions related to goals of the operator and his family. survive and grow. The first is a desire that the farm firm This implies that annual income must be sufficient to meet all required expenses. At the same time, a minimum level of income is assumed necessary to be used for family living expenses each 14 Table 3*1 Prices assumed for products sold and Inputs purchased Unit Item Milk 1/ Cows purchased Cull cows Calves C o m sold 2/ C o m purchased 2/ Urea Soybean oil meal Hired labor Land cwt. head head head bushel bushel ton ton hour acre Price per unit $ 5.50 350.00 160.00 30.00 .90 .95 110.00 104.00 3.50 350.00 2/ This represents the blend price currently being received for Grade A milk In south central Michigan. 2/ Ihis is the price for 26.5 percent moisture c o m sold at har­ vest Fime. Moisture Is discounted at 1/2 cent per 1/2 percent moisture above 15.5 percent and assumes a cost of 4 cents per bushel for hauling. Assuming a c o m price of $1.05 per bushel at harvest time, net sales price would be $.90. By offering $.95 per bushel, c o m of similar grade and moisture should be able to be purchased In the area. year. In addition, it Is assumed that the operator, by both ability and Inclination, wants to operate a dairy farm with most feed produced on the farm. Subject to these goals, the operator will attempt to combine his labor and Investments In such a way as to maximize his consumption and net worth over a period of years. Chapter IV THE LINEAR PROGRAMMING MODEL This chapter presents the general statement of the linear program­ ming (LP) problem to be examined, including a definition of the rows and activities of the basic LP tableau, and a discussion of the varia­ tions that will be made from the basic model in order to compare the alternative means of financing expansion of farm firms. 4.1 A General Statement of the Linear Programming Model Ihe multiperiod LP model to be used in this study corresponds to the general linear progranming problem: Given a set of M linear inequalities or equations in n vari­ ables, we wish to find nonnegative values of these variables which will satisfy the constraints and maximize or minimize some linear function of the variables. In matrix notation this can be written as: Max z = cx subject to: Ax <_ b x >_ 0 where A is an mxn matrix, x and c are lxn vectors, and b is an mxl vector [16], Implicit in the general LP model are the assumptions of lin­ earity, divisibility, additivity, and finiteness [31J. The multiperiod LP model used in this study is formulated according to these basic rules, but it approximates a form called "lower triangular." The tableau can be visualized in matrix foim 15 Most nonzero coefficients in the A matrix are found on or below the main diagonal. Each submatrix A^, k = 1, . . . , t represents activities initiated in any period of time. Some of these activ­ ities affect only restrictions within that time period. Other activities also affect restrictions in one or more of the subse­ quent time periods. The problem is solved as a unit, and thus, decisions made in period 1 affect those made in later periods and vice versa. 1/ 'Ihe objective function maximizes the value of z for the entire period. 4.2 The Basic Model The complete basic model encompasses a time horizon of 10 years. Although the farm production sections of the model are quite abbreviated, the base model contains 255 rows and 214 columns. However, only 171 of these rows are constraint rows, as 84 rows merely perform accounting calculations to save time in summarizing 1/ Irwin [21] suggests that there may be little lnpact on the solution from feedback of later period decisions. However, this may be a function of the particular model. 17 the results. Because of the large size of the matrix and the fact that much of the data for each activity Is repeated In subsequent periods, only representative portions of the model will be pre­ sented. The procedure for developing the conplete matrix from the data presented here Is explained In Appendix A. 4.2.1 Definition of constraint rows In the following definitions, each constraint row is Identified by the name used In the progranming model. The letter or number at the start of each row name designates the year(s) to which the restriction applies: (1) 1 means that it applies to each of the 10 periods, (2) R shows that It is a summary of that item for all 10 periods, and (3) a specific number means that It applies only In that year. 1LAND — Is a constraint on the total acres of land controlled by the operator during that year. on a one-year basis. Additions through renting can be made Additions through purchase are available In the year of purchase and all succeeding years. » w w iii w o^ v im o uu unc c u u iW C U i x q u m o u p p x jf qvci Xic w x c « iliO Initial labor base available is the annual labor supply of the operator and family labor reduced by the hours of labor needed for overhead work. Additional labor can be hired on an annual basis. 1CASH — is the liquid money supply used for purchases and pay­ ments . At the start of each year cash is available as the result of Income transferred forward from the previous year. Additional cash within each year can be obtained through borrowing. 1STCR — reflects the institutional limit of credit allowable on short (1-year) or Intermediate (5-year) term loans. Short term credit 18 refers to money borrowed for only one year, while intermediate term credit refers to debts which are to be repaid over a 5-year period. The same Items are assumed to serve as collateral for these two types of loans, and borrowing for both purposes cannot exceed these credit limits. Collateral for this restriction is equal to 75 percent of the current value of machinery, equipment, feed, and livestock. 1EDCR — reflects the Institutional limit on borrowing against collateral in the form of buildings and facilities such as silos. Debts may be contracted with the initial assumptions being 60 percent credit and a 15-year repayment period. (Applies only to years 1, 5, and 9— the only years in which additional investments in buildings are allowed.) iRECR — owned land. reflects the institutional limit on borrowing against Ihe initial assumptions are for borrowing up to 60 percent with the debt amortized over a 30-year period. (Applies only to years 1, 5, and 9— the only years in which additional investments in land are allowed.) iMCHY — field work. is a constraint on machinery and equipment available for Offsetting annual cash outlays and depreciation maintain the original stock of machinery sufficient to operate 200 acres of land. Additional equipment capacity can be purchased when over 200 acres are operated. 1T.SFAC — accounts for the capacity of livestock facilities, housing and feed storage for cows and replacements. 5MPCAP and 9MPCAP — limits the capacity of the original milking parlor to 130 cows unless expansion of the parlor is made. 1GRAIN — is an equation to allow c o m to be fed to dairy stock, 19 to be sold, or to purchase additional grain. OSALEG — allows raised c o m to be either sold or stored in the final year. 1FIXC — annually. is an equality which forces certain fixed costs to be met These costs are for family living, minimum ownership of machinery, and purchase of a milking parlor in year 1. 1QWNU — is a constraint requiring the owner to purchase a mini­ mum of 80 acres of land in year 1. RGRAIN — is a constraint to force the final year cropping program to be consistent with the previous year. 1TAXY — is an equation to record the amount of taxable income received each year. Taxable income consists of the capital gain or loss on purchased livestock, 50 percent of the sale price on raised live­ stock, plus regular income from sales of milk, grain, and other live­ stock. Allowable expenses include purchased feed, labor, seed, etc., depreciation on investment items, and interest paid on loans. Given that the stated operation is profitable, the positive level of taxable income can be used to levy income taxes, with the balance transferred to after tax income. 1TAX3 (J * 1, 2, 3) — are 3 constraints designed to approximate segnents of the progressive income tax. The first segment allows taxa­ tion at a low rate for the first $2,400 of taxable income. The taxation rate increases as taxable income increases. 1INVCR — is an equation for investment credit. 1TAXES — is an equation for Federal income taxes paid annually and which may be reduced by investment credit. 1ATAXY — is an equation for after tax income. This is equal to 20 net incane after deducting for income taxes, plus the 50 percent of Income received on raised dairy cattle which was not income for tax purposes. Net income after taxes must be great enougi to meet the $4000 annual minimum family consumption. INCASH — is an equation for the net amount of cash transferred to the succeeding year. It consists of net farm Income (minus income taxes and consurrption), savings, certain farm expenses and depredation. Parra expenses which are removed from both the 1CASH and iTAXY row must be added back through INCASH so they are not charged twice as annual expenses. Likewise, depreciation is an expense for tax purposes, but It is not an actual cash withdrawal. the cash flow. Hence, it may be added back into Hie actual purchase of Investment items Involves cash payments or acquisition of debts, but depreciation need not be removed fran available cash unless it is assumed the money is set aside and saved until replacements must be purchased. Hie following equations are simply used to record information that was felt to be of use in sumnarizing the results. Their inclusion has no effect on the optimum solutions, they merely record certain dimen­ sions associated with the solutions. 1GY — records the total amount of gross Income generated annually. 1STAX — records the total Social Security, State and Federal taxes, after deductions for investment credit, paid annually. 1CNS — records the annual expenditure for family living expenses. 1NETWR — records the net worth of the firm at the end of each year. iDEHT — 1PRINP — records total debt outstanding at the end of each year. records the total principal payments made each year. 21 1INTP — records the total Interest payments made each year. 1DEFR — records annual depreciation. RCNS — records the total amount of money allocated to family consumption during the 10-year period. KPAXY — records the 10-year total of taxable income. RATAXY — records after tax Income for the full 10-year period. RTAXES — records the total taxes paid for the 10-year period. 4.2.2 Definition of activity columns The complete basic model contains 214 activities In the A matrix. There are 25 basic activities each year, with 19 of them occurring In each of the 10 years; 1 occur­ ring In the first 9 years only; 1 occurring in years 1, 5, 8, and 9 only; 1 occurring In years 5 and 9 only; and 3 occurring only In years 1, 5* and 9. Activity colunns are Identified by the name used In the progranming model, and the letter or number at the beginning of the constraint Indicates whether it occurs In each model period (1) or In AM 1 MMA SMtJLJ X C U JG G U O • In order to concentrate the analysis on the effects of financial decisions, only one grain production and one dairy production possibility are assumed to exist each year. This allows the bulk of the matrix to present Invest­ ment alternatives, how to finance these investments, and relevant aspects of taxation and consunptlon. Activities are presented In final matrix form for a single year, as succeeding years can be derived from these activities. The procedure for developing the conplete matrix from the data 22 presented here Is explained in Appendix A. Background data used to develop certain activity coefficients are given in Appendix B. Production activities (Table 4.1) 1GRPD — The grain production activity produces c o m which is then available for the dairy enterprise or far sale off the farm. Only one- sixth of the c o m produced is assumed to be available for use by the dairy enterprise during the current year. The value of c o m produced but not used within the year is added to net worth. C o m is assumed to be harvested as high moisture c o m and stored in tower silos if fed to the dairy herd. If sold off the farm It is assumed to be har­ vested at 26.5 percent moisture and marketed Immediately. In order to maintain essentially the same enterprise combinations as in earlier years the RGRAIN row has entries in the final two years of the matrix to farce c o m acreage in the terminal year to be as large or larger than the previous year. This simply requires a +1 in the RGRAIN row of the 9DYPD activity and a -1 in the same row of the ftnVDI'i fci v V A V A v j f • 1DYPD — The dairy production activity Includes the raising of nurse crops, forage, and replacement dairy stock in addition to milk production. The activity is set up as if the dairy farm had been oper­ ating at a given level for seme time, with replacements equalling culls. When herd size is expanded, deviations from this pattern have to be accounted for, and this Is handled through the buy dairy facilities activity (1BDFC). Cows and replacements generate intermediate tern credit. Taxable 23 Table 4.1 Row Name Production activities for year 1 1/ Unit CNC 2/ Dollar 1LAND 1LABGR 1CASH 1STCR 1MCHY 1LSFAC 1QRAIN 1QY 1TAXY 1ATAXY INCASH 1NETV/R 2GRAIN 2NEIWR Acre Hour Dollar Dollar Acre Cow+R Bushel Dollar Dollar Dollar Dollar Dollar Bushel Dollar 1GRPD Dairy Production Activity ¥brkge " tows lfaW .97 3.18 31.86 2.635 18.46 65.31 .97 2.635 -13.75 31.86 65.31 -31.86 -74.25 -68.75 -61.87 -65.31 -103.72 31.5 84.35 -337.5 1. 82.5 -783.5 -673.15 -26. -84.35 -450. 2.635 49.96 149.66 -337.5 2.635 1. 82.5 -783.5 -607.84 —26. -149.66 -553.72 1/ See appendix tables B.1, B.2, and b.3 for additional details. Negative values In this and succeeding tables In this chapter Indicate an addition to the resource or restriction. 2/ The objective function (CNC) given in this and succeeding tables Is the discounted present value of consumption for each of the 10 years plus the discounted present value of the activities1 contri­ butions to the firm's net worth at the end of the 10th year. 24 Income Is a net figure ccnposed of milk sales, sales of calves and cull cows, and cash expenses for crop and livestock production. After tax Income represents the Income received from the sale of cull cows which Is not taxable, I.e., only 50 percent of the sale value of raised dairy cows Is taxable, so the additional Income is accounted for here. Use figure for net worth Is based on market value of one cow plus replace­ ment and 5/12 of the value of rougiage produced. Investment activities (Table 4.2) To reduce the divisibility problem, the activities far investment In land, buildings, and machinery are primarily limited to years 1, 5, and 9* However, since machinery Is assumed to be completely depre­ ciated and must be traded In after 7 years, machinery purchases may be made In year 8 to replace any machinery purchased In year 1. lBflEC — This activity allows additional machinery and equipment to be purchased when more than 200 acres of land are operated. The investment cost of $70 per acre is based on the per acre Investment for machinery and equipment of specialized dairy farmers In southern Michigan o5 reported In rewent TgIxcuiu reports [7j « psr acrs Invq oUu&iit held fairly constant for the small, intermediate and large size of farm groupings as reported In Telfarm, so no adjustment Is made for size of farm. An additional 20 percent depreciation Is assumed to be taken In the first year along with normal depreciation based on a 7-year life and 10 percent salvage value. Hence, If the optimal solution desig­ nated 300 acres of cropland for each of the 10 years, it would require 100 units of the 1BMEC activity to be purchased In both years 1 and 8. Depreciation Is an expense for taxable Income purposes, but this amount 25 Table 4.2 Investment activities for year 1 Activity name Row name Unit CNC Dollar 1LAND-0LAND 1CASH 1STCR 1BDCR IRECR 1MCHY-7MCHY 1LSFAC-0LSFAC 1GY 1TAXY 1INVCR 2/ 1ATAXY INCASH 1NETWR 10WNID 1DEPR 2CASH 2STCR 20Y 2TAXY 2ATAXY 2NCASH 2NEHWR 2DEFR 3CASH 3STCR Acre Dollar Dollar Dollar Dollar Acre Cow+R Dollar Dollar Dollar Dollar Dollar Dollar Acre Dollar Dollar Dollar Dollar Dollar Dollar Dollar Dollar Dollar Dollar Dollar Dollar Dollar Dollar Dollar Dollar Dollar Dollar Dollar Dollar Dollar Dollar Dollar Dollar Dollar Dollar Dollar Dollar Dollar 3TAXY 3ATAXY 3NCASH 3NETWR 3EEPR 4CASH 4STCR May Mt a x y mataxy mncash 4NETEWR Me e p r 5CASH 5STCR 5BDCR 5RECR IOTC- - M M T " -138.7 TO. -52.5 - - - - 5 H E 3 S - - H35RJ -27.78 -162.1 -1. 350. 1353.22 75. -539.7 -210. -1. 19.8 -3.27 -19.8 -50.2 -19.8 -43.55 7.2 -7.2 -43.0 -7.2 -33.89 7.2 -7.2 -35.8 -7.2 -1. 52. 257.2 -29.02 26. -231.2 -705.08 -350. 1. -127.48 43.75 75. 52. 158.5 26. -132.5 -688.5 -132.5 87.5 45. 48. 144. 24. -120. -638.25 -120. 3.5 3.5 -3.5 -350. 3.5 3.5 -3.5 -350. 3.5 -26.85 7.2 -7.2 -28.6 -7.2 40. 115. 20. -95. -590.75 -95. 3.5 -3.5 -350. 100. 3.5 -21.45 -395.7 —60 . -210. 26 Table 4.2 (cont*d.) Row name Unit 5MPCAP 5GY 5TAXY 5INVCR 5ATAXY 5NCASH 5NETWR 5U4FR 6CASH 6STCR 6GY 6t a x y 6ATAXY 6NCASH 6NETWR 6DEPR 7CASH 7STCR 7TAXY 7NCASH 7NETWR 7DEPR dCASH 8TAXY 8NCASH 8NEIWR 8Ufa)PK °CASH 9BDCR 9RECR 9MPCAP 9TAXY 9NCASH 9NETWR 9DEPR OCASH OTAXY ONCASH ONEIVfR ODEPR Head Dollar Dollar Dollar Dollar Dollar Dollar Dollar Dollar Dollar Dollar Dollar Dollar Dollar Dollar Dollar Dollar Dollar Dollar Dollar Dollar Dollar Dollar Dollar Dollar Dollar Dollar TV*1i1 ft Dollar Dollar Head Dollar Dollar Dollar Dollar Dollar Dollar Dollar Dollar Dollar lfiMsc Activity name 5MILKP 1BDFC 7.2 1. 40. 99.38 -7.2 -21.4 -7.2 20. -79.38 -562. -79.38 1LANC -1. 6.67 -7. 3.5 —6.67 -93.33 -6.67 -3.5 -350. 3.5 -16.05 7.2 -7.2 -14.2 -7.2 40. 90. 20. -70. -539.5 -70. 6.67 3.5 -6.67 -86.66 -6.67 -3.5 -350. 3.5 -10.65 -7. 60. —60. -479.5 —60. 6.67 -6.67 -79.99 -6.67 60. - 60 . -419.5 -6 0 . 6.67 -6.67 -73.32 -6.67 -251.7 -43.99 1. 60. —60 ■ -359.5 -60. -1. 6.67 -6.67 -66.65 -6.67 60. -60. -299.5 —60 • 6.67 -6.67 -59.98 -6.67 3.5 -3.5 -350. 3.5 3.5 -3.5 -350. -210. 3.5 -3.5 -350. 3.5 3.5 -3.5 -350. 3/ This activity was not needed before year 5. 2/ See Appendix Table B.4 for details on calculating investment credit. 27 is assumed to be Included in the cash flow for the farm operation, so an equivalent amount is added to the iNCASH row. 1BDFC — The buy dairy facilities activity Incorporates several different functions: (1) the purchase of dairy housing, feed storage facilities, and mechanical feeding equipment, (2) the purchase of addi­ tional cows, and (3) the cost of additional rou^iage needed in the first part of the year in which the expansion takes place (see Table 4.3)* This activity adjusts for the changes necessitated when herd expansion is brought about through the purchase of additional cows, not only in the first year but in later years as well. When no expan­ sion is underway the iDYPD activity coefficients apply. But when expansion occurs the net effect of the iDYPD and iBDPC activities give the proper coefficients for each row. Ihe basic model assumes there is no existing housing, feed storage for dairy cattle, or dairy cattle. before the iDYPD activity can enter. These items must be purchased And replacements must be purchased for cull cows in the 2nd and 3rd years until raised replacements are available. Thus, there is a cash outlay of $350 for the purchase of 1 cow in year 1, $43.75 for 1/8 cow in year 2, and $87.50 for 1/4 cow in year 3. Prom year 4 on, the 1/4 cow per unit needed for replacement is available from raised stock through the iDYPD activity. Likewise, although the iDYPD activity accounts for raising the necessary roughage, none will be available for the first 5 months of the expansion year, so a charge is made in the first year of the iBDPC activity. The adjustments to the iSTCR rows account for the fact that while short term credit is generated in the iDYPD activity for $337.50 based on 1 cow and replacement, when herd size is increased through purchases Table 4,3 Purchase of dairy facilities, dairy cows, and additional roughage combined in the first 6 years of the IBDPC activity Buy dairy facilities 1/ Row name Unit CNC Dollar -138.7 1CASH 1STCR 1BDCR 1LSFAC-0LSFAC 1GY 1TAXY 1INVCR 1ATAXY INCASH 1NETWR 1DEPR 2CASH 2STCR 2GY 2TAXY 2ATAXY 2NCASH 2NETWR 2EEPR 3CASH 3STCR 3GY 3TAXY 3ATAXY Dollar Dollar Dollar Cow+R Dollar Dollar Dollar Dollar Dollar Dollar Dollar Dollar Dollar Dollar Dollar Dollar Dollar Dollar Dollar Dollar Dollar Dollar Dollar Dollar TV-.11 899.5 3NETWR 3DEPR 4GY 4TAXY 4ATAXY En c a s h 4NETWR 4DEPR 5BDCR 5MPCAP 5GY 5TAXY 5ATAXY 5NCASH 5NETWR bUKPH 6GY 6TAXY Dollar Dollar Dollar Dollar Dollar Dollar Dollar Dollar Dollar Head Dollar Dollar Dollar Dollar Dollar Dollar Dollar Dollar Buy dairy cows 2/ Buy additional roughage 3/ -138.7 350. 75. 103.72 -539.7 -1. 60. -29.02 -60. -839.50 -60. 60. -60. -779.5 -60. 60. rs« —C uw -719.5 —60 • 60. -60. -659.5 -60. -395.7 1. 60. -60. -599.5 —6o. 60. IBDPC 52. 93.48 26. -67.48 134.42 -67.48 43.75 75. 52. 98.5 26. -72.5 91. -72.5 87.5 45. 48. 84. 24. Cr\• —yw 81.25 -60, 40. 55. 20. -35. 68.75 -35. 40. 39.38 20. -19.38 37.5 -19.38 40. 30. 103.72 -103.72 1353.22 75. -539.7 -1. 52. 257.2 -29.02 26. -231.2 -705.08 -127.48 43.75 75. 52. 158.5 26. -132.5 -688.5 -132.5 87.5 45. 48. 144. 24. ifon —▲ c.W• -638.25 -120. 40. 115. 20. -95. -590.75 -95. -395.7 1. 40. 99.38 20. -79.38 -562. -79.38 40. 90. 29 Table 4.3 (cont'd.) Row name Unit 6ATAXY 6NCASH 6NETWR 6DEFR Dollar Dollar Dollar Dollar Buy dairy facilities 1/ -60. -539.5 -60. Buy dairy cows 2/ Buy additional roughage 3/ IBDPC 20. -10. 20. -70. -539.5 -70. -10. 1/ Cash expense for year 1 is budgeted in Appendix Table B.5. iBDCRfis equal to 60 percent of C$899.50 (cash paid) -accumulated depreciation]. Depreciation is for 15 years, equal to 6-2/3 percent or $60.00 per year. Net worth is based on initial cost minus accumu­ lated depreciation. 2/ See Appendix Tables B.5 through B.ll for additional details. 3/ See Appendix Table B.12 for additional details. there Is something less than 1 cow and replacement available until year 4. The necessary adjustments to the 1TAXY and 1ATAXY rows result from fewer calves and cull cows sold in years 1 to 3, and for differences in expenses and Income for tax purposes with purchased versus raised cows. 3 H L K P and 9MILKP — Uils activity provides for the expansion of the milking parlor facilities when the herd size exceeds 130 cows. iLANC — lhe purchase of land makes the land avai lable in that and all succeeding years. of the land value. Real estate credit is assumed to be 60 percent Fran year 2 on, real estate taxes of $3.50 per acre, or 1 percent of the value of the land, must be paid. At the end of each period the full value of the land is added to net worth. Production resource acquisition and sale activities (Table 4.4) 1LANR — This activity allows additional land to be rented annually 30 Table 4.4 Production resource acquisition and sale activities, year 1 Row name Unit CNC Dollar HA ND 1LABOR 1CASH 1GRAIN 1GY 1TAXY INCASH 1NETTWR 2GRAIN 2NETWR Acre Hour Dollar Bushel Dollar Dollar Dollar Dollar Bushel Dollar lLANR B535 Activity name 1SGRAN 1BGRAN ISM -1. -1. 3.5 30. 30. -30. at a cost of $30 per acre.l/ 3.5 -3.5 1. -5.4 -5.4 5.4 5. 4.5 5.7 -1. .95 -1. 5.7 -5.7 -5.7 -5. -4.75 .95 -.95 -.95 Since at least 80 acres of land are required to be owned, it is assumed this is bare land rented for crop use only. 1HLAB — Allows any amount of hired labor to be hired at a compet­ itive wage by the farm operator. 1SGRAN — Allows grain to be sold off the farm at harvest time. IBGRAN — Allows corn to be purchased at harvest time. Since high moisture c o m must be purchased for storage in tower silos, the sum of purchased plus raised grain must be sufficient for the last 2 months of that year and the first 10 months of the following year. 1BUYG — Allows additional grain to be purchased during expansion for the ten-month period until raised grain is available in years 1, 5, 1/ This is approximately 8.5 percent of the assumed land value and corresponds to the current cash rental price in central Michigan. A price of 8 percent of the value of the property is suggested for bare land in Farm Management Handbook [15, p. 80]. 31 and 9 . Borrowing activities (Table 4.5) The four borrowing activities are differentiated by their source of credit and length of repayment terms. However, In each case they furnish cash which may then be used for any purpose needed within the model. The program determines which source of borrowed funds Is most desirable and this can be used up to the limits of that credit source. Having the lending activities defined In this manner will readily show the amounts of the various types of credit used. Any debt outstanding at the end of the year reduces net worth. Borrowing activities are limited both by the Institutional restraints assumed with regard to minimum equity required In various assets and by the repayment capacity of the farm operation. 1BM5T — This activity allows money to be borrowed for one year as long as the short tern credit limits and the ability to repay are not exceeded. 1EMIT — This activity allows money to be borrowed for a five- ••MMM JfC flU ' A «*n u p V -/ W ilC 4U> ±1J J U LLU i» 414 n a V CUM C U /X X 4 . WJf n f UW 1 • Aw w »pu^n i u « * v is made In five equal installments and the short term credit limit Is restored as repayments are made. 1BCR15 — This activity permits borrowing against equity In build­ ings and storage facilities. In the basic model equal payments are made over a 15 -year period, again with credit being restored as the principal is retired. 1RCR30 — This activity permits borrowing on a 30-year mortgage using land as collateral. Equal payments are made so as to amortize 32 Table 4.5 Row name Borrowing activities for year 1 Activity name TSm --------- XERET 3S5RI5--------- m dollar------------------- - _ _ _ _ _ - - - .2424 CNC 1CASH 1STCR 1BDCR 1RECR 1NETWR 1DEBT 2CASH 2STCR 2TAXY 2NCASH 2NETWR 2DEHT 2PRINP 2INTP 3CASH 3STCR 3TAXY 3NCASH 3NETWR 3DEHT 3PRINP 3INTP 4CASH 4STCR 4TAXY 4NCASH 4NETWR 4EEBT 4PRINP 4INTP 5CASH 5STCR 5BDCR 5RECR 5TAXY 5NCASH 5NETWR 5DEBT 5PRINP 5INTP 6CASH 6TAXY 6NCASH -1. 1. !m -1. 1. -1. .4045 -1. 1. 1. -1. 1.08 .08 -.08 .1 -.08 1. -1. .2505 .8295 1. -1. .1098 1. 1. -1. .0806 .08 .07 -.07 .9602 -.9602 -.0398 -.07 .1098 .07 -.07 .9894 -.9894 -.0106 -.07 .0806 .0672 -.0672 .9176 -.9176 -.0426 -.0672 .1098 .0693 -.0693 .9781 -.9781 -.0113 -.0693 .0806 .0642 -.0642 .8721 -.8721 -.0456 -.0642 .1098 .068 s -.0685 .9660 -.9660 -.0121 — .0685 .0806 -.08 .8295 -.8295 -.1705 -.08 .2505 .6454 .0664 -.0664 .6454 -.6454 -.1841 -.0664 .2505 .4466 .o r i 6 -.0516 .4466 -.4466 -.1989 -.0516 .2505 .2319 .7332 .0357 -.0357 .2319 -.2319 -.2148 -.0357 .2505 .0186 -.0186 .0611 -.0611 .8233 -.8233 -.0487 -.0611 .1098 .0576 -.0576 1. .0676 -.0676 .9530 -.9530 -.0130 -.0676 .0806 .0667 -.0667 33 Table 4.5 (cont'd.) Row name 6NEEWR 6LKH1' 6PKENP 6JOTP 7CASH 7TAXY 7NCASH 7NETWR 7EEBT 7PRINP 7INTP 8CASH 8TAXY 8NCASH 8NETWR 8lMJfi' 8PRINP 8INTP 9CASH 9BDCR 9RECR 9TAXY 9NCASH 9NEIWR 9DEBT 9PRINP 9XNTP OCASH OTAXY ONCASH ONETWR 01MJ1' OPRINP OIMTP lfiMsT Activity name U eHIT lbcftL5 -.2319 -.0186 .7712 -.7712 -.0522 -.0576 .1098 .0540 -.0540 .7154 -.7154 -.0558 -.0540 .1098 .0501 -.0501 .6557 -.6557 -.0597 -.0501 .1098 .4664 1RCR30 .9391 -.9391 -.0139 -.0667 .0806 .0657 -.0657 .9242 -.9242 -.0149 -.0657 .0806 .0647 -.0647 .9084 -.9084 -.0159 -.0647 .0806 1. .0459 -.0459 .5918 -.5918 -.0639 -.0459 .1098 .0414 -.0414 .5234 -.5234 -.0684 -.0414 .0636 -.0636 .8913 -.8913 -.0170 -.0636 .0806 .0624 -.0624 .8732 -.8732 -.0182 -.0624 34 the loan over a 30-year period. Taxation, consumption, and saving activities (Table 4.6) iTAk (k = 1, . . . , 4) — The four tax activities allow the rate of taxation to increase from 6.4 to 33 percent. These rates include State and Federal income taxes and Social Security taxes. based on a fmally of 4 using the standard deductions. They are All taxable income above the $20,000 is taxed at the 33 percent rate. iREDTX — This activity allows for reduction in the amount of Federal income taxes paid whenever there is unused investment credit. 1TINVC — Any unused investment credit is transferred to the following year. ICS — This activity appears only in years 1 through 9. This activity allocates after tax income between consumption and savings. The fixed cost activity assures a minimum level of consump­ tion of $4000 and it is assumed that 35 percent of net income after taxes will be used for consumption above this $4000 minimum.1/ The 65 percent for savings is added to the INCASH row. 1SAVE — This activity assumes that unused cash can be deposited In a savings account and earn 4 percent interest. iTNCAS — This activity allows the total amount of available cash transferred to the beginning of the following year to be recorded for checking and comparison purposes. 1/ An attempt was made to include a step function to accommodate decreasing rates of consumption and increasing rates for savings. How­ ever, since the primary need within the model is for additional cash, the LP routine selected the highest rate of savings activity exclu­ sively. Thus, a single consumption-savings function was developed for the model. Allocating a minimum $4000— and 35 percent of all additional net income after taxes to consumption is based on data on family con­ sumption by Brake [2]. The balance of net income after taxes (65 per­ cent) is then allocated to savings. Table 4.6 Taxes, consunption, and saving activities for year 1 Row name Unit CNC Dollar 1CASH 1TAXY 1TAXL 1TAX2 1TAX3 1STAX 1INVCR 1TAXES 1ATAXY 1CNS INCASH 1NETIVR 2CASH 2INVCR RATAXY RCNS KTAXY RTAXES Dollar Dollar Dollar Dollar Dollar Dollar Dollar Dollar Dollar Dollar Dollar Dollar Dollar Dollar Dollar Dollar Dollar Dollar 1TA1 I'?A2 1TA3 1TA4 Activity name 1Rfete 1TTNVC 1WCAS ICS -.3241 1.0 1.0 1.0 1.0 1.0 -.33 1.0 -.04 1..0 -.064 -,.174 1.0 -.25 -.936 -.109 -.826 -.179 -.75 -.258 -.67 1.0 1.0 1.0 -1.0 1.0 1.0 -.35 -.65 -.35 -1.0 -1.0 -.35 -1.0 -.064 -1.0 -,174 -1.0 -.25 -1.0 -.33 1.0 -1.0 1.0 -1.0 -1.0 36 Fixed cost activities (Table 4.7) 1FCQST — These activities require: (1) the purchase In year 1, and maintenance thereafter, of equipment to operate 200 acres of crop­ land; (2) the purchase of a milking parlor, milkhouse, and equipment In year 1; and (3) minimum levels of consumption each year. The first Item was required to be purchased In Its entirety to reflect the nec­ essity of a m i n i m m stock of machinery. The milking parlor Is assumed to be able to handle herds up to 130 cows. assets is Credit generated by these built Into the model through the RHS vector, along with machinery capacity, Investment credit, and additions to INCASH from depreciation. The amounts in the iFTXC rows force in the 1FCQST activ­ ities to the desired level. The value of the milking parlor and the value of the machinery, less their respective depreciation, Is added to net worth In each year. 4.2.3 Resource levels Nonzero Initial resource levels are assumed for only a small pro­ portion of the model rows (Table 4.8). 1STCR, iBDCR, 1MGHY, The Items shown In the RHS for iFTXC have Just been discussed In connection with the 1FCOST activities. The 10WNLD restraint requires a minimum of 80 acres of land to be purchased In the first year. While cropping operations are readily undertaken on rented land, It is assumed that at least this minimum acreage must be owned before making Investments In buildings and facil­ ities . The operator and his family are assumed to furnish up to 3,000 hours of labor annually. This Is less than Is reported by Telfam I Table 4.7 Activity Name IFCOST 2FC05T 3/ Allocation o: fixed investments and minimum family living expenses between iFCOST activities and resource constraints Required ourchaisos and mini mum consumption Purchase Purchase of Milking of Minimum Machinery \J Parlor 2/ Consumption Total Row Name Unit CMC Dollar 1CASH 1STCR 13PCR 1MCHY 1FIXC 1TAXY 1INVCR 1ATAXV 1CNS INCASH INETWR 1DEPR RCNS Dollar Dollar Dollar Acre Dollar Dollar Dollar Dollar Dollar Dollar Dollar Dollar Dollar 14,000 -10,500 1CASH 2STCR 2MCHV 2FIXC 2TAXY 2invcr 2AT.4XY 2CNS 2NCASH 2NETKR 2DEPR Dollar Dollar Acre Dollar Dollar Dollar Dollar Dollar Dollar Dollar Dollar 2,000 -10,500 -200 Model Allocation iFCOST RHS -1.187 16,800 30,800 -10,500 -10,080 -200 10.CS0 -200 2,000 -653 1,120 -798 4,000 -4,000 -2,000 -12,000 -2,000 -1,120 -15,680 -1,120 -40,000 2,000 -93 2,000 -10,500 -200 1,120 4,000 -4,000 -2,000 -12,000 -2,000 3,120 -1,451 4,000 -4,000 -3,120 -27,680 -3,120 -40,000 -1,120 -14,560 -1,120 3,120 -93 4,000 -4,000 -3,120 -26,560 -3,120 11.154 1.0 1.0 -.465 1.282 -1.282 -1.0 -8.872 -1.0 -12.82 10,500 10,080 200 3,120 .641 1.0 1.0 -10,500 200 3,120 93 1.282 -1.282 3,120 -8.513 -1.0 1_/ Annual depreciation of $2,000 is assumed to be equal to the annual expenditure necessary to maintain this stock of equipment. 2/ Sec Appendix Table B.13 for cost of milking parlor. 2/ 3FC0ST to OFCOST and right hand sides for these years are identical to 2FC0ST except for the iNETWR entries. In later years these values are; year 3 = -8.154, year 4 * -7.795, year 5 * -7.436, year 6 » -7.077, year 7 =» -6.718, year 8 - -6.359, year 9 - -6.000, year 10 « -5.641 38 Table 4.8 Right-hand side values for basic model Row name 2/ Unit 10WNID 1LAB0R 1CASH 1STCR 1BDCR 5BDCR 9BDCR 1MCHY 5MPCAP 9MPCAP 1PIXC 1TAX1 1TAX2 1TAX3 1INVCR JNCASH Acre Hour Dollar Dollar Dollar Dollar Dollar Acre Head Head Dollar Dollar Dollar Dollar Dollar Dollar Right-hand side 80 3,000 Variable 10,500 10,080 7,392 4,704 200 130 130 3,120 2,400 2,400 15,200 93 3,120 1/ When the first Item In the row name Is a number, It applies to only that year, a j applies to years 2 through 10, and an 1 applies to years 1 through 10. cooperators, since time spent on management activities Is Included In their estimates. Cash Is assumed available only in year 1 in an amount that varies between computer runs. used In the analysis: Three alternative cash levels for year 1 are $55,000; $70,000; and $95,000. $55,000 is slightly above the minimum amount needed for the operation to expand over time with the basic model. The larger amounts are used to Illus­ trate medium and large size starting situations. The Initial cash restriction for years 2 to 10 will always be zero, as the available cash for each of the subsequent years will be determined internally from farm profits and savings. 39 The restrictions for 1TAX1, 1TAX2, and 1TAX3 reflect the points at which there were significant changes in tax rates. Assuming a family of four, up to $2,400 taxable Income, the only tax payable Is Social Security. From $2,400 to $4,800 taxable Income, both Social Security and Federal taxes are due. are also payable. Above $4,800, State Income taxes Social Security reaches a maximum at $7,800 and although State and Federal income tax rates are rising In the range, the 25 percent tax rate was found to be a fairly good approximation for the entire range from $4,800 to $20,000. Above $20,000 taxable income 33 percent Is deducted for State and Federal taxes. 4.2.4 Definition of objective functions In any LP problem the objective function is used to reflect the goals the decision maker Is attenpting to maximize (or minimize) during the planning horizon. In this study, three objective functions are enployed to represent the long-range goals of an Individual farm operator (Table 4.9). Although none of these objective functions may be strictly representative of the goals of Individual farmers, In 41 n n 4*V \ - -*L-i Yi1 n ir • • - • • w * m f o K n 4j l■ f w a * *A W w fv * * w h w 4 aw ^1 w * should approximate some of the more pronlnent sets of goals held by Individual farmers. These satisficing constraints are the implicit goals of meeting a minimum consunption level and maintaining a solvent and profitable farm operation. The first objective function (CN) maximizes the net worth of the operation at the end of the 10-year period. The second (CC) maximizes the value of Income allocated to consumption over the entire period. And the third objective function (CNC) maximizes an equal weighting of 40 Table 4.9 Row name Nonzero entries for objective functions of the basic model 1/ Objective function cS (3RET - "— 1BDFC 1LANC 1BCR15 1RCR30 ICS IFCOST 2CS 2FC0ST 3CS 3FCOST iipe 4FC0ST 5EMEC 5BDFC 5MILKP 5LANC 5BCR15 5RCR30 5CS 5P00ST 6EMIT 6CS 6FCOST 7EMTT 7CS 7F00ST -138.7 -162.1 .2424 .4045 -6.6 -249.9 -27.78 -162.1 .3572 .4350 .1074 .2069 Row name Objective function 31 55 CMC dollar------138.7 - 162.1 .2424 .4045 -.3241 -.3241 -1.187 -1.187 -.3001 -.3001 -1.099 -1.099 -.2778 -.2778 -1.018 -1.018 -.2572 -.2572 -.942 -.942 -6.6 -249.9 -27.78 -162.1 .3572 .4350 -.2382 -.2382 -.872 -.872 .1074 -.2206 -.2206 -.808 -.808 .2069 -.2042 -.2042 -.748 -.748 dollar — 8EMEC 8EMIT 8CS 8FCOST 9GRPD 9EMEC 9BDFC 9MXLKP 9LANC 9SGRAN 9BGRAN 9BMTT 9BCR15 9RCR30 9CS 9FCOST 0GRPD 0DYPD 0SGRAN 0BEFAN 0BMST 0BMET 0CS 01NCAS OFOOST -16.6 .2989 -28.66 -19.9 -318.9 -40.14 -162.1 2.08 -2.08 .3842 .4448 .4583 -34.39 -222.22 2.50 -2.50 .4632 .4632 - 16.6 .2989 -.1891 -.1891 -.693 -.693 - 28.66 -19.9 -318.9 -40.14 - 162.1 2.08 - 2.08 .3842 .4448 .4583 -.1751 -.1751 -.641 -.641 -34.39 - 222.22 2.50 - 2.50 .4632 .4632 -.1621 -.4632 -2.91 — -.594 -.1621 -.4632 -3.504 V Ihese entries are the discounted present values using an 8 percent discount rate. 41 total consumption and terminal value of net worth. Each of these objective functions represents the discounted present values of the flow of consumption and/or stock of terminal net worth. Hie discount rate reflects the time preference for spendable funds and a discount for the uncertainty of future revenues. A discount rate of 8 percent Is assumed In computing these values. In the bulk of the analysis the final objective function (CNC) will be employed under the assumption that farm operators will continue to pursue the goal of building an equity In their farm operation, but not at the complete expense of foregoing an Increasing level of con­ sumption. Comparisons with results from the other objective functions (CN and CC) should provide some insight into the relative impact of these two competing goals on the long-run outcomes of the farm opera­ tion. 4.3 Variations on the Basic Model The basic model which has been presented up to this point Incor­ porates prices, yields, personal and Institutional behavioral con­ straints which correspond to those which exist in society today. Opti­ mum solutions will be determined for this basic model maximizing the CNC objective function for the three levels of Initial cash. These solutions will be used as the norm to which other solutions, subject to alternative financial constraints will be compared. Such compari­ sons will help to evaluate the potential effects of alternative financial constraints on minimum equity, length of repayment period, or other strategic variables. The optimum solutions determined by this model do not necessarily represent the outcome which can be achieved by any 42 one Individual following such a course of action. But comparisons of these outcomes can serve as the basis for recommending courses of action for a decision maker faced with such alternatives. The model Incorporates a large number of Items which can be varied to conpare their relative impact on the outcomes as determined by the model. This section describes the various alternatives to be examined and presents the changes that must be made in the coefficients of the LP model. 4.3.1 Goals of the farm operator Farm operators differ from one another In the goal or set of goals they hope to achieve. The pursuit of one goal may result in a quite different plan through time than pursuit of some different goal or goals. Ihe objective functions presented in Section 4.2.4 allow com­ parison of three primary goals: (1) maximizing net worth, (2) maximiz­ ing consumption, and (3) maximizing an equally weighted combination of net worth and consumption. Each of these primary goals is also subject to meeting the subgoals contained in the matrix itself. Ihese solutions will be compared with the solutions of the basic model. Other runs will only employ the CNC objective function, which is the combination of consumption and net worth. 4.3.2 Equity requirements Although the prevailing equity requirements from institutional lenders correspond to those in the basic model, it is known that large numbers of borrowers purchase land and other items with lower down payment through other lenders. What might be the effect of lower equity requirements on expanding farm size? What might it imply for financing 43 needs? In order to look at these and similar questions, the equity requirements were reduced from 25 and 40 percent on chattel and real estate loans respectively, to 10 and 20 percent respectively, on such loans. The changes needed to reflect this in the model are handled througi the iDYPD, iBMEC, 1BDFC, and iLANC activities and the RHS (Appendix Table A.4). Only the coefficients which change are presented. These values will allow borrowing to be as much as 90 percent on the pur­ chase of chattel items and up to 80 percent on the purchase of real estate. Comparisons of each of these solutions will be made with the basic solutions. The joint effects of initial cash, equity require­ ments, and length of repayment period will also be examined from the standpoint of determining their relative importance on capital accumu­ lation. 4.3.3 Length of repayment period The entrance of the Federal government into the field of agricul­ tural credit early in this century was Instrumental in providing farm loans that allowed for amortization of the loan and repayment over a longer period of time than was previously possible. But what are the relative effects on farm expansion of a 40-year loan versus a 20- or 30-year loan? Will the longer loan allow the operator to gain control of significant amounts of additional capital? To reflect differing lengths of repayment periods in the model, additional long term borrowing activities are developed (Appendix Table A.3). The 1BCR10 activities are for investments in buildings 44 and facilities and assume a repayment period of 10 years. Real estate debts can alternately be financed for 20 or 40 year periods through the 1RCR20 or 1RCR40 activities. Three combinations of those borrowing activities will be examined: (1) 1BCR10 and 1RCR20, (2) 1BCR15 and 1RCR30 (as In the basic model), and (3) 1BCR15 and 1RCR40. An Innovative means by which real estate might be financed In­ volves deferring principal payments for a number of years while the new organization Is becoming established. Then the farm operation may be able to more easily repay the debt out of a higher level of Income.!/ activities. This possibility Is presented In the 1DPA10 and 1DPA25 These activities completely amortize the debts In about the same number of years as the 1BCR15 and 1RCR30 activities assumed In the basic model. However, the deferred payment activities require only Interest payments for the first four years and then the loan Is repaid over the later years of the loan. These activities are assumed to be available to the borrower In years 1 and 5 only. By the 10th year the farm operation should be solvent enough to use conventional mortgages. 4.3.4 Removal of Investment credit allowance The basic model Incorporates investment credit which can be used as a direct reduction of Federal Income taxes. In view of the current discussions of tax law revisions, Including the suspension of Invest­ ment credit, it seems useful to examine the potential benefit of 1/ The Federal Land Bank Associations are able to make some loans of this type. However, It Is the author's impression that these are being used by older farmers with substantial equity who desire cash for other purposes rather than to help young farmers become established or expand their farm operations. Investment credit on the establishment and growth of a farm firm. Most runs will be made Including Investment credit. Removal of the UFEDTX activities for each year are the only changes that need to be made In any version of the model to exclude investment credit. Again comparisons will be made only with the set of solutions from the basic model. 4.3.5 Appreciation of land values Land values have been Increasing more or less steadily for the last three decades. This represents an Increasingly larger expense for the operator who Is attempting to become established or one who wishes to expand through the purchase of additional land. But appre­ ciation of land values may also provide benefits In the financial side of the farm operation, by providing a larger credit base as the land value Increases. Thus, it would seem that appreciation may affect the strategies of when and how to gain control of the land resource. To examine the effect of appreciation of land values on the prod­ uction and financial organization of the farm firm, solutions will be obtained with a 5 percent annual rate of appreciation assumed. leads to three primary changes: This net worth of owned land Increases over time, credit or borrowing potential Increases over time, and purchases of land made at a later point In time are more costly than earlier purchases. To Incorporate this possibility Into the model, only the 1LANC activities must be modified (Appendix Table A.5). Conparlsons will again be made with the set of solutions from the basic model. 46 4.3.6 Lower milk prices A price of $5.50 per cwt. Is assumed In the basic model. what extent would expansion be curtailed by lower prices? But to To examine the impact of lower milk prices, runs were made with the blend prices of milk assumed to be $5.15 and $4.80 per cwt., rather than $5.50 per cwt. as originally assumed. To Incorporate this change In the model, It Is only necessary to change the 1TAXY coefficient for the 1DYPD activities. For milk at $5.15 per cwt., iTAXY becomes -$562.34, and far $4.80 per cwt., It becomes -$516.84 compared to -$607.84 per cow assumed In the original model. Chapter V PRESENTATION AND ANALYSIS OP MODEL RESULTS 5.1 Results of the Basic Model The linear progranmlng results were organized to more readily pre­ sent the effects of the various situations on minimum equity, capital accumulation, and level and structure of debt— the major objectives of the study. Thus, seme data can be directly obtained from the LP solu­ tions, while other items such as debt payments require additional cal­ culations. The first five sections of the sumnary tables present data on the annual production, income, expenses, and investments of the farm. The final section provides an annual balance sheet as of December 31 of each year, and traces these measures of growth over time. Using corrparative analysis, the results from alternative formula­ tions of the model are compared with results from the basic model. The initial section presents detailed results for each year for the medium initial cash position used, so as to clearly demonstrate the operation of the multiperiod LP model. S /ii ^Vue* Tiaettlfe V4 4 VW y 5.1.1 W W 4 4W W A *44 A Later sections use abbreviated versions W *« 4** AW ^ ^Vftfnq W »«r 3 9 ~ ~ 10 Year Total# y NPeUy 1 Year 3 9 10 Year Total# \ / 317 317 ... ... ... ... 56 55 146 208 67 ... 228 228 105 ... 276 276 ... ... ... ... 56 54 148 202 100 ... 265 265 127 ... 334 334 ... ... ... ... 166 104 0.6 ... 121 1.2 ... 123 45 -- 148 IC9 C.S ICO C.9 ... ... ... 122 45 — 186 97 0.8 ... 123 1.3 ... ... ... 44 37 ... ... 70 27 237 2.8 517 120 317 ... 2C3 56 60 ... 25 31 ... ... 48 18 196 6,2 276 105 276 2C2 56 60 ... 62 44 — ... 70 27 254 0.5 334 127 334 — — 56 55 148 203 93 ... 24b 246 ... 119 1 1 ... ... ... 123 45 ... ... 69 26 234 2.4 314 119 314 ... 2C3 56 80 120 - .•- >T ?p 1e Ccrr. p.r.MkOO or sold Lii'i r 1 ir* j :•».. . . [M trv ; 111 :ica Lard t-c: :■»; » Cf " *S' . C'I'.tf TlXv H , A 1-. 1l-Vt’S1: t crvd.t Net Attcr tJKf* Conf.T;.::fc• Roir.vr;: .•••-it CC.se £..iileir • ..i' •r-'c ik*.'. on Gin-. x oi-.Tc-c istion TVI>t i.f •--: " <* S'i,::-ur 4/ V ./* La ;.J V 3ai.-- v,‘ Total j ise t. Murt-te;-. oiJt 4/ Lorg-Ursi C 4 I ft ft ft I ft r-i ^ ftftftftO fttfS y ftftc ift^ ftU ft n ^ ^ «-» -j r^* vf . jftfta e e > n u • M no 1 4 *-• * t & o I &> •0 * 0 f t « - J O * f l * 63 The Initial farm organization is once more identical in year 1 for each of the four models. Likewise, the changes in farm organization for the four models occur in the same fashion, but the size of the change for the various repayment terms differs according to ability to provide cash to serve as down payment for additional investments. 5.2.3 Summary of effects of alternative repayment terms Corrparison of the results from the models with different repayment terms indicates that delayed payment and longer repayment terms can aid a farm operator in expanding the size of his operation. In terms of total assets, level of production, and gross income, the longer terms help to speed the expansion process. occur in net worth. Increases of a lesser magnitude But this added size also requires a higher level of outstanding debt, a higher D/A ratio with but little increase in net income after taxes, consumption, or reinvestment income. Each of these models assumed the same long-range goals of the farm operator. However, in deciding on the particular strategy to follow, these goals must be considered in line with the other effects arising from contracting long tern debt by these various means= The conparison of results from the N10&20 and N15&^0 models illus­ trates how shorter repayment periods slow down the growth process. Repayment within 10 and 20 years still represents fairly realistic time periods for purchasing buildings and land respectively. But, if lenders try to set up real estate loans on too short a repayment basis, the annual payments can easily become more than the farm operation can handle. On the other hand, if repayment capacity Is not limiting, there Is little reason to amortize the loan over an extremely long number of years. 64 5.3 Effect of Alternative Levels of Beginning Cash on Firm Expansion and Minimum Equity Levels 5.3.1 Alternative levels of beginning cash with normal down payments Hie effects of varying the level of Initial cash can be seen from examining the results for the N15&30 and L15&30 models for $55,000, $70,000, and $95,000 levels of beginning cash. Fbr the N15&30 model the most evident effect Is In the scale of operation— both Initially and over time (Table 5.6). Increasing the level of beginning cash allows the firm to begin operations on a larger scale In year 1, pro­ vides a larger annual gross income, and leads to a larger net income (except for the $95,000 level) and increased net worth. The relative change In most production and Investment levels, gross Income and balance sheet values is an Increase of about 1 1/3 times from the $55,000 to the $70,000 level, and an increase of roughly 1 3/4 times from the $55,000 to the $95,000 level. However, for net farm Income after taxes, the Increases were more on the order of 1 1/4 times to $70,000 and 1 1/2 times to $95,000. This is associated with the exhaustion of certain fixed resources leading to added cash expenses as output Increases. Since farm machinery for 200 acres Is required to be pur­ chased In year 1, this represents a fixed cost for the firm whether It is used or not. Likewise, there Is no cash expense for up to 3000 hours of labor furnished by the farm operator and his family. Once the scale of the farm operation passes each of these points, the total cost curve becomes steeper and marginal costs are Increased for any given farm organization. A third point of change occurs when the number of cows milked exceeds 130, since this necessitates additional Investment In milking parlor capacity. In addition, as net farm Income Increases, Tabic 5.6--Comparisjn ui N15S3G results for three levels of bugi:.r:ing equity: $55,COO, $7C,OCO, and $S5,000 It.’:-: F jim 9 10 Year Totals 1/ 1 Beriming Equity S70 ,000 Year 10 Year 5 9 Totals 1/ 1 S95.U0O Year 5 9 10 Year Totals C r vr't i? „ 1 1 c n Ccej r:.Iced C c rr. ier ate Fcraoe projection Tctal acres lrp.:t A. - ;i r ioa or Sale Lead rotted Corn pcrckascd or sold lebrr hired Invest -errs jccet.r.t ry Dairy facilities Lar.d Tncc-*• Ter a Cross irccre Texes r:id Ir.vcs ire nt credit NY; it.cere after taxes Cors:.-p: ice: Building depreciation Other depreciation Debt F nv ’ r r Snort-tcrr-. 5/ bj Hcildir^s 6/ U n d 6/ Balarec Sheet Deta Total assets Short-tcrr. debt b j Lor^-terr debt Net worth Debc-asset ratio JV £/ Unit i $55,000 Ye .ir 5 Head Acre Acre Acre 40 3S 105 143 Acre 2/ 63 A.E. 3/ 32 — K.E. 4/ $1000 Acre Ccw+R Acre $1000 $1000 ... 200 40 80 29.1 0. J 0. 1 4. 1 4.3 0.-. 3.3 56 55 148 203 93 ... 119 -- 231 231 -... --- 245 245 314 314 120 37 0.1 ... 123 0.5 ... -... 123 45 — 165 108 0.6 -- ... 31 22 151 3.7 231 83 231 — — 26 ... 203 56 80 £6 27 173 200 549.3 4. i 5.2 5.1 4.5 66.5 3.7 0.8 18.0 8.9 9.1 6,4 4.6 $1000 $1000 $1000 22.3 3.3 l.-t 33.2 5.0 1.4 $1000 $1000 $1000 134. ! 20.1 48. 1 65.) 51.- 174.9 30.7 56.1 88.1 49.6 $ICC0 $1CC0 S1CC0 $1000 $tcoo $1000 $1000 Percent 68.6 1.5 1.2 12.0 86 -- 6.8 -... -... 79 ... 207 207 127 ... 156 ... 334 334 412 412 -... 127 140 0.4 254 123 1.3 -- 119 1.1 -- — 69 26 234 2.4 314 119 314 -207 79 80 -127 48 -- — 42 37 ... 626.9 29.5 63.7 4.9 113.7 65.8 47.9 47.2 41.3 41.1 0.5 0.7 6.9 5.0 1.9 4.5 5.8 10.0 6.3 3.9 162.7 46.6 19.0 255.7 40.1 83.7 126,9 50.4 256.9 33.2 84.3 138.9 45.9 21.2 146 1.8 ... — ... — — ... — 78 29 332 2.2 412 156 412 93.7 1.8 1.9 16.0 8.2 7.8 8.7 9.4 113.9 8.8 1.4 31.C 13.5 17.5 10.7 7.4 850.9 36.3 7.8 165.6 84.0 81.6 79.4 67.7 1.6 90.7 6.3 1.3 12.9 7.1 5.3 6.7 6.4 1.1 6.1 24.5 11.2 13.3 8.3 6.2 142.2 75.8 66.4 61.4 52.6 57.5 0.4 0.5 ' 5.6 4.6 1.0 5.8 7.5 27.4 4.4 1.4 44.7 6.6 1.4 13.6 3.2 5.3 178,7 60.4 21.8 34.0 5.8 1.4 61.C 8.6 1.4 17.4 10.5 7.0 235.9 78,6 25.2 167.9 25.4 57.2 85.3 49.2 230.6 41.4 69.1 120.1 47.9 342. C 53.5 113.7 169.8 50.4 342.8 44.2 113.5 185.1 46.0 215.0 31.5 69.3 114.2 46.9 300.5 56.5 85.2 158.8 47.2 443.9 68.1 154.6 221.2 50.2 444.3 56.1 147.9 24C.3 45.9 Totals ray not add due to rounding. Only 63 acres arc rented in year 1, bit 120 acres are rented in years 2. 3, and 4. Corn for ^rain then Increases to 101 acres and corn is told i ' i t the fare. 3/ Acre equivalent. Corn purchased (or sold) is reported as the acres replaced by (orrequired toproduce) thisamount ofgrain. 4/ Kan equivalent. Ore nan equivalent is assumed to be 2600 hours. 5/ Shurt-tcrn deb: in years 1 through 7, intermediate tern debt xn years 8, 9, and 10. 6 / Figures are for debt payment due on Jin. 1 of following year, rather than payment made incurrent year. Total figure is for 10 years. 66 the progressive income tax takes out increasing amounts of cash for taxes. Each of these points is encountered as the amount of beginning cash increases from $55,000 to $95,000, resulting in increased average variable costs and decreased average net returns over this span since gross income increases linearly (given the same farm organization) .1/ In addition, in a longer-run context, there are changes in the farm organization as the amount of beginning cash increases. With $55,000 initial cash, the only investment made, other than the required land and machinery purchase, is to invest in dairy facilities for 40 head of cows. C o m is produced for grain and no c o m is bought except as needed for expansion.2/ With $70,000 initial cash, investments are again made in dairy facilities, plus machinery for an additional 3 acres of land. included. No hired labor is needed and grain production is still At the $95,000 initial cash level, there is sufficient cap­ ital to allow the farm organization to specialize on the dairy enter­ prise using hired labor and purchased com. Each of these would imply a different cost curve in the context of a one-year planning horizon as different resources become fixed. Two other situations can be noted concerning the effect of the different levels of initial cash. First, at the $55,000 level, capital 1/ Another point of increased cost occurs when more than the required 80 acres of owned land is used. However, the output of all solutions requires more than this amount of land. 2/ In year 1, the c o m bought is necessary for feed since the first c o m crop is not harvested until 10 months after purchase of cows. But the fact that c o m grain acres are nearly identical to cow numbers indicates that in years 2-4 no c o m will be purchased. If c o m acreage is greater than cow numbers, it is an indication of the number of acre equivalents of c o m sold. This is due to the dairy activity requiring 82.5 bushels of c o m or .97 acres at the assumed production levels. Is so limiting that only 143 acres are operated in year 1. acres of owned machinery capacity are left idle. to Ihus 67 However, in years 2 an additional 67 acres are rented and used to produce grain which is sold off the farm. Since investments can only be made in years 1, 5, and 9, it is more profitable (in terms of the objective function) to make as large an investment in the dairy enterprise in year 1 as possible, then to expand the c o m production enterprise in year 2, using rented land and idle machinery capacity. Second, reinvestment income and net cash available for reinvestment are quite limited during the first year at the $55,000 level, and the only expansion that can be undertaken in year 5 is to Increase the size of the dairy herd. This expansion still does not require the full 200 acres for forage production, so the c o m grain enterprise i3 continued at a reduced level to utilize available machinery capacity. 5.3.2 Alternative levels of beginning cash with liberal down payments Examination of the results of the models incorporating more liberal credit terms reveals differences in scale again to be the major CXXCWW /rru,w> \ AOUXC c n \ I / « I t I .A C H 1 Q C j M IC [JX O X U 14C U . XAAW 4.*CCl©C X i A liC U *-* - - - - - - XilVXmHIJC after taxes is less than the increases in production levels, gross income, and balance sheet items. As beginning cash increases from $55,000 to $70,000, the increase in net income after taxes is about 1 1/10 times, while the increase for these other items is about 1 1/5 times. When beginning equity is Increased from the $55,000 level to $95,000, the increase is about 1 1/4 times for net income after taxes and about 1 1/2 times for production levels, gross income, and items in the balance sheet. Table 5./--Comparison of L15&3Q results for three levels of beginning equity: I tern Farm Orennization Cows milked Corn for grain Forage production Total acres Innut Acquisition or Sale ian.1 rental Corn purchased or sold Labor hired Tr.vestme nts Savings account Machinery Dairy facilities Lard Income Data Gross income Taxes paid Investment credit Net income after taxes Consumpt ion Keinvestment income Building depreciation Other depreciation Debt ravmcnt Short-term 4/ 5/ Building 5/ Land 5/ Balance Sheet Total assets Short-term debt 4/ long-term debt Net worth Debt-asset ratio 1/ 2/ 2/ 4/ 5/ Unit 155,CC0 Year 5 9 1 Head Acre A.cre Acre 67 22 17S 200 27f 276 Acre A.E. 2/ M.E. 3/ 120 98 2 102 $10C0 Acre Ccw+R Acre 147 137 387 524 105 — .2 — Beeinnir.c Eauitv S70.0C0 Yecr 10 Year Totals JL/ 5 9 I 85 ------- 19 1.8 .9 10 Year Totals _1/ --- — — — 76 3£ 194 248 42 250 7.5 524 147 524 130 I 111 164 --- --- 292 292 431 431 38 236 2.0 — --- 161 198 1.0 7.0 639 179 639 --- --- — 297 49 354 292 111 131 140 53 262 370 61 408 7.7 11.4 121.1 2.C 2.3 18.6 9.1 9.5 11.1 11.2 17C.9 6.9 3.7 35.3 15.0 20.3 15.2 16.4 1161.9 35.5 11.9 182.3 89.8 92.5 105.6 99.1 223 223 343 343 143 150 53 147 1.3 --- — — — 223 85 80 120 45 205 --- 2.5 --- --- 225 208 593 801 10 Year Totals 1/ — — .5 $95,000 Year 5 9 --- 179 167 472 639 — ... 200 67 80 $55,000, $70,000, and $95,000 ------— — --- 3.4 — 8.4 801 225 801 $1000 $1CQ0 $1000 $1000 $1000 $1000 $1000 $1000 49.3 .5 .6 6.3 4.8 1.5 5.2 6.5 71.4 5.0 1.4 17.5 £.7 £.8 7.4 7.3 111.4 4.3 2.2 24.3 11.1 13.2 10.C 11 .1 736.6 26.6 7.7 142.4 75.9 66.5 70.4 64.4 61.9 .3 .4 5.0 4.4 0.6 6.2 8.2 96.1 2.6 1.8 17.9 8.9 9.0 8.9 9.3 136. C 6.1 2.8 3C.1 13.1 17.0 12.2 13.1 912.8 30.2 9.4 157.9 81.3 76.6 84.8 78.1 $1000 $1000 $1000 37.3 6.8 1.8 61.3 S.7 6.2 22.7 13.2 11.8 312.6 32.4 55.6 44.9 8.2 1.8 75.3 18.7 6.5 27.5 16.8 14.4 375.0 111.8 62.0 58.7 10.2 3.0 92.7 14.7 8.9 34.4 20.4 18.1 465.2 140.4 83.8 191.2 34.5 84.4 72.3 62.2 319.8 56.S 15'.4 109.6 65.7 481.1 86.3 232.1 162.7 66.2 483.4 81.4 223.3 178.7 63.0 22S.2 41.5 96.7 90.0 60.6 379.5 69.7 172.5 134.3 64.3 585.4 104. C 284.1 197.3 66.3 587.2 97.8 273.4 216.0 63.2 3C4.2 54.4 129.9 119.9 60.6 486.6 85.8 226.0 174.8 64.1 738.5 129.9 357.5 251.1 66.C 739.2 121.6 344.0 272.6 63.0 $1000 $1000 $1000 $1000 Percent * 81.C .3 .2 4.0 4.C ... Totals nay not red due to rounding. Acre equivalent. Corn purchased (or sold) :s reported as the acres replaced by (orrequired toproduce)this amount of grain. Man equivalent. One man equivalent is assured to be 26C0 hours. Short-term debt in years 1 through 7, intermediate term debt in years 8, 9, and 10. Figures arc for debt payment due on Jan. 1 of following year, rather than payment made incurrent year.Total figure is for 10 years. There again Is a difference In farm organization In year 1 for the $55,000 level. The Initial expansion of the dairy herd Is not large enough to require 200 acres of cropland for forage production, so 22 acres of c o m for grain are raised in years 1 to 4. However, with the lower down payment requirements, the full 200 acres of machinery capac­ ity is utilized right from year 1. In year 9, the farm organization turns to production of both the c o m grain and the dairy enterprises at all three levels of beginning equity. This combination provides a lower cost of production per cow than would occur if specialization in dairy production had been con­ tinued. The low down payment requirements allow a larger sized opera­ tion to be controlled than was possible with the normal down payment requirements. Ey purchasing land, annual costs are reduced since the annual payment plus real estate tax— when a 20 percent down payment is made— is only $25.07 per acre of land, compared to $30.00 per acre for rented land. Likewise, the grain enterprise is not as labor intensive and the farm operation becomes a large user of hired labor. These effects, plus having a large share of net income taxed at the 33 percent rate in years 9 and 10, appear to make it more profitable to diversify the farm operation at that point. As an indication of how costs are changing, the average cost per cow can be compared including and excluding the grain enterprise in year 9. Although the farm organization differs, all products are marketed through the dairy enterprise in both cases, and so average variable cost per cow provides a basis for comparison. minus net income after taxes approximate variable costs. Gross sales Dividing this figure by cow numbers gives the average variable cost per cow. For the 70 organization shown In Table 5.7 at $70,000 beginning cash, the average cost in year 9 is $587 per* cow. When the grain production activities were excluded from the solution, the average variable cost per cow in year 9 rose to $608 for 186 cows. Net income after taxes declined in year 9 from $30,100 to $28,100 and the total for the 10-year period decreased from $157,900 to $155,600. The reduction that occurs in consumption is more than offset by increased net worth when the opera­ tion combines both grain and dairy production, and the overall effect is to increase the objective function value. 5.3.3 Sunmary of effects of alternative beginning equity levels The amount of equity available to the farm operator when he wishes to expand his farm operation can be seen to have a potent effect on both the speed with which growth can occur and the amount of that growth. If an operation is underfinanced it may not be able to effec­ tively utilize all its resources. Thus, it is necessary for a farm operator and his lender to examine the entire program and see whether the probable success of the operation might be improved by advancing a slightly larger loan than comfortably meets the loan limits based on equity requirements. There is also a need to consider relative prices and costs as the size of the operation changes. If grain prices are relatively cheap and the operator does not have the land quality or managerial ability for top c o m yields, it may be more profitable to purchase all c o m for grain. Similar decisions need to be made with other inputs. Like­ wise, tax management should enter into the decision to determine the probable impacts of income taxes. 71 5.4 Effect of Alternative Down Payment Requirements on Firm Expansion The results of the N15&30 and L15&30 models for $70,000 beginning cash illustrate the primary differences resulting from alternative down payment requirements (Table 5.8). As with the comparisons of beginning equity, the predominant difference appears to be the size of operation. The level of production activity, gross income, assets, and debts are from 1 1/2 to 2 times as great under the liberal credit terms as for the normal terms. However, this greatly increased size results in only about a 15 percent increase in final net worth and a 10 percent Increase in net income after taxes. This indicates that the average cost per unit of production must be substantially higher for the liberal down payment models. The ending level of debt outstanding for both operations is large conpared to most of today's dairy operations, amounting to $157,700 for normal terms, and $371,200 for more liberal terms. The debt pay­ ment for year 10 was $27,100 and $58,000 for the normal and liberal credit terms respectively, with about half consisting of short and intermediate term credit payments in each case. Loans of this magni­ tude, even the short term debt portion of them, are beyond the legal lending limits of many country banks today. In addition, there are probably few country banks with personnel who are able to properly assess the advisability of loans of this magnitude on a farm operation. Farm organization differs among some situations that have been men­ tioned earlier. With normal down payment, the dairy herd does not require 200 acres for forage production, and all c o m for grain is raised on the farm during years 1 to 4. But under the liberal down payment requirements, no c o m for grain is raised until years 9 and 10 Tabic 5.6**-Susnary of resales frc-m the K15&30 and L15&3C model* Co compare the effect of differed down payment requirements, $7C,CC0 beginning equity >V.del Name N155.30 Item F;- ' Cr^r.r.i .rati on C^v e r.i lV.ed C\-rr. for groi i Forage production Total acres T— '■ir Acoisisiticn or Sale I.jr.a rental Cora purchased or sold LaNor hired Savi .gs account Mac'-.:aery Doirv facilities Lar-d Trr, •v r.»M GrciS inco:r,e Tuxes paid T/.vestmcnc credit Net income after taxes Cc-isumpticn F.e investment ircose Building depreciation Other depreciation T\T t T..out Due -»/ jj/ E 1:; lding 5/ Land 5/ s a1n •ce Sheet Twial assets Short-term debt 4/ Long-term debt Net worth Dibt-asset ratio 1/ 2_/ 3/ 5/ Unit 1 Year 5 3 L15&30 10 Year Totals \ f Year 5 I Head Acre Acre Acre 56 55 14S 203 93 -245 245 119 — 314 314 — — — — 85 ... 130 ... 223 223 343 343 Acre A.u. 2/ M.E. 3/ 12 3 45 -- 165 ICS 0.6 -i19 1.1 — — 143 150 $1000 Acre Cov+R Acre __ 203 56 80 ... __ 42 37 — 69 26 234 2.4 314 119 314 — .5 ... 223 85 80 9 10 Year Totals 1/ 179 167 472 639 — ... ... 58 147 1.3 ... ... ... ... ... ... ... 297 49 354 7.0 639 179 639 120 45 205 2.5 5100C 51C0C 5100C 5100C 51C0C S100C 5100C 51C0C 41.1 0.5 0.7 6.9 5.0 1.9 4.5 5.8 6S.7 1.6 1.3 12.9 7.1 5.8 6.7 6.4 90.7 6.3 1.1 24.5 11.2 13.3 8.3 6.2 626.9 29.5 6.1 142.2 75.8 66.4 61.4 52.6 61.9 .3 .4 5.0 4.4 1.5 6.2 3.2 96.1 2.6 1.8 17.9 8.9 8.8 8.9 9.3 136.0 6.1 2.8 30.1 13.1 13.2 12.2 13.1 912.8 30.2 9.4 157.9 81.3 76.6 84.3 78.1 $iocc 5100c 51C0C 27.4 4.4 1.4 44.7 6.6 1.4 13.6 8.2 5.3 178.7 60.4 21.8 44.9 8.2 1.8 75.3 11.7 6.5 27.5 16.1 14.4 375.0 111.8 62.0 167.9 25.4 57 2 85.3 49.2 230.6 41.4 69.1 120.1 47.9 342.0 53.5 118.7 169.8 50.4 342.8 44.2 113.5 185.1 46.0 228.2 41.5 96.7 90.0 6C.6 376.5 69.7 172.5 134.3 64.3 585.4 1C4.0 284.1 197.3 66.3 587.2 97.8 273.4 216.0 63.2 $ 100c S100C $?ooc 5100C Perc;fit Totals may not add due to rounclng. Acre equivalent. Corn purchased (or sold) is reported as the acres replaced by (orrequired toproduce)this amount of grain* Man equivalent. Or.e man equivslcnt is assumed to be 2600 hours. Short-term debt in ycsrs 1 thrcugh 7, intermediate term debc in years 3, 9, and 10* Figures are for debt payment die on Jan. 1 of following year, rather than payment made incurrent year.Total figure Is for 10 years. 73 when all grain is raised on the farm. Ihe other major difference is that additional purchases of land above the minimum 80 acres occur in year 5 under liberal terms, but not until year 9 under normal down payment terms. As mentioned pre­ viously, this is a means of lowering average costs per dollar of revenue from pursuing a mixed strategy of milk and grain production. Liberal down payment requirements allow the farm operator to acquire control of a much larger operation than under normal terms. This allows a high sales volume to be reached quite early in the expan­ sion process. If the operator received favorable yields and prices for several years and then converted his debts to more conventional terms, he could probably be much better off in terms of net income after taxes at the end of 10 years than is indicated when he continues to expand. However, the danger in this situation is the high debt load and small amount of equity. The risks of loss are much greater if adverse prices or yields occur than for the individual who uses normal down payment financing. Under the liberal terms there is little reserve upon which to obtain additional credit, If needed. There is also a legal difference between buying with 20 percent down compared to 4o percent down. With less than a 30 percent down payment, the land would likely be bought on a land contract. In case of payment delinquency, the land can be more readily reclaimed by the lender than when the land Is purchased with a traditional mortgage. 5.^.1 Minimum equity situations for the N15&30 and L15&30 models The difference in down payment requirements also makes a substan­ tial difference in the minimum equity necessary to establish a viable 74 operation (Table 5*9). When 25 and 40 percent equities in chattel and real estate items respectively are required, as in the N15&30 model, at least $50,000 beginning cash is needed to establish a farm operation that meets the conditions built into the model. However, lowering the equity requirements to 10 and 20 percent down on chattel and real estate items respectively allows the minimum equity needed to drop to $35,000. Differences of this magnitude are of crucial importance to a young farm operator with good management ability who wishes to expand his dairy operation but is short on equity capital. Comparing the minimum equity position necessary to begin fanning for the N15&30 model with that for the L15&30 model, it can be seen that several other benefits besides the smaller initial equity stem from the lower down payment requirements. Even though the initial equity was $15,000 less, at the end of 10 years each of the production levels, incane figures, and all balance sheet items except net worth are greater than for the usual lending rules. However, total debts are nearly double and the D/A ratio is 63 percent compared to 45 per­ cent with normal down payment terms. This, of course, is the element of risk connected with the low down payment. If prices and yields remain favorable, the final outcome will be favorable; but a series of years with low prices and/or yields can more readily lead to bank­ ruptcy for the operator financed beyond normal lending limits. The fact remains that even $35,000 is more equity than many young fanners possess. An operation of this size and level of technology is still beyond the realm of most beginning fanners unless they have family help. The importance of father-son arrangements may be due to a lack of new tenure forms making it possible for young operators to Table 5.9 Effect of initial equity position on final size of operation, total incase, and final equity position for the N15I30 and L15$3G nodels Beginning cash level 1/ Item. M5&30 model Cows milked Total Income Land purchased Gross income "et income after taxes Consumption Reinvestment incore Total assets Tbtal debts ■ ’let worth L1 5 S30 model Ccv.’s milked TPtal acres Land p’ urehased Gross income Let income after taxes Comumption Reinvestment income Total assets Total debts Let worth Unit $3t,CGQ head Acre Acre 0,uOO $45,000 77.0 204.0 204.0 399.7 102.4 61.9 40.5 230.4 104.5 125.9 bo feasible vlGOQ $1000 $1000 $1000 $1000 solution $1030 $1000 Head Acre ■"ere $1000 $1000 $1000 $1000 $1000 $1000 $1000 9 6 .0 34i.o 3*11.0 477.6 104.4 6 2 .6 41.3 322.1 203.9 113.2 113.0 402.0 402.0 5 6 2 .6 1 1 7 .2 67.0 50.2 377.3 233.6 133.7 $3 0 ,0 0 0 1 3 0 .0 1 3 6 .0 463.0 463.0 64S.3 129.1 71.2 57.9 431.1 272.6 153.5 456.0 486.0 679.0 136.9 73.9 $55,000 $7 0 ,0 0 0 33.0 119.0 314.0 314.0 2 3 1 .0 231.0 459.3 113.7 65.3 47.9 2 6 1 .0 115.0 143.0 147.0 524.0 524.0 736.6 142.4 75.8 6 2 6 .9 $95 ,0 0 0 1 5 6 .0 412.0 412.0 850.9 142.2 75.3 66.4 343.1 157.7 190.4 1 6 5 .6 179.0 639.0 639.0 225.0 9 1 2 .8 157.9 81.3 6 3 .0 6 6 .6 7 6 .6 453.9 233.1 170.3 433.4 304.7 133.7 593.0 371.2 221.3 84.0 8 1 .6 450.9 204.0 246.9 8 0 1 .0 301.0 1161.9 132.3 89.3 92.5 746.1 465.6 230.5 1/ To indicate the necessary minimum equity to be-in farming under the assumed conditions, the . ‘.'15$30 and LI5130 models v;ere submitted wit;: beginning cash successively reduced in $5000 anounts. Solutions were obtained for beginning cash as lev; as $50,000 for N15I30 and $35,000 for L15&30. Below these amounts the operations could not be established (no feasible solution). 76 first prove their ability, and then move to an operation where they command sufficient resources to provide an adequate income. Low equity Insured loans could be one way to stretch a young operator's equity to gain control of more assets. However, there is also the problem that it would keep some individuals on the farm who would be better off in some other occupation. New tenure forms may be needed if there is a desire on the part of society to retain the individualistic element in farming as we have known it in the past. 5.5 Relative Effects of Alternative Repayment Plans, Beginning Equities, and Down Payment Requirements Examined The previous sections have independently examined the effects of each of three different variables on certain aspects of farm expansion, when the assumed goals of the farm operator are to maximize a combina­ tion of net worth and consumption. But the relative effect of one variable or another cannot be readily obtained from such an analysis. To get some indication of the relative effects of these three variables on each of several measures of growth, totals at the end of year 10 are compared using index numbers (Table 5.10). For each statistic the final year total or value for the $55*000 beginning cash level for the N15&30 model is taken as the base value. The same statistic for other repayment plans, beginning equity levels, and down payment requirements are then calculated as a percentage of this base value. This allows comparison of the effect of the three variables for each growth sta­ tistic for 2 k different combinations. For any given item the base number would reflect the combined effect of the three variables. Using the $55,000 beginning equity level for the N15&30 model as a base of 100, the contribution of each Table 5.10 Comparison of alternative solutions with basic model solution for various measures of growth Solution title 1/ Beginning Ease value Iquity Item 51000 percent value Gross income Net income after taxes Consumption Reinvestment income Total assets Total debts Net worth M5-'o0 H15J40 N10&20 NDelay L15&30 U5&40 L10&20 LDelay .------------------ percent of base value- 459.3 ICO $55,003 70,GC0 1^7 173 95,000 ICO 136 185 101 113.7 ICO 1C7 173 55,000 70,000 35,000 100 ICO 125 125 146 65.8 ICO 177 173 55,000 70,000 95,000 100 47.9 ICO 177 173 55,000 70,000 95,000 100 261.0 100 127 173 55,000 70,000 95,000 118.0 loo 1:37 93 123 175 106 144 194 160 199 253 161 200 252 151 188 233 175 212 271 146 99 125 145 100 125 146 125 139 160 125 140 160 122 135 157 126 140 161 100 115 128 ICO Ub 128 100 115 128 115 124 136 115 124 136 113 121 135 116 124 137 100 139 170 99 138 170 101 139 139 160 193 139 160 193 134 154 189 140 161 194, 100 133 173 101 38 118 153 106 141 183 188 134 174 229 288 192 233 293 147 174 217 212 254 321 55,000 100 7 0 ,0 0 0 134 r ’3 95,000 173 102 136 175 77 104 136 111 147 191 253 315 395 266 323 404 176 204 253 303 363 458 143.0 100 55,000 70,000 95,000 10C, 133 173 100 133 173 97 330 163 102 135 176 129 156 196 129 156 198 122 149 187 134 161 204 127 123 115 128 139 170 137 186 1/ See Table 5-3, p. 57, for definition of each title. 370 of the other items to gross income would be calculated as follows: (1) for repayment terms, use the difference between N15&30 and the other 3 models with normal down payment. The effect would be 1 percent for 15&40 years, minus 7 percent for 10&20 years, and 6 percent for NDelay repayment plans. (2) For beginning equity, use the difference between the levels of beginning equity of the N15&30 model. This amounts to 36 percent for the $70,000 level and to 85 percent for the $95,000 level. (3) For liberal down payment terms, use the difference between the N15&30 and L15&30 models at the $55,000 beginning cash level. This indicates an Increase of 60 percent resulting from the lower down payment requirements. (4) If the sum of these three items differs from the index of the Item being measured, the difference Is due to the interaction of the three Items. For example, the gross income level achieved by the NDelay model at the $95,000 beginning cash level of 19^ percent would have zero contribution from liberal down payment, 6 percent from the repayment plan, 85 percent from in­ creased beginning equity, and 3 percent Joint effects. The gross in­ come for the SDelay model at the same level of initial cash is 271 percent and the increase would be composed of the 6 percent for repay­ ment plans, 85 percent for beginning equity level, 60 percent for liberal down payment terms, and 20 percent joint effects. As always, the index number system Is partly a function of the base value chosen. But since the basic model with $55,000 beginning cash is near the minimum equity level to begin farming, this solution is used as a base. It can be seen in the table that the alternative repayment plans represent the least expansionary factor of the three variables examined with the largest increase being 11 percent on total debts for the 79 NDelay model. At the same time the N10&20 model resulted In a 23 per­ cent decrease In total debts compared to the N15&30 model. With respect to net income after taxes, consunption, and reinvestment Income, there weis no difference between the different repayment plans for normal lending rules and very small differences under the more liberal credit terms. The contribution of more liberal down payment terms varied from a low of 15 percent greater for consunption to a high of 158 percent for total debts. There Is also a negative joint effect between liberal credit terms and Increasing levels of beginning cash for net income after taxes, consunption, and reinvestment income. This is probably related to the underlying cost structure through the range examined. This negative joint or Interaction effect can be seen by comparing the index values for any item under the same repayment plans, but with different down payment requirements. F o r example, using consunption with the N15&30 and L15&30 models at $55,000 beginning cash, the contri­ bution of lower down payments is to raise consunption for the 10-year period by 15 percent. When beginning cash is $70,000 the table indi­ cates only a 9 percent increase goes to consunption with lower down payment, and at the $95,000 level only an 8 percent increase. Similar comparisons on items such as total debt show a positive interaction between increased beginning cash and lower dcwn payments. This suggests that a farm operator with smaller equity (such as the $55,000 level), who is able to obtain funds under the liberal down payment terms, would be better off in selecting shorter repayment periods. Net worth and consunption would be nearly as great as for longer repayment periods, while total debt and the degree of risk would be much smaller. 80 In assessing the Impact of increasing levels of beginning equity, it is also desirable to note the percentage increase in the amount of initial cash itself and the related effect on each of the statistics in the table. Increasing the amount of initial cash leads to at least proportional increases in all statistics except consumption when going from the $55,000 to the $70,000 level. Ihe increases from $55,000 to $95,000 beginning cash generally result in at least proportional increases for sill statistics except net income after taxes, consumption, and reinvestment income. The inpact of increasing the initial cash position has the least effect on consumption and net income after taxes, and the greatest effect on gross Income. In general, Its effect is much more expansionary than Is varying the repayment plans, but it Is less expansionary than obtaining more liberal credit terms. However, a potential borrower would need to weighs the cost of waiting until additional beginning equity is available against the alternative of following a more liberal credit strategy with the amount he has avail­ able. Knowledge of the relative effects of these variables on possible outcomes can be of importance to both lenders and borrowers. Depending on the goals of the operator, he may decide to choose a different combination when his major desire is to expand the size of the business in terms of size of production units and assets controlled, than if he is primarily concerned with maintaining an adequate income. From the results presented in the table, for an operator maximiz­ ing a combination of annual consunption and net worth, it is of no significance to the operator in terms of consunption which of the four repayment plans considered is chosen. But in terms of final net worth, 81 primarily In conjunction with liberal down payment terms, there Is some advantage to be gained from using the shorter 10- and 20-year repayment periods. However, the other Items In the table also need to be considered In making the decision especially when using liberal down payment terms. For example, would the delayed payment plan still seen favorable after considering that net Income after taxes is no greater, but total debts are roughly 1/5 greater than with regular repayment over 15 and 30 years? The questions of assessing the Importance of these related vari­ ables becomes of much greater importance In evaluating the decision of using normal versus liberal down payments in acquiring title to assets. Is an additional 15 percent consunption and 28 percent net worth adequate compensation for assuming the risk of an additional 158 percent of debt? Farm operators with different amounts of begin­ ning equity may choose to follow different strategies as a result of examining the potential outcomes of not only the primary goals of consunption and net worth, but also the outcomes of the related measures. 5 .6 Expected Congurnptlon. Net Worth and Debt at the End of 10 Years by Herd Size If dairy farm operators expand along the lines suggested here, it Is evident that the amount of debt outstanding per farm will Increase sharply. Brake [3] has estimated that by 1980 the average debt out­ standing per farm will be about $48,000 with a D/A ratio of 28.4 per­ cent. For only those farms grossing $40,000 and more of sales annually he estimates total assets in the range of $500,000 by 1980. If these farms had the same D/A ratio as for all farms, this would mean $142,000 debt per farm. 82 'Hie results of this study suggest the amount of debt that might arise on farms with dairy herds of various sizes from following differ­ ent financial strategies (Figure 5.1). Ihis diagram shows the out­ standing debt at the end of 10 years of expansion. Each line segjnent represents the debt associated with either normal or liberal down pay­ ments and a given repayment plan. The points used to plot the line correspond to the $55,000, $70,000, and $95,000 levels of beginning equity from lowest to highest point repsectively, for all but the N15&30 and L15&30 models. N15&30 begins with the $50,000 level, while L15&30 begins at the $35,000 level and also has observations at the $40,000, $45,000, and $50,000 levels in addition to the usual three. Hie diagram illustrates several relationships that have been brought out earlier. Greater expansions of herd size are realized from either (1) increased levels of beginning equity, (2) longer repayment periods, or (3) more liberal down payment requirements. This diagram also allows the amount of debt outstanding to be estimated for a given herd size from following various strategies. 1/ F o r e x a m p le , a herd size of 100 cows could be attained by any of 4 borrowing strategies, with the amount of debt outstanding varying roughly from $120,000 for N10&20 to $215,000 for L15&30. Likewise, for a 100 cow herd, consunption in year 10 varies from $9,100 for N10&20 to $7,700 for L15&30, and net worth varies from $175,000 for N10&20 to $120,000 for L15&30 (Figures 5.2 and 5.3). In addition, 1/ The names correspond to the alternative models defined in Table 5.3 on page 57. In the context of this discussion each name may be thought of as defining a strategy of borrowing, using a given repay­ ment plan and down payment requirements. The N15&40 and L15&40 results are not included since the results are so similar to the N15&30 and L15&30 results. 83 550 LDELAY 500 450 70, LI5 a 30 o*400 55 LIO a 2 0 250 200 7* NDELAY 55 - 150 NIO a 2 0 70 100 50 0 25 50 75 100 125 150 175 2 0 0 225 250 M 1 1rnK o r n f 2 75 7?r>T.TQ in Year 10. Figure 5.1 Relationship of herd size and outstanding debt at the end of 10 years, by beginning equity, repayment plan and downpayment requirement. 1/ 1/ The points on each line correspond to the results of the various models, defined in table 5.3, page 62, for the different beginning equity levels ($1,000). For example, the upper right hand point (95) refers to the $95,000 level of beginning cash for the LDelay model. Because of the linear relationships the points may be connected with straight lines. Interpolation can then be used to estimate the required beginning equity and debt associated with any given herd size. an 2.0 NDELAY N I5S 30 o o N i o a 20 9.5 LDELAY a. So 7.5 7.0 25 H U lU V C ii X- \^ W V o in Year 10. Figure 5.2 Relationship of herd size and annual consumption in year 10, by beginning equity, repayment plan and downpayment require­ ment. 1/ 1/ The points on each tine correspond to the results of the various models, defined in table 5.3, page 62, for the different beginning equity levels ($1,000). For example, the upper right hand point (95) refers to the $95,000 level of beginning cash for the LDelay model. Because of the linear relationships the points may be connected with straight lines. Interpolation can then be used to estimate the required beginning equity and consumption associated with any given herd size. 85 550 500 450 400 /■"N NDELAY o §350 LIO 8 20 N I5 a 30 NIO a 2 0 70 LDELAY ss 30 55 90 100 M| 50 25 50 75 Number of Cows in Year 10. Figure 5.3 Relationship of number of cows and net worth at the end of 10 years, by beginning equity, repayment plan and downpay­ ment requirement. 1/ JL/ The points on each line correspond to the results of the various models, defined in table 5.3, page 62, for the different beginning equity levels ($1,000). For example, the upper right hand point (95) refers to the $95,000 level of beginning cash for the LDelay model. Because of the linear relationships the points may be connected with straight lines. Interpolation can then be used to estimate the required beginning equity and net worth associated with any given herd size. 86 we can estimate the necessary beginning equity associated with a given herd size In year 10 by Interpolation between the points for any given strategy. For a 100 cow herd, about $67,000 beginning equity is needed with N10&20 compared to only $37,000 for L15&30. The L15&30 strategy which requires the least amount of beginning equity for any given herd size, also provides the least net worth and year 10 consumption Income, but it has the greatest amount of debt outstanding. This is true for all situations. For any given herd size, moving from shorter to longer repayment periods and/or from nor­ mal to liberal down payment requirements, the following occur: 1. The required beginning equity decreases. 2. The amount of net worth decreases. 3. Ihe level of consumption decreases. 4. Hie amount of debt outstanding Increases. Thus, the dual personality of lower down payments and longer repayment periods are brought out rather clearly. They allow a farm operator with limited capital to obtain a larger production unit per dollar of equity, but he must accept the risk of a greater debt load along with a lower level of consumption and a lower net worth than if his beginning equity were larger. 5.7 Summary of the Effects of Alternative Repayment Plans, Beginning Equities, arri ttown Payment Requirements on the Growth of Ehe Firm Three primary variables were examined for their effects on firm expansion. With respect to each variable, the primary effects conpared with a given starting cash position were: 1. The extended repayment plans for long term debt made virtually no difference in total consumption, and only 87 slight Increases In net worth. However, they can aid a farm operator In expanding the size of his farm operation. The levels of production, gross income, and total assets were Increased with the longer repayment plans, but they were accompanied by an even greater increase in outstand­ ing debt. The shorter repayment plans necessitated a greater amount of the total debt load to be In terms of short term debt. No differences In farm organization occurred as a result of using different repayment plans for long term debt. 2. Increased amounts of beginning equity led to roughly pro­ portional Increases In net worth as well as for most other size aspects of the farm: level of production, gross Income, total assets, and total debts. However, net in­ come, and especially family consumption, Increased less than proportionally. At the lower equity levels and with normal down payments the operation was underfinanced and could not utilize sill resources and still make the nec­ essary Investments. The larger levels of beginning equity allowed the size of the operation to Increase, both in year 1 and over time. The Interaction of the increased equity and cer­ tain fixed resources of the firm also led to changes in farm organization. With normal down payments, only family labor was used and both dairy and grain production took place until the last two years examined for the $55,000 and $70,000 beginning cash levels. With $95*000 beginning 88 cash there was sufficient capital to allow specialization on the dairy enterprise using hired labor and purchased grain. Similar effects were observed for the lower down payments, although the lower down payments seem to act as a substitute for additional beginning cash. 3. Lower down payment requirements brought about modest increases of 10 to 25 percent in consumption and net worth. Increases of 1 1/2 to 2 times occurred for the level of production, gross income, total assets, and debts. Ihe minimum equity necessary to begin a profitable operation was about 30 percent less with the lower down payment requirements. The lower down payments allowed specialization in dairy production from year 1 on. The ability to finance more purchases per dollar of equity brought about land pur­ chases in year 5 and discontinuance of renting. Changes in costs led to production of corn for grain in the final two years, rather than greater expansion of the dairy operation. When the 3 primary variables were examined Jointly, their effects were seen to be offsetting in terms of some of the outcomes, and rein­ forcing in terms of others. Increased beginning equity combined with lower down payments resulted in smaller increases in net income after taxes, consumption, net worth, and reinvestment income. Ihus, their mutual effects seem to offset some of their Impact when examined inde­ pendently. But for total assets and outstanding debt, their Joint effect was greater than was indicated from the sum of their individual effects. Greater beginning cash and lower down payments are comple­ mentary with respect to these Items. Chapter VI PRESENTATION AND ANALYSIS OF MODEL RESULTS FOR OTHER SELECTED GROWTH VARIABLES 6.1 The Effects of Alternative Goals of the Farm Operator All results presented thus far have assumed the goals of the farm operators as desiring to maximize a combination of annual consumption and terminal net worth (CNC). The results of the N15&30CN and N15&30CC models illustrate the production levels, investments, and financial positions from pursuing the alternative goals of maximizing only ter­ minal net worth (CN) or annual consumption (CC) respectively (Table 6. 1). 6.1.1 The effects of maximizing only net worth The maximization of net worth alone leads to only a small increase in net worth over that received when the goal was maximizing both con­ sumption and net worth. Only $1700 additional net worth was attained and it was accompanied by a $2600 reduction in total consumption. There is little difference in the results from the N15&30 and Nip&3uCN models until year y. At that; point investments in dairy production are emphasized rather than investing in both land and dairy as with the CNC objective function. This reduces total assets and long-term debt while increasing short term debt. Maximizing net worth alone leads to a much reduced D/A ratio— 40.8 percent compared to 45.3 percent. The emphasis on dairy production in year 9 allows gross income to increase sharply for the final two years. And in year 10, this $107,100 gross income is reduced by only $1400 for taxes and $9700 for consumption. Thus, $96,000 in cash is added to final net worth compared with a total of $76,200 cash when 90 Table of resales from N15&3G, N15S3QCN, ar.d N15£»30CC models to compare effects of alternative operator goals, $70,000 beginning equity Model 'C^rr.c _ _ _ _ _ _ _ _ _ _ _ _ Si 5i3C 1 1 Unit ?.-■ 9 N15S30CN 10 Yesr _________Year Totals 1 / 1 5 9 N15&30CC 10 Year Totals 1 _________ Year / 1 5 9 10 Year Totals 1/ Orr.-.r. ic.nc ion Core. i - r ^.rain ".rc^e preccction Tetjl acres Inner ^r," i'.iti'n or Sale l.j.id rc.-til Ccrr. pnrchcscJ or sold Labor hired Invest--:.-s Sjvi.'.’i account Mac',.-. -.cry Dairy I.ici'.ities Lend Tr-cr-e Data Cross ir.cer.e .O.,O S / S -d Invert: ; l credit Not i.:..ce jLti-r taxes Co O'".: i .v-0 Net: v, _: t io.cor.o Bui'.drrn depreciation Other depreciation Debt ’ .ir.-r Dee 5 a i1d ir p JJ lard ]_/ ~nlr:-.ec Sin "t Total Shert-tera: debt 0/ Lcr.e-tcrni debt lot worth Debt-assct ratio 1/ 2/ 3/ i, / 5/ 6/ 7/ Year * 5 _____ 56 55 148 203 294 132 1.6 --- 123 46 ... ... 44 38 ... 127 48 — 4.1 374 142 80 94 ... 142 ... 314 314 246 246 374 374 165 103 0.6 — 119 1.1 -... -- 122 46 ... 166 90 0.6 __ ... 69 26 234 2.4 314 119 314 ... 42 37 — 202 56 80 93 — 245 245 119 -- Acre A.E. 2/ M.E. 3/ 123 45 — $1000 Acre C o w ft Acre 203 56 SO _. ... ... --- 56 54 148 2C2 56 55 148 2C3 _ ... --... Head Acre Acre Acre -- 203 56 80 80 -211 211 — 93 0.4 SC 260 211 471 ... — — ... — ... — ... £121) 0.7 _* ... 8 24 131 260 ... 260 4/ 4.3 471 80 471 $1000 $1000 S loco $1000 $ iOCO S1C0Q $1000 $1000 41.1 0.5 0.7 6.9 5.0 1.9 4.5 5.8 63.7 1.6 1.3 12.9 7.1 5.8 6.7 6.4 90.7 6.3 1.1 24.5 11.2 13.3 8.3 6.2 626.9 25.5 6.1 142.2 75.8 66.4 61.4 52.6 41.1 .5 .7 6.9 5.0 1.9 4.5 S.8 69.1 2.5 .7 13.3 7.3 6.0 6.7 6.5 107.1 5.0 5/ r8 .5 9.1 9.4 9.7 8.8 661.6 24.7 7.0 134.8 73.2 61.6 64.2 57.6 41.1 .5 .7 6.9 5.0 1.9 4.5 5.8 59.2 3.2 .8 15.6 8.0 7,6 5.9 4.9 75.9 4.1 .9 19,6 9.5 10.1 5.9 7.7 558.7 31.5 5.5 145.5 76.9 68.6 53.4 48.9 $1000 $1000 $1000 27.4 4.4 1.4 44.7 $.6 1.4 13.6 8.2 5.3 178.7 60.4 21.8 27.4 4.4 1.4 45.0 6.6 1.4 16.0 9.6 1.4 133.9 63.2 14.0 27.4 4.4 1.4 39.1 5.8 3.6 17.9 5.8 3.0 170,2 52.4 36.0 167.9 25.4 57.2 85.3 49.2 230.6 41.4 69.1 120.1 47.9 342.C 53.5 113.7 169.8 50.4 342.8 44.2 113.5 185.1 46 J 167.9 25.4 57.2 85.3 49.2 230.6 41.6 69.4 119,6 -.8.1 313.6 62.5 82.2 163.9 46.1 315.4 51.5 77.1 186.8 40.6 167.9 25.4 57.2 35.3 49.2 245.4 36.2 89.5 119.7 51.2 343.9 51.4 130.2 162.3 52.8 336.6 37.7 125.5 173.4 48.5 $1000 $1000 $1000 $1000 Percent Tctals iMy rot add due to rounding. Acre equivalent, Corn purchased (or sold is reported as the acres replaced by (or required to produca) this amount of grain. Man eq.ivaler.c. On* man equivalent is a ;$umcd to be 2600 hours. Snvi: ,3 occurred in ;,oir A ($11CC) and year S (S12CC). S jl OC c ; in.vestrent credit was deferred :rom years 6 through 9 and used inyear 10. 5'; ort*urm debt ir. /ears 1 through 7, in.ermediate term deatin years8, 9, and 10. Fi£uiv, are for debt payment due or. Jan. I of following year, rather than payment made In current year. Total figure is for 10 years. 92 maximizing both net worth and consumption. In connection with this final year, when maximizing net worth, investment credit was deferred from years 6 to 9 and used to offset all Federal Income taxes due In year 10. The goal of maximizing net worth also led to the use of short term debt to alter the timing of c o m purchases In years l\ and 8, so as to have slightly larger amounts of Investment capital available In years 5 and 9. This was possible at the expense of lower consumption In years 4 and 8. While the above comparisons show that slight increases In net worth can be obtained when pursuing that goal alone, the primary impli­ cations of pursuing a goal of maximizing net worth rather than maxi­ mizing both net worth and consumption may be "when” rather than "how". Increases in consumption and net worth are both dependent on a high level of income, and it appears that maximizing both goals will give a result near to that attained when maximizing net worth alone and at little expense to consumption. The major factor involved when maxi­ mizing only net worth may be the time horizon involved and the point at which this net worth is to be maximized. 6.1.2 The effects of maximizing only consumption Little change occurs in total consumption when the objective is strictly to maximize consumption rather than maximize both consumption and net worth. Fbr the 10-year period, the $1100 increase in consump­ tion was accompanied by a $11,700 decrease In net worth. The result of the N15&30CN model indicated that increased net worth was obtained with only a small reduction in consumption, but the converse indicates how increased consumption levels can seriously inhibit the accumulation of net worth. 93 The emphasis on change in farm organization is evident from year 5 on. Dairy herd expansion is reduced, and additional land is purchased. In year 9, more land Is purchased and used in the production of c o m for sale while the herd size remains the same. This organization allows total assets and short term debts to be reduced, while long term debt is greater than for maximizing both net worth and consumption. Less hired labor is required for this organization, thus, reducing cash costs. The effect on farm organization between the goals of maximizing only consumption or only net worth Is quite evident. The emphasis Is on expanding the dairy herd with no additional land purchases when maximizing only net worth. But the emphasis shifts to land acquisition and limiting expansion of the dairy herd when maximizing consumption. Ihe emphasis on land ownership reduces gross sales, but allows slightly larger net Income after taxes. Ihe Investment in land requires a larger cash outlay In the year of purchase than land rental, and this slows the expansion process. However, In terms of operating costs, owned land is less expensive than rented land. An acre of purchased land with 40 percent down, amortized over 30 years, has an annual charge of $16.92 for both principal and interest, of which no more than $13.10 of interest Is tax deductible. Coupled with the $3.50 real estate tax, the tax deduction for owned land is at most $16.60 per acre compared to $30,00 per acre for rented land. Likewise, with greater emphasis on grain production rather than milk production, much less expense is incurred for hired labor. The net result is to lower average variable costs per cow and allow the farm organization to achieve slightly larger net income after taxes, despite sharply reduced gross income. The results of the models Incorporating alternative goals of the farm operator Indicate that only minor Improvements can be made to improve either one singly over what Is achieved when both are Included in the objective function. structure of the model. But this Is not too surprising, given the In order to increase net worth, net Income sifter taxes and reinvestment Income need to be large. But Increasing net Income necessarily Increases consumption as well. And the opposite Is true for any attempt to increase consumption alone. However, the Investments undertaken and the organization of the f a m can change to take advantage of differences in average costs and returns. Although it was not possible to test the idea with the present model, it would seem that other strategies may arise if different time horizons were considered. Over time, the dairy facilities purchased are completely depreciated out and thus make none or only a small con­ tribution to net worth. But land does not depreciate over time, although land values in general may fall. If the relevant time horizon encom­ passed 25 or 30 years, maximizing net worth alone may lead to a strategy of emphasizing land purchase rather than dairy production. 6.2 The Effects of a Repeal of Investment Credit An aid to expanding fanners in recent years has been the investment credit provision of the Federal income tax laws. This has allowed a direct reduction of income taxes payable through credit based on investments in machinery, equipment, and buildings with an expected life of 4 or more years. A repeal of this provision would reduce the rate of expansion (Table 6.2). Without the $6100 investment credit, taxes paid increased by $5700, and net income after taxes was reduced by $7000. Tabic o,2--A compariscn of results with and without investment crcd»t, $70,000 beginning equity M^del Name NI5&30 lion: F ;rn Or- .3r iia C i c n Cuvs Milked Corn for grain ip*'irage production Total ceres Ir.-' : Acquisition or Sale Lend rental Ccrr. purchased or sold Lsccr h:red S a c c o u n t Machinery Ojiry facilities Land Trr- -e r-ita C rots inrt r£ T jxv s no id I.'.voit:cnt credit i.-c.w after taxes Rcii.vojtrc.i: income Lu.ldinc depreciation Other depreciation IV.t 7 . v‘nt Due Short-term •■*/ 5/ liu.ldir.g 5/" Lend 5/ .ii ^c . lieec Total aase ts Sliert-tern debt £/ Lonj-tera debt Not »orth Eebt-assot ratio V 2/ 2/ A/ 2/ U.-iit 1 Year 5 NNOCR 9 10 Year Totals \1 I Year 5 9 10 Year Totals 1/ Head Acre Acre Acre 36 55 US 2C3 93 -245 245 119 — 314 314 ---... 56 55 143 203 233 238 Acre A.E. :/ y .. E . } / 123 45 -- 165 108 0.6 ... ---- 123 45 ... 158 116 0.6 $1000 Acre Cow+R Acre __ ... 42 37 -- ... 203 56 60 2.4 314 119 314 ... 203 56 80 ... 36 34 -- 67 26 226 10.0 3C6 116 306 119 l.l 69 26 234 90 -- 116 ... 306 306 -... __ -- -- __ ne i .i _ ... $1000 $1000 $1000 $1COO $1G0C $1000 $1000 $1000 41.1 0.5 0.7 6.9 5.0 1.9 4.5 5.8 63.7 1.6 1.3 12.9 7.1 5.8 6.7 6.4 90.7 6.3 1.1 24.5 11.2 13.3 8.3 6.2 626.9 29.5 6.1 142,2 ■ 75.6 66.4 61.4 52.6 41.1 1.2 ... 6.2 4.S 1.4 4.5 5.8 66.9 2.7 -- 88.2 7.2 -- 614.2 35.2 -- 11.0 6,4 4.6 6.5 6.2 22.9 10.6 12.3 8.1 6.0 135.2 73.3 61.9 60.2 51.8 $1000 $1000 $ tCuO 27.4 4.4 1.4 44.7 6.6 1.4 13.6 8.2 5.3 173.7 60.4 21.8 27.4 4.4 1.4 43.6 6.5 1.4 11.3 8.C 5.2 181.8 59.6 21.6 167.9 25.4 57.2 35.3 49.2 230.6 41.4 69.1 120.1 47.9 342.0 53.5 ne.7 169.3 50.4 342.8 44.2 113.5 185.1 46.0 167.3 25.4 57.2 84.7 49.4 224.7 40.4 67.8 116.5 48.2 331.8 52.1 115.3 164.4 50.5 340.6 51.4 UC.l 179.1 47.4 $1000 $1000 $1000 $1000 Perce.t T^tulc ray no: add due to rcmd.r.g. Acre equivalent. Corn purchase.! {or sold) is reported as the acres replaced by {orrequired toproduce) thisamount of grain. Man equivalent. Cne ran equiva.ent is assured to be 26CO hours. Shcrt-tcra debt in years 1 through 7, intermediate term debt in years 8, 9, and 10. Figures are for debt payment du .* on Jan. 1 of following year, rather than payment made Incurrent year. Total figure Is for 10 years. The primary effect of no investment credit is the direct reduction of net income after taxes and the related decreases in the size of operation. This is apparent in the smaller level of the productive enterprises and a lower level of net worth. results in a greater use of short term debt. Lower repayment capacity Total short teim debt payments are greater and while short term debt outstanding at the end of year 9 was less, additional borrowing was necessary in year 10. Brooker and Herr [6] estimate that about one farmer in five uses in­ vestment credit each year, with an average increase in disposable in­ come per farm of one percent per year. For the growth situation assumed in this study, the increase in disposable income averages over four percent per year. If the investment credit provision were not available to farm operators, it would mean a slower growth rate and a greater reliance on short term debt, thus making the operation more vulnerable to adverse consequences. management. It would also mean the loss of a valuable tool for tax New equipment purchases are often undertaken in years of high income so as to reduce the income tax payable. Such purchases can still be used as a tax management tool through rapid depreciation; but loss of investment credit means that It will no longer directly reduce the tax bill. Investment credit has provided a relatively simple way to reduce taxes in years of very high incomes while making needed investments. 6.3 The Effects of Appreciation of Land Values Appreciation of land values has been occurring over the past three decades in the United States. owners from appreciation: Ttoo primary benefits accrue to land (1) increased credit to keep in reserve or 97 use for additional borrowing, and (2) Increased returns when the land is sold. In the NAPPR model, a 5 percent rate of appreciation is assumed, and this appreciation is reflected throu^i increased real estate credit for land owned over time, higher prices for land pur­ chased at later points in time, and increased values for net worth. Thus, land bought at $350.00 per acre in year 1 with the *f0 percent down payment requirement would allow up to $210.00 to be borrowed to finance its purchase. By year 5 this land would be worth $*125.23 and would then provide $255.25 of real estate credit. This means credit reserves could be increased or additional money could be borrowed, using the land as collateral. By year 9 its value would have risen to $517.11 and furnish $310.27 of real estate credit. Similar effects would apply to land bought in years 5 and 9 . Ihe NAP&REF model includes these same coefficients, but also allows for refinancing of outstanding loans on land purchases. Over time, the principal is repaid and some lenders allow additional borrow­ ing to be undertaken up to the original value of the loan, as long as the original property has not declined in value. Comparing the results of the NAPPR model with the basic model, N15&30, it can be seen that in year 1 the same organization, income levels, etc. occur (Table 6.3). The only changes are that total assets are higher and the D/A ratio is lower, due to the appreciation of land values.1/ In year 5 expansion of the dairy operation Is less than in the basic model; land rental ceases, and 182 acres of land are purchased. 1/ With $95,000 of beginning equity, 223 acres of land was pur­ chased in year 1 rather than just the required 80. At the lower begin­ ning cash levels, the land purchases were deferred until a moderate­ sized dairy herd was established. Table 6 .j--S‘*."-*n3ry of results from the S'. £3t3Ct NAPPR, 3rd NAP&REF aocels to examine the effects of lard appreciation and refinancing, $70,000 boginning equity Model N.vie NAPPR N15S30 T ton I'rtit 1 Year 5 9 10 Year Totals 1/ 1 Year 5 NAP&REF 10 Year Tetals 1/ 9 Year 5 1 9 10 Year Total* 1 / F.^rn O.-v1*•:z t i on C .-i* :.v. I'^L-d Corn £cr r r ^ i n Fornge product ion Tct.il acres IrrM .‘-r.-it 1 s i t i o n herd 56 55 148 203 rental Acre A.E. 2/ M.E. 3/ 123 45 ... 165 ICS 0.6 Lab. ■/ l u r e d $1000 Acre Cow+R Acre ... 203 56 80 119 Dai;/ f ut ilities Lnoi 73 70 192 262 105 97 277 374 _ __ ... ... 245 245 314 314 -- ... ... _ 119 1.1 --- 123 45 -- ... ... ... ... 69 26 234 2.4 314 119 314 _ 42 37 -- 203 56 80 59 17 182 112 32 112 str: o nt s S jv ;. account Mcchtncry 56 55 148 203 ... or^ale Cv'iM p.,.rc:’ *aaed or s ol d I r v 93 Head Acre Acre Acre 1C 0.3 . — — — __ — 22 1.0 . ... 3.0 374 105 374 56 55 143 203 123 45 ... - 73 71 194 265 108 ICO 234 384 ... ... 2 0.3 24 1.0 ... ... __ _ 203 56 80 62 17 185 119 35 119 -... ... ... -... 2.0 384 108 384 11S.Cl^Lj.lill Cross .ucc-ne Taxes pai d Inv. t c r e d i t Net i nci .-e a l t e r t ax e s . C o r . s 1i.'-p t » k-n K ;.v 1. s r i- . i■,c i n c c r . e Bui ldi ng d e p r e c i a t i o n Ot her d e p r e c i a t i o n $1000 $1000 $1000 $1000 $1000 $1000 $1000 $1000 41.1 .5 .7 6.3 5. 3 1. 3 6. 5 5.5 65.7 1.6 1.3 12.9 7.1 5.8 6.7 6.4 90.7 6.3 l.l 24.5 11.2 13.3 3.3 6.2 626.9 29.5 6.1 142.2 75.8 66.4 61.4 52.6 41.1 .5 .7 6.9 5.0 1.9 4.5 5.3 53.9 3.6 .7 16.7 3.5 8.2 5.5 5.4 79.9 3.8 1.4 20.2 9.7 10.5 7.4 7.2 545.7 28.0 5.8 139.4 74.3 64.6 54.8 50.4 41.1 0.5 0.7 6.9 5.0 1.9 4.5 54,4 3.8 0,8 17.3 8.6 8.7 5.5 5.8 $1000 $1000 $1000 27.4 4.4 1.4 44.7 6.6 1.4 13.6 S.2 5.3 178.7 60.4 21.8 27.4 4.4 1.4 40.0 5.4 5,4 13.0 7.3 9.4 175.5 53.8 46.0 $1000 $1000 $1000 $1000 167.9 25.4 57.2 85.3 49.2 230.6 41.4 69.1 120.1 47.9 342. C 53.5 113.7 169.S 50.4 342.3 44.2 1:3.5 t',5.1 46, C 16". 3 25.4 57.2 S6.7 46,6 275.', 37.0 103.4 130,0 52.3 414.3 50.8 160.7 2C2.8 51.0 422.7 41.8 135.2 225.7 551.7 27.9 6.0 139.274.7 64.5 55.2 5.5 81.8 3.7 1.5 20.2 9.7 10.5 7.6 7.4 27.4 4.4 1.4 40.3 5.5 S.5 13.3 7.5 9.9 178.1 54.6 47.4 169.3 25.4 57.2 86.7 48.8 277.7 37.3 110.2 130.2 53.1 424.8 51.9 169.0 203.9 $2.0 433.1 42.7 163.4 227.0 47,6 SI. 0 Debt r.n-et.t ShuLt-tvrx Ul 5 I B u i l d i n g 5/ “ Lar.d 5/ Sal a••.£•• Si-' ?**C Total asse ts Sb. er t - t i . r n debt A/ L o r e - t e r n debt Secberth pebc ■•asset ratio jy 2/ V y V Percent 46,6 Totals may not add due to rounding. Acre equivalent. Corn purchased (or sold) Is reported as the acres replaced by (orrequired toproduce) thisamount ofgrain. Mar. equivalent. Cr.e man equivalent is assumed to be 2600 hours. Short-term debt in years 1 through 7, intermediate term debt in years 8, 9, and 10. Figures arc for debt payment due on Jan. 1 of following year, rather chan payment made incurrent year. Total figure is for 10 years. 99 Additional land and dairy facilities are purchased in year 9. more land is purchased and at an earlier point in time. Overall, With land ownership, the operation continues to raise all c o m for grain rather than buying com. The decreased emphasis on dairy production leads to lower gross incomes, while total net income after taxes is only $2800 less. Al­ though net income is lower overall, it is higher in years 4 to 6. Total assets and net worth both increase substantially over the 10 year period. Of course, this increased net worth is only realized if the property is sold. Also, if sold, the increase in value would be subject to capital gains tax, thus offsetting part of this gain. Hie Impact on the debt structure of the farm operation is one of the more important factors. Short term and building debt are somewhat less when land appreciation is considered, while land debt increases substantially. But while the land is the collateral that makes this borrowing possible, not all money borrowed against the land is used to purchase land. In year 5, borrowing against land was $3800 greater than was needed for the 182 acres purchased. amounts to $15,400. In year 9, the difference Thus, land appreciation increased the overall borrowing capacity of the farm operation and allowed more of its debt load to be in the form of long term debts— even though part of this money was used to meet other expenses. Land appreciation thus operates as a substitute for lower down payment requirements for an operator who owns land. Appreciation of land values and generally rising prices has no doubt led some individuals to make investments sooner in time than they may otherwise have done. Land purchases made at an early point in time 100 have often proven to be cheaper In terms of their initial, cost per acre. They have provided additional credit on loan funds as time passed, and they have been repaid with "cheaper" dollars. Once farm operators begin to expect appreciation, they place more emphasis on land ownership. 6.3.1 Ihe effects of land appreciation and refinancing read estate loans The effect of also allowing refinancing of real estate (NAP&REF model) allows slightly greater expansion to occur since this increases the amount of long term loans which can be obtained. In scxne cases, however, farm operators may prefer not to use this credit except in case of unexpected expenses. They may treat it more as a credit reserve. As the loan is repaid, this amounts to an increasing proportion of the loan. After 9 years of payments on the 30-year loan, only 11 percent of the principal had been retired. Over a longer period of time, this would represent a much greater source of credit reserves or expansion capital for the farm operator. ^ iI T A l.fA V t 1 1 r T >v»4 A A A A milk price of $5.50 per cwt. has been assumed in the previous models, corresponding to the blend price currently being received in south central Michigan. It was pointed out that repayment capacity was never the limiting factor, with the prices and yields assumed in the model. By lowering the price of milk, we get an indication of when repayment capacity begins to limit growth and its effects. 6.4.1 Normal down payment requirements and lower milk prices With milk at $5.15 per cwt. and normal down payment requirements, 101 repayment capacity is still sufficient to allow the same Investments to be made In year 1 as with the basic model (Table 6.4). However, lowering the price to $4.80 per cwt. brings about a different invest­ ment pattern in year 1. More long term debt is assumed, but short term debt is limiting, and 33 acres of machinery capacity go unused in year 1. By shifting from short term to long term debt, the annual payments are reduced. Related to this is the emphasis on purchasing land rather than renting. Land ownership allows additional long term debt to be acquired, and the annual cost per acre of land is less than for rented land. As the milk price is lowered, the emphasis in farm organization shifts from milk production to a combination of grain and milk prod­ uction. land acquisition is undertaken right from year 1 at the lowest milk price. The changes allow the annual average variable cost per cow to be reduced over the other farm organizations. In the N15&30 model, average variable cost was over $600 per cow in year 1. But as the income from milk sales per cow declines, it becomes necessary to switch to less costly production procedures. The average variable cost per cow in year 1 drops to about $550 per cow under the revised organization with milk at $4.80 per cwt. Even with this lower cost structure it barely meets the minimum consumption level of the faim.l/ Consumption and net worth are, of course, substantially reduced with the lower milk prices. Even with milk at the lower price, however, the operation is able to adjust the farm organization and make consid­ erable growth. 1/ With $55,000 beginning cash, the faim operation was not able to meet even this minimum with $4.80 milk. Table 6*4 Ccm pjrison of basic model when silk, prices sre varied frcn $5.50 to $5.15 and $4 . SO per cue., $7C,OCO beginning equity M5530 Item U 21 3/ 4/ 6V I! 1 93 9 Head Acre Acre Acre 55 55 t4S 203 119 245 245 314 314 Acre A.E. A/ M.E. 5/ 123 45 -- 165 105 0.6 -- $1000 Acre Ccu+R Acre -- -42 37 -- -- 203 56 £0 ... 119 1.1 69 26 234 10 Year Totals U i ----- 56 55 148 203 -... -- 123 45 -- 2.4 314 119 314 203 56 80 -- 10 Year Totals 1 / 76 2 201 203 105 ... 276 276 ----- 46 2/ 43 122 167 56 55 149 204 — 93 0.9 ---- 3/ 4 2/ 38 -- — -73 29 75 1.0 276 105 276 2 88 0.3 --20 121 N$4 .80 1 -- Year 5 18 -- 10 Year Totals 1/ 9 81 77 214 291 ------ -- ---- 0.5 -4 10 41 87 25 87 1.0 291 81 291 3.9 5.1 36.7 .7 1.4 10.5 6.3 4.2 4.5 3.7 54.6 1.5 l.l 12.7 7.1 5.6 6.0 5.6 386.1 12.6 5.0 88.5 57.0 31.5 45.6 40.8 200 46 163 $1000 $1000 $1000 $1000 $;cco $1000 $1000 $1000 41.1 0.5 0,7 6.9 5.0 1.9 4.5 5.8 66.7 1.6 1.3 12.9 7.1 5.8 6.7 6.4 90.7 6.3 1.1 24.5 11.2 13.3 8.3 6.2 626.9 29.5 6.1 142.2 75.8 66.4 61.4 52.6 38.6 .3 .3 4.5 4.2 0.3 4.5 5.8 52.9 2.4 .7 12.7 7.0 5.7 5.7 4.4 74.9 3.0 1.2 17.7 8.3 8.9 7.4 5.8 521.4 20.1 5.7 115.2 66.3 48.9 55.6 46.2 $10CC $1000 $1000 27.4 4.4 1.4 44.7 6.6 1.4 13.6 7.9 5.6 178.7 60.4 21.8 27.4 4.4 1.4 37.5 5.6 3.4 12 .4 7.3 4.7 179.5 54.6 28.6 24.4 3.8 2.8 22.5 4.5 3.4 10.2 5.9 4.9 147.5 45.0 34.6 16/.9 25.4 57.2 85.3 49.2 230.6 41.4 69.1 120.1 47.9 342.C 53.5 118,7 169.8 50.4 342.8 44.2 113.5 185.1 46.0 166.3 25.4 57.2 S3.’ , 49.7 231.8 34.8 £5.3 111.7 51.8 3C1.4 47.6 104. f. 149.8 50.3 39.1 98.2 161.1 '■6,0 173.1 22.6 69.2 81.3 53.C 194.2 2C.8 7S. 5 97.9 49.6 274.0 53.C 95.4 126.2 54.C 269.8 44.8 91.2 133,8 50.4 $1000 $1000 $1000 $1000 Percent Totals ray not add due to rounding. Corn grair, produced'-was 78 acres in years 2, 3, and 4 and corn uas sold each ofthese years. hand rc.-.teu ircreesed to 37 acres for ars 2, 3, and 4* Acre equivalent. Corn purchased (or so'.d) is reported as the acres replaced by (or required toproduce) Man equivalent, Cr.e man equivalent is .issumod to be 2ofQ hour*. Short-torn debt in years 1 through 7, intermediate term debt in years 6, 9, and 10. Figure: arc for debt payment due on Jan 1 of following year, rather than payment made in current year. 29.6 .3 .2 4.0 4.0 — thisamount ofgrain. Total figure is for 10 years. 102 Farn I ’V m n fza tion Cows milked C*m r pra in Forj'.;c production Total acres T;v*":t AC'.-::r.t icn or Sale Land rc .x ta l Ccrn purchased or sold Lob or h:rcd Tnv*. scmu -ts Snvirgj account M.nchir^ry Dairy facilities Land Irccmo Data Ct\ ji me*, .r.a Taxes pjid Invcbi■.o:■t credit Net ir.ci -.c after taxes Consi:;.,-C:on Rei.'vesti *.-t EuilJir.,; depreciation Other Jcprocration Debt r.ivmcnt Due Short-term n/ 1J Bui Id ir.g j J Land 7/~ Bal-ir'ce Pbeet Tatal assets Sbcrt-tcrrr. debt 6/ Lcr.g-ttr:r. debt Net v^rth Dobt-asset ratio Unit Year 5 Vo del S5.15 Year 5 9 , 103 In view of the above results, It would appear that a dairy organ­ ization that expanded its operations along these lines should be able to withstand some rather severe price drops. Repayment capacity still appears to be sufficient to support an ongoing operation, as the debt load for the N$4.80 model is nearly as large as that of the N15&30; but there is greater emphasis on long term debt. Ihe farm operator and his lender may be able to shift more of the debt to intermediate or long term debt, thus lowering his annual payments. But this will depend in part on what the debts consist of— feed bills, machinery, or whatever. Further expansion may not be possible, or at least proceed less rapidly, and family living expenditures would have to be reduced, but the farm operation need not be forced out of business. 6.4.2 Liberal down payment requirements and lower milk prices The effect of lower milk prices in conjunction with liberal down payment terms alters the farm organization right from year 1, even with milk at $5.15 per cwt. (Table 6.5). The initial expansion of the farm reduces herd size and emphasizes land purchase compared to the results obtained with a milk price of $5.50, thus bringing about a shift toward more long term debt and reducing annual payments. In year 1, long term debt is nearly 7/10 of the total debt in the L15&30 model. Hie proportion of long term debt rises to over 3/4 in the L$5.15 model and to 9/10 in the L$4.80 model. By year 9> the proportion of long term to total debt was slightly over 70 percent for all three models. While the initial year organization differed between the L15&30 and L$5.15 models, the expansion in years 5 and 9 proceeded along similar lines. Both models specialized in milk production until year 9 Tabic it.5--Compar ison of liberal dowr. payment requirement results with mi lk prices at $5.50, $5.15 and C4.80 per ewe., $70,000 beginning equity VnJel Name 1.55.15 Year 5 9 U5S30 I tern Unit i car 5 1 9 10 Year Totals \ j 1 LS4.80 10 Year Totals U Year 5 1 9 10 Year Total* 1/ Faria Or.' •: i it ion Curn for grain Foraqe production Total acres Tnp-'t .‘c^.iuition or Sale Land rcrtjl Corn yifchased or sold Labor h:rvd i ,\«■s ; Suvi.iqs account Machi nor/ Dairy facilities Lur.d T,. , <_, V.,» •iVi; Cross income Tuxes paid Investment credit Net iucs-.c a i u r taxes Ci s ;-Lio.l :•t. out income Lu iId i J .prcc Lat ton Other depreciation Dubt Puvrcnt Short-term 6/ TJ Buildtug 7/ T-ouJ 7/ Bo lance Fhref Total asrets Shorc-tLrm debt 6/ Lonq-urn debt worth Debt-assct ratio W y 2/ £/ y 6/ 7/ S/ 179 167 472 639 — — — — 79 — 2C7 207 58 147 1.3 --- — — ... 120 45 205 ... 297 49 354 7.0 639 179 639 Head Acre Acre Acre 85 -223 223 130 ... Acre A.E. 2/ K.E. 3/ 1C 3 150 $1000 A;re Ccw+R Acre ... 223 85 80 343 343 .5 2.5 296 296 151 141 398 539 — — — — 59 44 156 200 64 50 169 219 123 126 336 462 ... -... ... -- -- — -- -- 200 1.0 — — -- 141 61 27 -... ... 113 -- .4 — ... 207 79 207 ... 89 34 89 32 1.9 .1 --- 243 38 243 5.3 539 151 539 __ 200 59 200 .1 __ IS 5 19 (4) 1.5 ... 167 64 243 4/ 2.9 5/462 ~ 128 462 $1000 $1000 $1000 $1000 $1000 $1000 $1000 $1000 61.9 .3 .4 5.0 4.4 .6 6.2 8.2 96.1 2.6 1.8 17.9 8.9 9.0 8.9 9.3 136.0 6.1 2.8 30.1 13.1 17.0 12.2 13.1 912.8 30.2 9.4 157.9 81.3 76.6 £4.8 78.1 54.0 .4 .5 5.7 4.6 1.1 5.3 7.5 78.2 .4 .5 6.5 4.9 1.6 7.9 7.6 1C8.2 2.2 2.2 20.0 9.6 10.4 10.3 10.8 753.1 16.8 8.0 117.8 67.2 50.6 75.4 67.3 37.8 .4 .4 5.2 4.4 .8 4.7 5.9 41.9 .6 l.l 9.2 5.8 2.4 5.0 4.9 85.7 1.0 2.0 15.2 7.9 7.3 7.7 11.6 496.0 10.1 6.7 89.7 57.4 32.3 54.2 57.1 $1000 $1000 $1000 44.9 8.2 1.6 75.3 11.7 6.5 27.5 16.1 14.4 375.0 111.8 62.0 41.7 7.7 4.7 66.2 10.4 6.7 23,5 13.6 12.2 346.4 99.6 70.0 15.5 6.1 4.6 12.8 6.1 4.6 18.5 11.5 10.5 109.2 71.8 57.8 228.2 41.5 96.7 90.0 60.6 376.5 69.7 172.5 134.3 64.3 585.4 104.0 284.1 197.3 66.3 587.2 97.8 273.4 216.0 63.2 256.1 33.6 128.1 89.4 65.1 344.7 61.3 162.3 121.1 64.9 490.0 88.6 234.6 166.3 66.0 488.8 33.7 225.2 179.9 63.2 211.0 214.8 14.3 8/ 11.4 111.9 99.4 84.8 104.0 59.8 51.6 419.6 74.0 205.4 140.2 66.6 417.1 70.2 197.8 149.1 64.2 $1000 $1000 $1000 $1000 percent Tctals tr.ay not add due Co rounding* Acre equivalent. Corr. purchased (or sold) la reported as the acres replaced by (or required to produce) this amount of grain, V.an equivalent. One r.ar. equivalent is assumed to be 26C0 hours. Saving occurred in year 7 rather chan year 10. Ar. additional 76 acres of machinery was purchased in year S. This was used with 76acres of rented land Co raise 126 acres of corn In year o . Short-term debt in years i through 7, in ;ermediate termdebt in years 8, 9, and 10. Figures are for debt payment due on Jan. 1 of followingyear, rather than payment made In currentyear. Totalfigure isfor 10 years. Purchases c i buildings and land in year i were financed on short-term credit. 105 when c o m production was also undertaken. But In the L$4.80 model, cash Is more limiting. The Initial acreage operated was limited to 200 acres, just utilizing the fixed supply of machinery. Most, but not all c o m Is raised in years 1 to 8, and all c o m is raised In years 9 and 10. Small investments are made In year 5 In land and dairy facilities, but these Investments are paid with cash. All three sources of credit are in surplus In year 5, indicating there would not be sufficient improvement In consumption and net worth over time for it to pay to take on additional debt. Again, the reductions in milk price do not force the farm opera­ tion out of business, but the reductions in income are quite severe. Net income after taxes drops from $158,000 to $118,000, and to $90,000 as the milk price declines from $5.50 to $5.15, and $4.80 per cwt. respectively. This happens despite a $20,000 reduction of taxes between the results for the models with highest and lowest milk prices. The level of consumption is sharply reduced, with an average for the $4.80 price of only $1700 a year above the minimum $4000 level specified. This leaves little room for further belt-tightening. This farm operation may be able to withstand a drop in milk prices to $5.15, but the same may not be true at the $4.80 level— especially if the price drop occurs during the first 5-7 years of the operation. The large amount needed for annual payments in the L15&30 model— especially for short term debt— puts a severe strain on repayment capacity. In addition, the L15&30 model shows $138,000 debt in year 1, and $143,000 debt in year 5. The L$5.15 model indicates it only has capacity to handle $125,000 debt in year 1, $110,000 in year 5, and then only if the debt is largely long term. These amounts are not 106 strictly comparable, however, since the L15&30 model has already made the down payments and is operating on a larger scale. But the risk of failure would seem to be quite high in this situation. With the assets so highly indebted right from the start, there would be less chance of lenders being willing to grant additional loans against the property. An operator with 40 to 50 percent equity in his business would probably be more apt to be able to refinance and lower his equity to 30 than one who has 30 percent equity and desires to lower it to 20. 6.5 Sumnary of the Effects of OtherSelected GrowthVariables Several variables felt tobe of firm were included in the analysis. importance toexpansion of the The primary results of each when compared with the results of the basic model are as follows: 1. Maximizing a goal of net worth alone led to only a small increase in net worth and a small decrease in consumption compared to pursuing a combination of goals of net worth and consumption. The f a r m organization specialized in the dairy enterprise, utilizing all rented land except 1 U i 2. 04 J. r* n f* PH W » «* w a. w w Maximizing a goal of consumption alone led to only a slight increase in consumption, but this was accompanied by a rather large decrease in net worth. The dairy enterprise was limited in size as the emphasis was placed on land purchase. Both the dairy and grain enterprises were included in the final 2 years. 3. Repealing investment credit led to a direct reduction of disposable income, but the changes affected only the size of the organization. Net income after taxes was reduced 107 slightly more than 4 percent per year. Ihe lower Income led to a slightly smaller expansion and an Increased use of short term credit. 4. Appreciation of land values brought about sharply Increased acquisition of land as soon as possible. Under the lower beginning capital situation, expansion of the dairy herd occurred first and land purchase was delayed to year 5. C o m was raised for grain along with the dairy enterprise. Consumption was slightly reduced, while the appreciating land values allowed greater use of long tern debt. This additional borrowing, with land as equity, was used par­ tially for purposes other than land purchase. 5. Appreciation of land values and refinancing reinforced the tendencies noted for appreciation only. However, since early payments on land are composed primarily of interest charges, the impact would be greater in a longer run context. 6. Lower milk prices resulted in repayment capacity becoming more limiting. Changes occurred in farm organization, but with $55,000 beginning cash and a milk price of $4.80, it was not possible to operate the farm under the assumed conditions. lower milk prices led to investments and enterprises more dependent on long term debt in the early years. Land purchases increased and the farm organization diversified to c o m and dairy. At $4.80 per cwt. milk, the farm operation would be quite susceptible to failure from setbacks such as disease, poor yields, or other prob­ lems. Chapter VII IMPLICATIONS 7.1 Growth Factors Examined This study has examined several factors that are felt to be Impor­ tant In financing farm expansion. These results have implications for farm lenders, as well as farm operators interested in such expan­ sion. 7.1.1 Level of beginning equity The beginning equity position of the farm operator is a major factor in determining the potential growth that may be achieved. The primary effects of larger amounts of beginning equity were to increase the size of the farm operation, both in year 1 and over time. Each additional dollar of beginning equity led to approximately an additional dollar of assets by year 10, but only about 50 cents of additional con­ sumption. The greater initial cash positions allowed increased size of operation, but these increases were not the same for all aspects of the operation. There were also occasions in which the lower levels of beginning equity resulted In unused capacity. The necessity of making initial investments under strict borrowing limits related to assets resulted in insufficient funds for both investment and operating pur­ poses, even though there was adequate repayment capacity. In similar situations, farm lenders need to consider the entire picture to see if a loan, although larger than normal lending procedures may dictate, would be desirable to allow full advantage to be taken of the capital Investments. At the same time, some under-financed organizations may be better advised not to expand, but to search for other solutions. 108 109 This study also provided an Indication of the minimum level of equity necessary to begin dairy fanning. At least $50,000 was neces­ sary to establish an operation capable of providing $4000 a year for family living expenses, under the basic lending rules of 25 percent down on chattel items and 40 percent down on reail estate. When the down payment requirements were lowered to 10 percent on chattel items and 20 percent on real estate, this minimum equity dropped to $35,000. These amounts are dependent on the assumptions of the study, but they do give an Indication of the equity needed for dairy farms of this size and technology. For other farm types the level of required equity may be lower. A dairy farm, with the technology assumed in the model, requires over half of the Investment to be In buildings and livestock. Cash grain farmers, however, would need to invest primarily In land and machinery. Swine and feeder cattle operations would probably require a minimum investment somewhere between those required for dairy and cash grain farms. But livestock operations— especially hog farms— could be essentially a feeding operation with a small land base, purchasing all feeds from other sources. 1/ This alternative was not deemed to be economically feasible for providing forage on dairy farms In this study. On operations for which such conditions existed, the Investment could be sharply reduced. However, such an organization would lead to a primary dependence on short term credit to finance the feed and livestock purchases. 1/ An Indication of the Importance of this can be seen from the equivalent of 50 to 200 additional acres that would have been needed had all c o m for grain been purchased In this analysis. 110 A beginning equity of $35*000 to $50,000 is still more than most young or beginning farm operators would have, however. Although beginning equity was treated as a variable in this anaylsis, it is not a variable to any given individual. But the individual's equity posi­ tion, combined with what he views as the necessary size of his farm operation, may provide the incentive to search for ways to stretch his available equity. still applies. Hie old adage, "It takes money to make money," But there are substitutes for capital, and most of the other growth factors examined in the study are, in a sense, substitutes for beginning capital. 7.1.2 Alternative repayment plans on long term debt An operator with the primary goals of increasing his net worth and consumption, gains little advantage from the alternative repayment plans on long term debt. The various repayment plans offer flexibility in matching repayment capacity to the desired investment, and thus allow farm operators to gain ownership control over larger operations. Shorter repayment periods necessitate a greater dependence on short term ^ V>p sjLKi k / U 1 } O i i — « ha m a a iA C C U WCf n ■ — ha £ w m Ain IHO U CU1 4 m 1 a m a ha X iii^ O X C U lU C ha U 1 ha Oi ha « ■»4 ^ ha ah m m k /C H Il h3 ha Va 4* U C U l in the total debt load of the farm operation. The results do not indicate any great merit in deferred payment plans as a tool to aid farm incomes. They did allow the operator to own 15 to 20 percent more total assets at the end of 10 years, but with 30 to 35percent more debt. tial point is For a given individual, the essen­ whether oneis concerned with ownership control of assets or with increasing equity and consumption levels. For asset control, the deferred payment plans do provide some assistance. Ill 7.1.3 Smaller down payment requirements on short and long term loans Smaller down payments have a pronounced Impact on all aspects of the farm operation. The smaller down payments allow much greater expansion to occur for a given equity level and repayment plan, with only modest Increases In consumption and net worth. But the large increase In debt Implies that a much greater degree of risk is asso­ ciated with this growth. This risk arises from both the larger debt load and higher debt/asset ratios. There is also more risk from the legal standpoint in that purchases of land with less than 30 percent equity would likely be on a land contract, thus affording less legal protection for the purchaser in times of financial difficulties. At the present time, low equity loans of this type are available through individuals but normally not through lending institutions. Insured low equity loans, such as have been used by the Farmers Home Adminis­ tration and Federal Housing Administration, could encourage greater use of such loans while removing scxne of the risks to both borrower and lender. There are also interrelationships between these items. The com­ bined effects of a larger beginning equity and a lower down payment requirement are less than their individual effects would indicate for consumption and net worth. On the other hand, these factors are rein­ forcing with regard to total assets, and especially so in terms of total debts. The borrower needs to keep in mind that the same factors which allow him to expand his operation more rapidly, also lead to much greater debt loads and increased risks. Therefore, it is important to keep the total situation in mind when planning. 112 7.1.4 Goals of the operator In developing the model for this analysis it was assumed that the major goals over time for a farm operator were those of net worth and family consumption. But Interpretation of the results required consid­ eration of other goals as well. debt load? How does the operator view a heavy What about his willingness to assume risk? Is a possible 15 percent increase in consumption and a 30 percent increase in net worth an acceptable return for using low equity financing when it means assuming 2 1/2 times more debt? Lenders need to know not only how good a manager each individual is, but also what his primary goals are and how he might view the other questions that occur during faim expansion. 7.1.5 Appreciation of land values Appreciation of land values caused more land to be purchased, and at an earlier point in time. It also allowed additional borrowing on land to be made as it appreciated in value over time. money borrowed against land was used to purchase land. But not all the It merely allowed the farm operation to carry more of the debt load in the form of long f W qtw A t* W W J op r»or«4* * 4*V» mnwoir V *t o lt« O t tW J M W O uca H M W O W t t. O * AfHAr» nnnnAOoe W tO * • /lr>nr*o— 4 O elation increases borrowing capacity and can operate as a substitute for longer repayment plans. While appreciation is not an item either borrowers or lenders can control, appreciation or the expectation of appreciation can influence land purchases. 7.2 Other Factors Important to Growth Ihis analysis focused on the factors discussed above: beginning equity, down payment requirements, length of repayment, goals of the operator, land appreciation, and Investment credit. Each of these was 113 seen to be Important In Influencing the growth of the firm. other factors, though not explicitly But several examined, could also be seen to have a major impact on the actual growth achieved. These factors are: family living expenses, the tax structure, land rental, purchase of nonfarm inputs, required initial investments, and management ability. The amount of cash needed to meet family living expenses represents a major drain on the net income produced by the farm operation. In this study, consumption withdrawals took from $65,000 to $90,000 over the 10-year period, compared with additions to net worth of from $85,000 to $190,000. Since the operator can adjust his consumption withdrawals somewhat (within the needs and desires of his family), this is an item that needs to be explicitly considered by both borrower and lender in discussion of financial arrangements and planning. Taxes also represent a major reduction of net income, totaling from $20,000 to $38,000 over the 10-year period in this study. This was net of the rather sizable reduction due to investment credit as well. If the investment credit provision should be repealed, the rate of growth on such expanding operations would be reduced. In this study, net income after taxes was reduced about 4 percent per year. Repeal of the investment credit provision would also mean the loss of a valu­ able tool for tax management. The total annual outlay for Social Security taxes, and State and Federal income taxes is too large to ignore in any long-run planning. Within the model, increasing net worth was included as part of the primary goals of the farm operator. Despite this, land rental was still highly Important in expanding the farm operation. Control of the asset, at least in the earlier years and especially with limited 114 capital, can be more inportant than ownership In achieving rapid growth. This reemphasizes what has been occurring on many farms— that renting of farm land can be a valuable substitute for capital. Other rental forms are available and may be necessary for many indi­ viduals to have enough of a financial base to expand using technology of the type discussed here. The purchase of inputs such as feed grains may also benefit the overall growth of the farm business. Unused resources, such as labor or machinery, may dictate production of the needed grain, while compe­ tition for available cash between production expenses and investments may favor purchase of the grain. The actual decision made will be dependent on examining all the restraints on the business and seeing which procedure is best for it at a given point in time. A related aspect is the matter of fixed resources. This study assumed beginning equity was entirely in cash and that certain invest­ ments in land, buildings, and machinery were necessary in year 1 of the expansion process. For a given individual, the starting situation would more likely be some combination of assets in the form of land, buildings, machinery, livestock, and cash. Naturally, the growth possible, and the pattern by which this growth occurs, will vary depending on this beginning position. But the study illustrated the importance of fixed investments and unused capacity in the expansion process. When surplus machinery and labor were available, additional land was rented, and all c o m for grain was raised on the farm. As the family labor supply and stock of machinery was exhausted, it often became more profitable to purchase grain off the farm and use the land resource strictly for the necessary forage production. The actual 115 forms this may take depend as well on other factors, such as relative prices. But the set of resources available at the start of the expan­ sion does influence both the rate and path of expansion. Finally, the size and scope of the operation examined here have assumed an operator with above average management ability. But how many farmers have the production management ability to operate dairy farms of 100-200 cows? How many have the financial management ability to operate dairy farms with one-quarter to three-quarters of a million dollars of assets? And do the same persons necessarily have both of these management abilities? This analysis assumed an individual with both qualities, but it certainly will not apply to all individuals who wish to expand their operations. Yet overall management ability is one of the major factors affecting the success or failure of these operations. 7.3 Growth Factors and Decision Making A major purpose of this study has been to examine factors impor­ tant to growth and attempt to determine their relative inpact. Know­ ledge cf some cf the factors that affect growth can help both borrowers and lenders in planning for firm expansion. However, not all factors that affect the expansion of the firm can be controlled by either the farm operator or his lending agency. In planning for an expansion of the farm operation, it may be useful to classify these growth factors into the following three groups. The first category includes those factors over which neither the borrower nor lender has much control. These include beginning equity, prices, weather, the tax structure, and land appreciation. These items all affect the repayment capacity and growth of a farm operation, but 116 are not variables that lenders or borrowers can manipulate. In the second group are Items over which the operator can exert some Influence, but about all the lender can do Is to try and assess the operator's behavior. These Include the goals of the operator, his management ability (In financial matters as well as production), the size of operation, and his spending for family living expenses. These factors also affect repayment capacity, but they are primarily a func­ tion of the operator and his situation. Lenders can aid in planning and supervision, but the farm operator must do the execution. In the third category are items which can be affected by the ac­ tions of both lenders and operators. These Include alternative repay­ ment plans, down payment requirements, and sound financial planning. These items provide alternatives that can be adapted to a given repay­ ment capacity in order to meet an operator's goals. But in reconrnending one course of action over another, the related effects on other parts of the fann organization need to be pointed out and assessed. Chapter VIII SUIVMAHY AND CONCLUSIONS 8.1 Review of the Method and Underlying Assumptions A polyperiod programing model was developed to represent a south central Michigan dairy farm. The model provided only two activities per year for production alternatives with the balance devoted to in­ vestment, borrowing, taxes, consumption, input acquisition and sale, and fixed cost activities. The model assumed yields presently being received on similar soils by the better farm operators. Prices corres­ ponded to those currently being received and paid by fanners. The model encompassed a 10-year period and allowed investments to occur in years 1, 5, and 9. Borrowing was limited by institutional restraints based on equity by type of asset and by repayment capacity. In year 1, the model required the purchase of 80 acres of land, equipment to operate 200 acres, and a milking parlor to handle up to 130 cows. The operator and family were assumed to furnish 3000 hours of labor annually. A minimum of $4000 was assumed necessary each year for* family consumption. After tax income above this minimum was allo­ cated 35 percent to consumption and 65 percent for reinvestment. The primary goals of the farm operator were assumed to be maximizing the discounted present value of a combination of consumption and net worth. In order to test the effect of various items on growth of the firm, modifications were made in the basic model. were: Ihe items examined length of long term debt repayment period, level of beginning cash, down payment requirements, operator goals, appreciation of land values, investment credit, and changing milk prices. The effects of these different Items on production, income, and financial progress of 117 118 the farm operation were examined through comparative analysis. Since the model used was a programming model with perfect know­ ledge assumed by the model, the results are more favorable than would occur in most farm operations. Constant prices and yields through time, along with perfect foresight, allowed the model to take advantage of every favorable circumstance, no matter how slight. Nonetheless, the results suggest implications concerning the effects of the various items examined. 8.2 Sumnary of Primary Results 1. Three items were examined rather intensively: length of re­ payment period, amount of beginning cash, and down payment requirement on loans. The effect of longer repayment periods for long tern debt was negligible on total consumption; but did lead to slight increases in final net worth. These longer repayment plans also brought about rather modest increases in gross income, production levels, and total assets over the 10-year period. However, almost no difference resulted from the different repayment plans with respect to total net income t o X c S j oT&I I'Gilj.VG3 umGiYk inCGHiB* Tncr iG U g c j/ i/Gpa^TTiGn't pGI/iGClS did lead to larger debt loads and a higher debt/asset (D/A) ratio. 2. Increasing amounts of beginning cash led to Increasingly larger levels of net worth, as well as gross income, reinvestment income, total assets, and total debts. Smaller relative increases accompanied the larger amounts of beginning equity for net income after taxes and consumption. At the lower equity levels, cash was sometimes too limited to fully employ all fixed resources, In addi­ tion, limited capital forced expansion to be delayed to a later point in time. As the equity level increased, the farm organization changed 119 from a diversified one— producing both milk and c o m for grain— to one specializing in milk. 3. The most expansionary factor on size of the firm of these three factors was the lower down payment requirement. Production levels, gross income, assets, and debts all increased 1 1/2 to 2 1/2 times with the more liberal credit terms. However, its effect on the primary goals of consumption and net worth along with net income after taxes and reinvestment income was an increase of only 1 1/4 times. The lower down payment allowed the assets controlled to increase quite rapidly, but a high D/A ratio of about 60 percent meant that the operator's risk of failure was much greater than for an operator using normal terms. The effects of increasing costs as the firm began to hire labor, rent land, make additional investments, and be affected by the pro­ gressive income tax rates were all evident in the strategies pursued under different situations. Specialization in dairy production was generally striven for, but when capital was limiting in snail output situations and when costs became quite high in very large output sit­ uations, the farm organization diversified to include production of c o m for grain. Repayment capacity was not a limiting factor as long as the assumed milk price remained at $5*50. Thus, the predominant restraints on expansion were down payment requirements and beginning equity. 4. The minimum beginning cash necessary to operate a farm within the assumption of the model was $50,000 for normal down payment require­ ments and $35,000 with liberal terms. The smaller initial equity under the liberal terms allowed the operator to achieve a slightly 120 greater level of consunptlon but a lower level of net worth than was received with a larger amount of beginning cash and normal terms. The increase in consunptlon was accompanied by increased gross income, net income after taxes, and assets; but also by a much larger debt and higher D/A ratio. 5. Suimarizing the results for debts, consunptlon, and net worth by number of cows provided an indication of the initial equity nec­ essary to achieve a given herd size 10 years hence, by following dif­ ferent financial strategies. These strategies involve length of re­ payment period and down payment requirements. The impact of these decisions on debt oosition, net worth, and annual consunptlon could then be estimated so as to evaluate the pro's and con's of the different strategies. For a given herd size, increases in length of repayment period and more liberal down payment requirements led to (1) a need for less beginning equity, (2) a lower level of consunptlon, (3) a lower net worth, and (4) a greater debt load. 6. Little difference in results was obtained when a goal of maximizing only net worth was used. The farm organization specialized in dairy, using all rented land except for the required 80 acres of owned land. When the goal of maximizing only consunptlon was tried, little increase in consumption resulted; but it led to a sizable reduction in net worth. The farm organization put less emphasis on dairy production, purchased land, and produced grain both for feed and sale in years 9 and 10. The goal of maximizing a combination of net worth and consunptlon appears to be the most satisfactory. 7. When investment credit is not allowed, it directly affects net income after taxes, consunptlon, reinvestment income, and net worth. 121 With the high repayment capacity of the model, it had little effect on reducing overall growth in production levels. short term debt was necessitated. However, greater use of In a situation where repayment capa­ city was limited, the impact on growth over time may be more crucial than was noted here. 8. The appreciation of land values led to investment in land as soon as a modest-sized dairy herd was established. was only slightly reduced. Total consumption The appreciating land values not only placed emphasis on land ownership, but also were a source of funds for other purposes in later years. Land appreciation can be a very real motiva­ tion for investment in land at as early a point in time as possible for the credit advantages as well as long term gains and a hedge against inflation. When refinancing of loans on land was also allowed, it created only a small additional expansion. If a longer number of years were considered, the amount of principle retired would be much greater and its inpact would then be Increased. 9. Lowering milk prices from $5.50 to $5.15 and $4.80 per cwt. substantially altered the results of the expansion period. With normal down payment requirements and $55,000 beginning cash, the farm operation was unable to become established with milk at the $4.80 price level. With lower milk prices, limited repayment capacity brought about changes in farm organization and credit use. Lower milk prices led to a shift in land use from rented to owned land, and a diversification of production to include raising of c o m for grain. worth were substantially lowered. Income and net However, with milk prices of $5*15 per cwt., the farm operation was able to continue with few changes. Lower milk prices in conjunction with liberal down payment terms 122 reduced expansion in production levels and resulted In a shift toward land ownership. In year 1, the lower milk prices caused the farms to depend more heavily on long term debt. However, similar ratios of long term debt to total debt existed for all three price levels by the end of the 10-year period. on repayment capacity. The lower milk prices put a severe strain The high D/A ratios that existed, plus the limited repayment capacity represented a situation of high risk. The farm operation could probably continue with a drop in milk price to $5.15 per cwt., but if the original organization were suddenly faced with a $4.80 per cwt. milk price, it is questionable whether it could continue. 10. The model also provided an indication of the importance of adequately accounting for taxes and consumption in a study of this nature. The amount withdrawn for consunptlon alone was always greater than income available for reinvestment. Taxes were often equal to 1/2 of consunptlon. 8.3 Suggestions for Further Research Wriiie idie analysis presented in tills study examined nine separate variables that affect growth, only three of the variables were examined in detail: repayment periods, beginning equity, and down payment requirements. Additional analysis is needed on these variables, and on others not specifically examined in this study. In addition, fur­ ther analysis could consider alternative assumptions to those used in the study, and modifications of the model. Only three items were examined in conjunction with each other: repayment plans, beginning equity, and down payment requirements. All other items examined were for normal down payments and 15- and 30-year 123 amortization periods on loans, for buildings and land respectively. Further analysis could indicate the direction and magnitude of inter­ action between these different variables. For example, would land appreciation and lower down payments have offsetting effects on con­ sumption and reinforcing effects on debt when considered jointly, as did lower down payments and higher beginning equity? The substitution or complementary effects of these variables need to be examined further. Several variables that were examined only briefly or in a secondary manner merit further study. Only one rate of land appreciation was assumed and no allowance was made for appreciation in buildings and equipment. Neither was recognition made of potential increases in costs. Further increases in the cost of purchased inputs would seem to be a likely companion for appreciation of land values in the agricultural sector. Similarly, additional analysis could be done on goals of the operator. The importance of a particular strategy was shown to depend on the operator's desire to expand and willingness to assume debts as well as the primary goals of increasing consunptlon and net worth. Although not explicitly considered for analysis, consumption, taxes, and willingness to assume debts (or attitude toward risk) were seen to be important factors to an individual considering expansion. The large withdrawals for taxes and consumption emphasize their impor­ tance, but additional analysis is needed using alternative consumption functions. In addition, the large debt loads (compared to those nor­ mally found on Michigan dairy farms today) generate several additional questions. What are the attitudes of f a m operators to assuming debts of this magnitude? How about their willingness to assume the risk? What can farm lenders do to protect their interests on loans of this 124 magnitude? These questions indicate a need for additional research on both lenders and borrowers. Likewise, there are items that are highly relevant to the growth process which were not examined here. These include such items as semi-permanent or permanent debt, leasing of equipment, and tax advan­ tages that may accrue from other tenure forms such as incorporation. Tax withdrawals of $2000 to $4000 per year should be sufficient incen­ tive for operators to search for ways to reduce their tax load. Another major area of further research evolves from examination of the basic assumptions used in this analysis. What is the sensitivity of these results to alternative interest rates on loans? native yields and prices? Or to alter­ What would be the effects of varying the fixed corrmitments required in year 1? In addition, the form of the model used could be modified to take account of several items. The question of time horizon was mentioned. At the present time, no long term debt was completely amortized within the time horizon considered in the model. Would any of the conclusions be altered if the time span was lengthened? Another modification could be to limit expansion to the earlier years, then to consolidate the gains and pay off debts. This, of course, assumes a different set of goals for the farm operator. Would longer repayment periods appear more or less favorable under such circumstances? Variation in prices and yields, and the recognition of risk and uncertainty may require substantial modification of the model. The best way to evaluate the effects of such variation may be to modify the present multiperiod linear programming model and use it in com­ bination with a simulation model. The LP model could be altered to 125 have one period representative of the year In which investments are made, but with transfers accumulating debt payment and cash reserves for a period of years. Thus, a smaller multiperiod model could serve as the planning tool for year 1, while taking into account a longer time horizon. These year 1 actions would then be used in a simulation model to trace out the year by year effects for a variety of prices and yields until the next planning year was reached. New coefficients for expected prices and yields would then be inserted into the LP model, plus the updated resource levels and further investment plans deter­ mined. A series of runs with a simulator, in conjunction with the LP model, could give some indication of the riskiness of the various situations. There are other useful, yet rather simple modifications of the present model which could be made. These include the examination of other dairy technologies or other farm types. The model includes a large number of items crucial to the growth of the fim, and reflects the financial environment in which any farm must operate. But addi­ tional financial arrangements or alternative production technologies could be rather easily incorporated. Further research uses are depen­ dent on the ability of the interested researcher to modify the model and bring it to bear on relevant problems. BIBLIOGRAPHY BIBLIOGRAPHY [1] Brake, John R. Financing Farms - Now and In 1980, Research Report 46, Agricultural Experiment Station and Cooperative Extension Service, Michigan State University, East Lansing, March 1966. [2] Brake, John R. "Firm Growth Models Often Neglect Important Cash Withdrawals," American Journal of Agricultural Economics, Vol. 50, No. 3TPP." 769-772. [3] Brake, John R. "Inpact of Structural Changes on Capital and Credit Needs," Journal of Farm Economics, Vol. 48, No. 5, December 1966, pp. 1536-1545. [4] Brake, J. R. and M. C. Wirth. Trie Michigan Farm Credit Panel: A History of Capital Accumulation, Research Report 25, Michigan State University Agricultural Experiment Station, East Lansing, October 1964. [5] Brimmer, Andrew F. "Central Banking and Availability of Agri­ cultural Credit," American Journal of Agricultural Eco­ nomics, Vol. 50, No. 2, May 1968, pp. 357-365. [6] Brooker, G. L. and W. McD. Herr. "What the Investment Tax Credit Means to Agriculture," Agrl Finance, Vol. II, No. 4, July/August 1969, pp. 32-33. [7] Brown, L. H. and John Speicher. Telfarm Business Analysis Sunmary for Specialized Southern Dairy Fanns, 19p7, Agricultural Economics Report Uo. 103, Department""af Agricultural Economics, Michigan State University, East Lansing, September 1968. [8] Connor, Larry J. Costs and Returns for Major Cash Crops In Southern Michigan, Agricultural Economics Report No. 87, Department of Agricultural Economics, Michigan State University, East Lansing, November 1967. [9] Connor, Larry J., G. L. Benjamin, J. R. Brake, and W. F. Lee. Michigan Farm Management Handbook, Agricultural Economics Report No. 36, Department of Agricultural Economics, Michigan State University, East Lansing, October 1967. 126 127 [10] Currmtt, Jerry and Robert Ferber. Financial Stock Flow Rela­ tionships Among Central Illinois Fanners, Studies In Consumer Savings, No. 5, Bureau of Economic and Business Research, University of Illinois, Urbana, July 1965. [11] Davis, V. W. Economic Considerations in Choosing a C o m har­ vesting Method, Department of Agricultural Economics, ” University of Illinois and Farm Production Economics Division, ERS, USDA, AERR-63, March 1963. [12] Dorfman, Robert, Paul A. Samuelson, and Robert M. Solow. Linear Programming and Economic Analysis, McGraw-Hill Book' Company/ IncT, New York, 1956. [13] Eisgruber, L. M. Farm Operation Simulator and Farm Management Decision Exercise, Purdue Agricultural Experiment Station, Research Progress Report 162, February 1965* [14] Farm Credit Administration. Production Credit Association Borrowers and Their Loans, 196b, Bulletin CR-Io, Research and Information Division,' Washington, D. C., September 1968. [15] Farm Management Handbook, AE Ext. HUo, Department of Agricultural Economics, Cornell University, October 1966. [16] Hadley, G. Linear Programming, Addison-Wesley Publishing Company, Inc., Reading, Massachusetts, 1962. [17] Heldhues, Theodor. A Model of Farm Growth With a Comparative Dynamic Analysis of EEC Policy, Research on the Firm and Market, Research Paper 6508, Social Systems Research Institute, University of Wisconsin, November 1965. [18] Hoglund, C. R. Economics of Dairy Housing, Peed Storage and Manure Handling, Department of Agricultural Economics, Mimeo for Discussion at 10 Dairy Cattle Housing Short Courses, February and March 1967. [19] Hoglund, C. R. Economics of Growing Vs. Buying Feed for Dairy Herds of 40 to 2A0 Cows, AgrTculturalEconomics Report No. 83, Department of Agricultural Economics, Michigan State University, East Lansing, September 1967. [20] Hoglund, C. R., J. A. Speicher, and J. S. Boyd. Milking Efficiency, Investments, and Annual Costs for blfferent Milking Parlors, Agricultural Economics Report No. 85, Department of Agricultural Economics, Michigan State University, East Lansing, October 1967. [21] Irwin, George D. "A Comparative Review of Some Firm Growth Models," Agricultural Economics Research, Vol. 20, No. 3, July 1968, pp. 82-100. 128 [22] Johnson, Stanley P. MA Multi-Period Stochastic Model of Firm Growth," Unpublished Ph.D. Thesis, Texas A & M University, May 1966. [23] Maa?tin, J. Rod. "Polyperiod Analysis of Capital Accumulation and Growth Processes of Farm Finn, Rolling Plains of Oklahoma and Texas," Unpublished Ph.D. Thesis, Oklahoma State University, May 1966. [24] Michigan Department of Agriculture. MichiganAgricultural Sta­ tistics, Lansing, Michigan, July 1968. [25] Nelson, Aaron G. "Financing Representative Farms in 1975," Journal of Farm Economics, Vol. 42, No. 5, December i960, pp. 1380-1390. [26] Northeast Dairy Adjustment Study Comnittee. Agricultural Plan­ ning Data for the Northeastern United States, A. E. & R. S. 51, Pennsylvania State University, University Park, July 1966. [27] Patrick, George F. and Ludwig M. Eisgruber. "The Inpact of Managerial Ability and Capital, Structure on Growth of the Farm Firm," American Journal of AgriculturalEconomics, Vol. 50, No. 3, August 1968, pp. 491-506. [28] Penrose, Edith Tilton. The Theory of the Growth of the Firm, John Wiley and Sons, Inc. , 1959. [29] Plaxico, James S. "Dynamic Programming and Management Strategies in the Great Plains," Management Strategies in Great Plains Farming, Great Plains Council Publication No. 15, University of Nebraska College of Agriculture, Lincoln, August 1961. [30] Shapley, Allen V. "Alternatives in Dairy Farm Technology With Special Emphasis on Labor," Unpublished Ph.D. Thesis, Department of Agricultural Economics, Michigan State University, East Lansing, 1968. [31] Swanson, Earl R. "Programing Optimal Farm Plans," Farm Size and Output Research, Southern Cooperative Series Bulletin No. 56, Oklahoma Agricultural Experiment Station, Stillwater, June 1958, pp. 45-58. [32] Tostlebe, Alvin Samuel. Capital in Agriculture: Its Formation and Financing Since 1870, Princeton, Princeton University Press, 1957. [33] Vincent, Warren H. and Larry J. Connor. An Orientation for Future Farm Planning and Information Systems, Agricultural Economics Miscellaneous, 1968-5, Department of Agricultural Economics, Michigan State University, East Lansing, April 1968. APPENDICES APPENDIX A Procedure for Generating the Complete Matrix APPENDIX A PROCEDURE FOR GENERATING THE COMPLETE MATRIX A.l Constructing the Full 10-Year Matrix of the Basic Model Chapter IV presented the activities for year 1 of the basic model. Ihls appendix shows: (1) the combined activities for years 9 and 10, since these years contain some items not general to the entire matrix (Appendix Table A.l); and (2) describes how the year 1 activities can be used to generate the complete 10-year matrix. Appendix Table A.l illustrates the interdependence of the activ­ ities in the model, both within and between years. It also shows the coefficients for the 03ALEG and RGRAIN constraints which only apply to years 9 and 10. In constructing the overall matrix, the problem can be visualized in terms of the general model described on pp. 15-16. The C row, or objective function, for the basic model Is given under the CNC columns of Table 4.9, page 40. Table 4.8, page 38. c o e ffic ie n ts fox1 the The b vector, or RHS values, are given in Tables 4.1, 4.2, and 4.4 through 4.7 present the submatrix, i.e. all tne activities for year l. The procedure for constructing the full 10-year matrix Is, thus, to expand from the A^ submatrix to the complete A matrix. This expanded matrix must be adjusted for data given in the footnotes of these tables and in Appendix Table A.l. Since constant prices and yields were assumed over the entire period, coefficients in most of the activities remain the same, although the activities originate In different years. The year 1 activities can be classified in a way to simplify the matrix expansion (Appendix Table A.2). Eleven activities have coeffi­ cients which affect only the year in which the activity originates. 129 130 o o o o O ^ N h• 4I II 3 0< O O r* w Jfl -< N aan n f ~oid> O Ot 01 o o G a* O N N K B ia r< m u O U B > 4O * G I * * f>» H"l O I to O O ff 9> 0 oo B O IW « d ft»o « VO W) n a) n a) ■« « » &> 0t 01 M O r~.« •f Cs 0 ' HJ r| -G -a ay 3d «r u r- v: p y s k « in >• < ■< IJ I vi « >» a ,< r* ti *,> vi ' l | t / , O. i / (3 U 2 14 M < SsS3§N5-!lSeSF!g»gSS -j ^ x k x P? > 4 -Jif< l-iI 1• J J.v 4Vr*<^ f-* w a v* 6-:tja‘i>s ' s ? s £ 5 £ * k s ? s 5k a ? . fee- ’■ ■ ; ^ ;;.- ? c. •►*s s 5a 5 s 5*< ■* I U k y n >: ;t £££ p. o *J ? % ■ * ” '*-4'>£ z S fcS R - n “ ^ °5fi3fc“i’,:,,i!u ';‘"4"i»:3 S ^ S K 1-*""3 “ 5 5 f, R r*> nV 1 • »• »w o £ 4 «0 W f* 9> 1 L» 9 O *- o' j U> LhinV LA tt » 1 E if X CDw * 9 -J \o »J 0> CB • DMOAX K) IAO 9 OX » ip^ *•» LA LJ tA MM U LA fc* LA o o *- r- £5 • 4 4 OB — A- • (4 S? S » eooc> n r O j- ■r* #- 9 e> tit; 4 4 M O »> 1> 4 - LA *9 LA MN 9 a N M rs: TCI 132 Appendix Table A. 2 Designation of activities by years included in the model and by presence or absence of year to year linkage 1/ Activity coefficients affect: Activities occur in: One year only Two or more years Years 1 through 10 iDYPD 1TA3 iGRPD 1BMIT iLANR 1TA4 iSGRAN ICS iULAB iREDTX iBGRAN IT tiC A S iTAl iSAVE iBMST 1TA2 iFCOST Years 1 through 9 only --- ilTNVC Years 1, 5, 8, and 9 only --- iBMEC iBUYG Years 1, 5, and 9 only 1BDFC 1BCR15 iLANC 1HCR30 --- Years 5 and 9 only iMTLKP 1/ Year to year linkage refers to the effects that activities begun in one year* have on later years’ resources and costs. For examy i+1. J _ X I V C - O I A U I O _* U 1 * __________ y CTCLt -» X . OUl'U ----- ^3. . -.4- J ---- pi'UUU^(/lUli J — — - — -1-1 4 - I D ^I'CTVXX 3 ~ lUi' u o c XI i y x zc u . 133 The other fourteen activities have coefficients which affect both that year and one or more succeeding years. This table also gives the years In which each of the activities must be present In the model. To expand the A^ submatrix to the full matrix, each activity can be generated for the relevant years as shown In Appendix Table A.2. For example, 1DYPD is shown to occur in year 1 through 10, and all coefficients apply within the year the activity begins. Thus, 2DYPD necessitates all coefficients shown in Table 4.1 to be generated for year 2, i.e. 1LAND, 1DYPD = .97 becomes 2LAND, 2DYPD = .97 for year 2. In general, for r years after year 1, r = 0, 1, . . . , 9, the coeffi­ cients are labeled: (1+r) row name, (1+r) column name = coefficient value. Thus, in year 1, r = 0 and the labels are as they appear in Table 4.1. etc. For year 2, r = 1 and the labels become 2LAND, 2DYPD = .97, Since the 1DUYG activity occurs only in years 1, 5, and 9, the only relevant values for r are 0, 4, and 8, but the same procedure applies. For activities which have coefficients in both current and succeed­ ing year constraint rows, the procedure must be modified slightly. The year designation of the constraint row for the activity can be labeled s = 1, 2, . . . ,0. Then the general rule for each year in which the activity is needed becomes: (s+r) row name, (1+r) column name = coefficient value. Thus, for year 4, r = 3, and grain production coefficients of the 4GRPD activity are: 4GRAIN, 4GRFD = -13.75 5GRAIN, 4GRPD - -68.75 For any activity, succeeding years have the same number, or fewer 134 coefficients, since no consideration is given beyond year 10. Any activities which have entries in constraint rows RCNS, RTAXY, RATAXY, and RTAXES will include these constraints each year the activity occurs. The iPCOST activities require reference to the footnote of Table 4.7 to account for changes in net worth. The OSALEG and RGRAIN con­ straint requires 1 or more additional cards for 9GRPD, OGRPD, ODYPD, OSGRAN, and OBGRAN as shown in Appendix Table 1.1. A.2 Modifying the Basic Model The basic model uses the CNC objective function, with down pay­ ments of 25 percent on chattel items and 40 percent on real estate, and with 15 years repayment on building loans and 30 years repayment on land loans. To utilize the other objective functions (CN or CC) it is merely necessary to use the coefficients from Table 4.9 for the CM or CC objective functions. To allow for alternative Dayment plans for long term debt, the data shown in Appendix Table A.3 must be used. Additional activities must be generated for years 5 and 9, using the same principles as «ilsn.iiRRipH in .Section A :1 = In running the program, only the desired activities must be included in the matrix. To adjust the model for the lower down payments, the coefficients shown in Appendix Table A.4, along with the appropriate coefficients for succeeding year activities, must be generated. These cards are then substituted in the matrix for the identically labeled coefficients reflecting normal down payments. To avoid mistakes, two separate decks were used for normal and liberal down payments when running the pro­ gram. To adjust the basic model for land appreciation with normal down 135 Appendix Table A.3 Borrowing activities for year 1 with 10-, 20-, and 40-year repayment periods and deferred payment for 4 years with 10- and 25-year repayment periods Activity name Row name 1BCR10 1RCR20 1RCR40 - CNC 1/ CN 17 -1. 1. .0537 -.0537 -.0887 -.0537 .6786 -.6786 .1424 .0475 -.0475 -.0949 ■. .2704 .2704 .4211 .4211 dollar - .4354 .4354 -1. 1. 1. -1. .0944 .07 -.07 -.0244 -.07 .9756 -.9756 .0944 .0683 -.0683 -.0261 -.0683 .9495 -.9495 .0944 .0655 -.0655 -.0279 -.0655 .9216 -.9216 .0944 1. 1. -1. .0750 .07 -.07 -.005 -.07 .9950 -.9950 .0750 .0697 -.0697 -.0053 -.0697 .9896 -.9896 .0750 .0693 -.0693 -.0057 -.0693 .9839 -.9839 .0750 1. .0645 -.0645 -.0299 -.0645 .8917 -.8917 .0944 .0624 -.0624 -.0320 1. .0689 -.0689 -.0061 -.0689 .9778 -.9778 .0750 .0684 -.0684 -.0066 -1. 1. -1. 1. -1. .07 .07 -.07 1. 1. -1. .07 .07 -.07 -.07 1. -1. .07 .07 -.07 -.07 1. -1. .07 .07 -.07 -.07 1. -1. .07 •u/ -.07 1. -1. .07 .07 -.07 t-0• 1 1. -1. .1424 .07 -.07 -.0724 -.07 .9276 -.9276 .1424 .0649 -.0649 -.0775 -.0649 .8502 -.8502 .1424 .0595 -.0595 -.0829 -.0595 .7673 -.7673 .1424 .7332 .3279 .3279 1DPA25 0• 1 1CASH 1BDCR 1RECR 1NETWR 1DEBT 2CASH 2TAXY 2NCASH 2PRINP 2INTP 2NETWR 2DEDT 3CASH 3TAXY 3NCASII 3PRINP 3INTP 3NETV/R 3DEBT 4CASH Itrti*tnf 41AAX 4NCASH 4PRINP 4INTP 4NETWR 4DEBT 5CASH 5BDCR 5RECR 5TAXY 5NCASH 5PRINP 5IMTP 51'JETWR 5DEET 6CASH 6TAXY 6NCASH 6PRINP .0616 .0616 1DPA10 1. -1. .07 .7332 -.07 i. -1. .07 .07 -.07 1. .07 -.07 -.07 1. -1. .1424 .07 -.07 -.0724 -.07 1. -1. .0858 .07 -.07 -.0158 136 Appendix Table A .3 (cont'd .) Activity name Row name 1BCR10 1RCR20 1RCR40 1DPA10 1DPA25 -.07 .9276 -.9276 .1424 .0649 -.0649 -.0775 -.0649 .8502 -.8502 .1424 .0595 -.0595 -.0829 -.0595 .7673 -.7673 .1424 .4664 -.07 .9842 -.9842 .0858 .0689 -.0689 -.0169 -.0689 .9673 -.9673 .0858 .0677 -.0677 -.0181 -.0677 .9492 -.9492 .0858 - dollar -6INTP 6NETWR 6DEBT 7CASH 7TAXY 7NCASH 7PRINP 7INTP 7NETWR 7DEBT 8CASH 8TAXY 8NCASH 8PRINP 8INTP 8NETV/R 8DEHT 9CASH 9BDCR 9RECR 9TAXY 9NCASH 9PRINP 9INTP 9NEJrWR yiJEBT OCASH OTAXY ONCASH OPRINP OINTP ONETWR ODEBT -.0475 .5838 -.5838 .1424 .0409 -.0409 -.1015 -.0409 .4822 -.4822 .1424 .0338 -.0338 -.1086 -.0338 .3736 -.3736 .1424 .4664 .0262 -.0262 -.1162 -.0262 .2574 -.25/4 .1424 .0180 -.0180 -.1244 -.0180 .1330 -.1330 -.0624 .8597 -.8597 .0944 .0602 -.0602 -.0342 -.0602 .8255 -.8255 .0944 .0578 -.0578 -.0366 -.0578 ,7889 -.7889 .0944 -.0684 .9712 -.9712 .0750 .0680 -.0680 -.0070 -.0680 .9642 -.9642 .0750 .0675 -.0675 -.0075 -.0675 .9566 -.9566 .0750 1. .0552 -.0552 -.0392 -.0552 .7498 -.74y8 .0944 .0525 -.0525 -.0419 -.0525 .7079 -.7079 1. .0670 -.0670 -.0080 -.0670 .9486 -.y466 .0750 .0664 -.0664 -.0086 -.0664 .9400 -.9400 .0537 -.0537 -.0887 -.0537 .6786 -.6786 .1424 .0475 -.0475 -.0949 -.0475 .5838 -.5838 1. .0664 -.0664 -.0194 -.0664 .9298 -.9298 .0858 .0651 -.0651 -.0207 -.0651 .9091 -.9091 1/ Objective function values for both CNC and CN for years 5 and 9 are: 5BCR10 = .2704, 9BCR10 = .4297, 5RCR20 = .3982, 9RCR20 = .4519, 5RCR40 = .4499, 9RCR40 = .4609, 5DPA10 = .4297, 5DPA25 = .4559. 137 Appendix "Cable A.4 Row name 1BDFC Dollar Dollar Dollar Dollar Dollar Dollar Dollar Dollar Dollar Dollar Dollar Dollar Dollar Dollar Dollar Dollar -405. -63. 80. -719.6 1LANC 12,600 13,440 1 -45.18 -36.70 -32.22 -25.74 RHS • 1BMEC o 1DYPD CO Unit OJ 1STCR 1BDCR 1RECR 2STCR 3STCR 4STCR 5STCR 5BDCR 5RECR 6STCR 7STCR 8STCR 9STCR 9BDCR 9RECR OSTCR Coefficients for year 1 activities of the model to reflect minimum equity of 10 percent on chattel mortgages and 20 percent on real estate mortgages 12,600 12,600 12,600 12,600 9,856 80. 54. -527.6 -280. 12,600 12,600 12,600 12,600 6,272 -19.26 -12.78 -335.6 -280. 12,600 payment requirements, required substitution of the items shown in Appendix Table A.5* Of course, additional coefficients for the 5LANC and 9LANC activities must again be generated using the procedure desa l-i <9 4 O «4* J '■i 1 Modification of the basic model for low milk prices are discussed on page 46. This requires changing the iTAXY, 1DYPD =-607.84 coeffi­ cient for each of the 10 years to reflect the lower price of milk. 138 Appendix Table A.5 Modification of the 1LANC activity to reflect a 5 percent annual appreciation of land values 1 / 1LANC How name No appreciation ------------ With appreciation dollar----------- --- CNC CN -162.10 -162.10 -264.07 -264.07 1CASH 1RECR 1NETWR 2NETWR 3NETWR 4NETWR 5RECR 5NBIWR 6NE1WR 7NETWR 8NE1WR 9RECR 9NETWR ONEIWR 350.00 -210.00 -350.00 -350.00 -350.00 -350.00 -210.00 -350.00 -350.00 -350.00 -350.00 -210.00 -350.00 -350.00 350.00 -210.00 -367.50 -385.88 -405.17 -425.43 -255.26 -446.70 -469.04 -492.49 -517.11 -310.27 -542.96 -570.10 CN and CNC values are identical for 5LANC and 9LANC. Subsequent land purchases would cost $*125.43 per acre with 5LANC, and $517.11 per acre with 9LANC.The subsequent Increases on real estate taxes are not felt tobe significant enough to merit changing in the activities. 1/ *r._ Xii ___ ______-j c l o e ^ u u u . ___ -T*.*__________ ±. .t luai/iuii ■* 4- j ~ xi/ i d ~ i ~ ---- — culovj cu70uii«?u ~ j 4-i- « 4- i/i i d o 4-1-- i/lie — r ~ n 141 Appendix Table B.3 Dairy production activity— 13,000# average produc­ tion, mechanical feeding, herringbone parlor, coin silage, haylage, and grain ration, tower silos and liquid manure system 1/ Labor requirements Milking Feeding Manure handling Miscellaneous 16.9 3 •0 8.5 3.1 "31.5 hours Income Milk Sale Sale Sale sales (13,000# 8 $5.50/cwt.) of calves 1/20 § 30 of cull cow 1/4 8 160 of 2-yr. old cull3/40 % 160 Taxable After-tax $715.00 16.50 20.00 6.00 $?57.50 -20.00 6.00 $200 Expense General (bedding, breeding, vet., etc.) Feed handling Manure handling SBOM (500# 8 5.20/cwt.) 47.85 5.50 5.00 26.00 $ Net income 1/ Based on data in Shapley [30]. $673.15 -- -$26.00 142 Appendix Table B.4 Investment credit allowable on purchases of investment Items Value of treatment 1BMEC activity $ Estimated life Value of Investment credit 2/ qualified investment 1/ 70.00 7 years 30.00 345.45 15 years 15 years 30.00 345.45 2.10 24.18 39.17 15 years 39.17 2.74 $ 46.67 $ 3.27 1BDFC activity Free stall equipment Silos and unloaders Agitator, pump and liquid manure wagon 29.02 1BDFC Total iFCOST activities Milking parlor stalls and equipment 11,400.00 15 years 11,400.00 798.00 Initial machinery purchase 14,000.00 7 years 9,333.00 653.31 2,000.00 7 years 1,333.00 93.31 Annual machinery replacement 1/ One hundred percent of the value of items with an expected life of 8 years or more qualify for investment credit. Only 66 2/3 percent of the value qualify for items whose expected life is at least 6 but less than 8 years. 2/ Investment credit is 7 percent of the value of qualified investment. 143 Appendix Table B.5 Buy dairy facilities, excluding milking parlor, for 1BDFC activity Item Per 88 cows Free stall milking facility 1/ $22,970.00 Young stock and dry cow bams 16,340.00 Silos and unloaders 30,400.00 Liquid manure system for cows 2 / Total investment Per cow 9,446.00 $79,156.00 $899.50 1/ Includes free stall bam, feed bunk and feeding equipment, maternity stalls and calf pens. Published figure was reduced by $11,700.00 for value of milking parlor which was included in a separate activity. 2/ Published figure was reduced by $4,854.00 for value of tractor, scraper, loader, and manure spreader which is included in the machinery investment. Source: Boglund [18] and Hoglund, et al. [20]. 144 Appendix Table B.6 Estimated numbers of annua], cattle purchases, sales, births, and deaths to Initiate and maintain a 40-cow milking herd fear Bought Culled 1 2 3 4 5 6 7 8 9 10 40 5 10 5 10 10 10 10 10 10 10 10 10 — — --- ----- Raised Replacements ----- 10 10 10 10 10 10 10 Bom Died 1/ Sold 40 40 40 40 40 40 40 40 40 40 4 5 5 5 5 5 5 5 5 5 22 22 22 22 22 22 22 22 22 22 2-year Olds Sold _ _ _ 1 3 3 3 3 3 3 3 On a per cow basis, this means that purchased cows bought (B) and sold (S) would be as follows for each year: _________ Purchased Cattle Bought In Year________ 1 Purchased Cattle Sold In Year 1 2 3 4 5 6 2 IB, 1/3S 1/4S 1/4S 1/4S 1/8S 3 4 5 6 1/8B 1/4B 1/8S 1/4S Raised animals are available for replacement stock from year 4 onward. All purchased animals are assumed sold from the herd by the end of the year 6. Thus, cash expense for purchased cows in the 1BDFC activity is: year 1, $350.00 for 1 cow; year 2, $43.75 for 1/8 cow; and year 3, $87.50 for 1/4 cow. 1/ In year 2 and later It was assumed 4 calves died at birth and one heifer died at 6 to 19 months of age. 145 Appendix Table B.7 Jan. 1 of year Adjustments to short term credit when dairy cows are purchased 1/ Assumed animals in herd Cow/Yearling/2-year old 1 X — 2 1 ------ 3 1 1 4 on 1 1 Credit gene­ rated Credit shown Adjust­ in iSTCR row ment to in IDYPD ISTCR $262.50 $337.50 $75.00 ------ $262.50 $337.50 $75.00 — $292.50 $337.50 $45.00 $337.50 $337.50 1 ------ V Since the iDYPD activity assumes an ongoing dairy enterprise, it generates short term credit for a cow and replacements equal to $337.50. But when cows are purchased, raised replacement stock is not available until years 3 and 4. Therefore, the iSTCR constraint of the 1BDFC activity is adjusted to allow for this difference. It is assumed that up to 75 percent of the price of livestock can be borrowed against. 146 Appendix Table B.8 Depreciation costs on purchased cows 1/ Year Number of purchased cows held for: All year 6 months 9 months Depreciation Per cow 1 7/8 1/8 --- $48.42 2 3/4 --- 1/4 43.75 3 3/4 --- 1/4 43.75 4 1/2 --- 1/4 31.25 5 1/4 --- 1/4 18.75 6 --- --- 1/4 6.25 7 on --- — — --- --- 1/ All purchased dairy animals must be depreciated when filing on the cash basis of accounting for income tax purposes. Purchase price is $350.00 per cow. Assuming a $150.00 salvage value and a 4-year life, this gives annual depreciation of $50.00 per year— $37.50 for 9 months, and $25.00 for 6 months. It is assumed cull cows are in the herd an average of 6 months during the year in which they are culled, except for the year of purchase in which it is assumed they are kept for 9 months. 147 Appendix Table B.9 Adjustments to the 1TAXY row In the 1BDFC activity for capital gain or loss, depreciation, and sale or livestock when dairy cows are purchased iTAXY row of 1BDFC activity Year 1 Year 2 Year 3 Year 4 Year 5 Ye ar F Taxable income given in IDYPD activity 1/ (1) 1/4 cull cow sold @ $160 2/ (2) 11/20 calf sold g $30 (3) 3/40 of 2-year old sold g $160 2/ Taxable income when cows are purchased (5) Sale of 1/8 cull cow g $160 (6) Depreciation on this cow @ $50 per year (7) Purchase price & $350 (8) Capital loss on this sale 3/ C(5)+(6)-(7)] (9) Depreciation on cows 3/ (10) Sale of calves (11) Sale of other stock (12) Total return (8)-(9)+(10)+(ll) (13) *nAdjustment needed in -t• a ^ tm »i 20.00 20.00 20.00 20.00 20.00 20.00 16.50 16.50 16.50 16.50 16.50 16.50 6.00 42.50 6.00 42.50 6.00 6.00 42-.-50' W S & S 6.00 42.50 6.00 42.5(7 20.00 40.00 40.00 40.00 40.00 40.00 4.69 43.75 18.75 87.50 31.25 87.50 43.75 87.50 46.87 87.50 43.57 87.50 -19.06 -28.75 -16.25 48.42 43.75 43.75 16.50 16.50 16.50 ----2.00 -3.75 31.25 16.50 6.00 -0.63 18.75 16.50 6.00 -3.75 6.25 16.50 6.00 -50.98 -56.00 -41.50 -12.50 3.12 12.50 39.38 30.00 J.XHAX I\JW Ol inurvy activity [(4)-(12) = (13)] 4/ 93.48 98.50 84.00 55.00 1/ Milk sales are not shown as they are assumed to be the same with either raised or purchased cows. 2/ These are capital gains items, therefore, only 50 percent of the sale value enters the taxable Income row. 3/ fIhe capital loss and depreciation on cows are book expense items which are then added back to the iNCASH rows for each of these, years. 4/ These amounts represent decreases in the taxable income row for the year in which dairy facilities are expanded and the succeeding five years, due to the purchase of dairy cows. 148 Appendix Table B.10 Adjustments to the 1ATAXY row in the 1BDFC activ­ ity for capital gain or loss, depreciation, and nontaxable Income when dairy cows are purchased iATAXY row of 1BDFC activity Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 After tax income shown in IDYPD activity (1) 1/4 cull cow sold 6 $160.00 1/ (2) 3/40 of 2-year old % $160.00 1/ (3) Total in IDYPD After tax income when cows are purchased (4) 3/40 of 2-year old $160.00 i/ e (5) Adjustment needed in iATAXY row of 1BDFC activity C(3)-(4)] 20.00 20.00 20.00 20.00 20.00 20.00 6.00 6.00 6.00 6.00 6.00 6.00 26.00 26.00 26.00 26.00 26.00 26.00 2.00 6.00 6.00 6.00 24.00 20.00 20.00 20.00 — _ 26.00 26.00 1/ These are capital gains items of which one-half was reported as taxable income; the other one-half enters directly in after-tax income. 149 Appendix Table B.ll Adjustments to iNETWR of dairy animals for pur­ chased cows In 1BDPC activities 0 (1) iNEIWR shown in iDYPD activity 450.00 Amount in iNETWR when cows are purchased (2) Value of cow 350.00 (3) Depreciation on pur­ chased portion 48.42 (4) Value of replace­ 14.00 ment stock (5) iNETWR of dairy animals when cows are purchased 315.58 [(2)-(3)+(4)] (6) Correction of iNETWR for dairy animals in iBDFC 134.42 activity [(!)-(5)] Number of years after purchase 1/ 4 2 1 3 5 450.00 450.00 450.00 450.00 450.00 350.00 350.00 350.00 350.00 350.00 37.50 81.25 68.75 37.50 46.50 100.00 100.00 100.00 100.00 359.00 368.75 381.25 412.50 450.00 91.00 81.25 68.75 37.50 --- 1/ For example, cows purchased during year 1 with 1BDFC activity will have the INETWR row reduced by $134.42; the 2NETWR row by $91.00; etc., to account for the effect of purchasing additional cows. 150 Appendix Table B.12 Item Unit Cash expense In 1BDFC activity for additional roughage needed for the first five months when dairy cows are purchased Roughage needed first five months Price Total cost C o m silage Ton 4.8325 $8.00 $38.66 Haylage Ton 3.25 12.50 40.62 Oat silage Ton 1.4175 8.00 11.34 Hay Ton .4175 25.00 10.44 Urea Lbs. 48.325 .055 2.66 $103.72 Source: Hoglund [19], and mimeographed handout of background material. 151 Appendix Table B.13 Investment cost of double-4 herringbone milking parlor and equipment, milkhouse, milkhouse equip­ ment, and bulk tank Investment cost Building Stalls and feeders Milking system Heat, hot water, and other equipment Sub-total Bulk tank, 800-850 gallon 2/ Total 1/ Hoglund, et al. [20]. 2/ Farm Management Handbook [15]. $5,400.00 1,600.00 3,200.00 1,500.00 $11,700.00 5,100.00 $16,800.00 MICROFILMED - 1970