The Bottom Line: Pay Now or Face the Consequences

September 26, 2015 02:02 AM
The Bottom Line: Pay Now or Face the Consequences

This summer, I did a feasibility analysis for a client on installing additional drain tile, drainage water management structures and a subirrigation system. I thought it would be useful to share my analysis because I was pleasantly surprised by the value of such drainage practices—in real dollars and sustainability.

We used the following assumptions for the analysis:

  • The discount rate or the farm’s cost of capital is 10%.
  • The planning horizon is 20 years. 
  • The investment for drainage (tile spacing 30' to 40'), drainage water management structures, automation and water source is $4,100 per acre. 
  • At Rate 2, USDA financial assistance through the Natural Resource Conservation Service pays 75% or $1,310 per acre. Most systems qualify for Rate 1, a 90% payment of $1,571 per acre.
  • The net investment is $279,000 for 100 acres or $2,790 per acre.
  • Financial analysis assumes a 20-year period with a 10-year loan.
  • The loan amount is 72% of the $279,000 or $200,000 amortized over 10 years with equal payments of $24,658 per year.
  • Utilities cost $5 per acre, per year.
  • The estimated salvage value of the system is 100% of the original cost. 
  • The full amount of the net project cost is depreciated.
  • The tax rate on the earnings from the project are taxed at a 40% rate.
  • We projected a 50% increase in yields for corn and soybeans based on a 50/50 rotation. Data obtained from previous projects shows this is a realistic increase and even on the conservative side.
  • The field already had some drainage installed.
  • The Actual Production History (APH) is 165 bu. per acre for corn and 55 bu. per acre for soybeans.
  • Average corn and soybean prices for the next two decades are $5 and $12, respectively.

The drainage project’s Net Present Value (NPV) is $251,952, which means it will pay for itself and 
increase wealth by that amount in today’s dollars.
A positive NPV indicates the project is feasible.

The project covers all costs and will return $30,797 to $43,200 in cash each year. The Internal Rate of Return (IRR) is projected to be 41.38%. An IRR greater than 20% is desirable.

The Modified Internal Rate of Return (MIRR) is 18.17%. The difference between the IRR and MIRR is the IRR assumes you take the cash generated from the project, which is $32,902 the first year, and invest it each year in a similar project. The MIRR assumes that cash is reinvested at the farm’s cost of capital, which in this case is 10%.

Most likely, if the project is as profitable as projected, an informed buyer would pay for the $279,000 cost of the project plus the NPV, making the farm more valuable. Assuming this is a $7,500 per acre farm, the value to the buyer could be $12,800 ($7,500 $2,790 DWM investment $2,519 per acre NPV value.)

There are other significant benefits to a drainage project. A 70% to 80% reduction in nitrate and phosphorus loss adds up to real money and enhances the farm’s sustainability. In addition, implementing these practices might make a farmer less vulnerable to Environmental Protection Agency regulations and eliminate potential litigation, as in the case between the City of Des Moines and three Iowa counties (see “Highest Stakes in Iowa Nitrate Battle”).

My concern is regulators could implement punitive actions, such as losing crop insurance or federal crop program payments if nutrients are not managed. The bottom line is farmers should voluntarily do their part to 
reduce potential nitrate and phosphorus loss in drainage waste.

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