Capital Investment and Operational Costs

1. Capital Investment and Operational Costs

2. Introductory Comments • Cost = anything that reduces your business objective • Benefit = anything that contributes to it • Two types of costs: investment (capital costs) and operational (on-going)

3. General Assumptions • If you wish to assess the future success of your project, you must make several assumptions. • Assumptions will allow calculations to be completed and conclusions to be drawn. • Do you have access to unlimited capital (funding)? Will there be taxes to consider. • Others: market prices, dimensions/operational parameters, cost/amount of material, construction labor, utilities, etc. • Market prices are the most influential!

4. Doc K’s Assumptions… • I’ll be building a large flounder fingerling production farm. (Flounder Effect) • I don’t have land. • Semi-intensive technology • I need bank loan! • I don’t have the company formed yet!

5. Investments (Costs) • Preliminary (meetings, legal, land) • Construction (excavation, structures, buildings) • Equipment (vehicles, lab, etc.)

6. Preliminary Investments INVESTMENT COST (US$) PLANNING 30,000 LEGAL FEES 16,000 PREFEASIBILITY 30,000 BUSINESS PLAN, FEASIBILITY 50,000 DRAWINGS AND MAPS 20,000 LAND REGISTRATION 18,000 LAND PURCHASE (420 ha, 170 a)* 420,000 TOTAL PRELIMINARY COSTS 584,000 * REMEMBER, ALTHOUGH OUR FARM HAS 300 HA, 120 a OF PONDS, MORE LAND IS NEEDED

7. Spreadsheet 1- Preliminary Activities

8. Construction Costs • Earth movement ($1.00 - $2.00/cubic m) • Pumping station (a lot of concrete) • Water control structures (inflow/harvest gates) • Ancillary buildings (office, housing, kitchen, cafeteria/break room, ice plant, etc.) • Costs highly reflective of local conditions and is usually one of the highest costs…

9. Earthmoving Costs • Use of heavy machinery to clear, shape land • Along with land = largest single costs you will face (30-50%) • Typically calculated as 15% of total pond area as volume • Thus, 300 ha = 3 million sqm, 3 million x .15 = 450,000 cubic meters • @ $1.50 per cubic meter = $675,000

10. Pumps/Pumping Station • Also a major expense… • Number of pumps, size of the installation is determined by stocking density • 15% daily max exchange for a semi-intensive 300 ha farm with 1.25 m deep ponds, pumping 16 hours per day is 186,000 gpm • If each pump has a capacity of 40,000 gpm, we need at least five (one extra for redundancy, 6 x $60,000 = $360,000) • The pumping station must support this weight and therefore is almost solid concrete ($200,000)

11. Water Control Structures • Gates/wiers are used to distribute/control water flow to farm • Concrete construction & large (sediment pond gates), inflow type (filtering) and harvest type (effluent, harvesting) • Most ponds have two inflow gates ($1,000 ea) and one harvest gate ($2,000 ea) • Our farm will have 30, ten ha ponds: 2 sediment ponds gates ($5,000 ea, total of $10,000), 60 inflow gates (total of $60,000) and 30 harvest gates (total of $60,000) • Total construction investment for water control structures: $130,000

12. Ancillary Facilities • Ice plant (20 tons per day, used $70,000) • Freshwater well (150 gpm, $20,000) • Feed storage building ($15,000) • Fry acclimation center ($30,000) • Equipment storage ($15,000) • Mechanics shop ($10,000) • Office/Lab ($10,000) • Housing ($25,000) • Kitchen/cafeteria ($10,000) • Guard houses ($5,000) TOTAL = $210,000

13. Spreadsheet 1: preliminary, construction investment NOTE: THIS SPREADSHEET IS BEING BUILT AS I GO!

14. Equipment Investment TOTAL = $317,000 Plus contingencies = $348,700 huh???

15. Spreadsheet 1: preliminary, construction, equipment investment

16. Contingency Costs? • These are increases in line item costs based upon the probability that something could (will) go wrong! • Can’t predict future! Even in a budget. • Especially true for developing countries, areas where inflationary rates are high or material availability is variable (REM: Generator story??) • +10% investment = contingency costs • This increases our total investment costs to over $2,723,600 (nice, eh?)

17. (2) Operational Costs • Operational costs: day to day costs of production • Outlay of funds for inputs, services used in production • for short-run financial analyses, total costs include fixed and variable costs • fixed cost: one that does not change during production period (how can this differ?) • examples: land taxes, principal and interest on loans, insurance premiums, sometimes salaries, permitting, etc. • variable cost: one that does change (e.g., feed, fry, supplies, etc.)

18. (2) Operational Costs • Major cost components for our flounder facility include: • fry (local or imported) • salaries, benefits (fringe), employee costs • fuel (pumps, vehicles, generators) • fertilizer, pesticides, lime (other treatments) • consulting expenses (around $300/day) • vehicle expenses (maintenance) • electricity (if generated, then consider fuel) • maintenance (3% of total, spread-out monthly) • contingencies (10%, same as investments) • depreciation (variable, straight-line) • consulting fees (set as a contract)

19. Typical Operational Costs

20. (2) Operational Costs, Year 1 • Production, sales and administrative costs encountered at start-up • Shown in detail to help understand timing of funds released by bank • Shows transitions that typically occur in start-up • Some loan institutions also want to see Year 2 in detail

21. Spreadsheet 2: Operational Costs, Year 1

22. 3) Proforma Statement of Costs • Shows costs over 5 yr financial horizon 1) production costs 2) cost associated with selling product) 3) general and administrative costs not associated with production) • All have employee “benefits” and “costs” • benefits: social security, health, “13th month wage” • costs: lunch?, transportation, parties, awards

23. Spreadsheet 3: Proforma Statement of Costs

24. (4) Proforma Statement of Operations • Goal: determines your net income • Includes: 1) sales revenue; 2) cost of sales; 3) gross profit; 4) other costs/expenses; and 5) tax liability • gross profit taxes not included • net income before taxes (net present value, NPV) is what many bankers look at • Also must consider interest payments on credit! (Tony want’s his money too!) • Tax: income “tax” or “credit”, 12% • You wind up with net incomeafter taxes

25. Spreadsheet 4: Pro Forma Statement of Operations

26. (5) Proforma Statement of Cash Flow • A statement of the cash available to the company at various points in time • Used as a planning tool, different from profit • Important when considering expansion or diversification into new markets (ie., can you meet payroll and expand) • Helps to determine if you might need a loan, or you can pay for the expansion with internal funds

27. (5) Proforma Statement of Cash Flow • Three “cash flow” categories based on where money comes from: 1) Operations 2) Investments 3) Financing • Cash flow from operations is your net income. REM:previous spread • Depreciation is here considered a gain (like a tax write-off) • From net gain from operations, you subtract other cash flows (investments, payments on loans) • You add, as positive to Year 1, your loan principle • $1 million “cash at beginning of period” is what I brought to the table

28. Spreadsheet 5: ProForma Statement of Cash Flow

29. Sensitivity Analysis 5-yr Break Break Income Cash Even Even Criterion before taxes Flow IRR NPV Prod. Sales Baseline $21.4 M $18 M 141% $31 M 1.3 M $3.9 M $1 Price Drop $8.2 M $6.4 M 74% $11 M 1.9 M  same 10%  Surv. $13.5 M $11 M 105% $19 M 1.3 M same Feed  10c/lb $19 M $16 M 131% $27 M 1.5 M $4.5 M Price  Feed  $5.8 M $4.3 M 54% $7.2 M 2.2 M same

30. Financial Indicators Start-up Indicators (IRR, NPV, break- even) On-going Indicators (cash flow, income, balance sheets)

31. IRR • IRR = internal rate of return (or financial rate of return) • How much is the money you have invested in the project earning? • Projects that are accepted always have an equal to- or greater return than the opportunity cost of capital • If you can earn more by depositing your money in the bank, do it!

32. IRR (continued) • When developed from a series of cash flows, at least one value must be negative • Although IRR values vary from project to project, they are hard to use as a ranking tool • A project with a 25% rate of return is likely to be a better investment than one with 15%, but you are really estimating

33. NPV (NPW) • NPV = net present value (often, net present worth) • not a percentage, but a number • the present worth of benefits of a project less the present worth of costs • calculates the present value of an investment by using a discount rate and a series of future payments and income • discount rate can be the rate of inflation or the interest rate of a competing investment • in other words you are comparing the value of your project over a given time period to investment in another venture (opportunity) • IRR is the rate for which NPV equals zero

34. Start-up: Break-even Analysis • Break-even analysis is used to compare two different cost patterns and determine the point at which they are equivalent • usually compares points at which sales revenues equal production costs • this is then related to a production level (e.g., farm production in lbs/yr) or a sales price ($/lb) • any value above break-even normally represents increased profit