Table of Contents

2. Table of Contents • Introduction / Overview • Financial Health • Problem Statement • Discount Rate • After Tax Cash Flows • Recommendations & Summary

3. Introduction • Patrick Vincent • Kelly Grandt • Larry Jacques

4. Farm Overview • The Farm: • A large cattle producer in the state of Michigan • Raise Cattle, Hogs, Corn, Soybeans, and Winter Wheat. • Average 1,200 head

5. Farm Expansion Overview • The Investment: • Building a large solid floor confinement facility with capacity for 1,000 yearlings • Purchasing 1,000 yearlings

6. Objective The objective of this project is to project discounted cash flows for a cattle feedlot expansion utilizing an appropriate discount rate for 30 years.

7. Financial Health1999-2009 • Profitability Analysis • Liquidity Analysis • Solvency Analysis

8. Profitability • NFI • ROE • OM • ATO • Cattle Profitability • DuPont

9. Net Farm Income • Net farm income has grown steadily over • Two setbacks between 2001-2002 and 2007-2008

10. Return on Equity • 13.32% Average ROE • Peak of 26.7% in 2004 • Trough of -2.1% in 2002. • 13.32% is similar to the average and median of the Standard and Poor’s index • from 1956-1995

11. Return on Equity • 4.5% ROE in 2008 vs. industry rate of 2.5% • 3.6% in 2009 vs. industry rate of 1.6% • Outperformed industry by 80% in 2008; 125% in 2009

12. Operating Profit Margin • Fluctuating OM • Averaging 23.94% • Trough of 7.8% in 2002 • Peak of 41.10% in 2007 • 13.1 % OM in 2008 vs. industry rate of 10.0% • 13.5% OM in 2009 vs. industry rate of 11.3%

13. Operating Profit Margin • Firm outperformed industry average OM by 31% in 2008; 19% in 2009 • No data for industry averages in the period 1999-2007

14. Asset Turnover Rate • ATO steadily declining since 1999 with an average of 43.51%. • This may suggest the farm enterprise’s efficiency using its assets has deteriorated somewhat. • Let’s compare to the industry’s average

15. Asset Turnover Rate • 32.7 % ATO in 2008 vs. market rate of 27.4 % • Outpaced Industry by 19.3% • 33.8 % ATO in 2009 vs. market rate of 27.6 % • Outpaced Industry by 22.5% • Staggering outperformance of peers • Declining ATO may be industry problem

16. Cattle Profitability • 2009 Net loss of $143 per head in yearling feeding operation • 2008 $128 per head • Returns across industry sharply declined in 2009

17. DuPont Analysis Operating Profit Margin = Operating Income / Sales Asset Turnover Rate = Revenue / Assets Equity Multiplier = Total Assets / Total Equity

18. Liquidity • Current Ratio • Term-Debt Ratio • focuses on solvency and liquidity

19. Current Ratio • Averaged 8.3 during period • Trough of 4.24 in 1999 • Peak of 20.95 in 2003 • Suggests low liquidity risk • Cash and Cash Equiv. Ratio increased in 2007 • No industry standard available

20. Term-Debt Coverage Ratio • Term-Debt Coverage Ratio • High of 26 • Low of 1.67 • 2.01 in 2009

21. Term-Debt Coverage Ratio • Net farm income from operations • + Total non-farm income • + Depreciation • + Interest on term debt • + Interest on capital leases • - Total income tax expense • Withdrawals for family living • Total is divided by the sum of annual scheduled principal and interest payments on term debt and capital leases.

22. Solvency • Debt/Equity ratio has remained • acceptable • Fluctuating between .26 and .74 • Currently at .45 • Lacking Industry Averages

23. Problem Statement • Nature of Capital • Budgeting Problem • S.W.O.T Analysis • Risk Assessment

24. Nature of CapitalBudgeting Problem • To expand or not to expand? • Utilizing cumulative cash flows to aid decision making

25. SWOT Analysis • Strengths • Weaknesses • SWOT • Opportunities • Threats

26. Strengths • Minimum Liquidity Risk if NFI returns to ‘normal’ • Unlevered • High Current Ratio • Asset Turnover Rate is slightly higher than market • Operating Profit Margin is slightly higher than market • 2009 ROA & ROE is higher than • market

27. Weaknesses • Firm currently has a Low Return on Equity but we consider this temporary • EPA regulations • Relatively high feed costs • Low term debt coverage ratio • This ratio went below 1.8

28. Opportunities • Rightward shift in demand curve for beef • Emerging market consumers; end of recession • Growth of ethanol production is helping corn belt cattle feeders • Ethanol byproducts (DDGS) • can be a cheaper alternative • to corn

29. Threats • Market currently has extremely low ROE in 2008 and 2009 • JBS Processing Plant might go out of business • Production Risk • Input Cost Risk • Volatile cattle prices • Potential regulation

30. Risk Assessment

31. Risk Assessment Internal Risk External Risk

32. Internal Risk • Financial Risk • Decrease in liquidity • Increase in leverage • Volatile cash flow/ROE generation could hinder ability to repay large loan • Michigan feedlots require cover Securing financing from a company like Greenstone • Rising costs related to fuel, labor, and supplies • Disaster Risk Death or Illness of farmer(s)

33. External Risk • Macroeconomic changes • Decrease in demand for beef • Production Risk • Natural disaster • Shortage of cattle inventory • Volatile cattle prices • Feed prices increasing • JBS processing plant shutting down • EPA legal action

34. Computing the Discount Rate • WACC • Dividend Capitalization Model • Capital Asset Pricing Model • The Discount rate

35. Weighted Average Cost of Capital Where: Re = cost of equity Rd = cost of debt E = market value of the firm's equity D = market value of the firm's debt V = Company’s enterprise value (debt + equity); E/V = percentage of financing that is equity D/V = percentage of financing that is debt T = farm business’ tax rate

36. Computing ReDividend Capitalization Model Dividends per Share Cost of (for next year) Growth Rate Equity of Dividends Current Market Value of Stock + =

37. Computing ReCapital Asset Pricing Model • RPj = (Rmarket-Rf)Bj • RPj is the cost of equity • Bj is the security’s beta and • Rmarket is the market’s expected return • Rf is the risk free rate (usually the 10-year or 30-year U.S. Government bond)

38. Computing the Discount Rate • Chose a 12.5% discount rate • An industry professional recommended a rate between 12% • and 13%

39. After Tax Cash Flows

40. Upper Left • Upper Right • Lower Left • Lower Right After Tax Cash Flows

41. IRR of the Defender IRR : 12.5% Assumption: to continue having similar returns

42. IRR of the Challenger • The IRR is 8.6235%. • A discount rate this low • Volatility • Risk • Uncertainty

43. Initial Investment • Initial investment cost of $675,000 • Computed by averaging 750 and 1,250 head facilities • Industry professional confirmed number a reasonable figure

44. Gross Margin per Head

45. Gross Margin per Head

46. Annual Gross Margin per Head (Gross Margin per Head) * (Annual Turnover) * (Occupancy Rate) Gross Margin per Head is $601.76 Annual Turnover of 1.95 Occupancy Rate is 85% Annual Gross Margin per Head $995.71

47. Net Cattle Sales (Annual Gross Margin) * (Feedlot Capacity) Annual Gross Margin is $995.71 Feedlot Capacity of 1,000 head Total Annual Net Cattle Sales $995,712.21

48. Depreciation • Depreciated facility with GDS Method for 20 years • U.S. Farm Property Recovery Periods table* • ($675,000) / (20 yrs) = $33,750/yr • *2010 Farmers Tax Guide pg. 43

49. Manure Credit • Estimation based on per/head basis • Fluctuates from year - year • $13.00 per head/yr

50. Operating Interest per Space (Sum of Interest Expense per Turn) * (Annual Turnover)