1. Economics of Timber Production on Private Land in Indiana

2. Economics or Finance? Economics  Timber owner is in general a price taker  Competitive market position Market for high quality timber of preferred species is global, unitary to slightly elastic demand Market for low quality timber and non-preferred species is local, highly inelastic demand

3. National Hardwood Lumber Production MMBF Peaked in 1999, 12.6 bil 2010, 6.3 bil

4. Weighted Average Price, Quality Stand

5. Black Walnut Sawlogs

6. Black Walnut Sawlogs, Real

7. Beech Sawlogs

8. Beech Sawlog Prices, Real Typical “flat-line” trend for non-prime species

9. 1982 $’s Nominal $’s Trend line - 1.3%

10. Economics or Finance? Finance  Capital intensive Land Growing stock  Long-term  Highly appreciated

11. Position in Investment Markets Primarily a “life-style” investment  Highest and best use not timber production Cost of entry may exceed income potential Some vertical integration Not attractive to institutional investors and private equity capital  Can’t capture economies of scale  Can’t economically accumulate tracts into investment grade bundles Limits resale market to other lifestyle investors

12. Standard Measures of Financial Return Net present value (NPV)  Present value of discounted stream of revenues and expenses  V 0 = V n /(1+i) n Internal rate of return  Discount rate that makes NPV zero

13. NPV Calculation Enter land and timber growing stock as up- front CAPITAL cost  Standard assumption – capital costs based on fair market value,  Life style assumption – capital cost based on actual cost, or zero if inherited Discount (interest) rate used  Nominal – rate on long-term corporate bonds  Real – nominal reduced by average inflation rate

14. Real Interest Rate, 10-Yr. Treas. Sec., 3-Yr. Moving Average

15. NPV Calculation Time period  Date of acquisition, to  Expected date of death, or date of liquidation Ending return on capital  Bequest - none  Standard - sale price (FMV) of land and growing stock

16. Operating Costs Allocate between personal and business use Property taxes Management fees Depreciation on equipment Other

17. Operating Revenues Timber income  Generally assume all-age management with periodic harvests  Estimate mean annual increment  Project timber price Other income  Hunting lease payments  Non-timber forest products  Sale of development rights

18. Willingness to Pay for Land (WPL) Net present value of stream of revenues and expenses Represents amount that can be paid for land and growing stock  Discount rate represents opportunity cost of tying up capital in timber production instead of next best opportunity

19. Base Case, WPL, No Bequest Liquidate at dod, assumed to be 40 years 3% real discount rate Liquidate land at $1,500 per acre Liquidate all timber at $587/MBF real

20. Base Case, WPL, No Bequest Per acre costs  Annual - $20.00  Every 5 years - $250  Mean annual increment – 250 mbf  Harvest revenue Every 10 years, 2.5 MBF Price – quality stand price series, $643 nominal, $397 real  Linear real price increase, $4.33 per year

21. Base Case, WPL, No Bequest – Liquidate WPL 40 = $1,755 per acre, real WPL 40 = $2,845 per acre, nominal

22. Base Case, WPL, Bequest WPL 40 = $755 per acre, real WPL 40 = $1,208 per acre, nominal

23. Barton Tree Farm (BTF) Acreage – 292 Initial acquisition in 1980 Acquisition cost - $175,250 Total timber revenue - $324,800

25. BTF Initial Cost and Timber Revenues 1980 -$175,248.00 1984 $11,313.00 1985 $11,678.00 1988 $9,503.60 1990 $14,323.35 1995 $21,951.08 1997 $61,746.95 1998 $387.91 1999 $85,300.00 2001 $70,102.00 2005 $38,500

26. BTF Rate of Return, No Expenses, Bequest No operating or holding costs included  i = ($324,800/$175,250) 1/25 -1 = 7.4%  IRR = 2.50% nominal  Internal Rate of Return 3.65% nominal 2.65% nominal after-tax  Inflation averaged 2.31% from 1980 to 2005

27. BTF, Rate of Return, Bequest Annual cost - $15.05 per acre per year, $4,400 per year  Before tax IRR – 0.89%  After tax – 28% ordinary, 15% capital gain IRR – 0.5% after-tax

28. No Bequest, Liquidate $15.05 per acre per year cost Sell land for $1,500 per acre  $438,000 Sell 2,354 MBF timber for $660/MBF  $1,553,640 ($5,320/acre) IRR  Before tax – 10.8%  After tax – 10.2%