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Net Present Value Analysis Can Aid in Cattle Business Decision Making

Posted Aug. 1, 2004

Calf and cattle prices are at an all-time high (nominal prices). At this writing, calf crops are selling for fall delivery for $550 to $730 per head, depending on weight and delivery date. The cow-calf segment of the cattle industry looks great! How long will it last? Is it too late to "get in" the cow business? The answer, as all good economists will tell you, is it depends. An objective answer to the profit potential of cow-calf pairs purchased (or heifers retained) today can be arrived at by conducting a net present value analysis of the cost and income streams associated with owning cows for the next several years. The problem is that a number of assumptions about future events must be used as input "data" for the analysis. Therefore, the objective answer depends on the somewhat subjective assumptions one makes.

The most tenuous assumption is in regard to what calf prices will be for the next six or eight years. The following is my best effort for 550-pound steers and 525-pound heifers. If these prices don't materialize and you can remember, blame me. If they turn out to be remotely in the ballpark, I am indebted to Jim Robb of the Livestock Marketing Information Center for the several conversations he and I had as this article evolved.

Other assumptions are: annual cow and heifer cost of $260; a 28 percent marginal tax bracket; a 6 percent discount rate; a 92 percent calf crop for both cows and heifers; a five-year life for cows and eight-year (7 calves) life for heifers and a $37.75/cwt. price for cull cows at the end of the analysis period. Another assumption to simplify the analysis is 100% equity. Thus, the results indicate that an investment in a cow-calf pair or heifer at the stipulated buy price returns 6 percent on equity capital. Finally, a comparison is made between using the Section 179 tax deduction and not using the deduction. A reminder if a taxpayer is making money (paying taxes), he or she can deduct up to $102,000 of qualifying property in 2004 under Section 179 rather than depreciate the amount over the asset's useful life. This is a powerful tax management tool!

What are the conclusions? With the above assumptions, and claiming Section 179 deduction, one can pay $1,529 for a cow-calf pair and realize a 6 percent return on equity capital over five years. Not claiming Section 179 and taking depreciation reduces the amount that one can pay for the pair about $100 to still achieve a 6 percent return.

The heifer strategies are a whole different story. A taxpayer claiming Section 179 can only pay $657 for a yearling heifer to breed to calve next spring and hope to earn 6 percent on equity capital. The problem is, this heifer is currently bringing over $800 as a feeder animal. Why is this? Because of the time value of money, not having a calf to sell the first year of the analysis greatly reduces the "value" of the eight-year investment.

The financial hopelessness of retaining a raised yearling heifer in today's market environment is brutally illustrated in her net present value of only $473 versus a feeder value of over $800. This is due to no income stream from either depreciation or Section 179. The positive reasons to retain raised replacements, issues of quality and health, must be weighed against the very real financial costs. Are your genetics and your health program worth almost $400 per head? The difference between the net present value of a purchased pair and the retained yearling heifer is $1,056. Can you overcome this with increased production due to your genetics? I am taking the "economist's fifth" on this it depends!

You got to know when to hold 'em, know when to fold 'em...Know when to walk away and know when to run. - Kenny Rogers "The Gambler"

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