Estimating annual investment returns from forestry and agriculture in New Zealand

Abstract

This paper describes a method of estimating annual investment returns from forest growing businesses in New Zealand, using financial statement data. The method is also applied to survey data (derived from farm financial statements) published by New Zealand pastoral farming sector organisations. After data are adjusted for inflation, the total investment return is calculated as the sum of the cash return on assets, and the percentage change in asset value. The paper demonstrates that the total investment return calculated in this way is equivalent to the internal rate of return (IRR), for a single period of one year. The direct equivalence between this measure and the single-period IRR (calculated using discounted cash-flow analysis) is demonstrated algebraically and by example.

Calculated values for forestry show a wide range of investment returns for different businesses in any one year, although there has been a general trend for total returns to increase for forestry businesses since about 2008. Investment returns for dairy and sheep and beef generally follow similar trends, with dairy providing a higher return on average than sheep and beef over the period studied. The data for forestry and agriculture are not directly comparable, since the forestry data are extracted directly from the financial statements of individual businesses and the farming data are derived through a process of averaging financial returns from a large number of farms, with the objective of providing typical returns for benchmarking. The scale of the operations are also significantly different, with the benchmark dairy farm being 148 ha, the sheep farm 764 ha and the forest businesses ranging from 21,000 ha to 150,000 ha (most recent year in all cases).

The measure of total return used in this paper is attractive because it means the same measure can be used for evaluating existing businesses as would have been used to justify the initial set up of the business, or any projects that contributed to the business along the way. This provides a measure for ex post evaluation of existing investments that is consistent with one of the ex-ante decision criteria used at the time investment decisions are made. The method also provides separate estimates of the income or productive return, and the (usually) unrealised change in asset value. The paper demonstrates that the method can be applied to either individual company or industry average financial data equally easily. This method provides a viable alternative to using survey data to estimate annual investment returns.