Owning or operating corn Base Acres makes you eligible for corn direct payment No trigger for corn DP, just own or operate

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1 AAE 320 Spring 2012 Final Exam Name: 1) (20 pts. total, 2 pts. each) True or False? Mark your answer. a) T F Wisconsin s cranberry industry may be important in the state, but nationally it ranks quite low. b) T F Prices that Wisconsin dairy farmers receive for selling milk are determined just like prices for grains and livestock. c) T F Crop insurance is quite popular, even in Wisconsin, where more than half of corn and soybeans planted acres in 2011 were insured. d) T F GRIP with a 50% coverage level is by far the most popular crop insurance policy in Wisconsin for corn and soybeans. e) T F The U.S. average corn yield per acre has been on an increasing trend since about 1930; for many years before then it changed little. f) T F Partners, Payments and Planet is a simple way mentioned in class to describe the three aspects of sustainability. g) T F USDA data show that the average farm size in the U.S. and in Wisconsin has continued to increase in recent decades. h) T F USDA data show that most U.S. farm households earn most of their income from off-farm activities. i) T F Life Cycle Assessments typically focus on estimating energy used to produce, consume, and dispose a product over its life cycle. j) T F Surveys discussed in class show most consumers know about sustainability, are demanding it, and are willing to more pay for it. 2) (17 pts. total) For the questions below, assume you are a farmer who owns some crop land. 2a) (3 pts.) What is required for you to be eligible for a corn Direct Payment? Suppose you are eligible what triggers a corn Direct Payment? Owning or operating corn Base Acres makes you eligible for corn direct payment No trigger for corn DP, just own or operate 2b) (3 pts.) What is required for you to be eligible for a corn Counter-Cyclical Payment? Suppose you are eligible what triggers a corn Counter-Cyclical Payment? Owning or operating corn Base Acres makes you eligible for corn counter cyclical payment Trigger is USDA Marketing year average price for corn less than the target price minus the direct payment rate. For corn, this is $2.63 $0.28 = $2.35. MYA corn price less than effective price (here $2.35) 1

2 2c) (3 pts.) What is required for you to be eligible for a corn ACRE Payment? Suppose you are eligible what triggers a corn ACRE Payment? Owning or operating Base Acres and planting corn makes you eligible for corn ACRE payment Trigger: 2 parts, actual state revenue < state revenue guarantee and actual farm revenue < farm revenue guarantee Mark the boxes to indicate your answers to the following questions. 2d) (4 pts.) Suppose you own 10 acres of land and are eligible for a soybean Direct Payment. For each action below, would you Keep or Lose your soybean Direct Payment? Action Keep DP Lose DP Plant all 10 acres in alfalfa (a non-program crop) Plant soybeans on all 10 acres and sell the crop for $20/bu Build apartments on the whole 10 acres Plant all 10 acres in onions and sell them at farmers markets 2e) (4 pts.) Suppose you own 10 acres of land and are eligible for a soybean Counter Cyclical Payment (CCP). For each action below, would you Keep or Lose the soybean CCP? Action Keep CCP Lose CCP Plant all 10 acres in alfalfa (a non-program crop) Plant corn on all 10 acres and sell the crop for $20/bu Plant soybeans on all 10 acres and sell the crop for $20/bu Plant soybeans on all 10 acres and sell the crop for $3/bu 3) (12 pts. total) Answer the questions below, assuming you grew 30,000 bushels of corn. 3a) (3 pts.) Why are you eligible for a Marketing Assistance Loan, but your neighbor, who operates a dairy that buys all its grain and just bought 30,000 bushels of corn, is not eligible? Must grow/produce the crop to get MAL, cannot buy grain and use to get MAL, even if you are a farmer. 3b) (3 pts.) If you are eligible and the corn loan rate is $1.95 (you did not enroll in ACRE), what is the maximum Marketing Assistance Loan could you get? Max MAL = $1.95 x 30,000 = $58,500 2

3 3c) (3 pts.) If you took out the maximum Marketing Assistance Loan for your corn, under what conditions would you receive a Loan Deficiency Payment? On day pay off loan or sell grain, the posted county price < loan rate 3d) (3 pts.) What is the benefit to farmers for using Marketing Assistance Loans, even if they do not expect to receive Loan Deficiency Payments? MAL is a low interest loan that allows grower to pay off operating loans (usually at a higher interest rate) and then hold grain and sell later in season when prices are usually higher than at harvest. 4) (8 pts. total) Suppose a farm has an 80 ac field of corn in one insured unit with an average yield of 150 bu/ac as established by crop insurance rules. 4a) (3 pts.) Suppose the farmer buys 70% Yield Protection crop insurance. What is the per acre yield guarantee? What is the total yield guarantee for the full 80 ac unit? 70% x 150 bu/ac = 105 bu/ac guarantee 105 bu/ac x 80 ac = 8,400 bu guarantee for unit 4b) (3 pts.) Suppose the farmer actually harvests 6,000 bushels from the unit. What is the insurance indemnity, assuming a 100% price election of $6.00/bu? Indemnity = $6.00/bu x (8,400 6,000) = 6 x 2,400 = $14,400 4c) (2 pts.) Suppose later that year, the farmer actually sold the 6,000 bu of corn for $4/bu. How would this affect the crop insurance indemnity? Would not affect indemnity at all. 3

4 5) (9 pts. total) Suppose a farm has a 50 ac field of soybeans in one insured unit with an average yield of 40 bu/ac as established by crop insurance rules and a $12.00/bu Base Price. 5a) (3 pts.) Suppose the farm buys 75% Revenue Protection crop insurance. What is the initial per acre revenue guarantee? What is the initial revenue guarantee for the 100 acre unit? 75% x $12.00/bu x 40 bu/ac = $360/ac guarantee $360/ac x 50 ac = $18,000 guarantee for unit 5b) (3 pts.) The price increases over the season so that the official harvest price is $14.00/bu. What would be the final revenue guarantee for the 50 acre unit? Final guarantee uses the larger of the initial Base Price and the Harvest Price. Because the Harvest Price is 14 > 12, the final guarantee increases: 75% x $14.00/bu x 40 bu/ac = $420/ac guarantee $420/ac x 50 ac = $21,000 guarantee for unit 5c) (3 pts.) Suppose the farmer actually harvests 1,000 bushels of soybeans from the unit, what would be the insurance indemnity? Indemnity = $21,000 ($14/bu x 1,000 bu) = $21,000 $14,000 = $7,000 6 (14 pts. total) Answer the following question about crop insurance 6a) (3 pts.) What triggers an indemnity for the Group Risk Plan (GRP) crop insurance? Actual average yield for county < chosen yield guarantee 6b) (3 pts.) What triggers an indemnity for the Group Risk Income Plan (GRIP) crop insurance? Actual revenue for county < chosen revenue guarantee, where actual revenue is the Harvest Price x Actual average yield for county 4

5 6c) (4 pts.) Suppose you insure 100 acres of corn under a Group Risk Income Plan (GRIP) crop insurance policy and later that crop year become eligible for an insurance indemnity. For each event below, would you Keep or Lose the corn GRIP indemnity? Event Keep Indemnity Lose Indemnity Harvest a farm record high yield from your corn acres All your corn acres are flooded and you harvest nothing Sell your harvested corn for $1.50/bu (really low) Sell your harvested corn for $15.00/bu (really high) 6d) (4 pts.) Briefly explain how the federal government subsidizes crop insurance for farmers. Government pays a large part of the farmer s premium, so farmers pay less than actually fair premium for crop insurance Government also pays companies a subsidy for administering the insurance policy, so no premium load on policy. 7) (4 pts. total) Answer the following questions about business entities and liability. 7a) (2 pts.) Of the business entities discussed in class (sole proprietor, partnership, C and S- corporations, limited liability company), which provide some limited liability to the owners? C and S Corporations, LLCs (technically, also limited partnerships for the limited partners only) 7b) (2 pts.) When we say these entities have limited liability what do we typically mean liability for what is limited? Be brief. Owners are not liable for the Corporation or LLC debts, so lenders cannot take owners personal assets to cover the debts of the Corporation or LLC. Hence, lenders often ask owners to provide personal guarantee of loans to Corporation or LLC. Owners still liable for negligence when doing Corporation or LLC business. 5

6 8) (14 pts. total) Provide short answers to each of the following questions. Mark and Ann own a farm, with all assets owned as marital property with a right of survivorship under Wisconsin s marital property law. Among their assets is land worth $200,000 with a tax basis of $50,000. Use this information to answer each question below. Give a brief explanation for each answer. 8a) (2 pts.) If Mark and Ann gave the land to Bob, what is Bob s income tax basis in the land? Basis transfers with gift, so still $50,000 8b) (2 pts.) If Bob then sells the land for $200,000, how much gain must he report? Gain = Sale price basis = 200,000 50,000 = 150,000 8c) (2 pts.) Considering ordinary income tax, capital gain tax, and self-employment tax, which one or ones of these taxes would Bob owe on this gain? Land gets capital gains treatment, so owes cap gains tax on gain 8d) (2 pts.) If Mark died and then Ann gave the land to Bob, how much gain would Bob have to report if he sold the land soon thereafter for $200,000? At Mark s death, basis updates to date of death fair market value, so gain = 200, ,000 = $0: zero basis 8e) (2 pts.) If Mark did not die, but instead Mark and Ann contributed the land to a Limited Liability Company (LLC) that the two of them completely owned and the next day their LLC sold the land for $200,000, how much gain would the LLC realize? Sale triggers recognition of the gain, so gain still 200,000 50,000 = 150,000 8f) (2 pts.) Assume the LLC realizes gain from the sale, does it pay income tax on the gain? Do Mark and Ann (sole owners of the LLC) pay income tax on the gain? LLC does not pay taxes on gain, but passes gain though to the owners of the LLC, so Mark and Ann pay taxes. 8g) (2 pts.) Instead of selling the land, the LLC returns it back to Mark and Ann. Does the LLC and/or Mark and Ann have to pay income tax as a result of this transfer? Transfer out of LLC back to owners does NOT trigger recognition of gain, so no taxes due 6

7 9) (3 pts.) In class we discussed the Cool Farm Tool, the Field-to-Market Field Print Calculator, and Healthy Grown as examples of agricultural sustainability assessment tools or standards currently used by farmers. Briefly describe the types of questions farmers answer or the types of information they provide and the sorts of output these tools generate. Questions focus on farmer practices: tillage used, how decide on nutrient applications (use of soil tests, tissue tests, etc.), how decide insecticide applications (IPM), etc. Outputs: CO2 emission, water use, waste generated, energy use, greenhouse gases, etc. 10a) (4 pts.) Agricultural technology continues to develop and increase productivity, while the world population and income continue to grow as well. Use diagrams of supply and demand shifts for a crop (say corn) to show that if both of these changes occur at the same time, the crop price can either increase or decrease, depending on which change dominates. Let one diagram show how a price increase occurs and another how a price decrease occurs. Label the initial supply, demand, and price S 0, D 0 and P 0 and the new supply, demand, and price S 1, D 1, and P 1. P P D 0 D 1 S 0 S 1 Price decrease: supply shifts out more Price increase: demand shifts out more 10b) (3 pts.) In general, after correcting for inflation, what do the real prices show for major grain crops like corn, soybeans and wheat? In other words, which effect has dominated in the US over the last several decades? Data on real prices show DECREASE over last several decades. Only in last 2-3 years have real prices increased and still not much relative to 1970s 7

8 11) (6 pts. total) You are deciding the irrigation water for your potato crop. This table gives the water in acre-inches applied and the potato yield (cwt/ac). Water (acre-inches) Yield (cwt/ac) Marginal Product Value of Marginal Product a) (2 pts.) Use this table to show how to calculate the Marginal Product and then fill in the Marginal Product column in the table. Show your work for potential partial credit. MP = q/ x = ( ) / (18 15) = b) (2 pts.) Potatoes sell for $15/cwt. Show how to calculate the Value of Marginal Product for one example, and then fill in the Value of Marginal Product column in the table. VMP = MP x P = 3.33 x 15 = $ c) (2 pts.) If the cost to apply an acre-inch of water is $20, what is the profit maximizing water to apply based on the table above? VMP = r (input price) identifies optimal x level. $20 occurs half way between $25 and $15, so optimal x at half way between 21 and 24 inches, or ) (5 pts) Sweet Corn yield is Y = , where Y is yield (tons/ac) and is nitrogen fertilizer (lbs/ac). If the price of sweet corn is $120/ton and nitrogen fertilizer costs $0.60/lbs, what is the profit maximizing amount of nitrogen fertilizer to apply? Don t Forget to Check the Second Order Condition. Pi = 120( ) 0.6 dpi/d = 120( ) 0.6 = 0 (FOC) Solve for : = 0.6/120 = = = 0.195, so = 0.195/0.002 = 97.5 lbs SOC: d2pi/d2 = 120( 0.002) < 0, so passes 8

9 13) (5 pts. total) This table reports the cost ($/yr) for George to produce cranberries (barrels/yr). Barrels of Cranberries Fixed Cost Variable Cost Total Cost Marginal Cost 8, , , , , , , , , , , , , , , , a) (3 pts.) Using the table above, show how to calculate the Total Cost and Marginal Cost and then fill in the missing values in the table. Show your work for potential partial credit. TC = FC + VC = 100, ,000 = 300,000 MC = TC/ Q = (370, ,000) / (9,000 8,000) = b) (2 pts.) If a barrel of cranberries sells for $70.00, what is the profit maximizing number of barrels for George to produce? P = MC identifies optimal Q, so Q = 9,000 14) (14 pts. total) In 2010 you bought a planter for $50, a) (2 pts.) For your farm accounts you plan to keep the planter for 4 years. Calculate annual depreciation for the planter assuming a $10,000 salvage value. Fill in the table using Straight Line Depreciation. Show your work for potential partial credit. Year Depreciation During Year Value at Year End ,000 40, ,000 30, ,000 20, ,000 10,000 Annual Depreciation = (purchase price salvage value)/useful life = (50,000 10,000) / 4 = $10,000 9

10 14b) (2 pts.) You have been depreciating the planter for tax purposes using the standard IRS tax table below. Enter the depreciation claimed in 2010 and 2011 in the table below. Tax Depreciation Depreciation Claimed Year Year Rate % 50,000 x = $7, % 50,000 x = $12, % % % % % % 14c) (2 pts.) What is your income tax basis in the planter at the beginning of 2012? Basis = purchase price accumulated depreciation claimed Basis = 50,000 7,145 12,245 = 30,610 14d) (2 pts.) If you sold the planter at the beginning of 2012 for $40,000, how much gain or loss would you report on your income tax return? Gain = Sale price basis = 40,000 30,610 = 9,390 For parts e though g below, rather than using the table in part a, suppose instead you chose the Section 179 election and deducted the full cost of the planter for your 2010 taxes. 14e) (2 pts.) What is your income tax basis in the planter at the beginning of 2012? Fully depreciated, so $0 basis 14f) (2 pts.) If you sold the planter at the beginning of 2012 for $40,000, how much gain or loss would you report on your income tax return? Gain = 40,000 0 = 40,000 14g) (2 pts.) Briefly explain the tax benefit that farmers gain by choosing the Section 179 election for depreciating purchased machinery like this planter. Deduct cost form income immediately, so do not pay ordinary income taxes or self-employment taxes. When you sell it, only pay ordinary income taxes, so in short: Can avoid paying self-employment taxes on the income and delay paying ordinary income taxes 10

11 S 1 15) (12 pts. total) Use the simplified Balance Sheet and Income Statement below to answer these questions. Show your work for potential partial credit. BALANCE SHEET 12/31/ /31/ /31/ /31/2010 Current Assets 180, ,000 Current Liabilities 140, ,000 Non-Current Assets 390, ,000 Non-Current Liabilities 250, ,000 Total Liabilities 390, ,000 Equity 180, ,000 Total Assets 570, ,000 Total Liabilities and Equity 570, ,000 15a) (2 pts.) What is the Current Ratio on 12/31/2011? CR = current assets / current liabilities = 180,000 / 140,000 = b) (2 pts.) What is the Debt to Asset Ratio on 12/31/2011? DtoA = total liabilities / total assets = 390,000 / 570,000 = INCOME STATEMENT 12/31/2010 to 12/31/2011 Crop and Livestock Sales 310,000 Operating Expenses 140,000 Interest Expenses 20,000 Net Farm Income from Operations 150,000 Assume the farm family paid themselves $50,000 for their labor & management. 15c) (2 pts.) What is this farm s Return on Assets? ROA = NFIfO + Interest = UnpaidLabrMgmt = 150, ,000 50,000 = 120,000 15d) (2 pts.) What is this farm s Rate of Return on Assets? ROROA = ROA/Average Assets = 120,000 / ½(570, ,000) = 21.8% 15e) (2 pts.) What is this farm s Return on Equity? ROE = ROA Interest = 120,000 20,000 = 100,000 15f) (2 pts.) What is this farm s Rate of Return on Equity? ROROE = ROE/Average Equity = 100,000 / ½(180, ,000) = 64.5% 11