Eligibility: own or operate Base Acres. No trigger except owning /operating Base Acres.

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1 AAE 320 Spring 2013 Final Exam Name: KEY 1) (20 pts. total, 2 pts. each) True or False? Mark your answer. a) T F Wisconsin s vegetable processing industry (green beans, sweet corn, potatoes) may be important in the state, but nationally it ranks quite low. b) T F There are more career fire fighters than what the USDA calls commercial farms farms earning more than $250,000 in annual gross revenue. c) T F Most of the federal subsidies to farmers now come as crop insurance premium subsidies, not commodity support or conservation payments. d) T F Revenue Protection (RP) with a 70%-80% coverage level is by far the most popular crop insurance policy in Wisconsin for corn and soybeans. e) T F Because U.S. average yields per acre for most major crops have not been increasing for the last two decades, crop prices have been high. f) T F As discussed in class, only small/alternative retail and food companies have sustainability programs for farmers selling raw products to them. g) T F Median household income for commercial farm households has exceeded U.S. median household income for the last few years. h) T F Most USDA commodity support and crop insurance premium subsidies go to commercial farms earning more than $250,000 in annual gross revenue. i) T F The Cool Farm Tool is a Light System Assessment (LSA) tool for farms to estimate greenhouse energy use for lighting in winter. j) T F Consumer surveys discussed in class show substantial confusion and a general lack of concern about sustainability. 2) (17 pts. total) For the questions below, assume you are a farmer. 2a) (3 pts.) What is required for a farmer to be eligible for a corn Direct Payment? Suppose a farmer is eligible what triggers a corn Direct Payment? Eligibility: own or operate Base Acres. No trigger except owning /operating Base Acres. 2b) (3 pts.) What is required for a farmer to be eligible for a corn Counter-Cyclical Payment? Suppose a farmer is eligible what triggers a corn Counter-Cyclical Payment? Eligibility: own or operate Base Acres. Trigger is National Marketing Year Average Price of the crop associated with base acres is less than the target price minus the direct payment rate. 2c) (3 pts.) What is required for a farmer to be eligible for a corn ACRE Payment? Suppose a farmer is eligible what triggers a corn ACRE Payment? Eligibility: own or operate Base Acres and grow the crop that triggered the ACRE payment. Two triggers: Actual State Revenue less than the State Revenue Guarantee for that crop and the Actual Farm Revenue for that crop less than the Farm Revenue Guarantee. 1

2 Mark the boxes to indicate your answers to the following questions. 2d) (4 pts.) Suppose you have 10 acres of crop land and are eligible for a corn Direct Payment. For each action below, would you Keep or Lose your corn Direct Payment? Action Keep DP Lose DP Plant all 10 acres in alfalfa (a non-program crop) Plant wheat on all 10 acres and sell the crop for $50/bu Build apartments on the whole 10 acres Plant all 10 acres in broccoli and sell it at farmers markets 2e) (4 pts.) Suppose you have 10 acres of crop land and are eligible for a corn Counter Cyclical Payment (CCP). For each action below, would you Keep or Lose the corn CCP? Action Keep CCP Lose CCP Plant all 10 acres in alfalfa (a non-program crop) Plant wheat on all 10 acres and sell the crop for $50/bu Plant corn on all 10 acres and sell the crop for $20/bu Plant corn on all 10 acres and sell the crop for $1/bu 3) (12 pts. total) Answer the questions below, assuming you grew 20,000 bushels of soybeans. 3a) (3 pts.) Why are you eligible for a Marketing Assistance Loan, but your neighbor, who owns a dairy that buys all of its grain and just bought 20,000 bushels of soybeans, is not eligible? Only the 1 st producer of a grain crop can get a MAL, not a buyer, otherwise speculators could get a MAL. Your neighbor does not grow soybeans, so cannot get a MAL 3b) (3 pts.) If you are eligible and the soybean loan rate is $5.00 (you did not enroll in ACRE), what is the maximum Marketing Assistance Loan could you get? Maximum MAL = 20,000 x $5.00 = $100,000 3c) (3 pts.) If you took out the maximum Marketing Assistance Loan for your soybeans, under what conditions would you receive a Loan Deficiency Payment? If the posted county price for the crop is less than the loan rate on the day you pay back the MAL, then you trigger receiving a LDP. 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? Can use MAL as a low interest loan to help manage cash flow can use MAL to pay back operating or other loans at harvest time (when prices are typically at their lowest) and hold grain until later in the season when prices tend to be higher. 2

3 4) (8 pts. total) Suppose a farm has an 100 ac field of corn in one insured unit with an average yield of 160 bu/ac as established by crop insurance rules. 4a) (3 pts.) Suppose the farmer buys 75% Yield Protection (YP) crop insurance. What is the per acre yield guarantee? What is the total yield guarantee for the full 100 ac unit? 75% x 160 bu/ac = 120 bu/ac 120 bu/ac x 100 ac = 12,000 bu 4b) (3 pts.) Suppose the farmer actually harvests 10,000 bushels from the unit. What is the insurance indemnity, assuming a 100% price election of $6.00/bu? Indemnity = 6.00 x (12,000 10,000) = 6 x 2,000 = $12,000 4c) (2 pts.) Suppose the farmer actually sells the 10,000 bu of corn for $5/bu. How much does the crop insurance indemnity change? Price received for the actual sale does not affect the indemnity, only the chosen price election. 5) (9 pts. total) Suppose a farm has a 60 ac field of soybeans in one insured unit with an average yield of 35 bu/ac as established by crop insurance rules and a $12.00/bu Base Price. 5a) (3 pts.) Suppose the farm buys 80% Revenue Protection (RP) crop insurance. What is the initial per acre revenue guarantee? What is the initial revenue guarantee for the 60 acre unit? 80% x 35 x = $336/ac 336 x 60 = $20,160 For 5b and 5c, the price increases over the season so that the official harvest price is $14.00/bu. 5b) (3 pts.) What is the final revenue guarantee for the 60 acre unit? 80% x 35 x max(12.00, 14.00) x 60 = $23,520 5c) (3 pts.) Suppose the farmer actually harvests 1,800 bushels of soybeans from the unit, what would be the insurance indemnity? Actual Revenue = 1,800 x = $25,200 > $23,520 Actual Revenue > Revenue Guarantee, so NO INDEMNITY For 5d and 5e, the price decreases over the season so that the official harvest price is $10.00/bu. 5d) (3 pts.) What is the final revenue guarantee for the 60 acre unit? 80% x 35 x max(12.00, 10.00) x 60 = $20,160 NO CHANGE 5e) (3 pts.) Suppose the farmer actually harvests 2,100 bushels of soybeans from the unit, what would be the insurance indemnity? Actual Revenue = 2,100 x = $21,000 > $20,160 3

4 Actual Revenue > Revenue Guarantee, so NO INDEMNITY 6 (12 pts. total) Answer the following questions about crop insurance. 6a) (4 pts.) What is the difference between Revenue Protection (RP) and Revenue Protection with the Harvest Price Exclusion (RP-HPE) crop insurance policies? Explain the difference, assuming you have 100 ac of corn to insure, an average yield of 160 bu/ac, a 75% coverage level and the corn base price for RP and RP-HPE is $5.65 as it is this year. RP calculates the final revenue guarantee using the larger of the initial base price and the harvest price, so if the price increases during the season, the revenue guarantee also increases and if the price decreases, the revenue guarantee does not change. RP-HPE does not change the revenue guarantee whether the price increases or decreases. Thus for the numbers given, if the harvest price exceeds $5.65, then the RP guarantee increases, but the RP-HPE does not change. The federal government subsidizes crop insurance, paying about two-thirds of the actuarially fair premium for most farmers, so that, from a farmer s perspective, the loss ratio is about b) (4 pts.) What is the actuarially fair premium? For context, what is the actuarially fair premium for an insurance policy that pays $60/ac once every 3 years and zero the other 2 years? The fair premium is the break even premium, so that the premiums collected equal the indemnities paid out over several years and many locations and thus over the long term, neither the farmer nor the insurance company make money. For the case here, $20/ac is the fair premium: 1 year out of three the farmer gets $60/ac and the other two years gets $0/ac, or on average $20/ac. 6c) (4 pts.) Explain what a farmer loss ratio of 3.0 means. For context, what does a farmer loss ratio of 3.0 mean in terms of an average indemnity for a policy that costs $30 per acre? A loss ratio is indemnities/premiums, so a 3.0 means that on average, over the long-term, the farmer gets back $3 for every $1 paid in as premiums. For the numbers here, that means the average return should be $90/ac or 3 times the premium. 7a) (3 pts.) What triggers an indemnity for the Group Risk Plan (GRP) crop insurance? County average yield announced by NASS < the chosen county yield guarantee. 7b) (3 pts.) What triggers an indemnity for the Group Risk Income Plan (GRIP) crop insurance? Actual county revenue, which equals County average yield x the CBOT harvest price, less than the chosen revenue guarantee. 7c) (4 pts.) Suppose you insure 200 acres of soybeans under a Group Risk Plan (GRP) crop insurance policy and later that crop year become eligible for an insurance indemnity. For each event below, would you Keep or Lose the soybean GRP indemnity? Event Keep Indemnity Lose Indemnity Harvest a farm record high yield from your soybean acres All your soybean acres flood and you harvest nothing Sell your harvested soybeans for $6.00/bu (really low) 4

5 Sell your harvested soybeans for $18.00/bu (really high) 8) (12 pts. total) Refer to Cochrane s Treadmill to answer the following questions: 9a) (4 pts.) Why do early adopters of productive agricultural technologies capture the economic benefits of new technologies, while late adopters do not? Early adopters get higher yields/production and can sell at current prices, earning higher profits. But as more farmers adopt, the supply increase and the price begins to decline, so that late adopters have the same output (before they adopt), but sell at lower prices and so earn lower profits. 8b) (4 pts.) What does Cochrane s Treadmill imply will happen to farm size during extended periods of technological improvement? Because early adopters have larger profits than late adopters, they tend to invest and buy more land from those who are earning lower profits. As a result, early adopters tend to grow in size while late adopters tend to leave farmers and average farm size increases. 8c) (4 pts.) According to farm size data presented in class, what have been the recent trends in average farm size? Do these trends support or refute Cochrane s Treadmill? USDA data presented in class shows a fairly flat trend in average farm size, neither increasing nor decreasing much on average over time, or maybe even decreasing slightly over the last few years. This trend does not support Cochrane s Treadmill, but refutes it. 9) (4 pts. total) Answer the following questions about business entities and liability. 9a) (2 pts.) Which business entities discussed in class (sole proprietor, partnership, C and S- corporations, limited liability company) provide some limited liability to the owners? S Corp, C Corp, LLC 9b) (2 pts.) When we say these entities have limited liability what is meant liability for what is limited? Be brief. Lenders and others with claims against the business cannot take the owner s personal assets to meet the financial obligations of the business, i.e., the owner is not personally liable for the business debts. 10) (20 pts. total) Provide short answers to each of the following questions. Rob and Faye own a farm, with all assets owned as marital property with a right of survivorship under Wisconsin s marital property law. They have one son, Tom. Among their assets is land worth $500,000 with a tax basis of $100,000. Answer each question below. Give a brief explanation for each answer. 10a) (2 pts.) If Rob and Faye gave the land to Tom, what is Tom s income tax basis in the land? $100,000 because the Basis transfers with the gift. 10b) (2 pts.) If Tom then sells the land for $500,000, how much gain must he report? 5

6 Gain = FMV Basis = $500,000 $100,000 = $400,000 10c) (2 pts.) Considering ordinary income tax, capital gain tax, and self-employment tax, which one or ones of these taxes would Tom owe on this gain? Only Capital Gains Tax is owed on the gain from the land sale 10d) (2 pts.) If Rob died and then Faye gave the land to Tom, how much gain would Tom have to report if he sold the land soon thereafter for $500,000? At Rob s death, the Basis updates to the date of death FMV, so the Gain = FMV Basis = $0 10e) (2 pts.) If Rob did not die, but instead Rob and Faye 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 $500,000, how much gain would the LLC realize? Basis transfers, so Gain = FMV Basis = $500,000 $100,000 = $400,000 10f) (2 pts.) Assume the LLC realizes gain from the sale, does it pay income tax on the gain? Do Rob and Faye (sole owners of the LLC) pay income tax on the gain? No, an LLC does not pay taxes on gains, but passes them to shareholders Yes, Rob and Faye pay taxes as shareholders of the LLC 10g) (2 pts.) Instead of selling the land, the LLC returns it back to Rob and Faye. Does the LLC and/or Rob and Faye have to pay income tax as a result of this transfer? No, transfer of assets out of LLC does not trigger recognition of gain. 10h) (2 pts.) Instead Rob and Faye contributed the land to a C-Corporation that the two of them completely owned and the next day their Corporation sold the land for $500,000, how much gain would the Corporation realize? Basis transfers, so Gain = FMV Basis = $500,000 $100,000 = $400,000 10i) (2 pts.) Assume the Corporation realizes gain from the sale, does it pay income tax on the gain? Do Rob and Faye (sole owners of the Corporation) pay income tax on the gain? Yes, C Corporations pay taxes on gains then pass remaining gains to shareholders. Yes, shareholders of C Corporations (Rob and Faye) pay taxes on any gains distributed to them. 10j) (2 pts.) Instead of selling the land, the Corporation returns it back to Rob and Faye. Does the Corporation and/or Rob and Faye have to pay income tax as a result of this transfer? Yes, transfer of assets out of a C Corporation triggers recognition of gain, so both pay taxes. 6

7 11) (6 pts. total) You are deciding the nitrogen fertilizer for your sweet corn crop. This table gives the nitrogen fertilizer applied in pounds per acre and the sweet corn yield (tons/ac). Nitrogen (lbs/ac) Yield (tons/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/ = ( ) / ( ) = 1/25 = b) (2 pts.) Sweet corn sell for $100/ton. 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 = P x MP = 100 x 0.04 = c) (2 pts.) If nitrogen fertilizer costs $0.60 per pound, what is the profit maximizing amount to apply based on the table above (you may need to interpolate between entries)? VMP = r (input price) of $0.60 half way between 0.8 and 0.4, or at N of ½( ) = N of lbs/ac. 12) (6 pts) Green bean yield is Y = , where Y is yield (tons/ac) and is phosphorus fertilizer (lbs/ac). If the price of green beans is $80/ton and nitrogen fertilizer costs $0.60/lbs, what is the profit maximizing amount of nitrogen fertilizer to apply? Don t Forget to Check the Second Order Condition. π = 80( ) 0.6 FOC: dπ/d = 80( ) 0.6 = = = 0.32 = SOC: d 2 π/d 2 = 80(0.32) = 0.32 < 0 Satisfies SOC for a maximum 13) (7 pts. total) This table reports the cost ($/yr) for Marie to produce turkeys (pounds/year). Pounds of Turkey Fixed Cost Variable Cost Total Cost Marginal Cost Average Total Cost 113,000 30,000 64,000 94, ,000 30,000 72, , ,000 30,000 80, , ,000 30,000 88, ,

8 13a) (3 pts.) Using the table above, show how to calculate Total Cost, Marginal Cost & Average Total Cost, then fill in the table s missing values. Show your work for potential partial credit. TC = FC + VC = 30, ,000 MC = TC/ Q = (102,000 94,000) / (122, ,000) = 0.89 ATC = TC/Q = 94,000 / 113,000 = b) (2 pts.) If turkey sells for $1.00/pound, what is the profit maximizing pounds of turkey for Marie to produce? P = MC identifies the profit maximizing amount of Q to produce, which in the table occurs at Q = 130,000 pounds 13c) (2 pts.) Based on your Average Total Cost numbers in the table, if Marie produces and sells this amount of turkeys, will she earn a positive economic profit? How do you know? At this price and quantity, she will earn a positive economic profit because whenever the price exceeds the ATC, then the economic profit will exceed zero. 14) (14 pts. total) In 2011 you bought a combine for $70, a) (2 pts.) For your farm accounts you plan to keep the combine for 4 years. Calculate annual depreciation for the combine assuming a $20,000 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 ,500 57, ,500 45, ,500 32, ,500 20,000 Deprec = ¼(70,000 20,000) = 12,500 14b) (2 pts.) You have been depreciating the combine you bought for $70,000 for tax purposes using the IRS tax table below. Enter depreciation claimed in 2011 and 2012 in the table below. Year Tax Year Depreciation Rate Depreciation Claimed % $2, % $19, % % % % % % 70,000 x ,000 x

9 14c) (2 pts.) What is your income tax basis in the combine at the beginning of 2013? Purchase price accumulated depreciation = 70,000 2,499 19,285 = $48,216 14d) (2 pts.) If you sold the combine at the beginning of 2013 for $40,000, how much gain or loss would you report on your income tax return? Gain = FMV = Basis = 40,000 48,216 = 8,216 a LOSS of $8,216 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 combine for your 2011 taxes. 14e) (2 pts.) What is your income tax basis in the combine at the beginning of 2013? Fully depreciated in year 1, so Basis = $0 14f) (2 pts.) If you sold the combine at the beginning of 2013 for $40,000, how much gain or loss would you report on your income tax return? Gain = FMV = Basis = 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 combine. In the 1 st year you deduct the full cost of the asset ($70,000) from your income, which reduces both your ordinary income tax and self-employment taxes. When you sell the asset, the gain ($40,000) is only treated as ordinary income, so you avoid the self-employment tax. Thus Section 179 allows you to delay paying ordinary income taxes and to avoid paying any selfemployment taxes on the value of the asset. 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/ /31/2011 Current Assets 200, ,000 Current Liabilities 120, ,000 Non-Current Assets 450, ,000 Non-Current Liabilities 220, ,000 Total Liabilities 340, ,000 Equity 310, ,000 Total Assets 650, ,000 Total Liabilities and Equity 650, ,000 15a) (2 pts.) What is the Current Ratio on 12/31/2012? CR = current assets/current liabilities = 200,000 / 120,000 = b) (2 pts.) What is the Debt to Asset Ratio on 12/31/2012? DtoA = total liabilities / total assets = 340,000 / 650,000 =

10 INCOME STATEMENT 12/31/2011 to 12/31/2012 Crop and Livestock Sales 280,000 Operating Expenses 150,000 Interest Expenses 40,000 Net Farm Income from Operations 90,000 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 = 90, ,000 50,000 = 80,000 15d) (2 pts.) What is this farm s Rate of Return on Assets? ROROA = ROA / Average Assets = 80,000 / ½(650, ,000) = 12.7% 15e) (2 pts.) What is this farm s Return on Equity? ROE = ROA Interest = NFIfO UnpaidLabrMgmt = 40,000 15f) (2 pts.) What is this farm s Rate of Return on Equity? ROROE = ROE / Average Equity = 40,000 / ½(310, ,000) = 13.1% 10