15,000 5,000. 5,000 14,400 Total Benefits 20,000 Total Costs 19,400 Net Benefit 600

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1 AAE 320 Spring 2009 Final Exam Name: KEY 1) (25 pts. total) You are a hog farmer thinking of growing low phytate corn for your hog feed. Low phytate corn increases the bioavailability of phosphorus in corn so that hogs gain faster and the manure contains less phosphorus, but the seedcorn is more expensive and the corn yields lower as well. Conduct a partial budget analysis of growing low phytate corn for your hog feed. You currently farm with 1,000 acres of corn, with an average yield of 180 bu/ac. Use the corn market price of $4.00/bu as the price (opportunity cost) of your raised corn. Low phytate corn costs an additional $5/ac for the seed compared to conventional corn and yields 2% lower. With low phytate corn, the manure has lower phosphorus, so you can apply more manure per acre and thus do not have to haul the manure as far. You estimate that you could reduce your manure hauling costs by $5,000 per year. Due to more rapid weight gain on low phytate corn, you estimate that you could sell 100 more hogs per year at a market weight of 250 lbs for a price of $0.60/lb. Ignore all other costs and benefits in your analysis. Show your work for potential partial credit. a) (5 pts.) What is the Additional Revenues (if any)? Faster gain: $0.60/lb x 250 lbs/hog x 100 more hogs = $15,000 b) (5 pts.) What is the Additional Costs (if any)? Added seed costs: $5/ac tech fee x 1000 acres = $5,000 c) (5 pts.) What is the Costs Reduced (if any)? Reduced manure hauling cost = $5,000 d) (5 pts.) What is the Revenues Reduced (if any)? Yield drag: 2% yield drag x 180 bu/ac x 1000 acres x $4/bu = $14,400 e) (5 pts.) Use your numbers to fill in the Partial Budget below, and then calculate the Total Benefits, Total Costs, and Net Benefit. Additional Revenues Additional Costs 15,000 5,000 Costs Reduced Revenues Reduced 5,000 14,400 Total Benefits 20,000 Total Costs 19,400 Net Benefit a) (5 pts.) Suppose you inherent some farm land. Your spouse wants you to plant native grasses and let the land return to prairie, because It won t cost us anything. Briefly explain opportunity cost in this context. The opportunity cost here is the value given up rent from using the land for prairie as opposed to renting it out or planting a crop your self or enrolling it in CRP or similar conservation program. 2 b) (5 pts.) Briefly describe two different methods we discussed in class for determining machinery costs for budgeting purposes. Economic engineering approach or adjusting custom rates 1

2 3) (28 pts.) These questions concern federal agricultural programs discussed in class. a) (4 pts.) What triggers Direct Payments to farmers enrolled in commodity programs? There is no trigger for DP s. If you are enrolled and have Base Acres, you will receive a DP. b) (4 pts.) What triggers Counter Cyclical Payments to farmers enrolled in commodity programs? If the national marketing year average price for the crop falls below the CCP trigger, which is the target price minus the direct payment (DP) payment rate. c) (4 pts.) What triggers Loan Deficiency Payments to farmers enrolled in commodity programs? If the posted county price on the day you decide to pay back your marketing assistance loan is less than the loan rate. d) (4 pts.) What triggers ACRE Payments to farmers enrolled in commodity programs? If the actual state revenue is less then ACRE State Revenue Guarantee and the actual farm revenue is less than the ACRE Farm Revenue Guarantee. e) (5 pts.) Which program or programs make payments using Base Acres and Payment Yields? DP, CCP and ACRE. (MAL/LDP payments are based on the number of bushels enrolled in the program, not base acres.) f) (3 pts.) Which USDA Agency should farmers contact to learn about and to enroll in federal commodity programs such as ACRE and Loan Deficiency Payments? The USDA-Farm Service Agency (FSA), with offices located in each county. g) (3 pts.) Which USDA Agency should farmers contact to learn about and to enroll in federal disaster assistance programs such as SURE? The USDA-Farm Service Agency (FSA), with offices located in each county. h) (3 pts.) Who do farmers buy crop insurance from? Private crop insurance company. 4 a) (8 pts.) For each type of crop insurance policy below, indicate whether it is an individual or area-wide (county) policy and whether it is a yield or revenue policy. i) Crop Revenue Coverage (CRC): Individual revenue insurance ii) Actual Production History (APH): Individual yield insurance iii) Group Risk Income Plan (GRIP): Area-wide revenue insurance iv) Group Risk Plan (GRP): Area-wide yield insurance 4 b) (12 pts.) Consider individual crop insurance. i) What is meant by the coverage level? The coverage level is the percentage of the unit s average yield (revenue) that the famer chooses for his/her yield (revenue) guarantee. Available levels are 5-0% to 85% in 5% steps. 100% minus the coverage level is essentially equivalent to the deducible for the farmer. ii) What triggers an indemnity payment for yield insurance? Actual harvested yield below the yield guarantee. 2

3 iii) What triggers an indemnity payment for revenue insurance? Actual revenue below the revenue guarantee, where actual revenue is the unit s actual harvested yield times the official CRC harvest price, which is derived from the CBOT futures contracts. Note that the price is not the actual price the famer receives from selling the grain (they are not required to sell the grain, bit can feed it to their livestock). 5 a) (5 pts.) You invest $20,000 in your sister s farm to help her get started. She will pay back the $20,000 in 5 years plus 5% interest compounded annually. How much will she owe you? 20,000( ) 5 = $25, b) (5 pts.) How much money must be invested today earning a 4% interest rate compounded annually to have $4,000 in 4 years? 1 4,000 = $3, ( ) 4 5 c) (5 pts.) You have a field worth $3,000/ac if you sell it today. If you wait 2 years, you are confident you can sell it for $4,000/ac. Think of holding the land as an investment. What is the rate of return on holding the land expressed as an annually compounded interest rate? 4,000 3,000 1/2 1 = 15.47% 6 a) (15 pts.) What is the net present value (NPV) for a ginseng garden that costs $3,000 to plant in year 1, then costs $500 in years 2 and 3, and then generates a net return of $10,000 in year 4? Assume a 12% discount rate. Fill in the Present Value column in the table below. Show your work for potential partial credit. Year Net Return Present Value 1 Formula to use PV = FV 1-3,000-2, (1 + r) t PV 1 = -3,000/(1.12) 1 = -$2, PV 2 = -500/(1.12) 2 = -$ ,000 6, PV 3 = -500/(1.12) 3 = -$ NPV 2, PV 4 = 10,000/(1.12) 4 = $6, NPV is the sum of the PV s = = $2, If you assume the first year is year zero, then you get Year Net Return Present Value 1-3,000-3, ,000 7, NPV 3, PV 1 = -3,000/(1.12) 0 = -$3,000 PV 2 = -500/(1.12) 1 = -$ PV 3 = -500/(1.12) 2 = -$ PV 4 = 10,000/(1.12) 3 = $7, NPV: sum the PV 6 b) (5 pts.) What is the annuity equivalent to the time varying returns from the ginseng garden? 1 1 The annuity factor formula is K = 1 t r (1+ r), so that the annuity is C = NPV/K. Show your work for potential partial credit. 3

4 1 1 K = ( ) = Annuity is then 2,922.12/ = $962.06, or if you assume the first year is year zero, then the annuity is then 3,272.78/ = $1, ) (11 pts. total) You are deciding the seeding rate for your corn. This table gives the seeds planted per acre (1000 s of seeds per acre) and the yield (bu/ac). Seeds (1,000 s) Yield (bu/ac) Marginal Product Value of Marginal Product $ $ $1.33 a) (5 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 = Change in Q divided by change in X = ( ) / (33 30) = 1.00 b) (5 pts.) Corn sells for $4/bu. 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 = Price x MP = 4 x 1 = $4 c) (5 pts.) If the cost of seed corn is $2 for 1,000 seeds, what is the profit maximizing seeding rate based on the table above? Optimum is where VMP = price of the input, which here occurs between $2.67 and $1.33. the average of $2.67 and $1.33 is $2, so use the simple average of the input levels and get an optimal seed density of 0.5( ) = 37.5 thousands or 37,500 seeds per acre. 8) (10 pts. total) The table below reports the cost ($/yr) of producing specialty turkeys (lbs/yr) for Tubby Tom s Terrific Turkeys for making specialty turkey products. Turkey (lbs) Fixed Cost Variable Cost Total Cost Marginal Cost 2,125 1,000 6,875 7, ,400 1,000 8,250 9, ,629 1,000 9,625 10, ,800 1,000 11,000 12, a) (6 pts.) Use 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 = = $7.875 MC = change in total cost TC divided by change in output Q MC = ( ) / ( ) = $5.00 b) (4 pts.) If Tubby Tom s pays $6.00/lb for turkeys, what is the profit maximizing amount of turkeys to produce for Tubby Tom s? Price equal MC identifies the optimal output Q, which here occurs at 2,626 lbs of turkey. 9) (10 pts) Assume lima bean yield is determined by this function: Y = 1 + 2P 0.02P 2, where Y is yield (ton/ac) and P is applied phosphorus (lbs/ac). If the price of lima beans is $25/ton and 4

5 the price of applied phosphorus fertilizer is $0.80/lb, what is the profit maximizing amount of phosphorus fertilizer to apply? Don t forget to check the Second Order Condition. π = output price x yield as a function of phosphorus input price x phosphorus π = 25(1 + 2P 0.02P 2 ) 0.80P FOC: dπ/dp = 25(2 0.04P) 0.8 = 0 Solve FOC: simplify FOC: 50 1P = 0.8, or = P, so P = 49.2 lbs SOC: d 2 π/dp 2 must be negative. d 2 π/dp 2 = 25(0.04) = 1 < 0, so passes SOC 10) (10 pts. total) You buy a truck for $90,000 that you plan to use for 3 years. For this questions, calculate annual depreciation of the truck assuming a $0 salvage value. a) (5 pts.) Fill in the table using Straight Line Depreciation. Show your work for potential partial credit. Year Depreciation During Year Value at Year End Formula 1 30,000 90,000 30,000 = 60,000 Depreciation per year = (Initial cost 2 30,000 60,000 30,000 = 30,000 Salvage Value)/Useful Life 3 30,000 30,000 30,000 = 0 D = (90,000 0)/3 = 30,000 b) (5 pts.) Assume you deducted the depreciation reported above from your ordinary income on your Schedule F each year. You sell the truck in year 4 for $30,000 (not the $0 salvage value). Do you pay ordinary income tax, self-employment tax, and/or capital gains tax on this $30,000? In other words, what taxes are paid (if any) on depreciation recapture? Depreciation recapture is subject to only income tax, not self employment or capital gains taxes. c) (5 pts.) Below is the IRS depreciation table for an asset with 7-year recovery period using the half year convention. Calculate depreciation for this truck to claim for income tax purposes for year 3 and year 8, based on the table below: Depreciation Year Rate % % % Year 3: 15.03% x 90,000 = $13, % % % % % Year 8: 6.13% x 90,000 = $5,517 11) (5 pts.) Briefly explain the limited liability that owners of a Limited Liability Company (LLC) typically have as a result of using this form of business arrangement rather than the other business arrangements (partnership, corporation, and sole proprietorship) discussed in class. 12) (15 pts. total) Jack and Kate own a farm, with all assets owned as marital property under Wisconsin s marital property law. Jack and Kate bought land years ago for $250,000, but currently it has a fair market value of $550,000. Give a brief explanation for each answer. a) (5 pts.) Suppose Jack and Kate sell the land to their son Sawyer for $550,000. 5

6 i) How much gain would Jack and Kate have to report on their income tax return? Their gain is the sale price minus the basis (original purchase price), or Gain = 550, ,000 = $300,000 ii) What is Sawyer s basis for the land? His basis is the price he paid for the land, or $550,000 b) (5 pts.) Suppose Jack and Kate give the land to son Sawyer and Jack and Kate have used none of their lifetime gift tax exclusions on previous gifts. i) How much gift taxes would they have to pay on their gain in the land? None, as the value of their gift would be less than the total of their lifetime exclusions. ii) What is Sawyer s basis for the land? The basis transfers with the gift, so it would be the same basis as his parents had, or the original purchase price of $250,000. c) (5 pts.) Suppose Kate dies and then Jack gives the land to their son Sawyer. i) After Kate dies, what is Jack s basis in the land? At death of spouse, basis automatically updates to the fair market value, which here is $550,000. ii) What is Sawyer s basis for the land? The basis transfers with the gift, so it would be the same basis as his father had after Kate died, so $550, ) (20 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/ /31/2007 Current Assets 120, ,000 Current Liabilities 80,000 70,000 Non-Current Assets 530, ,000 Non-Current Liabilities 350, ,000 Total Liabilities 430, ,000 Equity 220, ,000 Total Assets 650, ,000 Total Liabilities and Equity 650, ,000 a) (5 pts.) What is the Current Ratio on 12/31/2008? CR = 120,000 / 80,000 = 1.5 b) (5 pts.) What is the Debt to Asset Ratio on 12/31/2008? D:A Ratio = 430,000 / 650,000 = INCOME STATEMENT 12/31/2006 to 12/31/2007 Crop and Livestock Sales 400,000 Operating Expenses 300,000 Interest Expenses 25,000 Net Farm Income from Operations 75,000 c) (10 pts.) Assume the farm family paid themselves $50,000 for their labor & management. i) What is this farm s Return on Assets? ROA = NFIfO + Interest Unpaid Labor & Mgmt ROA = 75, ,000 50,000 = 50,000 ii) What is this farm s Rate of Return on Assets? ROROA = ROA/Average Assets ROROA = 50,000 / [½(650, ,000)] = 8.0% 6