A. Crop Share Vs. Cash Rent Lease Analysis

Econ 230Name______

Lab #9Section: 9:00 _____ 10:00_____

Spring 2010

Lease and Land Purchase Analysis

(Due Monday, March 22, 2010)

The purposes of this lab are to (1) compare the cost of cash and crop share leasing, (2) estimate the maximum cash rent that you can afford to pay, (3) estimate the economic value of farm land based on its projected future earnings, and (4) look at the cash flow implications of financing a land purchase. You will need your FarmSim printouts from years 4, 5 and 6.

A. Crop Share Vs. Cash Rent Lease Analysis

Use information from your FarmSim Operation for years 4, 5 and 6 to compare how much it actually cost (or would have cost) you to rent land under a crop share lease compared to a cash lease. The cost of a crop share lease is:

(1) the value of the land owner's share (50%) of the gross income, minus

(2) the value of the land owner's share (50%) of the input costs (seed, fertilizer, pesticides and drying).

Note--If you did not grow any corn or soybeans in some year, leave that column blank. If you did grow a crop, but did not sell any, use the following prices given below. Include only corn for grain, not silage.

11.In what type of year (under what conditions) would you expect a crop share lease to be less expensive than a cash lease? More expensive?

12.Which type of lease arrangement would you consider the most risky for the tenant and why?

B. Maximum Cash Rent Analysis

Estimate your added income and added costs from cash renting additional land, assuming it is identical to the land you already own.

C. Value of Land (income capitalization approach)

The net income that could be earned from renting land would also be available if you purchased the land. You would not have to pay cash rent, but you would have to pay property taxes. Assume property taxes are $20 per acre.

1. Net income per acre from additional land rental$______/acre

1. Property taxes$______/acre

1. Equals added net income from land purchase$______/acre

Since the expected useful life of land is unlimited, the present value can be found by simply dividing the annual added net income from the land by the real discount rate. A portion of the cost of investments in fixed assets like farm land is offset by appreciation in value over time. To account for this we can subtract the expected rate of inflation from the discount (or interest) rate to get a "real" discount rate.

1. Long-term interest rate 7%

Expected rate of inflation in land values 3%

Real discount rate______

1. Present Value of Land: $ ______(Addl net income from land) ÷ ______(Real discount rate) = $_____ /acre.

D. Value of Land (comparative values)

Another method of estimating the value of land is by comparison with the sale price or valuation of other similar land. Find the current market value of your land (420 acres) from your Year 6 Net Worth Statement in FarmSim.

$______per acre

Based on information from parts C and D, how much would you bid for land? $ _ per acre

E. Financing

You can obtain credit for a land purchase from the First State Bank. Determine the payments in the first four years of a loan. Use your estimated bid for land. Payments are based on the even principal payment method, also called the decreasing total payment method. Terms are:

• Maximum of 75% of purchase price, financed for 25 years
• Variable interest rate on outstanding principal (use an expected average rate of 8%).

Note: You may finance less than the maximum if you wish, or you may finance more by refinancing your present land to obtain down payment money.

1. Calculate the payments for the first 4 years, in $ per acre, and enter them below. Remember, interest is charged on the principal remaining from the previous year. Page 354 in your textbook has an example.

1. Do you project that a land purchase will create a cash surplus or a cash deficit in years 7-10?

1. Where could you obtain cash to make up the cash flow deficit, if there is one?

F. Land Auction Instructions

1. 10,000 acres will be offered for sale in 100 parcels of 100 acres each. A separate bid may be made on each 100-acre parcel.
2. Minimum acceptable bid is $3,000 per acre.
3. Higher bids must be in increments of at least $100 per acre.
4. Land will be awarded to the highest bidder on each parcel.
5. You may submit as many bids as you wish. Be sure to put your Farmsim farm number and signature on each bid.
6. The land auction will close at 2:00 p.m. on Friday, March 26, 2010. The bid sheet will be posted on the bulletin board outside 174 Heady Hall.