Question

You own forest land in California. You estimate that California’s forest practice regulations will impact you financially in the following ways:

-Cost of a forest management plan is $100 per acre, to be obtained immediately.

-Additional harvesting cost to comply with the regulations: $250 per acre.

-Value of timber left standing after harvest to comply with regulations: $700 per acre.

-You plan to conduct two timber harvests: one five and another eight years from now.

-Your opportunity cost (in real terms) is 6 % per year.

Assume the additional harvesting cost ($250/ac) and value of timber left standing ($700/ac) are both incurred each time a timber harvest is conducted. What is the present value of the additional costs of California’s forest practice regulations?

Answer 1

The following assumptions are taken to arrive at the solution:-

1.Opportunity cost has to be taken as a discounting factor to arrive at the present value

2. Cost of forest management is an immediate expenditure i.e at the year beginning.

Present Value (PV) Formula

PV = Cash flow / Discounting factorⁿ

where cashflow = 950 every year end

discounting factor = 6%

n = number of years = 5 and 8

For 5 Years

PV = 950 / (1.06)¹ + 950 / (1.06)² + 950 / (1.06)³+ 950 / (1.06)⁴ + 950 / (1.06)⁵

PV = 896.23 + 845.50 + 797.64 + 752.49 + 709.90

PV = 4001.75

For 8 years

PV = 950 / (1.06)¹ + 950 / (1.06)² + 950 / (1.06)³+ 950 / (1.06)⁴ + 950 / (1.06)⁵ + 950 / (1.06)⁶ + 950 / (1.06)⁷+ 950 / (1.06)⁸

PV = 896.23 + 845.50 + 797.64 + 752.49 + 709.90 + 669.71 + 631.80 + 596.04

PV = 5899.30