Bunyan Lumber, LLC Closing Case: When should the company harvest the forest?
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Bunyan Lumber, LLC, harvests timber and delivers logs to timber mills for sale. The company was founded 70 years ago by Pete Bunyan. The current CEO is Paula Bunyan, the granddaughter of the founder. The company is currently evaluating a 7,500-acre forest it owns in Oregon. Paula has asked Steve Boles, the company's finance officer, to evaluate the project. Paula's concern is when the company should harvest the timber.
Lumber is sold by the company for its "pond value." Pond value is the amount a mill will pay for a log delivered to the mill location. The price paid for logs delivered to a mill is quoted in dollars per thousands of board feet (MBF), and the price depends on the grade of the logs. The forest Bunyan Lumber is evaluating was planted by the company 20 years ago and is made up entirely of Douglas fir trees. The table below shows the current price per MBF for the three grades of timber the company feels will come from the stand:
Timber Grade Price Per MBF
1P $1,150
2P $ 990
3P $ 840
Steve believes that the pond value of lumber will increase at the inflation rate. The company is planning to thin the forest today, and it expects to realize a positive cash flow of $1,200 per acre from thinning. The thinning is done to increase the growth rate of the remaining trees, and it is always done 20 years following a planting.
The major decision the company faces is when to log the forest. When the company logs the forest, it will immediately replant saplings, which will allow for a future harvest. The longer the forest is allowed to grow, the larger the harvest becomes per acre. Additionally, an older forest has a higher grade of timber. Steve has compiled the following table with the expected harvest per acre in thousands of board feet, along with the breakdown of the timber grade.
Years from today to Harvest (MBF) Timber Grade
begin harvest per acre 1P 2P 3P
20 6 10% 40% 50%
25 8.2 13 46 41
30 9.4 17 48 35
40 10.5 19 51 30
The company expects to lose 5 percent of the timber it cuts due to defects and breakage.
The forest will be clear-cut when the company harvests the timber. This method of harvesting allows for faster growth of replanted trees. All of the harvesting, processing, replanting, and transportation are to be handled by subcontractors hired by Bunyan Lumber. The cost of the logging is expected to be $160 per MBF. A road system has to be constructed and is expected to cost $60 per MBF on average. Sales preparation and administrative costs, excluding office overhead costs, are expected to be $21 per MBF.
As soon as the harvesting is complete, the company will reforest the land. Reforesting costs include the following:
Per Acre Cost
Excavator piling $160
Broadcast Burning 305
Site Preparation 155
Planting costs 240
All costs are expected to increase at the inflation rate.
Assume all cash flows occur at the year of harvest. For example, if the company begins harvesting the timber 20 years from today, the cash flow from the harvest will be received 20 years from today. When the company logs the land, it will immediately replant the land with new saplings. The harvest period chosen will be repeated for the foreseeable future. The company's nominal required return is 10 percent, and the inflation rate is expected to be 3.7 percent per year. Bunyan Lumber has a 35 percent tax rate.
Clear-cutting is a controversial method of forest management. To obtain the necessary permits, Bunyan Lumber has agreed to contribute to a conservation fund every time it harvests the lumber. If the company harvested the forest today, the required contribution would be $250,000. The company has agreed that the required contribution will grow by 3.2 percent per year.
Question: When should the company harvest the forest?
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To determine when Bunyan Lumber should harvest the forest, we need to calculate the net present value (NPV) of each possible harvest period and choose the one with the highest NPV. The NPV is a measure of the profitability of an investment, taking into account the time value of money.
Here are the steps to calculate the NPV for each harvest period:
1. Estimate the cash flows for each period:
- Calculate the harvest per acre for each timber grade using the table provided.
- Multiply the harvest per acre by the price per MBF for each timber grade to get the revenue from timber sales.
- Subtract the expected loss of 5% due to defects and breakage from the revenue to get the net revenue from timber sales.
- Calculate the cash flow from thinning, which is the positive cash flow of $1,200 per acre.
- Calculate the reforesting costs per acre.
- Subtract the costs from the net revenue and add the cash flow from thinning to get the total cash flow for each period.
2. Calculate the present value of each cash flow:
- Discount each cash flow using the company's nominal required return of 10% to account for the time value of money.
- Apply the inflation rate of 3.7% per year to all costs and revenues to adjust them to future values.
- Use the formula: Present Value = Cash Flow / (1 + Discount Rate)^Number of Years
3. Calculate the NPV for each period:
- Add up the present values of all cash flows for each period.
- Subtract the required conservation fund contribution from the NPV.
4. Choose the harvest period with the highest NPV:
- Compare the NPVs calculated for each period.
- Select the period with the highest NPV as the optimal harvest time for the company.
By following these steps, you should be able to calculate the NPV for each possible harvest period and determine when Bunyan Lumber should harvest the forest.