Tree Values

Case 5: Tree Values

Questions to address by each group before presentations as well as during the presentations:

1) What is the appropriate discount rate to use?

My assumption would be inflation + the price increase of lumber per year.

Avg. Inflation = 3%

Avg. price increase above inflation for wood is 1-3% (we would go with 2%)

3%+2% = 5%

This is the only thing I can think of, any other thoughts for this question would be great.

2) Assume that the appropriate cost of capital is 240 basis points above the ten-year government bond rate. To calculate the cost of capital, should you add the 240 bp to a ten-year Treasury Bond that yielded 6.04% in June2000 or a ten-year Treasury Inflation Protected Security (TIPS) that yielded 4.14% in June 2007? How do you decide?

Using the TIPS would be more accurate an this instant as we don’t have the actual rate of inflation we can use the TIPS for the discount rate, the cash inflows than do not need to be adjusted for inflation and than we can just use a growth rate as the increased price above inflation. Thus we can ignore inflation as it will be adjusted by the TIPS. As a result we can get a more accurate PV.

3) What is the simple cash flow and PV for a hypothetical tree with no grade changes?

For one tree it would depend upon the size and growth. If we are assuming 2” growth in 10 years than it could be one of two values.

14” = 110 Board Feet/ Tree

16” = 180 Board Feet/ Tree

Now if we use TIPS + 240 basis point for are discount rate and the growth rate as 2% to take in consideration of the price increase of wood the cash flow will simply be $40 MBF for the growth model because the growth rate takes in consideration the increase in cash flows and the TIPS will price in inflation. Thus to calculate the value of each tree we must change the unit to 1 Board Feet as follows.

$40/1,000 = 0.0400 per Board Feet.

Now we can...