Financial Analysis of
Timber Investments
Financial Analysis of Timber Investments
1,MODERN FINANCIAL ANALYSIS
OF TIMBER INVESTMENTS
2,EVOLUTION OF TIMBERLAND AS
AN ASSET CLASS
3,CONCLUSION
MODERN FINANCIAL ANALYSIS
OF TIMBER INVESTMENTS
? Capital Budgeting Techniques
? Capital Asset Pricing Model
? Timber Investment Analyses Using CAPM
and Capital Budgeting Techniques
? Timber Investments and the Efficient
Frontier
? Timber Investments and Option Pricing
Capital Budgeting Techniques
?The most often used capital budgeting
criteria for forestry investments are the
net present value (NPV),land expectation
value (LEV),and internal rate of return
(IRR).
Capital Budgeting Techniques
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? The NPV converts a series of periodic income flows to a
single number that can be used to compare mutually
exclusive investment alternatives over the same investment
horizon at a given discount rate.
? A positive NPV would be accepted an investment if enough
capital were available,If negative,one would reject that
investment,
Capital Budgeting Techniques
? The LEV calculates the present value of an infinite
series of projects (rotations).
? LEV is applied just like NPV in making investment
decisions,with positive LEVs inferring investment
acceptability and negative LEVs suggesting project
rejection,
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Capital Budgeting Techniques
The IRR is defined as that discount rate
that equates the present value of the
benefits with the present value of the cost.
Bt=a benefit at time t,i=annual discount rate,Ct=a
cost at time t,T=lifetime of project or rotation
length.
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?
?
? ???
T
t
tt
T
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Capital Asset Pricing Model
?The traditional finance and relatively
new forestry literature provides
various overviews of the capital asset
pricing model (CAPM) and its
applications to forestry.
Capital Asset Pricing Model
Rat=nominal rate of return of asset a in
time t,Rft is the nominal rate of return of
risk-free asset in time t,Ba is the index of
nominal nondiversifiable risk of asset a,
Rmt is the nominal rate of return of the
market portfolio in time t,and E is the
expected value operator.
)()( ftmtaftat RRERRE ??? ?
Timber Investment Analyses Using CAPM
and Capital Budgeting Techniques
? Wagner et al.(1995) analyzed typical
forestry investments using capital budgeting
techniques.
? DeForest et al.(1991) showed that timber
assets would be useful to add as a moderate
component of a portfolio in order to
enhance overall risk/return performance by
CAPM.
Timber Investments and the
Efficient Frontier
?The efficient frontier is used primarily to
make strategic asset allocation decisions
at the portfolio level.
?An inferior,or inefficient,portfolio is one
dominated from a risk/return perspective
by at least one other portfolio.
Timber Investments and the
Efficient Frontier
?Markowitz demonstrated how to map
out all risk /return efficient portfolios.
?Sharpe(1964) derived the CAPM using
the efficient frontier as a building block,
Timber Investments and the
Efficient Frontier
? When timberland is included as an asset
class alternative,the efficient frontier of
portfolios that maximizes expected return
for a given level of risk shifts upward.
? The standard portfolio is defined as one with
the following asset mix,60% large
capitalization common stocks,30%
corporate bonds,and 10% Treasury bills.
Timber Investments and
Option Pricing
?Financial economists have
developed models such as
the Black-Scholes option
pricing model and the
binomial option pricing
model to value traded
options.
EVOLUTION OF TIMBERLAND
AS AN ASSET CLASS
? the enactment of the Employee Retirement
Income Security Act by the U.S,Congress
in 1974
? The launch of the first pooled timberland
fund for institutional investors in 1981
? The symbiotic relationship between
institutional investors and forest products
companies
EVOLUTION OF TIMBERLAND
AS AN ASSET CLASS
? Some of the TIMOs allocated a portion of the
funds provided by institutional investors to
timberland outside of the United States.
? Financial economists developed agency theory
to analyze these conflicts of interest.
CONCLUSION
? Accurate historical measures of losses from
natural perils so that a greater variety of
insurance products can be developed.
? Analysis of the relationship of timberland
returns to those generated by other alternative
assets such as private equity,oil and gas,
managed commodities,and hedge funds.
? The assessment of timberland returns relative
to pricing factors other than the market risk of
the CAPM,
Timber Investments
Financial Analysis of Timber Investments
1,MODERN FINANCIAL ANALYSIS
OF TIMBER INVESTMENTS
2,EVOLUTION OF TIMBERLAND AS
AN ASSET CLASS
3,CONCLUSION
MODERN FINANCIAL ANALYSIS
OF TIMBER INVESTMENTS
? Capital Budgeting Techniques
? Capital Asset Pricing Model
? Timber Investment Analyses Using CAPM
and Capital Budgeting Techniques
? Timber Investments and the Efficient
Frontier
? Timber Investments and Option Pricing
Capital Budgeting Techniques
?The most often used capital budgeting
criteria for forestry investments are the
net present value (NPV),land expectation
value (LEV),and internal rate of return
(IRR).
Capital Budgeting Techniques
??
?
?
?
? ????
T
t
tt
T
t
tt iCiBN P V
00
)1()1(
? The NPV converts a series of periodic income flows to a
single number that can be used to compare mutually
exclusive investment alternatives over the same investment
horizon at a given discount rate.
? A positive NPV would be accepted an investment if enough
capital were available,If negative,one would reject that
investment,
Capital Budgeting Techniques
? The LEV calculates the present value of an infinite
series of projects (rotations).
? LEV is applied just like NPV in making investment
decisions,with positive LEVs inferring investment
acceptability and negative LEVs suggesting project
rejection,
T
T
t
tt
T
t
tt
i
iCiB
L E V
?
?
?
?
?
??
???
?
??
))1(1(
)1()1(
00
Capital Budgeting Techniques
The IRR is defined as that discount rate
that equates the present value of the
benefits with the present value of the cost.
Bt=a benefit at time t,i=annual discount rate,Ct=a
cost at time t,T=lifetime of project or rotation
length.
??
?
?
?
? ???
T
t
tt
T
t
tt I R RCI R RB
00
)1()1(
Capital Asset Pricing Model
?The traditional finance and relatively
new forestry literature provides
various overviews of the capital asset
pricing model (CAPM) and its
applications to forestry.
Capital Asset Pricing Model
Rat=nominal rate of return of asset a in
time t,Rft is the nominal rate of return of
risk-free asset in time t,Ba is the index of
nominal nondiversifiable risk of asset a,
Rmt is the nominal rate of return of the
market portfolio in time t,and E is the
expected value operator.
)()( ftmtaftat RRERRE ??? ?
Timber Investment Analyses Using CAPM
and Capital Budgeting Techniques
? Wagner et al.(1995) analyzed typical
forestry investments using capital budgeting
techniques.
? DeForest et al.(1991) showed that timber
assets would be useful to add as a moderate
component of a portfolio in order to
enhance overall risk/return performance by
CAPM.
Timber Investments and the
Efficient Frontier
?The efficient frontier is used primarily to
make strategic asset allocation decisions
at the portfolio level.
?An inferior,or inefficient,portfolio is one
dominated from a risk/return perspective
by at least one other portfolio.
Timber Investments and the
Efficient Frontier
?Markowitz demonstrated how to map
out all risk /return efficient portfolios.
?Sharpe(1964) derived the CAPM using
the efficient frontier as a building block,
Timber Investments and the
Efficient Frontier
? When timberland is included as an asset
class alternative,the efficient frontier of
portfolios that maximizes expected return
for a given level of risk shifts upward.
? The standard portfolio is defined as one with
the following asset mix,60% large
capitalization common stocks,30%
corporate bonds,and 10% Treasury bills.
Timber Investments and
Option Pricing
?Financial economists have
developed models such as
the Black-Scholes option
pricing model and the
binomial option pricing
model to value traded
options.
EVOLUTION OF TIMBERLAND
AS AN ASSET CLASS
? the enactment of the Employee Retirement
Income Security Act by the U.S,Congress
in 1974
? The launch of the first pooled timberland
fund for institutional investors in 1981
? The symbiotic relationship between
institutional investors and forest products
companies
EVOLUTION OF TIMBERLAND
AS AN ASSET CLASS
? Some of the TIMOs allocated a portion of the
funds provided by institutional investors to
timberland outside of the United States.
? Financial economists developed agency theory
to analyze these conflicts of interest.
CONCLUSION
? Accurate historical measures of losses from
natural perils so that a greater variety of
insurance products can be developed.
? Analysis of the relationship of timberland
returns to those generated by other alternative
assets such as private equity,oil and gas,
managed commodities,and hedge funds.
? The assessment of timberland returns relative
to pricing factors other than the market risk of
the CAPM,
