Deciding to trade

Agriculture.com Staff 03/16/2010 @ 2:59pm

A recent study by Waterstreet Solutions, a risk-management and financial consulting company in Peoria, Illinois, explains that if producers trade their machinery every seven years instead of every 5 years, over the course of 40 years, they will save more than a half million dollars. This has started a debate about when to trade machinery and the factors affecting that decision. Kevin Dhuyvetter and Terry Kastens, ag economists with Kansas State University, say there is more to look at than time when trading equipment.

Joe Delheimer, director of finance at Waterstreet says, "It goes against the grain of what we're used to doing in ag. But if farmers are going to be really successful in this volatile environment, they have to pay attention to all of the numbers. And equipment is one item on the balance sheet that can add up quickly."

Delheimer used a formula that suggests trading a combine every seven years instead of every five. Multiplying the savings over a 40-year farming career results in an extra $582,616 for the farmer who trades less often. Here's how it works.

The study begins with a $275,000 combine for the first year. If a producer trades after five years, a new combine would cost $309,515, based on a 3% increase in sticker price each year for the new machine. "By waiting to trade until year seven, you would have an older combine but an additional $7,938 in working capital for years five and six," explains Delheimer. Here is the formula:

$309,515 (cost of new machine in year 5) - $275,000 (cost of original machine) = $34,515 x 23% = $7,938.

"The newer machine is costing you $7,938 more in depreciation, fuel, and repairs for years 5 and 6," says Delheimer.

The difference is multiplied by 23% because "it is the universally accepted accounting figure to cover depreciation, fuel, and repairs," the study says. While older machines tend to have higher repair costs, their depreciation is lower. The final number in the equation is the operating savings for the year.

The study says, "Years 7, 8 and 9 show an increased cost on the seven-year rotation of $4,335 per year. That's because we're now replacing equipment in that column, and depreciation, fuel, and repairs for the newer machine will be more."

In year 10, if producers are trading equipment every five years, they will be buying a new combine at $358,813 based on the 3% increase in price. But producers who trade a combine every 7 years will have paid $328,364 in year 7.

The study continues with the same scenario for 40 years. At the end of that, the savings equals $128,644. "We take the numbers in the far right column (the positive and the negative numbers) and put them into a net cash flow projection," says Delheimer. "Really, we're putting that money into our working capital. When we have an asset as a part of our operation, we want it working for us every year and earning a minimum of 8% for us. That's our opportunity cost. Many of our clients seek an even higher return on their money through their farming businesses."

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