FOREST RESOURCE ECONOMICS

CHAPTER II. TIMBER PRODUCTION ECONOMICS

Ha/NLU-Econ/Forest resource economics/lecture notes

I. Financial objective for timber production

• In timber production, the time aspect needs to be considered.

• The question is when to harvest the timber plot (e.i determine the
optimal rotation for timber production),
• The rotation ages not only can but always be changed to suit the
changing objectives of management,
• The problem of rotation determination is a problem in capital
theory,
• Two important issues: investment and financial objectives of the
firm.
• Forest growing stock is forest capital, and the question of
howmuch capital should be invested for how long a time is an
important one to timer production economics.
I. Financial objective for timber production

I. Time is a factor in timber production

• Time will be treated as an explicit input in timber production.
• All other inputs are assumed to be fixed, if the amount of time
increases, the total production of timber increased.
• The biological production function of a timber species is
illustrated as follows:
I. Financial objective for timber production

Average product (AP)

• The average product is derived by dividing the total physical
product by the corresponding input (time in this case) .
• AP = TP/T
• In forestry this is also called Mean Annual Increment (MAI).
I. Financial objective for timber production

Marginal product (MP)

• The change in total product with respect to a change in one input
is called marginal product (MP), other factors re held constant
(ceteris paribus).
MP = ΔTP/ΔT
• For a very small change in T it becomes:
MP = ∂TP/∂T
• When time is the input and is kept in unit of one year, foresters
called this current annual increment (CAI).
I. Financial objective for timber production

The relationship between TP, MP, AP:

I. Financial objective for timber production

To decide when to cut the stand, we have to consider the

revenues and costs of growing that wood crops at certain age.
• By transforming the physical product and inputs into monetary
terms we have revenues and costs.
•Revenue presented in (price x yield) at certain age.
•Price usually varied with diameter or kind of products we are going
to produce. There are some differences in price of different products
but assume that price P to be the same.
TR=P. Y
TR: Total revenue
P: price
Y: yield
I. Financial objective for timber production
Cost:
• In timber production, some expenditure occurred not at the same
time.
• Accumulate the expenditure over the years do not cover all
costs. The cost with time needs to be considered.
• In most economic analysis of production, the time cost is
ignored. But in timber production, time is one of the chief inputs
and overlook time in a timber production analysis would be a
serious oversight.
• The difference between total cost and accumulated expenditure
is the interest charge.
• The consideration of time is actually the process of comparing
revenues and costs that occur at different point in time.
I. Financial objective for timber production
Cost and revenue in timber production:
Approches for determining rotation age
1. Use of Net Present Worth (NPW) or Net Present Value
(NPV)
2. Use of soil expectation value (SeV)
3. Internal Rate of Return (IRR)
4. Forest rent
5. Financial maturing.
 Net Present Worth (NPW)

Where:
• Rt: Revenue received at time t.
• Ct: Cost incurred at time t
• R: Rotation age
• i: interest rate
• T: time in year (with t=0 is the present )
(PNW gives the same result ad NPV)
 Soil (or land) expectation Value

Where:
• Rt: Revenue received at time t.
• Ct: Cost incurred at time t
• R: Rotation age
• i: interest rate
• T: time in year (with t=0 is the present )
 Internal Rate of Return

Where:
• Rt: Revenue received at time t.
• Ct: Cost incurred at time t.
• R: Rotation age.
• IRR: Internal Rate of Return.
• T: time in year (with t=0 is the present ).
 Forest Rent (FR):

• Forest rent is the term given to the average annual net revenue
when net revenue is defined as total (gross) revenue less total
cash outlay (or total revenue minus all costs except interest
charges)
• Dividing this net revenue by the corresponding age give the
average annual net revenue or forest rent.
FR = Average annual net revenue = Net revenue
Age
Forest Rent (FR):
 Forest Rent (FR):

• The rotation of maximum forest rent may be found by

determining the point of tangency between a line drawn from the
origin to the net revenue curve (Point A)

Optimal rotation age

 Financial Maturity:
• Used to determine when timber is 'financial mature“.
• If the rate of return from the stand equal to the available
alternative rate of return on investment capital (instead of to the
percent change in costs), the stand is said to be "financial
mature" .
• To calculate the rate of return from a forest stand the expected
change in market value during the selected period is divided by
the market value at the beginning of the period, then normally
reduced to the corresponding one-year rate.
 Financial Maturity:

Optimal rotation age

• Alternative rate of return is the opportunity cost of capital to the owner of a

timber stand. If the best of the alternative to him is putting in the bank for
earning interest rate, then the interest rate becomes the opportunity cost of
investing in timber production (timber growth).
• The actual costs of timber production are not specifically brought into the
analysis.
 Comparing the objectives:
PNW and SeV:
• SeV is simply the Present Net Worth of an infinite series of
periodic incomes.
• The Present Net Worth calculations consider income from only
one rotation, while SeValues are derived from incomes extending
over an infinitely long succession of identical rotations.

SeV and Financial maturity:

• In financial maturity approach, costs were not specifically brought
into the picture.
• Obmission of two cost items (annual costs and the value of
successive rotations) leads to a difference between rotations
determined by SeV and Financial Maturity approaches.
 Comparing the objectives:
Forest rent:
• Forest rent calculation give the same result as an SeV
calculation if interest rate were zero.
• Forest rent was found to be an objectively inappropriate to
modern forestry.
• Maximization of soil expectation value, present net worth, or
internal rate of return still remain possible ojectives.
II. FACTORS AFFECTING ROTATION LENGTHS
1. Impact of growth factors
2. Impact of changing product prices
3. Sites
4. Silviculture imputs
5. Interest rates
6. Taxes
7. Impact of uncertainty
 II. FACTORS AFFECTING ROTATION LENGTHS
IMPACT OF GROWTH FACTORS
• Growth facors: such as site, spacing, species, etc.
• In timber production, diferent species have different growth
curves and therefore different rotation lengths.
• One possible effect on optimum imvestment time of sustituting a
faster growing species or strain.
II. FACTORS AFFECTING ROTATION LENGTHS
IMPACT OF GROWTH FACTORS
 II. FACTORS AFFECTING ROTATION LENGTHS
IMPACT OF GROWTH FACTORS
• Optimal rotation age of Species 2 (With higher growth rate)
is longer than species 1.
 II. FACTORS AFFECTING ROTATION LENGTHS
Effect of changing product prices
• The increase in product price will shift the total revenue curve
upward.
• With trees the value per unit of volume usually increases as tree
diameter increases.
• Under given cost situation, each unit value increase tends to
lengthern the desirable investment period.
II. FACTORS AFFECTING ROTATION LENGTHS
Effect of Sites
• Different sites give different production function
• If price is constant, total revenue increased with higher yield from
beter sites.
• Assuming costs do not vary with site, improved site will usually
lenthern the rotation age.

• Note: if an increase in silviculture inputs costs, one can no longer be sure that the
lengths of rotation age will be lengthened on better sites for (other things being
equal) increasing costs lead to shorter rotation length.
 II. FACTORS AFFECTING ROTATION LENGTHS
Silviculture inputs
• Many sivicultural activities in timber production can affect either
the amount or the timming of revenues and costs.
• Does the change in discounted revenues produced by
silvicultural measures more than offset the change in discounted
cost?
• Since such operations can affect either costs or revenues or
both, the length of the investment period may also be affected.
• Example: thinning.
• May lengthern or shorten rotation age.
 II. FACTORS AFFECTING ROTATION LENGTHS
Changing interest rate
• The effect of increasing interest rates is best seen from the
curves of discounted cost and revenue.
• With increasing interest rates, total cost rise faster and
discounted revenue moves to the left. Hence higher interest
rates lead to shorter rotation age.
 Effect of taxes
The property taxes:
• With property tax, the rotation age willl be shorter as compared
with no property tax.
• The discounted total cost curve vill rise more rapidly with an
increase in the tax level.
• Since the tax effect is always to increase the slop of the cost
curve, rotation age will be shortened.
 Effect of taxes
Yield tax:
• A yield tax usually reduces total revenue by some constant
percentage.
• Since the slope of the revenue curve is reduced (with a yield
tax), while costs are unchanged, the yield tax tend to shorthern
the rotation age.
 II. FACTORS AFFECTING ROTATION LENGTHS
Effect of uncertainty
 II. FACTORS AFFECTING ROTATION LENGTHS
Effect of uncertainty
• The most important effect of time on timber production comes
through the uncertainty that is associated with future happening.
• The calculation of optimal rotation age is based on forecast of
future costs, timber prices and yield.
• The accuracy in the determination of rotation age is therefore
depends on the accuracy of the forecast of future costs, timber
prices and yield.
• There are uncertainty in the prediction of the level of costs,
timber prices and yield in the future. This would result in the
'band' of possible yields, revenue and cost.