Pro Forma Analysis Topic Coverage 1. Definition of Pro forma analysis. 2. Alternative approaches to projecting net benefits from production and investment.

Pro Forma Analysis

Topic Coverage1. Definition of Pro forma analysis. 2. Alternative approaches to

projecting net benefits from production and investment opportunities.

3. Input to capital budgeting and valuation decisions.

PAST FUTUREPRESENT

Historical analysis

Comparative analysis

Historical price and yield trends

Pro forma analysis

Forming expectations about future prices, costs and productivity

Ad hoc extrapolations

Projections based upon available outlook data

Projections based upon econometric analysis

Point Forecast AssumptionsFarm

programpolicies

Macro-economicpolicies

Foreigntrade

policies

Globalmarketevents

Weatherand

disease

BaselineScenario

One scenario examined

What does this mean for: Crop and livestock prices? Unit input costs and farmland prices? Debt repayment capacity and credit risk? Asset valuation and collateral risk?

PE

QE

Assumes perfect knowledge of outcomes in all 5 areas!!!!

Assumes perfect knowledge of outcomes in all 5 areas!!!!

Structural Pro Forma AnalysisFarm

programpolicies

Macro-economicpolicies

Foreigntrade

policies

Globalmarketevents

Weatherand

disease

Scenario# 1

Scenario# 2

Scenario# 3

Scenario# 4

Scenario# 5

Scenario# 6

Scenario# 7

Scenario# 8

Scenario# 9

Multiple scenarios examined

D S

P

Q

Supply-side risk for a given price…

Supply-side risk for a given price…

QLQEQH

PE

Structural Pro Forma AnalysisFarm

programpolicies

Macro-economicpolicies

Foreigntrade

policies

Globalmarketevents

Weatherand

disease

Scenario# 1

Scenario# 2

Scenario# 3

Scenario# 4

Scenario# 5

Scenario# 6

Scenario# 7

Scenario# 8

Scenario# 9

Multiple scenarios examined

D S

P

Q

Demand and supply-side risk and potential price variability…

Demand and supply-side risk and potential price variability…

QLQEQH

PH

PE

PL

Ad Hoc Modeling Approaches

?

Naïve model – using last year’s prices, costs and yields

Simple linear trend extrapolation of historical prices, costs and yields

Using assumptions made by others

Econometric Model Approach

?Capturing future

supply/demand impacts on prices and unit costs

Linkages to commodity policy

Linkages to domestic economy

Linkages to the global economy

Historical Data on Fixed Input Sales to Producers

2000 2001 2002 2003 2004 2005 2006

Timeline Required for Capital Budgeting…

Assume it is the year 2000 and John Deere wants to project farm machinery and equipment sales over the next six years to determine if plant expansion is necessary.

2000 2001 2002 2003 2004 2005 2006

Timeline Required for Capital Budgeting…

Assume it is the year 2000 and John Deere wants to project farm machinery and equipment sales over the next six years to determine if plant expansion is necessary.

Capital budgeting models of investment decisions require projections of the annual farmfarm revenue and cost values over the entire 2001 to 2006 time period.

Econometric Analysis Based on Time Trend Extrapolation

IT = f(YearT)IT = f(YearT)

A linear time trend projection of future farm machinery and equipment sales therefore does a poor jobpoor job of predicting future sales activity.

A linear time trend projection of future farm machinery and equipment sales therefore does a poor jobpoor job of predicting future sales activity.

Econometric Analysis Based on Investment Theory

IT = f{[E(PT)×E(QT)]/E(cT)}IT = f{[E(PT)×E(QT)]/E(cT)}

An econometric model based on investment theory does a muchmuch better jobbetter job of predicting future sales activity.

An econometric model based on investment theory does a muchmuch better jobbetter job of predicting future sales activity.

Crop Market Model

Demand equationDemand equation::Qd = a0 - a1(Price) + ai (demand shifters)

Supply equationSupply equation::Qs = b0 +b1(price) + bi (supply shifters)

Market equilibriumMarket equilibrium::Qd = Qs

Crop Market Equilibrium

Quantity

Price

Pe

Qe

D S

Demand consists of:-Food use-Feed use-Exports-Ending stocks

Demand consists of:-Food use-Feed use-Exports-Ending stocks

Supply consists of:-Beginning stocks-Production-Imports

Supply consists of:-Beginning stocks-Production-Imports

Histogram for Wheat Prices

3.345 3.145 3.945 - .80 +.80

Wheat Projections Made in 1997

$2.00

$2.50

$3.00

$3.50

$4.00

$4.50

$5.00

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

Actual/Baseline Prolonged Asian Crisis USDA

Actual Forecast

Estimating the Annual Supply and Use of Wheat

Income elasticityIncome elasticity

Cross price elasticityCross price elasticity

Econometric Analysis – Food Use

Own price elasticityOwn price elasticity

Observed and Predicted ValuesFor Wheat Food Use

Remaining Steps to Forecasting the Price of Wheat

Develop similar econometric equations for feed use, exports and ending stock demand.

Develop econometric equations for production and import supply.

Substitute the estimated equations into the market equilibrium definition (Q(QDD=Q=QSS)) and solve for the price where excess excess demand equals zerodemand equals zero.

Crop Market Model

Demand equationDemand equation::Qd = a0 - a1(Price) + ai (demand shifters)

Supply equationSupply equation::Qs = b0 +b1(price) + bi (supply shifters)

Market equilibriumMarket equilibrium::Qd = Qs

ConclusionsEconometric models are preferred over

naïve models and linear time trend models.

Much more accurate.Provide much more information (e.g.,

elasticitieselasticities).Allow for sensitivity analysissensitivity analysis with

independent (exogenous) variables when evaluating potential variabilitypotential variability about expected trends.