discounted cash flow and agricultural investment-a reply

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294 DISCOUNTED CASH FLOW AND AGRICULTURAL INVESTMENT-A REPLY K. D. COCKS Ulziversity of California, Da:sis Upton and McClements have suggested that the opportunity cost of capital, perhaps approximated as the market rate of interest, is preferable to personal discount rate in calculating the net present value of a project. Now, they may be right, because all model building is abstraction from the red world and, without empirical testing, we can only use other abstractions to validate a model. However, I prefer to think that a farmer’s time preference for consumption is not an exogenous variable determined by impersonal market forces but some- thing which he can discover by introspection. Many good farmers will tell you they can earn more at the margin in farming than in long-term bonds (say) and, that if they are going to invest rather than consume, then they certainly want to earn more than the long-money rate. Investment requires effort and, remembering inflation, it is just not worth the bother to invest (on farm) at long-money rates. As to the difficulty of introspecting, I think farmers (Australian ones anyway) are pretty smart as a group and usually have no trouble in mastering the required concept. If I may paraphrase a well-known persuasive message, “Let’s put the farmer back into farm management“. Upton and McClements offer market rates as an approximation to oppor- tunity rate. Such an approximation is inescapable if we adopt their approach because the opportunity rate is itself a function of the project chosen and, with some exceptions, cannot be calculated ex ante. This, in fact, is the objection they should have raised to my assumption of known re-investment rates, not that the re-investment project is a competitor for opening capital. It is easy to think of a project which is not feasible till some fiiture date-one requiring much capital for example. It must always be difficult to estimate re-investment rates when investments interact but that is not my problem-I’m against all “isolated project” techniques. The obvious alternative is to use dynamic linear programming and let the machine calculate the re-investment rates over all complexes of investment possibilities.

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Page 1: DISCOUNTED CASH FLOW AND AGRICULTURAL INVESTMENT-A REPLY

294

DISCOUNTED CASH FLOW AND AGRICULTURAL INVESTMENT-A REPLY

K. D. COCKS Ulziversity of California, Da:sis

Upton and McClements have suggested that the opportunity cost of capital, perhaps approximated as the market rate of interest, is preferable to personal discount rate in calculating the net present value of a project. Now, they may be right, because all model building is abstraction from the red world and, without empirical testing, we can only use other abstractions to validate a model.

However, I prefer to think that a farmer’s time preference for consumption is not an exogenous variable determined by impersonal market forces but some- thing which he can discover by introspection. Many good farmers will tell you they can earn more at the margin in farming than in long-term bonds (say) and, that if they are going to invest rather than consume, then they certainly want to earn more than the long-money rate. Investment requires effort and, remembering inflation, it is just not worth the bother to invest (on farm) at long-money rates.

As to the difficulty of introspecting, I think farmers (Australian ones anyway) are pretty smart as a group and usually have no trouble in mastering the required concept. If I may paraphrase a well-known persuasive message, “Let’s put the farmer back into farm management“.

Upton and McClements offer market rates as an approximation to oppor- tunity rate. Such an approximation is inescapable if we adopt their approach because the opportunity rate is itself a function of the project chosen and, with some exceptions, cannot be calculated ex ante. This, in fact, is the objection they should have raised to my assumption of known re-investment rates, not that the re-investment project is a competitor for opening capital. It is easy to think of a project which is not feasible till some fiiture date-one requiring much capital for example. It must always be difficult to estimate re-investment rates when investments interact but that is not my problem-I’m against all “isolated project” techniques. The obvious alternative is to use dynamic linear programming and let the machine calculate the re-investment rates over all complexes of investment possibilities.