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Capital Investment and Operational Costs

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Introductory Comments Cost = anything that reduces your business objective Benefit = anything that contributes to it Two types of costs: investment (capital costs) and operational (on-going)

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General Assumptions If you wish to assess the future success of your project, you must make several assumptions. Assumptions will allow calculations to be completed and conclusions to be drawn. Do you have access to unlimited capital (funding)? Will there be taxes to consider. Others: market prices, dimensions/operational parameters, cost/amount of material, construction labor, utilities, etc. Market prices are the most influential!

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Doc K’s Assumptions… I’ll be building a large flounder fingerling production farm. (Flounder Effect) I don’t have land. Semi-intensive technology I need bank loan! I don’t have the company formed yet!

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Investments (Costs) Preliminary (meetings, legal, land) Construction (excavation, structures, buildings) Equipment (vehicles, lab, etc.)

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Preliminary Investments INVESTMENTCOST (US$) PLANNING 30,000 LEGAL FEES 16,000 PREFEASIBILITY 30,000 BUSINESS PLAN, FEASIBILITY 50,000 DRAWINGS AND MAPS 20,000 LAND REGISTRATION 18,000 LAND PURCHASE (420 ha, 170 a)*420,000 TOTAL PRELIMINARY COSTS584,000 * REMEMBER, ALTHOUGH OUR FARM HAS 300 HA, 120 a OF PONDS, MORE LAND IS NEEDED

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Spreadsheet 1- Preliminary Activities

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Construction Costs Earth movement ($1.00 - $2.00/cubic m) Pumping station (a lot of concrete) Water control structures (inflow/harvest gates) Ancillary buildings (office, housing, kitchen, cafeteria/break room, ice plant, etc.) Costs highly reflective of local conditions and is usually one of the highest costs…

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Earthmoving Costs Use of heavy machinery to clear, shape land Along with land = largest single costs you will face (30-50%) Typically calculated as 15% of total pond area as volume Thus, 300 ha = 3 million sqm, 3 million x.15 = 450,000 cubic meters @ $1.50 per cubic meter = $675,000

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Pumps/Pumping Station Also a major expense… Number of pumps, size of the installation is determined by stocking density 15% daily max exchange for a semi-intensive 300 ha farm with 1.25 m deep ponds, pumping 16 hours per day is 186,000 gpm If each pump has a capacity of 40,000 gpm, we need at least five (one extra for redundancy, 6 x $60,000 = $360,000) The pumping station must support this weight and therefore is almost solid concrete ($200,000)

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Water Control Structures Gates/wiers are used to distribute/control water flow to farm Concrete construction & large (sediment pond gates), inflow type (filtering) and harvest type (effluent, harvesting) Most ponds have two inflow gates ($1,000 ea) and one harvest gate ($2,000 ea) Our farm will have 30, ten ha ponds: 2 sediment ponds gates ($5,000 ea, total of $10,000), 60 inflow gates (total of $60,000) and 30 harvest gates (total of $60,000) Total construction investment for water control structures: $130,000

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Ancillary Facilities Ice plant (20 tons per day, used $70,000) Freshwater well (150 gpm, $20,000) Feed storage building ($15,000) Fry acclimation center ($30,000) Equipment storage ($15,000) Mechanics shop ($10,000) Office/Lab ($10,000) Housing ($25,000) Kitchen/cafeteria ($10,000) Guard houses ($5,000) TOTAL = $210,000

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Spreadsheet 1: preliminary, construction investment NOTE: THIS SPREADSHEET IS BEING BUILT AS I GO!

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Equipment Investment TOTAL = $317,000 Plus contingencies = $348,700 huh???

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Spreadsheet 1: preliminary, construction, equipment investment

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Contingency Costs? These are increases in line item costs based upon the probability that something could (will) go wrong! Can’t predict future! Even in a budget. Especially true for developing countries, areas where inflationary rates are high or material availability is variable (REM: Generator story??) +10% investment = contingency costs This increases our total investment costs to over $2,723,600 (nice, eh?)

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(2) Operational Costs Operational costs: day to day costs of production Outlay of funds for inputs, services used in production for short-run financial analyses, total costs include fixed and variable costs fixed cost: one that does not change during production period (how can this differ?) examples: land taxes, principal and interest on loans, insurance premiums, sometimes salaries, permitting, etc. variable cost: one that does change (e.g., feed, fry, supplies, etc.)

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(2) Operational Costs Major cost components for our flounder facility include: fry (local or imported) salaries, benefits (fringe), employee costs fuel (pumps, vehicles, generators) fertilizer, pesticides, lime (other treatments) consulting expenses (around $300/day) vehicle expenses (maintenance) electricity (if generated, then consider fuel) maintenance (3% of total, spread-out monthly) contingencies (10%, same as investments) depreciation (variable, straight-line) consulting fees (set as a contract)

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Typical Operational Costs

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(2) Operational Costs, Year 1 Production, sales and administrative costs encountered at start-up Shown in detail to help understand timing of funds released by bank Shows transitions that typically occur in start-up Some loan institutions also want to see Year 2 in detail

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Spreadsheet 2: Operational Costs, Year 1

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3) Proforma Statement of Costs Shows costs over 5 yr financial horizon 1) production costs 2) cost associated with selling product) 3) general and administrative costs not associated with production) All have employee “benefits” and “costs” –benefits: social security, health, “13th month wage” –costs: lunch?, transportation, parties, awards

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Spreadsheet 3: Proforma Statement of Costs

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(4) Proforma Statement of Operations Goal: determines your net income Includes: 1) sales revenue; 2) cost of sales; 3) gross profit; 4) other costs/expenses; and 5) tax liability gross profit taxes not included net income before taxes (net present value, NPV) is what many bankers look at Also must consider interest payments on credit! (Tony want’s his money too!) Tax: income “tax” or “credit”, 12% You wind up with net income after taxes

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Spreadsheet 4: Pro Forma Statement of Operations

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(5) Proforma Statement of Cash Flow A statement of the cash available to the company at various points in time Used as a planning tool, different from profit Important when considering expansion or diversification into new markets (ie., can you meet payroll and expand) Helps to determine if you might need a loan, or you can pay for the expansion with internal funds

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(5) Proforma Statement of Cash Flow Three “cash flow” categories based on where money comes from: 1) Operations2) Investments3) Financing Cash flow from operations is your net income. REM:previous spread Depreciation is here considered a gain (like a tax write-off) From net gain from operations, you subtract other cash flows (investments, payments on loans) You add, as positive to Year 1, your loan principle $1 million “cash at beginning of period” is what I brought to the table

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Spreadsheet 5: ProForma Statement of Cash Flow

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Sensitivity Analysis 5-yrBreakBreak IncomeCashEvenEven Criterionbefore taxesFlowIRRNPVProd.Sales Baseline$21.4 M$18 M141%$31 M1.3 M$3.9 M $1 Price Drop$8.2 M$6.4 M74%$11 M1.9 M same 10% Surv.$13.5 M$11 M105%$19 M1.3 Msame Feed 10c/lb$19 M$16 M131%$27 M1.5 M$4.5 M Price Feed $5.8 M$4.3 M54%$7.2 M2.2 Msame

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Financial Indicators Start-up Indicators (IRR, NPV, break- even) On-going Indicators (cash flow, income, balance sheets)

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IRR IRR = internal rate of return (or financial rate of return) How much is the money you have invested in the project earning? Projects that are accepted always have an equal to- or greater return than the opportunity cost of capital If you can earn more by depositing your money in the bank, do it!

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IRR (continued) When developed from a series of cash flows, at least one value must be negative Although IRR values vary from project to project, they are hard to use as a ranking tool A project with a 25% rate of return is likely to be a better investment than one with 15%, but you are really estimating

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NPV (NPW) NPV = net present value (often, net present worth) not a percentage, but a number the present worth of benefits of a project less the present worth of costs calculates the present value of an investment by using a discount rate and a series of future payments and income discount rate can be the rate of inflation or the interest rate of a competing investment in other words you are comparing the value of your project over a given time period to investment in another venture (opportunity) IRR is the rate for which NPV equals zero

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Start-up: Break-even Analysis Break-even analysis is used to compare two different cost patterns and determine the point at which they are equivalent usually compares points at which sales revenues equal production costs this is then related to a production level (e.g., farm production in lbs/yr) or a sales price ($/lb) any value above break-even normally represents increased profit

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