ESTIMATION OF FEASIBILITY PARAMETERS TO ESTABLISH AND OPERATE A HAY PROCESSING FACILITY IN DIAMOND VALLEY EUREKA COUNTY, NEVADA

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1 TECHNICAL REPORT UCED ESTIMATION OF FEASIBILITY PARAMETERS TO ESTABLISH AND OPERATE A HAY PROCESSING FACILITY IN DIAMOND VALLEY EUREKA COUNTY, NEVADA UNIVERSITY OF NEVADA, RENO i

2 Estimation of Feasibility Parameters to Establish and Operate a Hay Processing Facility in Diamond Valley Eureka County, Nevada Report Prepared by Thomas R. MacDiarmid, Karl A. McArthur John F. Balliette, Vera L. Baumann William L. Cooper, John G. Burch and Thomas R. Harris Thomas R. MacDiarmid is a Research Associate in the Department of Agricultural Economics at the University of Nevada, Reno. Karl A. McArthur is a Research Associate in the Department of Agricultural Economics at the University of Nevada, Reno. John F. Balliette is the Extension Educator with the Eureka County Cooperative Extension in Eureka, Nevada. Vera L. Baumann is the Executive Director of the Eureka County Chamber of Commerce and Economic Development in Council in Eureka, Nevada. William L. Cooper is a Report Reviewer assigned to the University Center for Economic Development at the University of Nevada, Reno. John G. Burch is a Professor in the Department of Accounting and Computer Information Systems at the University of Nevada, Reno. Thomas R. Harris is a Professor in the Department of Agricultural Economics and Director of the University Center for Economic Development at the University of Nevada, Reno. March 1995 UNIVERSITY OF NEVADA RENO The University of Nevada, Reno is an Equal Opportunity/Affirmative Action employer and does not discriminate on the basis of race, color, religion, sex, age, creed, national origin, veteran status, physical or mental disability, and in accordance with university policy, sexual orientation, in any program or activity it operates. The University of Nevada employs only United States citizens and aliens lawfully authorized to work in the United States. ii

3 This publication, Feasibility Parameters to Establish and Operate a Hay Processing Facility in Diamond Valley Eureka County, Nevada, was published by the University of Nevada Economic Development Center. Funds for the publication were provided by the United States Department of Commerce Economic Development Administration under University Centers Program contract # Also funds for research for this project were provided by the Eureka County Commissioners. This publication's statements, findings, conclusions, recommendations, and/or data represent solely the findings and views of the authors and do not necessarily represent the views of the United States Department of Commerce, the Economic Development Administration, Eureka County Commissioners, University of Nevada, or any reference sources used or quoted by this study. Reference to research projects, programs, books, magazines, or newspaper articles does not imply an endorsement or recommendation by the authors unless otherwise stated. Correspondence regarding this document should be sent to: Thomas R. Harris, Director University Center for Economic Development University of Nevada, Reno Department of Agricultural Economics Mail Stop 204 Reno, Nevada UCED University of Nevada, Reno Nevada Cooperative Extension Department of Agricultural Economics iii

4 Summary An estimation of feasibility parameters to establish and operate a hay processing facility in Diamond Valley is provided in this report. These parameters are designed to be used in a feasibility study of an actual hay processing facility. For further study, however, these parameters must be adapted to conform with specific facility configurations and specific marketing and business plans. The feasibility parameters that were investigated include hay market price, facility capacity, facility investment cost, facility operation cost, hay processing cost, transportation margin, and hay transportation cost. Estimates of these parameters provide answers to general questions concerning: the hay price per ton for cubes and double-compressed bales in comparison to standard bales; the volume of hay that a facility would process; the investment cost of land, buildings and other improvements required to set up a facility; the investment cost for a dual cubing system; the investment cost for a dual compressing system; the investment cost for support equipment; the operating cost of the facility; the operating cost of each individual piece of equipment; the total facility processing cost per ton to cube and or compress hay; the alternative transportation modes for shipping hay; the freight rates for alternative transportation modes; and, the destination costs of shipping hay to several regional locations. These parameters taken together help assess the overall feasibility of a hay processing facility but do not determine the potential feasibility associated with an actual hay processing facility. A feasibility study of an actual hay processing facility would be required to determine the potential associated with the given facility. Additional tasks for this study would include: investigation of forward contracting and participation from local hay growers; identification of a well defined market for processed hay in terms of volume and price; consideration of a cooperative organization, an ownership structure, and the day-to-day operation; development of a business plan; collection of forecasted market price, operating cost, and interest rate trends; determination of long-term, intermediate-term, and short-term debt levels; and, evaluation of iv

5 financial performance using pro forma financial statements for a future accounting period of up to ten years. Each of these tasks must be performed to determine the potential feasibility of an actual hay processing facility. v

6 1. Introduction The Diamond Valley area of north central Nevada is well known for the production of premium quality hay. Hay growers in the area are interested in alternative marketing possibilities that include cubing and double compressing their hay. Identified in this report are the feasibility parameters to establish and operate a hay processing facility. Background The hay situation in Diamond Valley provides a prime example of a mature industry. Economic growth in this farming sector has historically been fueled by acreage expansion and technological advances which allowed increased production levels. In the Diamond Valley area, constraints on irrigation water have curtailed the economic possibilities of acreage expansion for increased hay production and area growers already utilize modern hay growing practices and technology. One possible direction for economic growth in the local hay industry is vertical integration into value-added further-processed hay products. Marketing potential of Diamond Valley hay may be improved by further processing into a form which allows more economic transportation, storage, convenience, or, other benefits greater than the cost of processing. This study is part of an on-going effort to encourage economic growth in Eureka County. Establishing a hay processing facility in the Diamond Valley area would broaden the economic base of the local community supplying local employment and income, and an increased tax base. The information contained in this report is useful for analyzing the feasibility of locating a hay cubing and or double compressing facility in the Diamond Valley area. Estimates of investment costs, operation costs, and transportation margins are included. The estimated feasibility parameters provided in this study will be helpful in efforts to establish and operate a hay processing facility in Diamond Valley. 1

7 Hay Marketing The fundamental relationship between the cost of producing and transporting hay to a given market and the price that the market will bear is more important than ever before. Diamond Valley hay growers face a static or shrinking resource base and a global marketplace. Successful hay marketing depends on these factors: the cost to grow the hay, the cost of processing the hay, the cost of transporting the hay to market, and the market price received for hay. In this study, the cost of growing hay includes the cost of producing, harvesting and baling the hay into standard three wire bales. Producing and marketing hay in this form, the Diamond Valley hay industry exhibits classic symptoms of maturity. Production costs of alfalfa and other hay in the Diamond Valley area are well known and documented in county extension service literature as well as individual grower's on-farm records. The potential of hay growing lands to produce hay is fully capitalized into its valuation. There are no foreseeable changes in the cost factors associated with local hay production which would allow for economic growth. Processing Diamond Valley hay might offer the potential of economic growth for the local hay industry. Processing in this study refers to further processing of hay beyond or other than baling in standard bales. To be considered feasible, the estimated extra costs associated with processing hay must be less than the value of the projected benefits of the processing. A normal profit margin must exist to justify the allocation of resources to establish and operate a hay processing facility. Processing hay into forms other than standard bales offers several potential benefits which could make it a feasible enterprise in the Diamond Valley area. A major limiting factor in the geographic distribution of any product is the cost of transporting the product to the point of consumption. The cost of transporting hay from the farm or from the processor to its final consumer will be referred to as the transportation margin. This margin is either absorbed by the buyer in the form of higher costs, or by the seller in the form of 2

8 smaller profit margins. Transportation costs for standard baled hay to current markets are well known and established. In this report, costs for transporting processed hay are examined in relation to the costs of transporting standard bales and to the cost of processing. Advantages in transportation costs could allow the market for local hay to expand geographically. Hay is sold by weight. Standard baled hay is bulky relative to its weight with an average density of about twelve and a half pounds per cubic foot. Volume constraints are approached long before weight limits are fully realized under many of the common modes of long distance hay transportation. This represents a loss of potential transportation efficiency in terms of cost per unit of weight. The full potential of the various transportation modes could be realized with an economically feasible method of reducing the volume to weight ratio of the hay. High volume to weight ratio of standard bales also translates to high storage volume per ton. If costs per unit of storage space are constant, per ton storage costs would decrease proportionately with a drop in volume to weight ratio. Storage costs may be greater or less per unit of space for hay in another more compact form however. Storage cost savings per unit of weight may not vary proportionately with the volume reduction per unit of weight as hay is processed. Any cost savings gained, however, would constitute a value added and would contribute towards covering processing costs. Cubing and double compressing hay are two alternatives to marketing hay in standard three wire bales. Both alternatives yield lower volume to weight ratios in the finished product as well as other marketing advantages for local hay growers to consider. In the cubing process, the hay is ground and compressed under extreme pressure into cubes which vary from an inch square by one and a half inches long, to several inches long or wide. These cubes can be shipped in bulk or in bags. Cubed hay can be easily stored and machine fed to livestock, offering further advantages to consumers. During the cubing process it is possible to blend extra premium grade hay with lesser grades of hay to supply a uniform product to the buyer. This offers a further advantage to hay growers by allowing them to capture the total 3

9 value of extra premium hay and conversely, to add value to lesser grades of hay while offering a consistent product to buyers. Double compressing, involves further compressing standard baled hay into smaller, more condensed bales. The double compressed bales handle easier than standard bales and as in the case of cubes, the increased weight to volume ratio improves transportation and storage efficiency. Both of these processes result in differentiated, value added products. Each of these products has its own set of benefits and drawbacks. The monetary value placed on these attributes by a given feed buyer depends on many factors. Relative costs of all inputs determine the value placed on hay and hay products by the purchaser. Labor inputs can be reduced with handling efficiencies, land inputs can be reduced with storage efficiencies. Transportation efficiencies along with other value added features can allow a wider economic distribution range. Market prices farmers receive for their hay are externally determined. Economic theory dictates that buyers will purchase their feed requirements at the lowest possible price given all other things being equal (ceteris paribus) such as carbohydrates, protein, and roughage. The prices that buyers are willing to pay are determined by prices of hay available from all sources as well as other feed substitutes and extenders. Per ton market prices for like-quality hay in different forms vary within the same geographic area. This variation can be accounted for by value added features other than transportation efficiencies such as advantages in storage and handling of the end product. The summation of the value added in further processing the hay must be larger than the cost of processing to be economically feasible. This would include efficiencies in transportation, storage, and handling. It would also include the extra value captured through blending of different quality hays in the cubing process. 4

10 Objectives The focus of this study is on the feasibility of establishing and operating a hay processing facility in the Diamond Valley area. There are many methods of analyzing investments which generally measure the investment in terms of profitability relative to other investment options. Profitability is a major concern. Just as growers would not have any incentive to grow hay at market prices which will not cover their cost of production including a normal profit margin, hay processors, be they the growers themselves or independent concerns, will not be encouraged to operate without a normal profit margin either. The cost of further processing must be justified by the increased unit price received over and above the unit cost of processing. Feasibility however, also requires that the business venture be possible as well as profitable. For example, capital requirements may be too large for local growers to handle, or the amount of hay dedicated to further processing may not allow an economic cost of production to be maintained. This analysis seeks to identify parameters upon which profitability and possibility hinge. Internal rates of return, payback time-frames and other analysis can be easily done by potential investors using the information provided in this report with their own subjective interest rates and time-frame requirements. 2. Feasibility Parameters The feasibility parameters are given in seven sections. The first section shows hay market prices. The second section addresses processing capacity. The third section involves investment costs. Estimates of gross capital required to establish a new hay processing facility are presented in this section. The fourth section deals with operation costs of the facility. Hay processing costs for cubing and double compressing are then provided in the fifth section. The sixth section presents transportation margins corresponding to different modes of transportation and a representative selection of destinations. Finally, hay transportation costs for shipping standard bales, cubes, and compressed bales are compared in the seventh section. 5

11 Hay Market Price Hay market prices for alfalfa hay are presented in Table 1. These prices are seasonal average prices. They are presented to show a comparison between prices for hay in standard bales versus cubes and double compressing bales. Taking the Nevada standard bale price and comparing it to the California standard bale, cube, and compressed bale prices shows the potential for processing hay. The Nevada standard bale price is net to the grower whereas the California prices are on a delivered basis. Hay processing potential exists if the hay price received for cubes and or compressed bales covers the additional cost of processing and the cost of transportation. Facility Capacity The facility capacity refers to the plant size, in capacity per unit of time, for the potential hay processing facility. Often, due to economies of size, average (and marginal) per unit costs of production will be lower at the same level of production for a plant with larger capacity than for a plant of smaller capacity. In this scenario the economies of size are greater than the cost of unused capacity. This suggests that it would be economically more efficient to have a relatively larger capacity plant with idle capacity than a smaller plant being utilized to full capacity. There are two additional benefits of excess capacity in the case of hay processing. First, there is the benefit of timeliness. In a modern electronically linked global market place, excess plant capacity can allow managers to respond quickly to unforeseen or transient market conditions. The second benefit is that the economies of size allow a larger range of profitable output levels. That is to say that in years where, due to market forces, it is beneficial to sell more hay in standard bales, the per unit cost of processing the remainder of the hay is not overly affected and in a year where it is beneficial to sell more hay in processed form, the extra demand can be met at an economically efficient cost. There exists a suitable, ready market for the bulk of Diamond Valley hay. However, market conditions are such that possibly about thirty thousand tons of Diamond Valley hay a year are sold at less than satisfactory price levels. Thirty thousand tons of hay per year was the bench 6

12 mark figure for deciding on the size of individual cubing and compressing units and on the number of individual units which would be required. It was decided that two cubing units capable of processing from eight to ten tons per hour each and two double compressing units capable of further compressing seven and one half tons per hour each would provide the best processing options for the situation at hand. Table 2 provides estimated plant capacities at various levels of operation. When the facility cubes alfalfa hay for five hundred hours it will cube about eight thousand tons of hay. The same amount of time compressing will process seven thousand five hundred tons of double compressed hay. If the facility runs five hundred hours on both processes it will process about fifteen thousand five hundred tons of hay in total. At one thousand hours of processing per year on each process, the plant has produced thirty one thousand tons of product. Running the processes separately one thousand hours each for a total plant time of two thousand hours is approximately one year's worth of processing time on a single shift basis. The plant size as studied then, can easily process the estimated thirty thousand tons of alfalfa hay for which marketing alternatives are being sought. The construction of a facility to cube, and or double compress hay in the Diamond Valley requires a substantial capital investment. A substantial commitment of hay is also necessary. The cost of processing hay must be spread over many tons in order to reach some efficient point of operation. Identifying an economic feasibility range in terms of tons of hay processed annually was an integral part of estimating the investment requirements and the costs of operation for a hay cubing and or double compressing facility in the Diamond Valley area. Facility Investment Cost The investment cost for a cubing and or double compressing facility can be grouped into three categories, the purchase of land plus buildings and other site improvements, the purchase of a processing system or systems, and the purchase of necessary support equipment. 7

13 Representative dollar amounts required for these three investment categories can be found in Table 3. Land and Improvements The investment in land and improvements may involve development of a new site or the expansion or conversion of an existing facility. In any case, a hay processing facility involves an investment in land and improvements. Growers or other investors who own an existing site suitable for such a facility would be in a better position than investors who do not. The estimated required investment in land and improvements is $624,460. Details are shown in Table 3. It is felt that a well coordinated and detailed site specific technical engineering analysis must be done prior to actually establishing a hay processing facility. Hay by its very nature is a stored product. The storage function is integral to the hay marketing process. Hay is stored either by the grower, the middle man, or the buyer until it is fed to livestock. Inventories depend on current market prices and the perceived future prices and availability of hay and hay products, and feed substitutes and extenders such as grain and commodity by-products of food and fiber production. Hay inventories are also sensitive to the relative storage costs in different locals. For instance, urban race tracks pay a premium for real estate square footage relative to the same square footage in rural northern Nevada. Storage in rural northern Nevada is also relatively cheaper than that in countries such as Japan. Proper storage planning can equip hay processors to capitalize on the comparative advantage they have in this marketing function. Two 100' by 100' storage buildings 24' at the eaves on 6" mesh reinforced concrete floors over 2" sand fill have been incorporated into the estimated capital requirements of the facility. One building would be a minimum for a hay cubing facility yet may be larger than absolutely necessary for the compressing facility alone. Two buildings would be advisable for the cubing process alone or with the double compressing process operating under the same roof. The estimated figures allow $117,180 each for these buildings. 8

14 For analysis of both processes separately and together, the processing equipment is housed on a common slab, partially in the open and partially under cover in part of one storage building. Estimated figures involving a cubing process either alone or in combination with a compressing process, include both buildings. Analysis of the compressing facility alone includes only one building. There are trade-offs to consider between amount of exposure equipment and equipment systems have to the weather and noise, dust, and accessibility considerations. These buildings are felt to provide a good compromise. Storage tends to play a larger role in the marketing and processing of cubed hay than it does with marketing and processing double compressed hay. Buyers contract months ahead of actually taking delivery and often have agents in the field to physically examine the product they are buying. A certain amount of storage capacity also contributes to the economic efficiency of processing cubed hay by allowing for more efficient utilization of equipment and personnel. The double compressing process typically requires less storage than cubing. Much of this process is done on a just-in-time basis. It is easier and more efficient to load double compressed hay into transportation containers and box cars as it is processed. There is about a 5% expansion factor if it is stored. This of course translates into an increase per unit of weight in the freight costs to market. A typical double compressing facility alone would not require as much storage space as estimated. The trade-offs between costs of having storage and the costs of not having storage have been considered in this analysis. Extra storage capacity can be utilized to ensure a steady supply of standard baled hay for processing during inclement weather for both processes. Extra space can also be utilized in both processes to make production runs more efficient in terms of labor and machine usage. A cubing facility might benefit from greater and more elaborate storage than included in the estimate, yet could do with less. A double compressing facility alone could do with a smaller less elaborate storage building than estimated. These storage figures are mid-range for the combined process and the cubing process alone and towards the higher range of possible costs for the double compressing facility by itself. 9

15 The $125,000 estimate allowed for an office is a midrange figure. It is conceivable that a portable office or a portion of the storage area might be used. Also, an existing office could be utilized. In the case of expanding an existing hay facility the office could either be on-site or a large portion of the office function could be done on a remote basis utilizing an established office off-site. Regardless, there will be an investment in office space required for any hay processing facility. A hay processing plant will require a shop facility where repairs and minor fabrication can be done and tools and some equipment and maintenance supplies can be safely stored. In the estimate, $100,000 is allowed for the construction of a shop and garage building. The cubing and further compressing systems must be installed on a concrete slab. The slab must strong, smooth and large enough to accommodate the operation, and maintenance of the equipment systems including the necessary support equipment. The slab as estimated is 10,000 square feet in size and will provide enough strength and room for both processing systems and their support equipment to operate on with some cushion for spill-over functions such as receiving hay in inclement weather and temporary storage of standard and processed bales and cubes. The purchase price is estimated as approximately $42,000. The slab as estimated is 6" mesh reinforced concrete on a 4" sand base. The estimate provides for the processing slab to be skirted by a receiving area. The paving requirements of the receiving area are less than that of the direct processing area. The estimates provide for asphalt paving which is less durable than concrete yet more durable than improved earth while being somewhere intermediate in price. The estimate allows for 20,000 square feet of area covered with 3" asphalt on a 6" sand base with an estimated cost of $32,600. Depending on the site chosen and decisions made by investors, the costs of the slab and paved receiving areas could be lower or greater. For example, for the same degree of load carrying capacity and efficiency there may be different costs due to local soil conditions. Also there can be trade offs between degree of surface improvement and operational costs in the form of efficiency, level of repairs to equipment, and product losses. 10

16 A method of weighing incoming and outgoing trucks is a necessary part of hay processing. Included in the estimate is a $40,000 investment in a truck scale. It is possible that a scale would be already owned by hay growers or in place nearby as part of another operation. Not provided for in the analysis are costs of a feed analyzer and costs associated with engineering services for construction. Feed analysis can be provided by outside sources. Purchase of a feed analyzer might be warranted depending on volume processed and costs of analytical services. Facility design and site development require specialized technical skills of mechanical and civil engineers. A detailed analysis of plant layout and site requirements would be required before any construction could begin. Cubing and Compressing Equipment The cubing system itself includes two cubing units, a feeding and cube handling system, a tub grinder to grind the standard hay bales, a cube cooler, a metal detector system to ensure that the finished cubes are free of wire or other metal debris, two horizontal conveyors to take away the cubes and a telescoping piler to stack the cubes into storage as well as a control panel to operate the system. A dehydrator was not included in the estimate because the moisture content of the hay should be low enough without further drying. The full price of this equipment system installed is $472,756. The compressing system is comprised of two compressor units with spare parts, a control panel, and the necessary hydraulic oil. It has a delivered and installed price of $456,025. Support and Miscellaneous Equipment The two processing systems require support equipment to operate. Some of this equipment is common to both processes. At the heart of any hay operation using standard baled hay is the squeeze. This piece of equipment is common to both processes and is used to unload hay from trucks and to place it in temporary storage or to feed the processing operation. Other facility support equipment which is used for both operations are the two pickup trucks, shop tools 11

17 and equipment, office furnishings, a sample grinder and a computer with a printer. These again are mid-range figures. Managers may opt to own only one pickup for instance and or some of the equipment may already be owned. The compliment of equipment included in this study should be viewed as a representative set up only. The possible combinations of equipment used in a hay processing facility are varied. Specific to the double compressing process is the forklift with a hay rack attachment. This combination is used to remove the finished product from the processing area and load it into containers or boxcars. In the estimated investment requirements $32,000 is allocated for a forklift and hayrack attachment. The cubing process has specific support equipment requirements as well. Loading and moving bulk cubes around the facility requires a front loader with an estimated investment of $80,000. The concrete pad on which the cubed hay is stored must be smooth and sturdy enough to withstand the demands of this operation. In some instances, cubes can be loaded into trucks with just the front loader. For controlled loading in tight containers a telescoping piler is more efficient. Since one telescoping piler is used to store cubes during processing, a second telescoping piler costing an estimated $32,025, is included in the estimated requirements for the hay cubing facility. One option not included in the study would be an auger action piler. For either type of loading system the front loader is used to feed the piler which delivers the cubed hay into containers, hopper trailers, and hopper rail cars. Total Investment Cost The total capital investment as estimated for both processing systems is $1,834,770. The capital required for cubing alone is estimated at $1,346,641. Finally the estimated capital requirements for a compressing facility alone are $1,132,809. Table 4 provides a comparison of the different plant options studied. Estimated investment for both processes separately is $2,479,450 which is $644,680 more than combining the two processes in the same plant. 12

18 Facility Operation Cost The estimated costs of operation for a hay processing facility include property taxes and insurance, labor costs, and machine costs. Labor costs include compensation paid to management and other salaried personnel as well as hourly wages paid. Machine costs are the estimated costs associated directly with operating the cubing and compressing systems, and other individual machines exclusive of labor and ownership costs. Property Tax and Insurance Table 5 shows first year taxes for real and personal property in Eureka County based on the investment values estimated. Property taxes are considered a fixed cost of doing business. Inflation rates, tax rates and assessed valuations of the property can all influence the actual annual costs of taxes. A typical annual insurance coverage has been included in the ownership costs section. Rates vary between insurance companies and for different situations. There are options available as to what is insured what is not and the amounts to insure for. Some insurance such as liability insurance on motor vehicles is required by law. Insurance is an important part of business financial planning and should not be overlooked. Specifics of the estimated insurance costs are found in Table 6. Labor Cost The estimated labor costs of a hay processing facility are divided into two distinct categories, fixed and variable. Details of estimated labor costs can be found in Table 7. Fixed costs are associated with salaried personnel such as managers, mechanics and secretaries. In the case of a plant manager, or mechanic, the nature of the job requires intimate knowledge of and specialized training in the process, and machinery. It is more efficient to keep these personnel employed all year than to lay-off during slow times and re-train new personnel A secretary is 13

19 needed to answer the phones, and to perform other day to day office duties on a steady continuous and business-like basis. Regardless of the amount processed these functions must be performed. The figures for fixed labor costs are representative within a relevant range of production. There could be some cost variability associated with these job functions however. In the upper end of production ranges studied, there would possibly be assistant managers, mechanic's helpers and part-time office help. Salaries can also vary depending on the availability of qualified personnel. Variable labor costs of hourly personnel are associated with jobs which require only general rudimentary training. A larger rate of turnover in hourly personnel relative to that of salaried employees can be economically tolerated. It should be kept in mind however, that business continuity is no less dependent on good hourly personnel than it is on salaried personnel. Machine Operation Cost The direct costs associated with operating an individual machine or a system of machines involve the cost of power to drive the machine, in either electricity or fuel costs, and repairs and maintenance to keep the machines and components operational. Formulas for power requirements are well known and relatively accurate. Variability of use factors such as loading factors and travel factors which vary with efficiency of plant layout, can cause variability in estimating costs of these inputs. Maintenance costs are also fairly easily estimated using manufacturer's guidelines. The costs of repairs over time for given equipment and components however are highly variable and difficult to accurately estimate. Repair costs are generally estimated based on actual repair data. Estimates for the hay processing systems found in the tables of this report relied heavily on information originating from the equipment manufacturers themselves due to a lack of generally available data sources for repair costs on such systems. Repair costs of other individual machines were estimated using cost and use factors thought to reflect the actual demands of the two processes. While there is much 14

20 repair cost data available for equipment such as front loaders and forklifts, there is also a large degree of variability in repair costs due to operator skill, specific job applications, degree of loading, quality and frequency of maintenance, and environmental conditions such as weather, pavement quality, and exposure to dust and corrosive chemicals. The problem of estimating repair costs for processing systems and individual machines is compounded by the fact that repair characteristics of different types of machinery behave differently over time. Repair costs may be directly proportional to use levels or they may increase with time and use. When proportional to use levels, repair and maintenance costs do not affect the replacement decision for the machine or system. In such a case, the per unit costs of ownership such as depreciation, taxes, housing, and insurance will continue to drop over time while per unit costs of repairs and maintenance stay steady. The average cost per unit of production then over the life of the machine will tend to decline over time with use. When costs of repairs increase with use however, there will be some economically efficient point at which the machine should be replaced due to rising repair costs. The optimal point at which the machine should be replaced is where the annual per unit cost becomes larger than the total average per unit cost, known as the accumulated costs. The costs of depreciation, and other ownership costs, and repairs and maintenance comprise the accumulated costs of the machine. Initial annual costs are high due to purchasing of the machine. A rising cost of repairs with use causes the annual per unit cost to rise after reaching a minimum point. Starting at the point where annual per unit costs exceed the average accumulated costs, the rising repair costs will begin to pull the average accumulated costs per unit up. Estimating machine costs is further complicated by the question of whether the repairs of a machine or system comprise a capital investment which is depreciable or an expensible repair. Since ownership costs are included in the analysis, this becomes more of an accounting problem. It is imperative to financial planners to keep in mind, however, that there are trade-offs between the costs of maintenance, cost of repairs, and investment requirements. 15

21 The rebuilding of a forklift for instance, is generally thought of as a capital investment not a repair. In the case of a forklift, studies show that under typical applications, repair costs in the seventh year run more than the sum of repair costs incurred in the first six years of use. The cost of a "rebuilt" forklift can be up to ninety percent of its original purchase price. It doesn't matter if a manager decides to piecemeal the repairs after the six year period or invest in rebuilding the owned machine, a rebuilt machine, or even a new machine, costs will be incurred one way or another. At some point the repairs will constructively replace the piece of equipment the question of when and how to replace equipment involve efficiency. True economic efficiency will involve factors such as relative costs and availability of machinery, parts, labor, and capital, and tax consequences of the different alternatives. There are also questions of timeliness, employee morale, and company image to be considered when making equipment repair, maintenance, and replacement decisions. For estimating repair costs the concept of a relevant range in terms of hours of life and annual hours of use is useful. Using a forklift for an example again, the expected life of the forklift would be about eight years using it for one eight hour shift for about two thousand annual hours of machine use. Removing the forklift from service after six or seven years can reduce the repair and maintenance costs anticipated in the eight year cycle by nearly fifty percent. However, the removal would require investment in a replacement forklift. When annual hours of use are increased by overtime or an additional shift, the service life of the forklift would be shortened and either replacement would have to take place sooner or higher average per unit expenses would be incurred. The machine costs for the plant as studied include what was reasonably considered to be the equipment necessary to operate the facility in an efficient manner. The plant includes a cubing system, a double compressing system, and a complement of support equipment. The equipment included is thought to be representative of a hay processing facility. Other combinations are possible however. The costs of operating the two processing systems and the support equipment are estimated and presented in the following tables. Costs are expressed in average annual per 16

22 unit costs. The cost for example of a repair anticipated in the last year of machine life will be annualized or averaged back over the entire machine life so that the average cost for the first hour or per ton is the same for the last. The hourly electricity requirements for the cubing operation are listed in Table 8. Repairs and maintenance were estimated using manufacturer's guidelines. For this system, repair costs are assumed to be proportional to output levels within the relevant range of production. Estimated per unit costs are based on an eight ton per hour cubing rate. The manufacturer rates the capabilities of this system at eight to ten tons per hour. Costs per hour of plant time and per ton of product for a range of production levels can be seen in Table 9. The compressing system hourly electricity requirements are listed in Table 10. Estimated costs per hour of use and per ton of processing are found in Table 11. Here, as in the case of the cubing system, the costs are estimated to vary proportionally with the production levels. For any relevant range this is thought to be representative. The hay squeeze is an efficient machine for unloading trucks of baled hay from the fields and for moving baled hay around the facility. Typically these machines are diesel powered. Included in the estimate is a basic squeeze. Repair costs per hour of use are expected to increase with higher use levels. Estimated costs of fuel use, and repairs and maintenance on a per hour of processing time and per ton of hay processed are provided in Table 12. Variability in actual per hour and per ton costs of operating a hay squeeze can be expected depending on factors such as actual application and use, degree of loading, user skill, and working environment. A forklift with a hayrack attachment is essential to the loading of double compressed hay into the tight confines of boxcars and shipping containers. Table 13 provides estimates of the fuel and oil costs as well as the costs of repairs and maintenance associated with this machine. The forklift and hayrack are specific to the double compressing process in the analysis but this piece of equipment can be used to feed hay into the staging area of the cubing process also. As in the case of the hay squeeze, variability can be expected due to variability of operating circumstances. 17

23 Service life for the forklift was based on a seven year life at two thousand annual hours of use adjusted to a ten year period. The effect of increased annual use on forklift replacement is shown in Table 13. When the forklift and hayrack attachment are used more than 1,400 hours per year, the service life is shortened accordingly from ten years or fourteen thousand total hours of service life to nine and two thirds years of service life at fourteen thousand hours of use. The service life of the forklift becomes seven years at two thousand hours of annual use. Specific to the cubing process is the front loader. Expected repairs on this piece of equipment, beyond regular maintenance are few. However scheduled overhauls are quite expensive and there are other parts which will need attention with increased use. The estimates in Table 14 reflect an increasing average annual per hour cost of repairs with increased use. Fuel and oil costs are proportional to production levels. Variability can be expected due to variable operating circumstances. A second telescoping piler is included in the estimate for loading cubed hay into containers for export. This piler is separate from the telescoping piler included in the cubing system. The use factor for this piler is low and costs are figured accordingly. Cost estimates are shown in Table 15 and reflect increasing costs of repairs per hour of use. The actual costs of operating the two pickup trucks will be heavily influenced by replacement decisions. Pickups have increasing costs of repairs with increasing levels of use. The estimated costs for the two trucks are shown in Tables 16 and 17. Repair costs will decline as replacement and thus investment goes up. In this area management has much latitude in which to operate. Depreciation Depreciation is a very real cost of ownership. Depreciation is the decrease in asset value caused by age, obsolescence, and wear and tear on non-replaceable components of the asset. The major component of depreciation is age therefore it is treated as a fixed cost. The actual dollar value of depreciation is dependent on interest rates and inflation. Often the depreciation 18

24 allowed for tax purposes is quite different from the actual depreciation of the asset in question. In Table 18 the depreciation shown is estimated as the average annual decline in asset value over its assigned economic life. This is a typical straight-line depreciation schedule. Actual depreciation can only be determined at resale time. A point to ponder is that typically, the salvage value of fixed equipment systems covers its removal costs for a net salvage value of zero. Many complex factors other than age are involved in determining the actual economic life of an asset. For estimation purposes a typical economic life in years was assigned to each asset. Hay Processing Cost Estimated processing costs are presented in Tables 19 through 36. Costs are presented for a cubing only facility, a compressing only facility, and for a mixed process facility capable of doing both. For each type of facility there is a table which shows the costs per ton spread over a range of total annual processing hours and tonnage's of production for all of the variable cost categories, and all of the fixed cost categories except depreciation and interest. The estimated costs per ton for all cost categories except the annual payment category are the same for all debt level scenarios. For each type of facility, costs for five debt load scenarios are presented. The costs include annual loan payments based on a 9% interest rate at various down payment or original equity percentages, and no depreciation costs. There are two loans. A land and improvement loan is amortized for twenty years. An equipment loan is amortized for ten years. The debt loads are 100% down payment (100% equity and zero debt) on the estimated investment requirements for each type of facility, 70% down payment, 50% down payment, 30% down payment, and finally no down payment (100% debt no equity) on the required investments. To reflect true costs, depreciation and interest paid would be substituted in the place of the loan payment. Actual depreciation can only be determined at the time of sale or trade-in, however. It is felt that using payments as a "cost" is a more realistic way of assessing the viability of a processing facility. The gross estimated costs for each cost category are presented for a range of various annual 19

25 hours of operation. Total costs of production are also presented on a per ton basis for each of the various levels of operation. Cubing Cost Tables 19 through 24 provide estimates of costs associated with cubing hay in a cubing only facility. Projected costs are subject to variability due to a variety of circumstances. Figures in these tables are thought to be representative of this process within the context of the study as a whole. Costs per ton vary from $67.79 per ton cubed at three hundred hours of processing time annually and four thousand, eight hundred tons cubed with 100% financing on required facility investment, to an estimated $13.14 per ton to process thirty two thousand tons a year at two thousand hours of processing time with no annual payment. Compressing Cost Tables 25 through 30 provide estimates of double compressing costs. These costs range from a high of $67.88 per ton at three hundred hours and four thousand five hundred tons with 100% financing to a low of $15.20 per ton at two thousand hours processing time and thirty thousand tons of production with no annual payment. Mixed Cubing and Compressing Cost Cost estimates for running both processes in the same facility are presented in Tables 31 through 36. Estimated per ton costs of production for a mixed process facility vary from a high of $87.57 at three hundred hours of total processing time, with 100% financing to a low of $14.14 per ton at two thousand hours of total processing time with no annual payment included. Fifty percent of the time is spent on each process (separately) for two thousand hours total processing time, results in sixteen thousand tons of cubed hay and fifteen thousand tons of compressed hay produced. 20

26 Transportation Margin The delivered price paid by hay buyers includes transportation and other transactions and marketing costs as well as the net price received by the grower or other seller. It does not matter who directly pays the transportation and other transactions costs, they are still part of the final cost of hay delivered to a buyer. Who in effect pays the larger or smaller share of these costs is determined through buyer-seller negotiation. Transportation costs vary on a per unit basis with the distance transported. As hay is transported further from the grower, transportation costs are expected to grow larger. On account of this either the buyer, the seller, or both, must absorb more of the transportation costs and conversely give up more in the way of profit margins. At some point transportation costs will be to high and trade will not occur. Prohibitively high transportation costs either due to high per unit per mile costs or simply due to large distances between two areas can cancel out any absolute or comparative advantage in hay growing that one of the regions may have over the other which would otherwise exist in the absence of transportation costs. Conversely economic advantages may be enhanced or become apparent with improved transportation efficiency. Road mileage's from the Diamond Valley area to destinations representative of an expanded hay marketing area are listed in Table 37. The distances provide a context in which to examine the potential of transporting and selling hay across the United States, and the potential of transporting hay to West Coast sea ports. Hay is relatively a high bulk commodity. A primary objective of processing hay is to lower the per ton per mile cost of transportation. For any given hay price required by growers or other sellers of hay and hay products to make a normal profit and remain in business, a lower per mile per ton cost of transportation geographically expands the economic marketing range for their hay. For each transportation dollar spent per ton on standard baled hay either more processed hay can be transported the same distance or the same amount of hay can be transported further for that dollar. 21