Review of Agricultural Economics Volume 24, Number 2 Pages 540 545 Trucking to Port 1 Marv Painter Eldon Boone, a grain farmer in Manitoba, Canada, has traditionally delivered his grain locally and had it transported to port by rail. Because of rising costs for cleaning, handling, and freight, he has decided to assess the feasibility of trucking his own grain to port. This case looks at the feasibility analysis of Mr. Boone investing in his own grain cleaner, truck, and trailer and bypassing the regular handling and rail transportation system by trucking his own grain to port. A sensitivity analysis is provided to assess the risk associated with the investment. Eldon Boone is a grain farmer near Virden, Manitoba. In 1996, after a number of years of increasing rail freight rates, he decided to look into cleaning his own grain and hauling his wheat to port at Thunder Bay, Ontario. 2 The 2,000-km round trip takes about 11 or 12 hours each way. Boone says, the elevators take their share, the railways take their share, and we re trying to have a little profit left at the end of all these costs. What really got him started was the idea of an on-farm grain cleaner. The elevators won t give you 0% dockage and I was looking to get rid of that cleaning charge, too. Western Canadian farm income peaked in 1976 and declined 48% by 1996 (figure 1). The declining profitability and tightening margins resulted from expenses increasing at a faster rate than revenues. Costs associated with new technologies (equipment and inputs) rose at the same time commodity prices decreased. Average farm size increased rapidly to take advantage of economies of size; however, even the larger-scale producers felt the pinch. Until 1994, the Canadian government subsidized rail freight rates for grain (referred to as the Crow Rate). With the subsidy removed, rail freight rates for grain tripled in 1995, increasing farmers expenses while commodity prices were declining. Exporting raw commodities from western Canada was becoming unprofitable. Farmers were advised to look for opportunities further along the supply chain. Instead of loading rail cars with raw commodities, such as wheat, and shipping to port, they were expected to add value in order to capture profits. Marv Painter is Associate Professor, Department of Management and Marketing, at the University of Saskatchewan.
Trucking to Port 541 Figure 1. An index of farm income in Western Canada (1965 1996) Source: Saskatchewan Department of Agriculture and Food. Agriculture Statistics. Regina, Saskatchewan, December 2000. Examples were cleaning grain before shipping (previously grain was cleaned at port since the transportation rates were subsidized), growing specialty crops and cleaning and bagging for export, making pasta out of durum wheat, producing ethanol from grain, using grain to increase livestock production, and so on. Eldon Boone is considering adding value by providing a grain-cleaning and transportation service. He is displeased with the higher rail freight rates and local elevator grain handling fees. His plan is to clean his own grain at the farm and transport it directly to port for export, thus eliminating the increased local elevator handling fees and rail freight rates. In addition, Boone will be able to offer grain-cleaning services to other farmers in the area, thereby making full use of the grain-cleaning equipment. Finally, Boone will be able to sell the screenings by-product from grain cleaning as feed for livestock. Boone s plan is to invest $180,000 in an International 9400, with 460 Cummins and Timpte Super B trailers that haul 43 tonnes per trip. He will also invest $10,000 in a grain cleaner and $10,000 for other equipment (assume a 30% capital cost allowance 3 (CCA) rate for the truck and equipment). Boone s calculations indicate that he can net about $15.00 per tonne by hauling his own grain instead of shipping by rail to port (table 1). Boone expects that he can truck to port 2,000 to 2,400 tonnes per year. At 43 tonnes per trip, that is about 50 trips per year, totaling approximately 100,000 km per year. Boone has accounted for regular maintenance costs on the truck, but he expects that there will be major repairs and maintenance of $30,000 at the end of the fifth year. Based on discussions with local livestock producers, he estimates that he can get $50/tonne net for screenings. At an average of 2.5% dockage, he expects about 50 to 55 tonnes of screenings per year. Boone also expects to be able to custom clean about 1,000 tonnes of grain per year at a rate of $3.40 per tonne. Because of inflation, Boone expects that both
542 Review of Agricultural Economics Table 1. Total costs to ship grain by rail and truck Cost Category $ Cost/Tonne Total Cost $ Shipping by rail a Elevation 10.30 442.90 Cleaning 3.40 146.20 Rail freight 23.60 1,014.80 F.A.F. (Seaway Freight) 11.98 515.14 Canadian Grain Commission fees 0.47 20.21 Total costs to ship by rail $49.75/tonne $2,139.25 Shipping to port by truck b Weighing/inspection 0.77 33.00 F.A.F. (Seaway Freight) 11.98 515.14 Canadian Grain Commission fees 0.93 40.00 Total port costs $13.68/tonne $588.14 Trucking costs c Fuel 7.00 300.00 Driver 8.75 376.25 Ontario fuel permit 1.72 75.00 Truck/trailer maintenance 4.00 172.00 Total trucking costs $21.47/tonne $923.25 Total costs to ship by truck $35.15/tonne $1,511.39 a Cash ticket deductions for 43 tonnes at UGG, Hargrave, Manitoba. b Cash ticket deductions for 43 tonnes at Parrish & Heimbecker Terminal at Thunder Bay. c Boone did not include the cost of license and insurance in the calculation since the truck is also used for other purposes in his farming operation. revenues and expenses associated with trucking and cleaning will increase by approximately 2% per year. The CCA rate for the truck and equipment is 30% and Boone s income tax rate is 21% (Canadian Controlled Private Corporation). Based on this information, is trucking to port a good investment from a financial point of view? Financial Background The analysis in this case includes a cost/benefit analysis, to determine whether the transportation cost savings associated with trucking instead of using rail are great enough to warrant the capital investment in the truck and equipment. The capital costs are $180,000 for the truck and trailers, $10,000 for a cleaner, and $10,000 for other equipment, for a total investment of $200,000. Another cost, the major truck repairs of $30,000, is expected to occur at the end of year 5 (figure 2). The main cash inflow is the transportation cost reduction of $14.60 per tonne (total cost to ship by rail of $49.75 per tonne minus the total cost to ship by truck of $35.15 per tonne). A secondary cash inflow is a by-product, the sale of the screenings from cleaning the grain before shipment. Mr. Boone expects to be able to sell screening for $50 to $75 per tonne. It is expected that there will be 2,150 total tonnes of grain each year, with an average of 2.5% as screenings. A third inflow is from custom cleaning 1,000 tonnes of grain at $3.40 per tonne.
Trucking to Port 543 Figure 2. Investment analysis spreadsheet for trucking to port a Net Cash Flow After Tax = Net Income + CCA Expense (depreciation). Depreciation is added back because it is used to calculate net income but it is a noncash expense. Therefore, to get cash flow, do not deduct depreciation (or add it back to net income). These inputs produce a total cash inflow before tax of $37,478 in the first year, which is expected to increase each year at the rate of 2.0%. Figure 2 calculates a Net Present Value (NPV), using a discount rate of 10% (all equity financing is assumed so this is the required return to equity; however, the analysis could easily incorporate an amortized loan for part of the capital costs), and an Internal Rate of Return (IRR). 4 Sensitivity Analysis Using the Spreadsheet Model The spreadsheet model was used to assess the risk associated with the trucking investment. The risk analysis was completed by noting the change in the key decision variables, the NPV and IRR, to changes in various inputs. Where a break-even analysis is used, it refers to NPV break-even (NPV = 0 and IRR = required return of 10%). In each sensitivity analysis, only one input variable changes and all others remain unchanged.
544 Review of Agricultural Economics Table 2. Sensitivity analysis input changes Worst Case Best Case Transport cost savings per tonne (+$1.60, $5.00) $9.60 $16.20 Net screenings value per tonne $40.00 $80.00 Growth in cash flow per year 0.0% 3.0% Major repairs in year 5 $60,000 $30,000 Custom cleaning tonnes 500 1,500 NPV (at 10% discount rate) ($80,901) $55,465 IRR (1.3%) 16.1% 1. Break-even level of capital costs = $211,093. If Mr. Boone is able to purchase the capital assets at a lower cost, the NPV and IRR will increase. 2. Break-even level of transport cost savings per tonne of grain shipped = $13.61. This represents a decrease of $0.99 from the expected cost savings of $14.60 per tonne. Cost savings could be decreased by this amount, leaving the NPV at zero. This could result if trucking costs increase relative to rail transport costs (e.g., CN Rail and CP Rail lower freight rates, which is unlikely, or a special road tax added to diesel fuel for trucks, which is very possible). 3. Break-even level of net value of screenings per tonne = $10.57. This represents a significant decrease in the net value of screenings and will likely not occur. Even though screenings prices could be lower than the $50 per tonne projected, it is unlikely that a decrease in screenings prices alone will cause a break-even NPV. 4. Break-even level of growth in cash flow per year = 0.5%. If all rail freight costs and all trucking costs would grow at the same rate per year, then the net cost savings would also grow at that same rate. Therefore, as growth in cash flows increases while the required rate of return does not, the NPV also increases. 5. Break-even tax rate = 33.5%. This implies that if governments increased the tax rate from 21% to 33.5%, the NPV would be reduced to zero. 6. What happens if the major repairs in year 5 double to $60,000? NPV = ($3,623) and the IRR = 9.6%. 7. What happens if the cost of fuel increases by 50%, from $7.00 per tonne to $10.50 per tonne? The total cost to ship by truck increases to $38.65 per tonne, reducing the net cost savings from $14.60 per tonne to $11.10 per tonne. NPV = ($28,293) and the IRR = 6.5%. However, if diesel fuel costs increase, both trucking and rail costs will be affected, which may leave the cost savings per tonne unchanged. 8. Results using the changes in inputs as listed in table 2. Conclusion Should Mr. Boone proceed with the investment? After a thorough analysis, Mr. Boone must decide whether to invest or not. Many entrepreneurs would proceed with this investment because they would see very little downside risk even in the worst case, the investment is close to recovering its capital
Trucking to Port 545 costs, although with no return on investment. On the other hand, if the rail companies continue to increase freight rates, Mr. Boone could be in a very profitable position hauling his own grain, which may allow him to expand his trucking operation to increase those profits. Mr. Boone must look at all his options where else could he invest his $200,000 and what returns could be earned in those alternative investments? For each alternative, he must consider both expected return on investment as well as risk. For example, stock market returns have averaged about 11% over the long term. Bonds are paying 5% to 7%. He also could consider other agribusiness investments, such as purchasing farmland, acquiring new equipment technology, or investing in other value-added agribusiness ventures. Part of the risk assessment for each option should include how well the investment option diversifies his existing farm investment. Given that some of the options are passive investments, it would leave Mr. Boone to also consider other off-farm employment opportunities. If a similar analysis is done for all the alternatives, he should be in a good position to make an informed investment decision. Teaching Note The facilitator will want to make sure that the participants clearly understand the difference between cash flows, net income, and NPV and IRR. It would be useful to have the spreadsheet analysis model available with a laptop computer and screen when the case discussion takes place. There will be much discussion about inputs, and disagreement will likely occur. Having the model available allows the case facilitator to easily change inputs and note that income, cash flow, NPV, and IRR changes immediately. The model also is useful for showing participants how an analysis like this can be done with a spreadsheet to provide the important information necessary for making investment decisions. Endnotes 1 This case is adapted from: Strautman, B. Trucking to Port. The Western Producer (Farming), 2, 2(February, 1999):4 7. 2 Thunder Bay is located on Lake Superior and is a major portal for shipping export grain from Canada. 3 Capital Cost Allowance is the prescribed depreciation method for tax purposes. The CCA rate is applied each year to the declining balance, with the exception that in the first year, only one-half of the normal rate is applied. For example, in year 1, CCA expense = $200,000 15% = $30,000, in year 2, CCA expense = $170,000 30% = $51,000, and so on. 4 There are many good introductory finance textbooks that can be used to explain time value of money, Net Present Value, and Internal Rate of Return.