Forest Finance Simplified: Three Steps and an Example

We learn by doing. This is true for learning to ride a bike, catch a boomerang, and conduct financial analysis. When analyzing current and potential investments, multiple approaches exist, and the one you choose depends on your objectives and priorities. This article includes an example from the updated and recently published 7th Edition of Forest Finance Simplified, which emphasizes a simple, systematic approach to conducting financial analysis that strengthens skills and minimizes errors.

Financial Analysis in Three Steps

First, specify the question (“what is the question?”). Value-added analysis or research starts by clarifying a question to answer and the audience we’re preparing this for. Our analysis helps someone – a client, a colleague, the person in the mirror – make a decision. If this someone does not agree on the question or understand the analysis, then we’ve done nothing useful.

Second, apply the appropriate formula to answer the question. Deciding which financial criterion to use depends on the question asked. When evaluating whether a specific investment satisfies basic discounted cash flow (DCF) criteria, certain questions may favor one metric over another.

Third, check the results. What do they mean? Do the numbers make sense? Through checking results consistently over time, we develop a sense for ranges and logic, which improves our general fluency and intuition in forestry and finance. (At some point, anyone can distinguish a longleaf pine from a loblolly… right?)

Example: Your Neighbor Sells Some Forestland
A neighbor offers to sell you 40 acres of adjoining forestland that will be ready to harvest in about eight years. Your forester thinks the timber and land will be worth about $2,700 per acre at that time. If your discount rate (opportunity cost) is 5%, what would you be willing to pay for this land, on a per acre basis, today?

First, confirm the question: What is the present value today of $2,700 assuming a 5% discount rate and an eight-year investment period?

Second, we apply the present value formula:

Present Value = Future Value/(1 + rate)ⁿ
= $2,700/(1 + .05)⁸
= $1,827.47

Third, check the results. Discounting $2,700 at 5% for 8 years is the mirror of taking $1,827 and investing at 5% for 8 years. You decide to take a closer look at the property and see if the neighbor will accept $1,750 per acre while discussing the matter over a cold beer.