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Using the WACC methodology to improve the assessment of projects in the french farming industry. Empirical evidences from farm's results of Isère

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par AnaŽl BIBARD
Grenoble Graduate School of Business - MBA 2012
  

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Abstract

The remarkable rise of the soft commodities prices in 2007/2008 represented just a reminder of the importance of agriculture for humanity. The Arab spring found its base on this mold and pulled down many regimes considered as stable few months before, like Tunisia or Egypt. Eventually, these price records could be reached again in 2012, due to a severe drought in the USA. To meet the challenge of feeding the world while developing more sustainable forms of production, advisory services must play a great role to help farmers in their decisions regarding their production as well as their investments. However, it appears that some financial consultants use really low actualization rates for agriculture, even lower than the risk-free rate. The purpose of this paper is therefore to present the different methods that could be used to determine more appropriate discount rates for farming businesses, and particularly the Weighted Average Cost of Capital and the bond yield plus risk premium model as presented by the French tax authority.

Historical results of farms from Isère over 5 years were studied to determine if the leverage has a significant impact on the profitability, and if signs of financial distress could be identified for the higher leverages. The statistical tests performed confirmed the underlying hypothesis of the WACC theory: the cost of capital is reduced by the increase of the leverage, up to a limit where financial distress overcomes the advantage of the lower cost of debt. The optimal capital structure for farms of Isère seems to range between 40-60% leverage, and up to 60-80% in the cases of the most stable production such as dairy farms.

This paper provides indications about how to establish the actualization rates for agricultural consultants, based on the WACC methodology and the method recommended by the tax authorities. The data analysis confirmed that the actual rates used by practitioners are clearly undervalued, leading to an over-valuation by two to four times in their asset valuation studies. The WACC and the bond yield plus risk premium methodology both seem to be applicable for small and medium farming businesses. However, further researches are necessary to validate the robustness of the WACC methodology in the agricultural context for non listed companies.

Abbreviations

ANOVA: Analysis Of Variance

CAP: Common Agricultural Policy

CAPM: Capital Asset Pricing Model

CNCER: Conseil National des CERFRANCE (national council of the CERFRANCE) EBITDA: Earnings Before Interest, Taxes, Depreciation and Amortization

EEP: Expected Equity Premium

FADN: Farm Accountancy Data Network, or RICA: Réseau d'Information Comptable Agricole FAO: Food and Agriculture Organization

FTE: Full-Time Equivalent

GDP: Gross Domestic Product

Ha: hectare, 10 000 m2 or 2.47105 acres

HEP: Historical Equity Premium

IEP: Implied Equity Premium

IMF: International Monetary Fund

NPV: Net Present Value

NSP: Ne Se prononce Pas (No Answer)

OECD: Organization for Economic Cooperation and Development REP: Required Equity Premium

ROA: Return On Asset

ROE: Return On Equity

SAFER: Société d'Aménagement Foncier et d'Etablissement Rural SAS: Statistical Analysis System

SMIC: Salaire Minimum Interprofessionnel de Croissance. The minimum salary in France. SPSS: Statistical Package for the Social Sciences

TCA: Total Cultivated Area

USD: US dollars

WACC: Weighted Average Cost of Capital

WTO: World Trade Organization

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