Forest valuation and risk

Abstract

This paper aims to illustrate ways in which sources of risk can affect the valuation of a commercial plantation estate. Deterministic and stochastic analyses of a hypothetical commercial plantation estate are compared. Both are built on a long-term harvest schedule of wood flows that typifies current planning and valuation practices for large commercial plantation estates. The stochastic analyses incorporate typical systematic risks, including those associated with harvest yields, costs, prices and fire. Deterministic valuation using a market discount rate that includes a risk premium underestimates the expected value of the combined asset. Applying such a discount rate to a stochastic valuation would double count risk. Stochastic analysis forces owners to focus on a risk-free discount rate reflecting their time preference for net income flows over time, rather than using a valuer’s current discount rate. Stochastic analyses of valuations enable better assessment of the sensitivity of valuations to the impact of fire frequency, climate change, product prices in the immediate future and land prices, as illustrated in this study.

Keywords:

• Valuation
• stochastic processes
• Monte Carlo method
• simulation
• deterministic models

Acknowledgements

This paper owes much to the many colleagues with whom I have worked on a number of plantation company boards, commercial consultancies and government inquiries and consultancies dealing with radiata pine and other plantations in Australia and elsewhere. None should be held responsible for the views expressed. Special thanks are due to Jerry Leech and Brian McGlynn for their constructive comments on an early draft and to three anonymous reviewers for helpful further comments.

Notes

1. A proprietary software package available from Remsoft Inc., Fredericton, Canada.

2. Current long-term bond rates in United States and Australian markets are lower and would imply lower ‘market’ and ‘risk-free’ discount rates.

3. This is not to deny that plantation (and grassland) fires can move very rapidly such that the fire front may be invincible under the most extreme conditions (McAneney et al. 2009) that characterise the worst fires. But the most extreme conditions only last for a day or so and the problem then becomes one of containment within the limits of the available resources.