Risk-Adjusted Cotton Budgets by mercy2beans107

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									                              Risk-Adjusted Cotton Budgets
                                           Gregg Ibendahl and John Anderson


Introduction                                                     in a fairly simple manner. The budget is designed to be
Budgets are basic planning tool used by farmers,                 used with Excel for user interaction but the printed ver-
ranchers, lenders, and policy makers. Budgets show               sion is useful as well.
the revenue and costs associated with one unit of
the enterprise. For crop budgets, the unit is typically          Yields
an acre while for livestock the unit is often on a per           Yield variability is incorporated by using a triangular
head basis. Budgets help farmers with production                 distribution. A triangular distribution has the advantage
planning, estimating expenses, estimating profit, and            of only needing three data points. Producers just enter a
deciding upon an enterprise mix. Budgets help lenders            typical yield, a worst case yield and a best case yield. The
to determine the size of an operating loan and to help           yields around the typical yield have the highest probability
gauge the ability of a producer to repay a loan.                 of occurring while the yields near the worst case and best
                                                                 case have the lowest probability of occurring.
Budgets are really one of the simplest planning tools as
                                                                 Prices
they do not provide any optimization and only show basic
                                                                 Price variability is incorporated by asking producers to
arithmetic needed to calculate revenue, expenses, and net
                                                                 enter the December futures price and the number of weeks
income. Despite their simplicity, budgets are easy to use
                                                                 to harvest. The price variability is modeled by taking the
and can be shown on a single sheet of paper. They are easy
                                                                 natural log of prices and then adding variability to this
to manipulate and are readily understood by most users.
                                                                 distribution. The variability is adjusted by the number of
Budgets are often used as the basis of other planning and
                                                                 weeks to harvest. The longer till harvest, the more vari-
optimization tools.
                                                                 ability that is possible with prices.
One of the big weaknesses of budgets is that they only
                                                                 To determine overall revenue variability, the stochastic
show single point estimates for the revenue and expense
                                                                 yield and price are multiplied together to get a stochastic
items. Thus the ability of a budget to incorporate enter-
                                                                 revenue number. The other inputs are held constant. In
prise riskiness is very limited. Some attempts have been
                                                                 this stochastic budget, a simulation is run that looks at
made to show an enterprise’s riskiness by adding on a
                                                                 many combinations of yields and prices. Clicking on the
sensitivity table that shows net returns for a range of yields
                                                                 “Run” button in the Excel spreadsheet causes a 1000 point
or prices. While this approach is better than nothing, it
                                                                 distribution to be created. This distribution is shown in
does not include anything about the probability of each
                                                                 the “Distribution of Cotton Returns” graph. The graph
state of the sensitivity table occurring. A sensitivity table
                                                                 shows the probability of obtaining a given return or lower
seems to imply that each cell of the table is just as likely
                                                                 along the left axis. The bottom axis shows the return over
to occur as another.
                                                                 variable costs. This graph shows the possible returns and
What budgets need is a way to include stochastic in-             risks associated with growing the crop.
formation about yields and prices while still keeping
                                                                 One difficulty with the “Distribution of Cotton Returns”
the budget as a tool that is simple to use. Ideally, the
                                                                 graph is that it may be difficult for producers to initially
incorporation of risky aspects would include something
                                                                 interpret. A simpler version of the same information is
about the probability of each state of nature. The budget
                                                                 shown in the figure just below. This is a stoplight analysis
demonstrated here meets these objectives. It introduces
                                                                 of the simulated returns over variable costs. The graph is
yield and price variability while still maintaining an easy
                                                                 called a stoplight graph because it shows three level of
to use interface. The output of the results is also presented

    The authors are both Associate Extension Professors in the Department of Agricultural Economics,
    Mississippi State University.
                                               Distribution of Cotton Returns

                                                 1.000



                                                 0.750
  P(RVC)




                                                 0.500



                                                 0.250



                                                 0.000
           ($300.00)




                       ($200.00)




                                   ($100.00)




                                                         $0.00




                                                                      $100.00




                                                                                   $200.00




                                                                                                 $300.00




                                                                                                               $400.00




                                                                                                                             $500.00
                                                                 Return over VC

                                                     RVC 1            RVC 2          RVC 3
Figure 1. Distribution of Cotton Returns
income. The worst returns are shown in red, the middle                 The next step is to press the “Run” button. This causes
returns are shown in yellow, and the best returns are                  Excel to analyze a 1000 combinations of draws from the
shown in green. Thus, the name of the graph comes from                 stochastic yields and stochastic prices. The program cor-
the color coding.                                                      rectly weights the draws so that those yields and prices
                                                                       most likely to occur do occur.
In this budget, a user can set the breakpoints between red
and yellow and between yellow and green. This is ac-                   The output of the analysis is shown in Figures 1 and 2.
complished by changing the cells for upper cut-off value               Figure 1 shows the probability of obtaining a given return
and lower cut-off value. Normally the lower cut-off value              or lower. For example, a $100 or lower return over vari-
would be set to zero as producers would want to know                   able costs is likely around 75% of the time. That means a
the probability of breaking even. The upper cut-off value              return above $100 is likely around 25% of the time.
would be based on whatever profit goal the producer had
in mind.                                                               Figure 2 makes this a little easier to understand by setting
                                                                       ranges. Returns above the upper cut-off value are shown
Use of the Excel Cotton Budget                                         in green while returns below the lower cut-off value are
In order to use the interactive cotton budgets, users need             shown in red. Returns in-between the upper and lower
a copy of Excel and macros must be enabled. A user input               cut-off values are shown in yellow.
is indicated by a blue box. A user inputs the currents De-
cember futures price and the number of weeks to harvest.               Figure 2 is really just a simplification of Figure 1. For
These two pieces of information are all that is needed to              example, the probability of earning above $100 for sys-
make the price stochastic.                                             tem 1 is actually 22%. The probability of not covering
                                                                       variable costs for system 1 is 49%. The cut-off values are
On the yield side, users just enter a most likely, worst, and          user changeable so users can experiment with different
best case yield. Three production budgets are included so              levels.
users can analyze any or all of the systems.
                                                                       The last page of this handout shows the budgets for the
  StopLight Analysis Results
  Upper Cut-Off Value               100.00
  Lower Cut-Off Value                 0.00
                      System 1 System 2 System 3
  Prob(Unfavorable)          0.49     0.53    0.43
  Prob(Cautionary)           0.29     0.27    0.31
  Prob(Favorable)            0.22     0.21    0.26
  StopLight Chart for Probabilities
                 StopLight Chart for Probabilities Less Than 0.000 and
                                 Greater Than 100.000

         100%                                                            15.48201
          90%                   0.22                            0.21     14.44988
                                                                                  0.26
                                                                         13.41774
          80%
                                                                         17.54628
          70%                                                                   0
                                0.29                            0.27
          60%                                                                     0.31
          50%
          40%
          30%
                                0.49                            0.53
          20%                                                                     0.43
          10%
            0%
                             System 1                         System 2          System 3

Figure 2. Stoplight Analysis

three production systems. Users should modify these as
needed for their particular situation. In particular, users
should adjust the input prices as these change often. Fuel
and fertilizer prices change frequently.
Estimated Costs and Returns per Acre
From Alternative Cotton Production Systems



Income
           Current Dec CT futures        61.25 cents/lb                 System 1               System 2                  System 3
           Weeks to harvest                 24                   8R-38", solid, cons.     8R-38", solid, no-till 8R-38", solid, cons.
                                                                 tillage, BtRR            BtRR                   tillage, BGII/Flex
                                           Cotton Yield (lbs)
                                                 most likely           875                      800                      900
                                                       worst           400                      400                      400
                                                        best          1275                     1275                     1275


        Item                        Unit        Price/Unit       Quantity    Amount       Quantity Amount          Quantity     Amount
Expenses
    Glyphosate Herbicides
        Round-up Original           pt                    2.78        0.00   $     -                $       -                $         -
        Round-up Original Max       oz                    0.24       77.00   $   18.48        77.00 $     18.48           99 $       23.76
        Round-up Ultra Max          pt                    5.97        0.00   $     -                $       -                $         -
        Round-up Ultra Dry          lb                    8.51        0.00   $     -                $       -                $         -
        Round-up WeatherMax         oz                    0.32        0.00   $     -                $       -                $         -
                                                                                                    $       -                $         -
    Other Herbicides                                                                                $       -                $         -
        2,4-D Amine 4               pt                  1.66          1.00   $    1.66         1.00 $      1.66            1 $        1.66
        Fluomenturon 4lb            pt                  4.64          1.50   $    6.96         1.50 $      6.96              $         -
        Dual II Magnum              pt                 13.55          1.00   $   13.55         1.00 $     13.55            1 $       13.55
        Diuron 80%                  lb                  3.44          1.00   $    3.44         1.00 $      3.44          0.5 $        1.72
        Other 1                                                              $     -                $       -                $         -
        Other 2                                                              $     -                $       -                $         -
        Other 3                                                              $     -                $       -                $         -

    Insecticides
         Temik 15G Gypsum           lb                    3.03        3.50 $     10.61         3.50 $     10.61          3.5    $    10.61
         Acephate 90%               lb                    8.09        1.52 $     12.30         1.52 $     12.30         1.52    $    12.30
         Centric 40WG               oz                    4.60        2.00 $      9.20         2.00 $      9.20            2    $     9.20
         Karate Z                   oz                    3.00        2.00 $      6.00         2.00 $      6.00          0.5    $     1.50
         Bidrin 8L                  oz                    0.81        8.00 $      6.48         8.00 $      6.48            2    $     1.62
         Other 1                                                           $       -                $       -                   $      -
         Other 2                                                           $       -                $       -                   $      -
         Other 3                                                           $       -                $       -                   $      -
         BW Eradication Fee         acre                  5.50        1.00 $      5.50         1.00 $      5.50               1 $     5.50

    Seed
        Cotton Seed BtRR              1,000             0.44         52.50 $     23.10        52.50 $     23.10         52.5 $       23.10
        Technology Fee              cap/ac             49.00          1.00 $     49.00         1.00 $     49.00            1 $       49.00

    Growth Regulators
        Mepiquat Chloride           oz                    0.51       22.00 $     11.22        22.00 $     11.22           22 $       11.22

    Soil Fertility
          Phosphorus (46% P2O5)     cwt                15.00         0.175 $      2.77        0.175 $      2.77        0.175 $        2.77
          Potash                    cwt                14.00          1.50 $     22.15         1.50 $     22.15           1.5 $      22.15
          UAN (32%)                 cwt                13.00          4.00 $     54.86         2.00 $     27.43             4 $      54.86
          Am. Nit. (34%)            cwt                17.00               $       -           2.00 $     35.87               $        -
          Other N                   cwt                                    $       -                $       -                 $        -
          Lime                      ton                40.00          0.50 $     20.00         0.50 $     20.00           0.5 $      20.00

    Harvest Aids
        Thidiazuron 4 lb            oz                    2.67        2.00 $      5.34         2.00 $      5.34            2 $        5.34
        Ethephon 6E                 pt                    5.12        1.33 $      6.81         1.33 $      6.81         1.33 $        6.81
        Tribufos 6 lb               pt                    6.72        0.50 $      3.36         0.50 $      3.36          0.5 $        3.36

    Custom Fees
        Aerial App (5 gal)          appl                  4.50        2.50   $   11.25         2.50   $   11.25           2.5   $    11.25
        Aerial App (3 gal)          appl                  3.50        4.50   $   15.75         3.50   $   12.25         3.75    $    13.13
        Fertilizer App              appl                  5.00        1.00   $    5.00         1.00   $    5.00             1   $     5.00
        Gin & Haul                  lb                    0.09      875.00   $   78.75       800.00   $   72.00          900    $    81.00
        Insect Scouting             acre                  7.00        1.00   $    7.00         1.00   $    7.00             1   $     7.00

    Labor
        Operator Labor              hour                  9.41        1.37 $     12.86         1.24 $     11.69        1.376 $       12.95
        Hand Labor                  hour                  6.44        0.70 $      4.48         0.70 $      4.51           0.7 $       4.51

    Fuel
           Tractors                 gal                   2.41       10.42 $     25.11         9.19 $     22.16       10.419 $       25.11
           Self-Propelled           gal                   2.41        4.77 $     11.49         4.77 $     11.50        4.857 $       11.71

    Repair & Maint.
        Implements                  acre                  1.00        8.28 $      8.28         6.99 $      6.99         8.28 $        8.28
        Tractors                    acre                  1.00        4.00 $      4.00         3.54 $      3.54            4 $        4.00
        Self-Propelled              acre                  1.00       13.19 $     13.19        13.19 $     13.19        13.25 $       13.25

    Interest on Op. Capital         acre                  1.00       23.22 $     23.22        22.93 $     22.93        22.58 $       22.58

    Total Direct Expenses                                                    $ 513.16                 $ 505.22                  $   499.78

Net Returns
         Most Likely Yield                                                   $ 22.78                  $ (15.22)                 $   51.47
         Worst Case Yield                                                    $ (268.16)               $ (260.22)                $ (254.78)
         Best Case Yield                                                     $ 267.78                 $ 275.72                  $ 281.16

								
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