Bunyan Lumber LLC timber harvesting and forest management operations

Bunyan Lumber

In order to determine the best time to harvest the timber, the data needs to be organized and calculations performed for each of the different potential start times. Sunk costs/decisions such as the decision to thin the trees now are not included in the calculation, because the decision of when to cut the trees does not affect the decision to thin the forest. The other information presented in the case is valid, including the tax rate. The latter is important because it is not necessarily going to be charged each year -- for example if the company posts a loss there will be no taxes.

When using net present value to make a decision such as this, the rule of thumb is that any project with a positive NPV is good, but that when the options are mutually exclusive then the option with the highest NPV should be selected. In this situation, the four options are clearly mutually exclusive.

The calculation must take into account inflation, which is the same rate for everything except the conservation cost. The calculation must also factor in the changes in the timber quality, a variable that will affect the bottom line because of the different prices for the different timber. It stands to reason that there is economic incentive for the firm to cut at a point where the timber will have the highest percentage of 1P timber. However, the time value of money is an important consideration here because that could diminish the present value of these future cash flows. It cannot be assumed that the higher net cash flow is going to be the higher net present value. Thus, the calculation was conducted in Excel in order to illustrate which of the four options is the best option for the Bunyan Lumber company.

The NPV calculations for the four harvesting options are as follows:

20-Year

25-Year

30-Year

35-Year

1P Price

2051

2P Price

1979

3P Price

MBF, net

51300

66975

80513

86925

Revenue

58060165

91415661

132119933

171492089

Cost of Logging

17310140

27101275

39069162

50583545

Cost of Road

6700699

10490816

15123547

19580727

Sales/Admin

2345245

3671786

5293241

6853255

Reforesting

13184247

15810627

18960199

22737183

Conservation

563268

659346

771813

903464

Pre-Tax Flows

17956565

33681810

52901972

70833915

Tax

6284798

11788634

18515690

24791870

Net Income

11671768

21893177

34386282

46042044

PV

1734934

2020653

1970628

1638365

The finding of the calculation is that the timber should be harvested in the 25th year. This is option has the highest rate of return given the assumptions. The worst time to harvest the timber is the 35th year. This decision derives from the rule of thumb that when choosing among options that are mutually exclusive, the option with the highest net present value should be selected. We can see that the net cash flow from the project increases the longer the company waits, but that the present value of the harvest begins to decline after the 25-year mark.