Capital Recovery Costs: An Important Component of Enterprise Budgeting

Although it is early in the harvest season for many crops grown in the South, it is time to begin revising your annual enterprise budgets in preparation for the 2024 growing season. Enterprise budgets are forward-looking estimates of production costs on a per acre basis for a particular enterprise and production method (e.g, cotton on non-irrigated land).

When it comes to enterprise budgets, direct operating costs are straightforward. If a grower plans to use an input, they specify the amount they plan to use per acre and multiply that by the price per unit of that input. The product is an estimate of the operating cost per acre to charge to that enterprise.

Some overhead costs, also known as ownership costs, are more complex because they are noncash expenses. One may wonder why it is important to charge noncash expenses to an enterprise. There are two reasons for this. First, the use of owned equipment causes wear and tear over time. Eventually, owned equipment needs to be replaced. The loss in value overtime, or depreciation, should be charged to the enterprise for the use of that equipment. Second, the capital invested in the equipment could be invested elsewhere and earn a percentage return on that investment. This opportunity cost, or interest expense, should also be charged to the enterprise. 

One effective method of calculating these noncash overhead costs is using the capital recovery method. The capital recovery method enables growers to estimate an annual per acre cost in present day dollars based on the useful life of the equipment used by the enterprise. The following equation can be used to calculate annual capital recovery cost per acre.

-where n represents the useful life of the equipment and i represents the interest rate. The table below lists capital recovery factors (CRF) by year (n) and interest rate (i).

Some row crops are more capital-intensive than others because they require commodity-specific harvest equipment. This is certainly the case for cotton and peanuts in the South. Grain growers need one combine to harvest their grain, and different headers can be switched out to harvest corn, soybeans, and wheat/other small grains. Cotton farmers need a cotton picker or stripper to harvest cotton, and it cannot be used to harvest any other crop. Peanut farmers need a digger/inverter to dig and invert peanut vines and then use a peanut picker to pick the peanuts off the vines. Like cotton, peanut harvest equipment cannot be used to harvest any other crop. 

Figure 1 provides an example of annual capital recovery cost per acre at different interest rates for cotton, peanut, and grain harvesting equipment. The appropriate interest rate to select depends upon the grower, their risk tolerance, and desired rate of return on their investments. The average range is between 8-10%, with 9% highlighted on the chart.

The harvest equipment used in this example are based on typical equipment sizes used in Georgia (6-row equipment on 36-inch row spacing) and are assumed to be new. Capital recovery costs can also be calculated on used equipment based on the equation above. Table 1 lists the assumptions on purchase price, salvage value, useful life, and total annual harvest acres. Note, since the harvest equipment is only being evaluated in this article, the tractor has similar total acres to the sum of the peanut digging and picking quipment which are pulled by the tractor, with some allowance for turnaround at the end of the rows. The grains combine is assumed to harvest multiple crops like corn and soybeans.

Table 1 Title: Assumptions on purchase price, salvage value, useful life, and total annual harvest acres.

Figure 1 Title: Sensitivity Analysis of the Annual Capital Recovery Cost per Acre for Cotton, Peanut, and Grains Harvest Equipment.

Chart Source: Author created, using a capital recovery factor table, data on purchase prices, and assumptions on salvage value, useful life, and annual use.

It is evident that cotton and peanuts are more capital-intensive because of the specific harvest equipment and those enterprise budgets need to account for those higher costs per acre. Furthermore, interest rates matter. As interest rates increase, capital recovery costs do too.

While this is only an example for harvesting equipment, this method should be used for each machine used in producing a specific enterprise and added together to determine the total annual capital recovery cost. Table 2 lists a range of capital recovery factors by year and interest rate to aid growers in tabulating these costs on all of their equipment owned by the farm.

Table 2 Title: Capital Recovery Factors (CRF) by Year (n) and Interest Rate (i)

Useful Life(Years)2.0%3.0%4.0%5.0%6.0%7.0%8.0%9.0%10.0%11.0%12.0%13.0%14.0%15.0%

Smith, Amanda R. “Capital Recovery Costs: An Important Component of Enterprise Budgeting.Southern Ag Today 3(41.3). October 11, 2023. Permalink