Is Growing Oranges in Florida a Good Investment?

Is Growing Oranges in Florida a Good Investment? Abstract We provide a financial model to evaluate an orange grove investment in Florida, the producing region supplying around 90% of U.S. domestic production of orange juice. A representative orange grower planting early-mid varieties for the processed market is featured in the case. The study assumes that an existing grove has become disease-infested to a degree that there is little, if any economic value in maintaining it. The grower is left with the choice to replant the grove or to convert the land to other uses. The replanting baseline model yields a 9.7% Modified Internal Rate of Return (MIRR) and the Monte Carlo simulation shows that MIRR is equal or higher than the 7.5% hurdle rate around 81% times the model is simulated. The risk of managing an orange grove is higher than a decade ago mainly due to the presence of citrus greening, a disease that reduces yields and degrades fruit quality, causing variability in productivity and operating costs. Opportunities for growers include planting incentive programs implemented by both the government and major citrus processors and from policy changes such as the possibility of changes in depreciation of new investment for income tax purposes. Readers of this case study are expected to challenge the assumptions of the financial model and consider additional elements of risk and opportunities on their assessment of the potential orange grove investment. By 2017, after several years of a declining supply of oranges and high prices, replanting a grove with significant or total devastation by diseases could represent an opportunity for growers in Florida to meet the demand for processed oranges. The State of Florida supplies around 90% of U.S. domestic orange juice production. The risk of managing an orange grove, however, is higher than a decade ago, mainly due to the presence of huanglongbing (HLB, also known as citrus greening), a disease that reduces yields and degrades fruit quality. This case study provides a capital budgeting model to evaluate a potential orange grove investment. Due mainly to citrus greening, orange production in the State of Florida has decreased every year since the 2011–12 crop season. Total orange production in the 2015–16 season, at 81.7 million 90-pound boxes, was approximately one-third of production relative to the 2003–04 season, prior to greening.1 Research efforts to mitigate the negative effects of greening are underway on several fronts, but the disease is still a major threat for this industry.2 Furthermore, according to the Commercial Citrus Tree Inventory by the USDA’s National Agricultural Statistics Service (NASS), new plantings have been less than tree removals over the past ten seasons, leading to a slow decline in the bearing tree inventory. The economic impact of citrus greening was estimated to be $4.393 billion over the period 2012–13 to 2015–16, causing the loss of at least 7,945 jobs (Court et al. 2017). Similarly, Farnsworth et al. (2014) estimated the impact of greening slightly over $1 billion during the 2012–13 season. The challenge for both public and private entities has been, in recent years, to develop programs that incentivize new tree planting despite the production risks posed by greening. Efforts to better understand the financials behind a grove investment, such as this study, may help decision makers in this industry.3 We next describe a typical orange grove investment and present results for a baseline model. This is followed by a description of risks and opportunities. Citrus greening constitutes the main source of risk, causing variability in productivity and operating costs. Opportunities include planting incentive programs implemented by both the government and major citrus processors, and from policy changes such as the possibility of changes in depreciation of new investment for income tax purposes. Recent improvements in citriculture practices may also benefit orange producers. A concluding remarks section ends this study. Readers of the case are expected to challenge the assumptions of the model and consider additional elements of risk and opportunities on their assessment of the potential orange grove investment. Assumptions for a Grove Investment Model This study assumes that a grove is greening-infested to a degree that there is little, if any economic value in maintaining it. The grower is left with the choice to replant the grove or to convert the land to other uses. While we discuss alternative crops at the end of this document, the study focuses on the analysis of replanting the orange grove. Replanting implies: (a) investing capital to reestablish the grove (establishment); (b) maintaining the young trees until they become productive at about three to four years old (early caretaking); (c) performing cultural activities to keep the grove productive (caretaking and reset); (d) harvesting and transporting the fruit to the processing facility (harvest and haul); and (e) selling the fruit (selling). Citriculture practices and cost structures presented in this case do not apply to every grower or situation, but are representative of a typical, medium-size grove. Practices and costs are based on research experiments or surveys to growers and suppliers conducted by personnel from the University of Florida’s Institute of Food and Agricultural Sciences (UF-IFAS), an institution covering extension and research efforts on the citrus industry. The case focuses on a grower planting early-mid varieties for the processed market in Southwest Florida.4 Establishment (Initial Investment) and Early Caretaking (Additional Investment) Reestablishing an orange grove includes both fixed cost and variable cost investments. Reestablishment begins with the removal of existing trees and cleanup of the area.5 Land preparation follows tree removal. The acquisition and installation of an irrigation system is also part of the initial investment, although in the case of replanting an existing plot, part of the irrigation system is already in place. Planting cost involves both the cost per tree and number of trees to plant and the cost of planting, staking, and watering the young trees. Variable investments depend mainly upon planting density, which is a decision made by the grower. Table 1 provides investment per acre at “Year 0”, replanting time, assuming a planting density of 225 trees per acre. Planting density is a relevant decision for a grove investment as will be discussed later in this study. Most existing groves in Florida are planted at 145–150 trees per acre, while some new plantings are at 220–225 trees. Densities equal to or higher than 300 trees may qualify as an Advanced Production System (APS). This system is an experiment started in 2009 by a research team at UF-IFAS envisioned to help the industry to survive greening and remain competitive by testing innovative horticulture practices. APS not only involves higher densities, but is a technology that includes a switch away from micro sprinklers to computer-controlled drip irrigation, which also includes fertigation through the irrigation system. This is an important feature of APS which promotes early maturation of the young trees, meaning more fruit early in tree life, thus reducing the payback period of an investment. A detailed explanation of APS is provided in the “horticultural practices and planting density” section. Table 1. Establishment and Early Caretaking Costs (without Resetting) for a Conventional Grove in Southwest Florida Investment item  Year 0  Year 1  Year 2  Year 3  Fixed costs/investment:          Tree removal and land preparation ($ per acre)  933.3        Irrigation investments ($ per acre)a  400.0        Variable costs/investment:          Tree cost ($ per acre)  1,912.5         Density (number of plants per acre)  225         Cost per tree ($)  8.5        Planting, staking and watering (PS&W) ($ per acre)  371.3         PS&W ($ per tree)  1.65        Total initial investment  3,617.0        Early caretaking -horticultural activities    603.7  657.0  632.5  Indirect costs    42.7  45.9  45.9  Total additional investment    646.4  702.9  678.4  Investment item  Year 0  Year 1  Year 2  Year 3  Fixed costs/investment:          Tree removal and land preparation ($ per acre)  933.3        Irrigation investments ($ per acre)a  400.0        Variable costs/investment:          Tree cost ($ per acre)  1,912.5         Density (number of plants per acre)  225         Cost per tree ($)  8.5        Planting, staking and watering (PS&W) ($ per acre)  371.3         PS&W ($ per tree)  1.65        Total initial investment  3,617.0        Early caretaking -horticultural activities    603.7  657.0  632.5  Indirect costs    42.7  45.9  45.9  Total additional investment    646.4  702.9  678.4  Note: Per acre estimations by Morris, Muraro, and Castle (2011), adjusted by authors as follows: 1) figures were adjusted by the CPI as of the end of 2016 USD values; 2) cost per tree is $8.5 as in Spreen and Zansler (2016); and 3) superscript a indicates that irrigation investment for a new grove is estimated by Morris, Muraro, and Castle (2011) at $1,093 (2016 dollars equivalent) per acre. When reestablishing the grove, however, a grower can reuse part of the irrigation infrastructure, but the pipes and emitters would have been destroyed and would need replacement; this is estimated to cost $400 per acre as in Spreen and Zansler (2016). Early caretaking- horticultural activities include weed control, sprays (insecticides, fungicides, and foliar nutrients), fertilizer, sprouting, irrigation, and disease control-related efforts. Indirect costs include supervision, overhead, and miscellaneous. Morris, Muraro, and Castle (2011) estimated $260 per acre in permits and fees. We ignore this cost as an establishment cost since it represents sunk costs for replanting decisions, as permits already exist. Early caretaking activities, including weed control, foliar spray, fertilizer application, sprouting, and irrigation, as well as disease-related efforts are conducted during the first 3 years while trees are young and unproductive (table 1). An example of disease-related efforts is the Citrus Health Management Areas (CHMA) program, which coordinates neighboring citrus growers to work together to combat the Asian citrus psyllid, the vector that spreads greening. Indirect costs (e.g., supervision and overhead) are part of maintaining a grove. Not included in table 1 are costs related to resetting, an activity that growers perform even during the unproductive life of the grove. While some early caretaking activities may occur immediately after planting, it is assumed that all costs accrue by the end of the year, as is standard in capital budgeting. At the end of 2016, under Internal Revenue Service (IRS) rules, total establishment and early caretaking costs are depreciated using a 10-year straight-line depreciation schedule, with the first depreciation expense reported in the income statement only when the grove becomes productive, generally in the fourth year after planting.6 Caretaking The cost of cultural activities significantly increases when trees become productive. The Citrus Research and Education Center (CREC) at IFAS-UF surveys growers and suppliers every season. Table 2 provides caretaking costs from these surveys for a typical irrigated, productive grove in Southwest Florida during selected crop seasons under greening and during 2005-06, prior to greening. Total caretaking costs (without reset and indirect costs) were $773.9 per acre prior to greening ($920 in 2016 CPI adjusted dollars), increased 55% to $1,199.2 per acre ($1,387 in 2016 dollars) with the arrival of greening during 2006–07, and are $1,651.3 and $1,524.6 during 2014–15 and 2015–16, respectively. Table 2. Cost of Production (without Resetting) for Processed Oranges Grown in Southwest Florida, Selected Seasons ($ per acre) Activity  2005–06  2006–07  2014–15  2015–16  Avg. 2014–16  Weed control  197.2  193.6  248.2  210.1  229.1  Spray Programa  143.9  420.3  666.0  611.6  638.8  Fertilizer  207.9  250.4  487.0  454.2  470.6  Pruning  28.7  31.6  31.5  49.8  40.7  Irrigationb  166.7  182.9  198.1  180.9  189.5  Other citrus greening relatedc    90.9  20.6  18.0  19.3  Citrus Cankerd  29.4  29.4        Total cost of prod. w/o resets  773.9  1,199.2  1,651.3  1,524.6  1,588.0  Indirect costse  109.0  109.0  92.1  160.0  126.0  Activity  2005–06  2006–07  2014–15  2015–16  Avg. 2014–16  Weed control  197.2  193.6  248.2  210.1  229.1  Spray Programa  143.9  420.3  666.0  611.6  638.8  Fertilizer  207.9  250.4  487.0  454.2  470.6  Pruning  28.7  31.6  31.5  49.8  40.7  Irrigationb  166.7  182.9  198.1  180.9  189.5  Other citrus greening relatedc    90.9  20.6  18.0  19.3  Citrus Cankerd  29.4  29.4        Total cost of prod. w/o resets  773.9  1,199.2  1,651.3  1,524.6  1,588.0  Indirect costse  109.0  109.0  92.1  160.0  126.0  Source: Adapted by authors from the Southwest Florida Orange Budget Costs by the Citrus Research and Education Center, IFAS-UF. Available at: http://www.crec.ifas.ufl.edu/extension/economics/southwest_florida.shtml. Note: Superscript a indicates the inclusion of insecticides, fungicides, and enhanced foliar nutrients; b denotes that depreciation charges, originally included in the budget reports up to the 2011-12 season, are excluded by authors; c denotes the inclusion of tree removal and site cleanup preparation, field inspections for greening, and Citrus Health Management Areas (CHMA) program costs; d indicates mandatory citrus Canker decontamination costs; e denotes the inclusion of management costs and taxes/regulatory costs. Interest, originally included in the budget reports, are excluded by authors. Foliar spray that also includes application of insecticides and fungicides is applied for disease and pest management purposes. With greening, “enhanced” foliar sprays that include both macro and micro nutrients are used to improve the health of trees and with the intent to mitigate the effect of the disease though the application of nutrients via the leaves. As a consequence, foliar spray cost is the item among all caretaking activities that increased the most as the incidence of citrus greening spread. Fertilizer program cost experienced the second-highest growth as growers incorporated micro nutrients such as calcium to mitigate the effects of greening (Muraro 2012). Foliar spray and fertilizer together represented around 70% of caretaking costs in the two most recent seasons. Furthermore, these costs vary significantly among growers, as groves may face greening severity differently. Singerman (2015) reports the volatility of those costs across respondents: standard deviation for foliar spray is $199 and $333 for fertilizer program. Other costs, in table 2, have remained similar over the years (i.e., greening has not caused other costs to increase). Reset Once the replant decision is made, the grower may replace diseased, damaged, or unproductive trees in the reestablished grove to keep the level of trees at the original planting density, a practice known as reset. Resetting is more critical during epidemic diseases because it contributes to suppression of the vector of the disease by partially cleaning the grove on a continuous basis. The trade-off is the cost of this activity, the time lag between planting time and production, and the higher susceptibility of young trees to citrus greening. Currently, the common practice in Southwest Florida is to reset. A study prior to greening demonstrates that resetting was more profitable for a grove diseased by the citrus tristeza virus (Muraro, Roka, and Stansly 1999) compared to other alternatives such as doing nothing and continuing to cultivate for several years before deciding to replant the entire grove. According to the annual survey by the extension department at IFAS-UF, resetting cost growers $25.8 per tree per year on average during the two most recent seasons (including tree removal, site preparation, planting (cost of trees included) and supplemental caretaking for the young recent planted trees), and growers reset, on average, 9 trees per acre every year, starting the first year even when plants are unproductive and maintaining this practice during the complete life of the grove. Resetting 9 trees per acre implies an annual tree loss rate in the range of 4% to 6% for planting densities from 150 to 225 plants per acre. Morris, Muraro, and Castle (2011) state that loss rates can be kept low by employing the standard citrus greening management protocol from the start at replanting time rather than later when infection rates could get out of control. These authors estimate a 5% loss rate for a replanted grove, a 2% loss due to greening, and a 3% loss due to other causes. Harvesting and Hauling Early-mid varieties of oranges in Florida are typically harvested between late November and February. Oranges are mostly hand-picked, with only a small portion of total acreage harvested mechanically. Picked fruits are placed in field bins and then loaded into trailers. Fruits in trailers are then transported to the processing plant. Table 3 provides harvesting and hauling costs for selected seasons. During 2015–16, average harvesting costs increased 23% relative to the previous season, from $1.99 to $2.44 per box. Singerman, Burani-Arouca, and Futch (2016) suggest this jump is partially due to a more severe greening attack, which causes trees to produce smaller fruits, reducing harvesting efficiency (labor cost has also increased as growers rely on foreign workers, and harvesting under greening has become more arduous). The correlation between tree productivity and harvesting cost is negative. The eventual mitigation of the effects of greening, and consequently the increase of productivity, may reduce harvesting costs. Mechanical harvesting would likely also decrease costs. However, mechanical harvesting is less likely in the mid-term while greening prevails in the region (Moseley, House, and Roka 2012). Regarding hauling, costs vary according to the distance between the grove and the processing plant. Table 3 provides hauling costs per box of 90 pounds, which are used as standard in this industry. Table 3. Harvesting and Hauling Costs for Processed Oranges in Southwest Florida, Early-Mid Varieties ($ per 90-Pound Equivalent Box) Activity  2005–06  2014–15  2015–16  Avg. 2014–16  Harvesting:          Weigh. Avg.  1.945  1.990  2.440  2.215  Minimum  1.550  1.680  1.880  1.780  Maximum  2.750  2.350  3.420  2.885  Hauling, according to mileage:          1 to 30  0.428  0.370  0.440  0.405  31 to 50  0.498  0.470  0.530  0.500  51 to 80  0.632  0.599  0.610  0.605  81 to 100  0.735  0.776  0.700  0.738  100 +  0.840  0.960  0.640  0.800  Activity  2005–06  2014–15  2015–16  Avg. 2014–16  Harvesting:          Weigh. Avg.  1.945  1.990  2.440  2.215  Minimum  1.550  1.680  1.880  1.780  Maximum  2.750  2.350  3.420  2.885  Hauling, according to mileage:          1 to 30  0.428  0.370  0.440  0.405  31 to 50  0.498  0.470  0.530  0.500  51 to 80  0.632  0.599  0.610  0.605  81 to 100  0.735  0.776  0.700  0.738  100 +  0.840  0.960  0.640  0.800  Source: Citrus Research and Education Center, IFAS-UF, adapted by authors using “Harvesting Charges” reports from several years. Available at: http://www.crec.ifas.ufl.edu/extension/economics/harvesting_charges.shtml. Opportunity Cost A grower considering replanting the orange grove has the possibility to rent his/her land. The forgone value of renting is an opportunity cost and needs to be charged to the project under evaluation even though this opportunity cost does not imply an actual cash flow. The farm land average cash rent per acre in Florida in 2016 was $102 according to the USDA National Agricultural Statistics Service (USDA-NASS 2016). Prices and Yields Prices and yields constitute a major source of uncertainty for the grower. Oranges are intentionally produced either for juice processing or for fresh consumption (generally, costs are higher to produce for the fresh market). According to the Florida Department of Citrus (FDOC), approximately 96% of Florida orange production is currently utilized for juice processing. Some growers enter into fixed-price contracts with processors, but many orange producers in Florida participate in a pool, meaning that they receive the average price of the pool of producers. Table 4 provides aggregate statistics of weekly prices paid to pooled growers during the 2014–15 and 2015–16 seasons in dollars per pound solids for early-mid varieties in Florida. Figure 1 illustrates the increasing prices during the last season, mainly due to the supply shortage of oranges in Florida because of citrus greening. Table 4. Statistics of Yields and Prices for Early-Mid Oranges for Processing in Florida, Based on Weekly Data during the 2014–15 and 2015–16 Seasons Statistic  Price ($ per pound solid)  Yield (pound solids per box)  Mean  2.012386  5.755276  Std. Deviation  0.138036  0.283026  Minimum  1.895000  5.394349  Maximum  2.240000  6.237169  Statistic  Price ($ per pound solid)  Yield (pound solids per box)  Mean  2.012386  5.755276  Std. Deviation  0.138036  0.283026  Minimum  1.895000  5.394349  Maximum  2.240000  6.237169  Source: FDOC (2015) and FDOC (2016). Full reference given in the reference section. Note: Yields are expressed in pounds solids per box, and prices in dollars per pound solid (yields for tangerines and eliminations included). Post-estimate weekly prices, USD per pound solid, are final spot and contracted prices established for current fruit season only, reported by the FDOC. Prices from the beginning of the season, particularly when the total level of production is very low, are significantly lower than regular prices during the rest of the season. Thus, data when production level did not reach 1 million 90-lb. boxes per week are excluded from table 4. Figure 1. View largeDownload slide Weekly prices, 2014–15 and 2015–16 seasons ($ per pound solid) orange juice in Florida Source: FDOC (2015) and FDOC (2016). Figure 1. View largeDownload slide Weekly prices, 2014–15 and 2015–16 seasons ($ per pound solid) orange juice in Florida Source: FDOC (2015) and FDOC (2016). Yields are determined by climate, management practices, and to a great extent by the degree of greening infestation in a grove. Greening degrades the fruit, reducing both quantity and quality, expressed in number of boxes per tree and total pounds solids per box (juice yield), respectively. Staff from the Florida Department of Agriculture and Consumer Services (FDACS) measure the juice content of per fruit delivered to processors. Average yields are made public by the state on a weekly basis through the harvesting season. Table 4 also provides pooled grower statistics of orange juice pounds solids per box (90 pounds) during the two most recent seasons. Figure 2 plots yields per week during the recent seasons. Figure 2. View largeDownload slide Weekly yields, 2014–15 and 2015–16 seasons (pound solids per box) orange juice in Florida Source: FDOC (2015) and FDOC (2016). Figure 2. View largeDownload slide Weekly yields, 2014–15 and 2015–16 seasons (pound solids per box) orange juice in Florida Source: FDOC (2015) and FDOC (2016). Yields also depend upon the age of trees. Table 5 provides production per tree estimation by the FDACS during several seasons. Fruit and juice yield estimates are based on surveys conducted by this agency between August and harvest and using the number of bearing trees in the Commercial Citrus Inventory. Since estimates are according to field surveys, yields in table 4 and 5 are presumably tilted towards groves managed under conventional horticulture practices and infected by greening. Singerman and Useche (2016) surveyed growers covering around 30% of total citrus acreage in Florida, and found that 57% reported that at least one tree in every single acre of their groves was greening-infected, and fruit yields have been reduced about 40% due to the effects of greening. Table 5. Yield per Tree Age for Early-Mid Oranges in Florida, in 90-lb. Box per Tree for Southern Florida Crop season  3 to 5 years  6 to 8 years  9 to 13 years  14 to 23 years  24+ years  Prior to greening            2004–05  1.00  2.70  2.50  3.50  3.90  During greening            2011–12  1.40  1.70  2.30  2.70  3.80  2012–13  0.50  1.10  2.10  2.50  3.70  2013–14  0.30  1.10  1.90  2.20  3.10  2014–15  1.00  1.00  1.20  2.30  3.10  2015–16  0.50  1.60  1.90  1.40  2.40  Weighted average during greening  0.70  1.40  1.90  2.30  3.10  Crop season  3 to 5 years  6 to 8 years  9 to 13 years  14 to 23 years  24+ years  Prior to greening            2004–05  1.00  2.70  2.50  3.50  3.90  During greening            2011–12  1.40  1.70  2.30  2.70  3.80  2012–13  0.50  1.10  2.10  2.50  3.70  2013–14  0.30  1.10  1.90  2.20  3.10  2014–15  1.00  1.00  1.20  2.30  3.10  2015–16  0.50  1.60  1.90  1.40  2.40  Weighted average during greening  0.70  1.40  1.90  2.30  3.10  Source: 1. During greening period data from USDA-NASS (2017). 2. Prior to greening data from USDA-NASS (2010). Available at: https://www.nass.usda.gov/Statistics_by_State/Florida/Publications/Citrus/. Baseline Model Result We put together assumptions from the previous section in a capital budgeting model. Table 6 gives projected free cash flows (FCFs) for the grove investment in dollars per acre.7 Initial investment is from table 1. Revenues depend upon volume (number of productive trees and number of boxes per tree, table 5; and the mean of weekly juice yields, table 4) and price (mean of weekly prices, table 4). The number of productive trees for any given year depends on the mortality rate. This baseline model assumes a flat 5% tree loss rate, as discussed previously for a grove following standard citrus greening management protocol. This assumes that every year 5% of the total trees die and are replaced by resetting. Considering a 225 planting density, after the end of the first year around 11 trees are replaced (figures rounded), leaving 214 one-year old trees and 11 recently planted. By the fourth year, when the grove becomes productive, only 183 are 4 years old (number rounded down, table 6), with small groups of three-, two-, one-year old, and recently planted trees. Since the mortality rate and density planting are kept constant over time, beginning in year 4 we have the same number of productive trees every single year. Operating (caretaking, resetting, harvesting, and hauling) and indirect costs are the average of the two most recent seasons. We assume an average of 50 miles as the distance from the grove to the processor. Table 6. Projected Free Cash Flows for the Baseline Orange Grove Item  Year 0  Y1  Y2  Y3  Y4  Y5  Y6  Y7  Establishment  3,617                Early caretaking    610  670  652          Indirect costs    43  47  47          Reset    286  289  292          Revenues          1,544  1,559  3,150  3,181   Volume (PS/Acre)          737  737  1,475  1,475   Yield (PS/box)          5.76  5.76  5.76  5.76   # boxes per tree          0.70  0.70  1.40  1.40   Productive trees (trees per acre)      183  183  183  183   Price ($/PS)          2.09  2.12  2.14  2.16  Oper. Costs & Expenses        3,096  3,120  3,514  3,542  Caretaking w/o resets          1,652  1,669  1,686  1,702   Spray program          665  671  678  685   Fertilizer program          490  495  500  505   Other caretaking          498  503  508  513  Reset          295  298  301  304  Harvesting          295  298  602  608  Hauling          67  67  136  137  Indirect costs          131  132  134  135  Depreciation          655  655  655  655  Operating Income          −1,552  −1,561  −364  −361  Income taxes          −466  −468  −109  −108  Net Oper. Profit After Taxes        −1,086  −1,092  −255  −253  Opportunity cost (rent)  103  104  105  106  107  108  109  Free Cash Flow  −3,617  −1,042  −1,110  −1,096  −537  −544  292  293  Terminal Value                  FCF + Terminal Value  −3,617  −1,042  −1,110  −1,096  −537  −544  292  293  Item  Y8  Y9  Y10  Y11  Y12  Y13  Y14  Y15  Revenues  3,213  4,404  4,448  4,493  4,538  4,583  5,603  5,659   Volume (PS/Acre)  1,475  2,001  2,001  2,001  2,001  2,001  2,422  2,422   Yield (PS/box)  5.76  5.76  5.76  5.76  5.76  5.76  5.76  5.76   # boxes per tree  1.40  1.90  1.90  1.90  1.90  1.90  2.30  2.30   Productive trees (trees per acre)  183  183  183  183  183  183  183  183   Price ($/PS)  2.18  2.20  2.22  2.25  2.27  2.29  2.31  2.34  Oper. Costs & Expenses  3,571  3,872  3,904  3,937  3,970  4,003  3,609  3,645  Caretaking w/o resets  1,720  1,737  1,754  1,772  1,789  1,807  1,825  1,844   Spray program  692  699  706  713  720  727  734  742   Fertilizer program  510  515  520  525  530  536  541  546   Other caretaking  518  523  529  534  539  545  550  556  Reset  307  310  313  316  319  322  326  329  Harvesting  615  842  851  859  868  877  1,072  1,082  Hauling  139  190  192  194  196  198  242  244  Indirect costs  136  138  139  141  142  143  145  146  Depreciation  655  655  655  655  655  655      Operating Income  −358  532  544  556  568  580  1,994  2,014  Income taxes  −107  160  163  167  170  174  598  604  Net Oper. Profit After Taxes  −251  372  381  389  398  406  1,396  1,410  Opportunity cost (rent)  110  112  113  114  115  116  117  118  Free Cash Flow  294  916  923  931  938  945  1,279  1,291  Terminal Value                18,540  FCF + Terminal Value  294  916  923  931  938  945  1,279  19,832  Item  Year 0  Y1  Y2  Y3  Y4  Y5  Y6  Y7  Establishment  3,617                Early caretaking    610  670  652          Indirect costs    43  47  47          Reset    286  289  292          Revenues          1,544  1,559  3,150  3,181   Volume (PS/Acre)          737  737  1,475  1,475   Yield (PS/box)          5.76  5.76  5.76  5.76   # boxes per tree          0.70  0.70  1.40  1.40   Productive trees (trees per acre)      183  183  183  183   Price ($/PS)          2.09  2.12  2.14  2.16  Oper. Costs & Expenses        3,096  3,120  3,514  3,542  Caretaking w/o resets          1,652  1,669  1,686  1,702   Spray program          665  671  678  685   Fertilizer program          490  495  500  505   Other caretaking          498  503  508  513  Reset          295  298  301  304  Harvesting          295  298  602  608  Hauling          67  67  136  137  Indirect costs          131  132  134  135  Depreciation          655  655  655  655  Operating Income          −1,552  −1,561  −364  −361  Income taxes          −466  −468  −109  −108  Net Oper. Profit After Taxes        −1,086  −1,092  −255  −253  Opportunity cost (rent)  103  104  105  106  107  108  109  Free Cash Flow  −3,617  −1,042  −1,110  −1,096  −537  −544  292  293  Terminal Value                  FCF + Terminal Value  −3,617  −1,042  −1,110  −1,096  −537  −544  292  293  Item  Y8  Y9  Y10  Y11  Y12  Y13  Y14  Y15  Revenues  3,213  4,404  4,448  4,493  4,538  4,583  5,603  5,659   Volume (PS/Acre)  1,475  2,001  2,001  2,001  2,001  2,001  2,422  2,422   Yield (PS/box)  5.76  5.76  5.76  5.76  5.76  5.76  5.76  5.76   # boxes per tree  1.40  1.90  1.90  1.90  1.90  1.90  2.30  2.30   Productive trees (trees per acre)  183  183  183  183  183  183  183  183   Price ($/PS)  2.18  2.20  2.22  2.25  2.27  2.29  2.31  2.34  Oper. Costs & Expenses  3,571  3,872  3,904  3,937  3,970  4,003  3,609  3,645  Caretaking w/o resets  1,720  1,737  1,754  1,772  1,789  1,807  1,825  1,844   Spray program  692  699  706  713  720  727  734  742   Fertilizer program  510  515  520  525  530  536  541  546   Other caretaking  518  523  529  534  539  545  550  556  Reset  307  310  313  316  319  322  326  329  Harvesting  615  842  851  859  868  877  1,072  1,082  Hauling  139  190  192  194  196  198  242  244  Indirect costs  136  138  139  141  142  143  145  146  Depreciation  655  655  655  655  655  655      Operating Income  −358  532  544  556  568  580  1,994  2,014  Income taxes  −107  160  163  167  170  174  598  604  Net Oper. Profit After Taxes  −251  372  381  389  398  406  1,396  1,410  Opportunity cost (rent)  110  112  113  114  115  116  117  118  Free Cash Flow  294  916  923  931  938  945  1,279  1,291  Terminal Value                18,540  FCF + Terminal Value  294  916  923  931  938  945  1,279  19,832  Note: Numbers rounded. Notice that due to projected inflation (1%), prices and costs vary every year. Furthermore, the beginning price at time zero (the average of two last seasons, 2.01 in table 4), is compounded by the inflation rate so that year 4 is 2.09. The same is done for all costs. Life of a Grove (Duration of the Project), Terminal Value and other Financial Assumptions Resetting increases costs and potentially reduces total volume as some infested trees that might continue producing are replaced with unproductive young trees. Resetting is advisable, however, since it increases the life expectancy of the grove. For valuation purposes, resetting gives a “perpetual” life to a citrus grove (Singerman, Burani-Arouca, and Futch 2016; Morris, Muraro, and Castle 2011). When valuing a project on perpetuity it is customary to project free cash flows over a foreseeable horizon (up to year T), and then estimate a terminal value that reflects the present value of all FCFs occurring thereafter (PVT). A common and convenient approach to estimating the terminal value is to use the constant growth model, which assumes that the FCFs grow at a constant growth rate, g, beyond T, known as the steady-stage period. Terminal value (in present value terms, PVT) is estimated by applying the following equation: PVT = FCFT+1 / (WACC-g), where WACC is the weighted average cost of capital or opportunity cost of capital (this equation is the reduced form of an infinite series of FCFs growing at g, and discounted at WACC; refer to Schill 2013). In valuation analysis, g is conventionally assumed to be between 0 to 3%. In general, g should not be higher than the overall growth rate of the economy. Terminal value is usually a large component in a valuation, so sensitivity analysis is recommended. In order for the constant-growth model to be applicable to citrus production, the project is expected to enter a steady stage in the terminal year, implying that all transitional effects are over. This baseline assumes that T is year 15 based on the fact that the investment cost is fully depreciated by then, operating income is stable (table 6), and the grove is already mature (yields have reached a stable level that year). Furthermore, greening, a major transitional effect, should be under control by then. We assume a 0.5% growth rate, g, after year 15. The opportunity cost of capital or WACC is assumed to be 7.5%. The cost of capital in previous studies for citrus varies between 5% to 10% (Muraro, Roka, and Stansly 1999; Spreen and Zansler 2016). The FCFs for the baseline model are in table 6. The Modified Internal Rate of Return (MIRR) is 9.7%, and the Net Present Value (NPV) is $2,597 per acre.8,9 Scenario Analysis and Simulation The previous result is only a point-estimate of the baseline model. Grove care varies across regions and block such that inputs differ from our assumptions based on various factors. Scenario or “What If” analysis, where selected assumptions are expected to move within reasonable ranges, is advisable for capital budgeting evaluation. Graham and Campbell (2001), by surveying Chief Financial Officers in the United States, report that around 52% of companies use scenario analysis as one of their tools when evaluating investment projects. As one of the purposes of this study is to feature a case for teaching purposes, we do not provide scenario analysis results. Students are expected to perform this analysis by incorporating different elements of risks and opportunities in the sector (description below). The baseline model result could be considered as a “most likely” scenario, on which the level of greening severity continues as it is, in the near future. Scenarios on which greening improves and worsens could be considered. Scenario analysis results could be contrasted and complemented with simulation results. Simulation can be performed to incorporate simultaneous changes in assumptions that, presumably, follow a determined statistical distribution. Figure 3 provides an example of Monte Carlo simulation. Students are expected to challenge and discuss these assumptions. Juice quality (e.g., pounds solids per box) and prices are assumed to follow a normal distribution with a mean and standard deviation according to data of the two most recent seasons. Similarly, spray and fertilizer costs, which together account for 70% of caretaking costs, follow a normal distribution. Tree loss rate is assumed to vary uniformly between 2% and 6%. Harvesting costs vary uniformly with minimum and maximum values during the last two seasons, in table 3. Finally, expedited depreciation (more below) has a 50% chance to be approved for use in citrus. Figure 1 shows the distribution of MIRRs when 1,000 simulations are run. MIRR is equal to or higher than the hurdle rate of 7.5%, around 81% times the model is simulated. Figure 3. View largeDownload slide Distribution of modified internal rate of return results for 1,000 Monte Carlo simulations Figure 3. View largeDownload slide Distribution of modified internal rate of return results for 1,000 Monte Carlo simulations Risk and Opportunities The quantitative analysis could be complemented by incorporating elements of risks and opportunities in citrus, featured in this section. Citrus Greening In Florida, greening is caused by the bacterium Candidatus Liberibacter asiaticus, transmitted by Diaphorina citri, an insect known as the Asiatic citrus psyllid (the vector, hereafter).10 Vectors retain the pathogen for life following 15 to 30 minutes access feeding on a diseased plant, and transmit it to other plants after feeding for as little as 15 minutes (low likelihood of transmission) or for one hour or more (Mead and Fasulo 2014). The bacterium causes root dysfunction, and infected oranges generally present an irregular pattern of leaf chlorosis and scattered spots of green. Effects of greening on productivity include fruit drop, fruit deformation, poor juice quality, and general tree decline (Mead and Fasulo 2014; Tansey et al. 2017). Detected in Florida in 2005, greening has been referred to as the most destructive disease of citrus known (Gottwald et al. 2012). Over the course of more than a decade, growers have tried different strategies to contain greening and gained some experience in dealing with the disease. To reduce greening spread, early strategies included aggressive scouting for the disease and removal of greening symptomatic trees. This practice, however, is costly when a large number of trees are infected (Tansey et al. 2017) and nearly all growers do not remove greening-symptomatic trees (Singerman and Burani-Arouca 2012). Aggressive control of the vector and area-wide insecticide spray management programs can be cost effective even when greening incidence is high (Tansey et al. 2017). Although control of the vector is a short-term solution while a cure is sought (Grafton-Cardwell, Stelinski and Stansly 2013), it is likely the most important strategy that growers have to delay and reduce the effects of greening (Tansey et al. 2017). Citrus Health Management Areas (CHMAs), started in 2010 and coordinated by UF-IFAS Extension and FDACS, is a program to fight the vector over a wide geographical area. In addition, foliar nutrition spray programs may reduce trees stress caused by the infection and help tree productivity by allowing foliage to acquire nutrients that are otherwise limited by the root dysfunction caused by the bacterium (Tansey et al. 2017).11 Both foliar nutrition sprays and vector control are currently common practices in Florida for helping growers to contain greening, but have significantly increased production costs, as shown in table 2.12 Some studies have casted doubt, however, on whether costs of these practices individually implemented offset the benefits (Gottwald et al. 2012; Tansey et al. 2017), and propose more integrated practices (Gottwald et al. 2012) such as foliar sprays, area-wide vector management, plus removal of greening symptomatic trees. Horticultural Practices and Planting Density In 2009, a research team at UF-IFAS began APS, an experiment envisioned to help the industry to survive greening and remain competitive until a long-term solution is available (Schumann, Syvertsen, and Morgan 2009).13 A block of trees cultivated under standard growing practices (e.g., granular fertilizer and micro sprinkler irrigation) was compared to blocks with non-standard practices including drip fertigation, open hydroponics, alternative rootstocks, and high plant densities. Schumann et al. (2012) reported the progress of the research when 3-year-old trees were harvested. The integration of non-standard practices, APS, produced early high fruit yields. That is, the normalized production level of the 3-year-old trees is equivalent to what would not have been achieved until year 5 under conventional practices. High planting density was the most significant contributor to higher early yields in the experiment. Blocks planted at 363 trees per acre contributed 57% of normalized gains (measured as soluble solids pounds per acre) compared to a 22% contribution of drip fertigation—open hydroponics, and 21% of rootstock. Planting density affects investment profitability. By choosing a low density, a grower foregoes potential revenue. Planting too many trees, on the other hand, increases costs and may diminish yield per tree since neighboring plants would compete for nutrients and sunlight utilization by the crop canopy. In practice, growers decide the planting density according to their groves’ particular conditions and the planting density within ranges considered best practices. Plants in this experiment were attacked by greening. The incidence of greening was statistically higher and more severe on plants cultivated under conventional practices than under APS. While “[APS] failed to avoid infestation… or to adequately offset the symptoms of greening once trees became infected,” (Gruber et al. 2015), APS components optimize early yields and partially mitigate greening. “Greening-affected trees will remain smaller, with lower yields per tree – conditions which are better dealt with and compensated for with high planting densities and APS than with traditional low densities and conventional citriculture,” (Schumann et al. 2012). Possibly due to APS, orange growers in Florida are adopting high density planting. Prior to greening, orange trees were planted at densities around 150–175 trees per acre. Currently, the density of new plantings by small- and medium-sized growers is estimated to be around 225 trees per acre. Large growers could afford to plant at higher planting densities and APS, which increases establishment and production costs. Best practices on planting density vary over time, and depend upon the prevailing citriculture technology. During the 1950s, for instance, orange groves in Florida were planted at about 70 trees per acre. As freezes in the 1980s devastated many of those groves, new plantings moved further south with tree densities reaching 145 trees per acre with the aid of better technology allowing for higher density (Goldberg and Hogan 2004). Given the perennial nature of citrus cultivars, densities significantly vary during structural industry changes that require new plantings, such as natural disasters or epidemic diseases. Citrus Replanting Incentive Programs Governmental agencies have programs implemented to help citrus growers to reduce the risk of a new or renovated grove investment. Singerman (2016) summarizes these programs. We next highlight the features of the programs that relate to the grove investment model. Private entities have also implemented programs to incentivize citrus replanting. Announced in 2014, the Tree Assistance Program (TAP) of the USDA Farm Service Agency (FSA), reimburses growers for replanting trees lost to the effects of citrus greening. The TAP provides cost-sharing financial assistance after the grove accumulates tree mortality in excess of 18% over a period up to six years. In particular, the program covers 65% of cost per tree and planting cost and 50% of site preparation, subject to eligibility provisions and with capped support. Based on characteristics of the TAP, Spreen and Zansler (2016) note that this program is only available to small- to medium-sized growers because of income limits imposed by the government. The goal of the TAP is to reach a large number of growers in Florida, as its target is to have 6 million new trees planted by 2018. In general, the TAP is a support program limiting resetting costs in case of severe greening attacks. The Citrus Grove Renovation / Re-establishment Support Program (CGRR) is a relatively new program available to Florida growers, announced in August 2016. CGRR is a program implemented by the FDACS. This support is limited to growers planting an entire grove and targets investments in irrigation and nutrient management systems. As discussed previously, one of the strategies currently used by growers against greening precisely involves these investments. CGRR would cover 100% of the cost of engineering and design and 75% of investments that qualify for improvement of irrigation and nutrient management systems. Similar to the TAP, the CGRR is subject to eligibility provisions and pre-established capped amounts. While table 1 provides the investments required to establish a traditional grove, the CGRR program gives room for technology improvement, particularly for technology targeted to contain the negative effects of greening. The Abandoned Grove Abatement Initiative (AGAI) is another support program by the FDACS. AGAI supports growers for the removal and destruction of abandoned groves due to greening, to reduce the spread of the pathogen. Thus, a grower planting a new grove in Florida, eligible for AGAI, would avoid this cost and focus on the establishment costs instead (table 1). In any case, removal costs are considered sunk costs for capital budgeting purposes, as they need to be incurred regardless of the decision to re-plant the grove with citrus or use it for other purposes. An additional benefit of the AGAI for landowners is the fact that it provides tax benefits related to land values if the farmer decides to replant citrus. Private entities also have programs to incentivize replanting of orange groves. However, these programs are not available to a typical grower in Florida, but rather to growers with ties to those firms. Minute Maid, the subsidiary of the Coca-Cola company, has a program consisting of a long-term contract offered to growers (see Spreen and Zansler 2016). In 2014, Florida’s Natural announced major commitments to incentivize citrus plantings in Florida and renewed the program in 2017 (see Trejo-Pech, Spreen, and House 2018). Expedited Depreciation A bill on tax reductions expected to benefit Florida citrus growers was introduced in the U.S. Senate in September 2016. If passed, the Emergency Citrus Disease Response Act of 2016 would allow citrus growers to apply expedited or accelerated depreciation for income tax purposes. That is, instead of accumulating grove establishment costs and early caretaking costs during the non-bearing portion of grove life, costs would be “expensed” or reported in the income statement during the year incurred. Reporting expenses earlier rather than later in the investment horizon alleviates growers’ cash flow needs, particularly during the non-productive grove period. The overall value of a grove improves due to the time value of money. According to the model in this study, the value of a grove would increase about $600 USD per acre by using expedited depreciation instead of normal depreciation, as currently allowed by the IRS. Size of Grove The baseline model in this study is presented on a one-acre basis. While it would be difficult to define small, medium, and large orange growers, for this study a small grower is one with up to 200 acres cultivated, a medium-sized grower has 200 to 500 acres, and a large grower has more than 500 acres. Grower size may capture the scale effects of fixed costs and bargaining power on selected inputs. We mention a few instances where grower size affects profitability. Caretaking costs may be lower for a large grower, as orange farmers typically receive discounts for bulk purchases (Singerman 2015), and small growers may have higher caretaking costs. Financial costs could also be affected. The opportunity cost of capital for a large grower might be lower relative to a small grower as access barriers to capital and interest rates could be lower. The Next-best Alternative to Replanting Oranges The grower may choose to consider alternative crops to plant. Some alternative crops, emerging due to citrus greening mainly, include but are not limited to peaches, olives, and blueberries. An analysis of alternative crops is not covered in this study. The CREC has recently published a profitability study on blueberries (Singerman et al. 2016). Compared to oranges, planting blueberries requires a significantly higher investment of above $35,000 per acre for the first year. According to the study, which presents alternative price and yield scenarios, blueberry cultivation provides positive NPVs at moderate yield and high prices, using 10% as cost of capital. At the same time, blueberry prices have varied year over year, and the infrastructure is still in the developmental phase. Finally, the representative orange grower featured in this study may decide to rent or sell its land. The opportunity cost of renting is already incorporated in the capital budgeting model. The selling option is outside of the scope of this study. Concluding Remarks This study presents a capital budgeting model to evaluate a potential orange grove investment. The study features a representative grower in Southwest Florida with his grove infested by greening to a degree that it makes no economic sense to continue maintaining it. The grower has the choice of replanting the grove or converting the land to other uses. While many Florida growers may have strong incentives to replant an orange grove devastated by greening (such as a long tradition of planting this crop, governmental supports to fight citrus greening, industry knowledge developed through time, etc.), growers need a financial model to make more informed decisions. We provide results of a baseline model, along with Monte Carlo simulation. Users of this case study are expected to challenge the baseline assumptions and replicate the model with alternative scenarios. Ultimately, they should decide whether it is optimal to continue growing oranges in Florida considering both financial metrics and risks and opportunities. Footnotes 1 The Florida citrus harvest and marketing seasons extends from November 1 to October 31 of the following year. 2 The USDA’s National Institute of Food and Agriculture, for instance, awarded about $14 million in grants in 2017 to four research institutions to fight citrus greening (Johnson 2017). 3 The following CBS videos clearly communicate the problem that growers in Florida face due to citrus greening. “Citrus disease attacks Florida's oranges” (https://www.youtube.com/watch?v=T5nqVmliUaM), and “Florida farmers struggling with citrus greening disease” (https://www.youtube.com/watch?v=C8VKwj9y3wc). 4 Early-mid varieties of oranges in Florida include Hamlin, Pineapple, and Mid-Sweet. These varieties are typically harvested between late November and February. Valencia, also known as late orange, is harvested between March and June. Early-mid and late varieties have different production costs, prices and yields. In Florida, during the last two seasons, approximately 47% of total orange production came from early-mid varieties. 5 When reestablishing an entire grove, revenues from commercially productive trees, if any, are foregone. Foregone revenues (and foregone costs) are not considered in this model for project evaluation purposes since it is assumed that the decision to reestablish an entire grove is made by the grower when the grove generates negative Net Present Value. 6 To simplify the estimations in this case study, we ignore bonus depreciation. Under this regime, 50% of the cost of new trees can be written off the year they are expended. 7 Investment in working capital is assumed to be zero, implying that investment in current assets (inventories and account receivables) equal investment in current liabilities (excluding short-term loans). 8 The MIRR provides a more conservative rate of return than the conventional Internal Rate of Return (IRR) since it uses a more realistic reinvestment rate (e.g., the opportunity cost of capital in this instance). In general, the MIRR provides a more accurate metric than the IRR (Kierulff 2008). The MIRR is also less prone to errors when simulation analysis is performed, as in this study. When simulating results, many times there is a possibility that in some cases cash flows change signs more than one time over the investment horizon, thus producing an incorrect IRR or simply producing errors in the spreadsheet. 9 The expected inflation rate of the baseline model is assumed to be 1%, while income taxes are assumed to be 30%. 10 Other species of the bacterium are Candidatus L. africanus, the cause of citrus greening in Africa, and Candidatus L. Americanus, which affects some regions in Brazil (Mead and Fasulo 2014). 11 This includes both macro nutrients (nitrogen, phosphorus, and potassium salts) and micro nutrients (magnesium, boron, and zinc salts). 12 Other control strategies under evaluation include thermal and antimicrobial treatments, not widely used yet due to practicality of implementation or regulatory hurdles (McCollum and Baldwin 2016). 13 The overall APS’s aim was stated as: “…enhance citrus production and reduce abiotic stress and disease pressure by optimizing daily water and nutrient levels for trees growing on sandy soils. This system also promotes rapid canopy development by incorporating high planting densities” (Schumann, Syvertsen, and Morgan 2009). References Court C., Hodges A.W., Rahamani M., Spreen T.H.. 2017. Economic Impacts of the Florida Citrus Industry in 2015–16. Economic Impact Analysis Program, Food & Resource Economics Department. University of Florida. 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Citrus Research and Education Center, Lake Alfred, IFAS. University of Florida. Available at: http://www.crec.ifas.ufl.edu/Extension/Economics. Schill M. 2013. Business Valuation: Standard Approaches and Applications. Darden Business Publishing, University of Virginia  UV6586: 1– 17. Schumann A., Hostler K., Waldo L., Mann K.. 2012. Advanced Production Systems for Florida Citrus: Research Update, Huanglongbing Impacts and Production Forecasts. Citrus Industry . August 2012, 6– 12. Schumann A., Syvertsen J., Morgan K.. 2009. Implemented Advanced Citrus Production Systems in Florida - Early Results. Proceedings of the Florida State Horticultural Society  122: 108– 13. Singerman A. 2015. Cost of Production for Processed Oranges in Southwest Florida, 2014/15. Food and Resource Economics Department, UF/IFAS Extension. FE986, University of Florida. December. Singerman A. 2016. Summary of Three Incentive Programs Available to Florida Citrus Growers. Citrus Research and Education Center, IFAS Citrus Extension. University of Florida. Available at: http://www.crec.ifas.ufl.edu/extension/economics/articles.shtml. Singerman A., Burani-Arouca M.. 2012. Evolution of Citrus Disease Management Programs and Their Economic Implications: The Case of Florida’s Citrus Industry. Food and Resource Economics Department, IFAS Extension. FE915, University of Florida, October. Singerman A., Burani-Arouca M., Futch S.. 2016. 2015/16 Harvesting Charges for Florida Citrus: Picking, Roadsiding and Hauling. Citrus Research and Education Center, Lake Alfred, IFAS. University of Florida, July. Singerman A., Burani-Arouca M., Williamson J., England G.. 2016. Establishment and Production Cost for Southern Highbush Blueberry Orchards in Florida: Enterprise Budget and Profitability Analysis. Food and Resource Economics Department, IFAS Extension. FE1002, University of Florida, November. Singerman A., Useche P.. 2016. Impact of Citrus Greening on Citrus Operations in Florida. Food and Resource Economics Department, IFAS Extension. FE983, University of Florida, February. Spreen T., Zansler M.. 2016. Economic Analysis of Incentives to Plant Citrus Trees in Florida. HortTechnology May  26 6: 720– 6. Google Scholar CrossRef Search ADS   Tansey J.A., Vanaclocha P., Monzo C., Jones M., Stansly P.A.. 2017. Costs and Benefits of Insecticide and Foliar Nutrient Applications to Huanglongbing-Infected Citrus Trees. Pest Management Science  73: 904– 16. Google Scholar CrossRef Search ADS PubMed  Trejo-Pech C.J., Spreen T.H., House L.. In Press. Florida’s Natural® and The Supply of Florida Oranges. International Food and Agribusiness Management Review. U.S. Department of Agriculture, National Agricultural Statistics Service (USDA-NASS). May 2010. Florida Citrus Statistics, 2008–09. Available at: https://www.nass.usda.gov/Statistics_by_State/Florida/Publications/Citrus/Citrus_Statistics/index.php. U.S. Department of Agriculture, National Agricultural Statistics Service. 2016. Southern Region News Release. Land Values and Cash Rents. August 2016. Available at: https://www.nass.usda.gov/Statistics_by_State/Regional_Office/Southern/includes/Publications/Economic_and_Demographic_Releases/Land_Value/Land_Values(Aug)2016.pdf. U.S. Department of Agriculture, National Agricultural Statistics Service. 2017. Florida Citrus Statistics, 2015-16. March 2017. Available at: https://www.nass.usda.gov/Statistics_by_State/Florida/Publications/Citrus/. Zansler M. 2016. Florida Citrus Outlook 2016-17 Season. Economic & Market Research Department, Florida Department of Citrus. Working Paper 2016-1. October 2016. Available at: http://www.floridacitrus.org/grower/resources/economic-research/. © The Author(s) 2018. Published by Oxford University Press on behalf of the Agricultural and Applied Economics Association. All rights reserved. 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Is Growing Oranges in Florida a Good Investment?

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Abstract

Abstract We provide a financial model to evaluate an orange grove investment in Florida, the producing region supplying around 90% of U.S. domestic production of orange juice. A representative orange grower planting early-mid varieties for the processed market is featured in the case. The study assumes that an existing grove has become disease-infested to a degree that there is little, if any economic value in maintaining it. The grower is left with the choice to replant the grove or to convert the land to other uses. The replanting baseline model yields a 9.7% Modified Internal Rate of Return (MIRR) and the Monte Carlo simulation shows that MIRR is equal or higher than the 7.5% hurdle rate around 81% times the model is simulated. The risk of managing an orange grove is higher than a decade ago mainly due to the presence of citrus greening, a disease that reduces yields and degrades fruit quality, causing variability in productivity and operating costs. Opportunities for growers include planting incentive programs implemented by both the government and major citrus processors and from policy changes such as the possibility of changes in depreciation of new investment for income tax purposes. Readers of this case study are expected to challenge the assumptions of the financial model and consider additional elements of risk and opportunities on their assessment of the potential orange grove investment. By 2017, after several years of a declining supply of oranges and high prices, replanting a grove with significant or total devastation by diseases could represent an opportunity for growers in Florida to meet the demand for processed oranges. The State of Florida supplies around 90% of U.S. domestic orange juice production. The risk of managing an orange grove, however, is higher than a decade ago, mainly due to the presence of huanglongbing (HLB, also known as citrus greening), a disease that reduces yields and degrades fruit quality. This case study provides a capital budgeting model to evaluate a potential orange grove investment. Due mainly to citrus greening, orange production in the State of Florida has decreased every year since the 2011–12 crop season. Total orange production in the 2015–16 season, at 81.7 million 90-pound boxes, was approximately one-third of production relative to the 2003–04 season, prior to greening.1 Research efforts to mitigate the negative effects of greening are underway on several fronts, but the disease is still a major threat for this industry.2 Furthermore, according to the Commercial Citrus Tree Inventory by the USDA’s National Agricultural Statistics Service (NASS), new plantings have been less than tree removals over the past ten seasons, leading to a slow decline in the bearing tree inventory. The economic impact of citrus greening was estimated to be $4.393 billion over the period 2012–13 to 2015–16, causing the loss of at least 7,945 jobs (Court et al. 2017). Similarly, Farnsworth et al. (2014) estimated the impact of greening slightly over $1 billion during the 2012–13 season. The challenge for both public and private entities has been, in recent years, to develop programs that incentivize new tree planting despite the production risks posed by greening. Efforts to better understand the financials behind a grove investment, such as this study, may help decision makers in this industry.3 We next describe a typical orange grove investment and present results for a baseline model. This is followed by a description of risks and opportunities. Citrus greening constitutes the main source of risk, causing variability in productivity and operating costs. Opportunities include planting incentive programs implemented by both the government and major citrus processors, and from policy changes such as the possibility of changes in depreciation of new investment for income tax purposes. Recent improvements in citriculture practices may also benefit orange producers. A concluding remarks section ends this study. Readers of the case are expected to challenge the assumptions of the model and consider additional elements of risk and opportunities on their assessment of the potential orange grove investment. Assumptions for a Grove Investment Model This study assumes that a grove is greening-infested to a degree that there is little, if any economic value in maintaining it. The grower is left with the choice to replant the grove or to convert the land to other uses. While we discuss alternative crops at the end of this document, the study focuses on the analysis of replanting the orange grove. Replanting implies: (a) investing capital to reestablish the grove (establishment); (b) maintaining the young trees until they become productive at about three to four years old (early caretaking); (c) performing cultural activities to keep the grove productive (caretaking and reset); (d) harvesting and transporting the fruit to the processing facility (harvest and haul); and (e) selling the fruit (selling). Citriculture practices and cost structures presented in this case do not apply to every grower or situation, but are representative of a typical, medium-size grove. Practices and costs are based on research experiments or surveys to growers and suppliers conducted by personnel from the University of Florida’s Institute of Food and Agricultural Sciences (UF-IFAS), an institution covering extension and research efforts on the citrus industry. The case focuses on a grower planting early-mid varieties for the processed market in Southwest Florida.4 Establishment (Initial Investment) and Early Caretaking (Additional Investment) Reestablishing an orange grove includes both fixed cost and variable cost investments. Reestablishment begins with the removal of existing trees and cleanup of the area.5 Land preparation follows tree removal. The acquisition and installation of an irrigation system is also part of the initial investment, although in the case of replanting an existing plot, part of the irrigation system is already in place. Planting cost involves both the cost per tree and number of trees to plant and the cost of planting, staking, and watering the young trees. Variable investments depend mainly upon planting density, which is a decision made by the grower. Table 1 provides investment per acre at “Year 0”, replanting time, assuming a planting density of 225 trees per acre. Planting density is a relevant decision for a grove investment as will be discussed later in this study. Most existing groves in Florida are planted at 145–150 trees per acre, while some new plantings are at 220–225 trees. Densities equal to or higher than 300 trees may qualify as an Advanced Production System (APS). This system is an experiment started in 2009 by a research team at UF-IFAS envisioned to help the industry to survive greening and remain competitive by testing innovative horticulture practices. APS not only involves higher densities, but is a technology that includes a switch away from micro sprinklers to computer-controlled drip irrigation, which also includes fertigation through the irrigation system. This is an important feature of APS which promotes early maturation of the young trees, meaning more fruit early in tree life, thus reducing the payback period of an investment. A detailed explanation of APS is provided in the “horticultural practices and planting density” section. Table 1. Establishment and Early Caretaking Costs (without Resetting) for a Conventional Grove in Southwest Florida Investment item  Year 0  Year 1  Year 2  Year 3  Fixed costs/investment:          Tree removal and land preparation ($ per acre)  933.3        Irrigation investments ($ per acre)a  400.0        Variable costs/investment:          Tree cost ($ per acre)  1,912.5         Density (number of plants per acre)  225         Cost per tree ($)  8.5        Planting, staking and watering (PS&W) ($ per acre)  371.3         PS&W ($ per tree)  1.65        Total initial investment  3,617.0        Early caretaking -horticultural activities    603.7  657.0  632.5  Indirect costs    42.7  45.9  45.9  Total additional investment    646.4  702.9  678.4  Investment item  Year 0  Year 1  Year 2  Year 3  Fixed costs/investment:          Tree removal and land preparation ($ per acre)  933.3        Irrigation investments ($ per acre)a  400.0        Variable costs/investment:          Tree cost ($ per acre)  1,912.5         Density (number of plants per acre)  225         Cost per tree ($)  8.5        Planting, staking and watering (PS&W) ($ per acre)  371.3         PS&W ($ per tree)  1.65        Total initial investment  3,617.0        Early caretaking -horticultural activities    603.7  657.0  632.5  Indirect costs    42.7  45.9  45.9  Total additional investment    646.4  702.9  678.4  Note: Per acre estimations by Morris, Muraro, and Castle (2011), adjusted by authors as follows: 1) figures were adjusted by the CPI as of the end of 2016 USD values; 2) cost per tree is $8.5 as in Spreen and Zansler (2016); and 3) superscript a indicates that irrigation investment for a new grove is estimated by Morris, Muraro, and Castle (2011) at $1,093 (2016 dollars equivalent) per acre. When reestablishing the grove, however, a grower can reuse part of the irrigation infrastructure, but the pipes and emitters would have been destroyed and would need replacement; this is estimated to cost $400 per acre as in Spreen and Zansler (2016). Early caretaking- horticultural activities include weed control, sprays (insecticides, fungicides, and foliar nutrients), fertilizer, sprouting, irrigation, and disease control-related efforts. Indirect costs include supervision, overhead, and miscellaneous. Morris, Muraro, and Castle (2011) estimated $260 per acre in permits and fees. We ignore this cost as an establishment cost since it represents sunk costs for replanting decisions, as permits already exist. Early caretaking activities, including weed control, foliar spray, fertilizer application, sprouting, and irrigation, as well as disease-related efforts are conducted during the first 3 years while trees are young and unproductive (table 1). An example of disease-related efforts is the Citrus Health Management Areas (CHMA) program, which coordinates neighboring citrus growers to work together to combat the Asian citrus psyllid, the vector that spreads greening. Indirect costs (e.g., supervision and overhead) are part of maintaining a grove. Not included in table 1 are costs related to resetting, an activity that growers perform even during the unproductive life of the grove. While some early caretaking activities may occur immediately after planting, it is assumed that all costs accrue by the end of the year, as is standard in capital budgeting. At the end of 2016, under Internal Revenue Service (IRS) rules, total establishment and early caretaking costs are depreciated using a 10-year straight-line depreciation schedule, with the first depreciation expense reported in the income statement only when the grove becomes productive, generally in the fourth year after planting.6 Caretaking The cost of cultural activities significantly increases when trees become productive. The Citrus Research and Education Center (CREC) at IFAS-UF surveys growers and suppliers every season. Table 2 provides caretaking costs from these surveys for a typical irrigated, productive grove in Southwest Florida during selected crop seasons under greening and during 2005-06, prior to greening. Total caretaking costs (without reset and indirect costs) were $773.9 per acre prior to greening ($920 in 2016 CPI adjusted dollars), increased 55% to $1,199.2 per acre ($1,387 in 2016 dollars) with the arrival of greening during 2006–07, and are $1,651.3 and $1,524.6 during 2014–15 and 2015–16, respectively. Table 2. Cost of Production (without Resetting) for Processed Oranges Grown in Southwest Florida, Selected Seasons ($ per acre) Activity  2005–06  2006–07  2014–15  2015–16  Avg. 2014–16  Weed control  197.2  193.6  248.2  210.1  229.1  Spray Programa  143.9  420.3  666.0  611.6  638.8  Fertilizer  207.9  250.4  487.0  454.2  470.6  Pruning  28.7  31.6  31.5  49.8  40.7  Irrigationb  166.7  182.9  198.1  180.9  189.5  Other citrus greening relatedc    90.9  20.6  18.0  19.3  Citrus Cankerd  29.4  29.4        Total cost of prod. w/o resets  773.9  1,199.2  1,651.3  1,524.6  1,588.0  Indirect costse  109.0  109.0  92.1  160.0  126.0  Activity  2005–06  2006–07  2014–15  2015–16  Avg. 2014–16  Weed control  197.2  193.6  248.2  210.1  229.1  Spray Programa  143.9  420.3  666.0  611.6  638.8  Fertilizer  207.9  250.4  487.0  454.2  470.6  Pruning  28.7  31.6  31.5  49.8  40.7  Irrigationb  166.7  182.9  198.1  180.9  189.5  Other citrus greening relatedc    90.9  20.6  18.0  19.3  Citrus Cankerd  29.4  29.4        Total cost of prod. w/o resets  773.9  1,199.2  1,651.3  1,524.6  1,588.0  Indirect costse  109.0  109.0  92.1  160.0  126.0  Source: Adapted by authors from the Southwest Florida Orange Budget Costs by the Citrus Research and Education Center, IFAS-UF. Available at: http://www.crec.ifas.ufl.edu/extension/economics/southwest_florida.shtml. Note: Superscript a indicates the inclusion of insecticides, fungicides, and enhanced foliar nutrients; b denotes that depreciation charges, originally included in the budget reports up to the 2011-12 season, are excluded by authors; c denotes the inclusion of tree removal and site cleanup preparation, field inspections for greening, and Citrus Health Management Areas (CHMA) program costs; d indicates mandatory citrus Canker decontamination costs; e denotes the inclusion of management costs and taxes/regulatory costs. Interest, originally included in the budget reports, are excluded by authors. Foliar spray that also includes application of insecticides and fungicides is applied for disease and pest management purposes. With greening, “enhanced” foliar sprays that include both macro and micro nutrients are used to improve the health of trees and with the intent to mitigate the effect of the disease though the application of nutrients via the leaves. As a consequence, foliar spray cost is the item among all caretaking activities that increased the most as the incidence of citrus greening spread. Fertilizer program cost experienced the second-highest growth as growers incorporated micro nutrients such as calcium to mitigate the effects of greening (Muraro 2012). Foliar spray and fertilizer together represented around 70% of caretaking costs in the two most recent seasons. Furthermore, these costs vary significantly among growers, as groves may face greening severity differently. Singerman (2015) reports the volatility of those costs across respondents: standard deviation for foliar spray is $199 and $333 for fertilizer program. Other costs, in table 2, have remained similar over the years (i.e., greening has not caused other costs to increase). Reset Once the replant decision is made, the grower may replace diseased, damaged, or unproductive trees in the reestablished grove to keep the level of trees at the original planting density, a practice known as reset. Resetting is more critical during epidemic diseases because it contributes to suppression of the vector of the disease by partially cleaning the grove on a continuous basis. The trade-off is the cost of this activity, the time lag between planting time and production, and the higher susceptibility of young trees to citrus greening. Currently, the common practice in Southwest Florida is to reset. A study prior to greening demonstrates that resetting was more profitable for a grove diseased by the citrus tristeza virus (Muraro, Roka, and Stansly 1999) compared to other alternatives such as doing nothing and continuing to cultivate for several years before deciding to replant the entire grove. According to the annual survey by the extension department at IFAS-UF, resetting cost growers $25.8 per tree per year on average during the two most recent seasons (including tree removal, site preparation, planting (cost of trees included) and supplemental caretaking for the young recent planted trees), and growers reset, on average, 9 trees per acre every year, starting the first year even when plants are unproductive and maintaining this practice during the complete life of the grove. Resetting 9 trees per acre implies an annual tree loss rate in the range of 4% to 6% for planting densities from 150 to 225 plants per acre. Morris, Muraro, and Castle (2011) state that loss rates can be kept low by employing the standard citrus greening management protocol from the start at replanting time rather than later when infection rates could get out of control. These authors estimate a 5% loss rate for a replanted grove, a 2% loss due to greening, and a 3% loss due to other causes. Harvesting and Hauling Early-mid varieties of oranges in Florida are typically harvested between late November and February. Oranges are mostly hand-picked, with only a small portion of total acreage harvested mechanically. Picked fruits are placed in field bins and then loaded into trailers. Fruits in trailers are then transported to the processing plant. Table 3 provides harvesting and hauling costs for selected seasons. During 2015–16, average harvesting costs increased 23% relative to the previous season, from $1.99 to $2.44 per box. Singerman, Burani-Arouca, and Futch (2016) suggest this jump is partially due to a more severe greening attack, which causes trees to produce smaller fruits, reducing harvesting efficiency (labor cost has also increased as growers rely on foreign workers, and harvesting under greening has become more arduous). The correlation between tree productivity and harvesting cost is negative. The eventual mitigation of the effects of greening, and consequently the increase of productivity, may reduce harvesting costs. Mechanical harvesting would likely also decrease costs. However, mechanical harvesting is less likely in the mid-term while greening prevails in the region (Moseley, House, and Roka 2012). Regarding hauling, costs vary according to the distance between the grove and the processing plant. Table 3 provides hauling costs per box of 90 pounds, which are used as standard in this industry. Table 3. Harvesting and Hauling Costs for Processed Oranges in Southwest Florida, Early-Mid Varieties ($ per 90-Pound Equivalent Box) Activity  2005–06  2014–15  2015–16  Avg. 2014–16  Harvesting:          Weigh. Avg.  1.945  1.990  2.440  2.215  Minimum  1.550  1.680  1.880  1.780  Maximum  2.750  2.350  3.420  2.885  Hauling, according to mileage:          1 to 30  0.428  0.370  0.440  0.405  31 to 50  0.498  0.470  0.530  0.500  51 to 80  0.632  0.599  0.610  0.605  81 to 100  0.735  0.776  0.700  0.738  100 +  0.840  0.960  0.640  0.800  Activity  2005–06  2014–15  2015–16  Avg. 2014–16  Harvesting:          Weigh. Avg.  1.945  1.990  2.440  2.215  Minimum  1.550  1.680  1.880  1.780  Maximum  2.750  2.350  3.420  2.885  Hauling, according to mileage:          1 to 30  0.428  0.370  0.440  0.405  31 to 50  0.498  0.470  0.530  0.500  51 to 80  0.632  0.599  0.610  0.605  81 to 100  0.735  0.776  0.700  0.738  100 +  0.840  0.960  0.640  0.800  Source: Citrus Research and Education Center, IFAS-UF, adapted by authors using “Harvesting Charges” reports from several years. Available at: http://www.crec.ifas.ufl.edu/extension/economics/harvesting_charges.shtml. Opportunity Cost A grower considering replanting the orange grove has the possibility to rent his/her land. The forgone value of renting is an opportunity cost and needs to be charged to the project under evaluation even though this opportunity cost does not imply an actual cash flow. The farm land average cash rent per acre in Florida in 2016 was $102 according to the USDA National Agricultural Statistics Service (USDA-NASS 2016). Prices and Yields Prices and yields constitute a major source of uncertainty for the grower. Oranges are intentionally produced either for juice processing or for fresh consumption (generally, costs are higher to produce for the fresh market). According to the Florida Department of Citrus (FDOC), approximately 96% of Florida orange production is currently utilized for juice processing. Some growers enter into fixed-price contracts with processors, but many orange producers in Florida participate in a pool, meaning that they receive the average price of the pool of producers. Table 4 provides aggregate statistics of weekly prices paid to pooled growers during the 2014–15 and 2015–16 seasons in dollars per pound solids for early-mid varieties in Florida. Figure 1 illustrates the increasing prices during the last season, mainly due to the supply shortage of oranges in Florida because of citrus greening. Table 4. Statistics of Yields and Prices for Early-Mid Oranges for Processing in Florida, Based on Weekly Data during the 2014–15 and 2015–16 Seasons Statistic  Price ($ per pound solid)  Yield (pound solids per box)  Mean  2.012386  5.755276  Std. Deviation  0.138036  0.283026  Minimum  1.895000  5.394349  Maximum  2.240000  6.237169  Statistic  Price ($ per pound solid)  Yield (pound solids per box)  Mean  2.012386  5.755276  Std. Deviation  0.138036  0.283026  Minimum  1.895000  5.394349  Maximum  2.240000  6.237169  Source: FDOC (2015) and FDOC (2016). Full reference given in the reference section. Note: Yields are expressed in pounds solids per box, and prices in dollars per pound solid (yields for tangerines and eliminations included). Post-estimate weekly prices, USD per pound solid, are final spot and contracted prices established for current fruit season only, reported by the FDOC. Prices from the beginning of the season, particularly when the total level of production is very low, are significantly lower than regular prices during the rest of the season. Thus, data when production level did not reach 1 million 90-lb. boxes per week are excluded from table 4. Figure 1. View largeDownload slide Weekly prices, 2014–15 and 2015–16 seasons ($ per pound solid) orange juice in Florida Source: FDOC (2015) and FDOC (2016). Figure 1. View largeDownload slide Weekly prices, 2014–15 and 2015–16 seasons ($ per pound solid) orange juice in Florida Source: FDOC (2015) and FDOC (2016). Yields are determined by climate, management practices, and to a great extent by the degree of greening infestation in a grove. Greening degrades the fruit, reducing both quantity and quality, expressed in number of boxes per tree and total pounds solids per box (juice yield), respectively. Staff from the Florida Department of Agriculture and Consumer Services (FDACS) measure the juice content of per fruit delivered to processors. Average yields are made public by the state on a weekly basis through the harvesting season. Table 4 also provides pooled grower statistics of orange juice pounds solids per box (90 pounds) during the two most recent seasons. Figure 2 plots yields per week during the recent seasons. Figure 2. View largeDownload slide Weekly yields, 2014–15 and 2015–16 seasons (pound solids per box) orange juice in Florida Source: FDOC (2015) and FDOC (2016). Figure 2. View largeDownload slide Weekly yields, 2014–15 and 2015–16 seasons (pound solids per box) orange juice in Florida Source: FDOC (2015) and FDOC (2016). Yields also depend upon the age of trees. Table 5 provides production per tree estimation by the FDACS during several seasons. Fruit and juice yield estimates are based on surveys conducted by this agency between August and harvest and using the number of bearing trees in the Commercial Citrus Inventory. Since estimates are according to field surveys, yields in table 4 and 5 are presumably tilted towards groves managed under conventional horticulture practices and infected by greening. Singerman and Useche (2016) surveyed growers covering around 30% of total citrus acreage in Florida, and found that 57% reported that at least one tree in every single acre of their groves was greening-infected, and fruit yields have been reduced about 40% due to the effects of greening. Table 5. Yield per Tree Age for Early-Mid Oranges in Florida, in 90-lb. Box per Tree for Southern Florida Crop season  3 to 5 years  6 to 8 years  9 to 13 years  14 to 23 years  24+ years  Prior to greening            2004–05  1.00  2.70  2.50  3.50  3.90  During greening            2011–12  1.40  1.70  2.30  2.70  3.80  2012–13  0.50  1.10  2.10  2.50  3.70  2013–14  0.30  1.10  1.90  2.20  3.10  2014–15  1.00  1.00  1.20  2.30  3.10  2015–16  0.50  1.60  1.90  1.40  2.40  Weighted average during greening  0.70  1.40  1.90  2.30  3.10  Crop season  3 to 5 years  6 to 8 years  9 to 13 years  14 to 23 years  24+ years  Prior to greening            2004–05  1.00  2.70  2.50  3.50  3.90  During greening            2011–12  1.40  1.70  2.30  2.70  3.80  2012–13  0.50  1.10  2.10  2.50  3.70  2013–14  0.30  1.10  1.90  2.20  3.10  2014–15  1.00  1.00  1.20  2.30  3.10  2015–16  0.50  1.60  1.90  1.40  2.40  Weighted average during greening  0.70  1.40  1.90  2.30  3.10  Source: 1. During greening period data from USDA-NASS (2017). 2. Prior to greening data from USDA-NASS (2010). Available at: https://www.nass.usda.gov/Statistics_by_State/Florida/Publications/Citrus/. Baseline Model Result We put together assumptions from the previous section in a capital budgeting model. Table 6 gives projected free cash flows (FCFs) for the grove investment in dollars per acre.7 Initial investment is from table 1. Revenues depend upon volume (number of productive trees and number of boxes per tree, table 5; and the mean of weekly juice yields, table 4) and price (mean of weekly prices, table 4). The number of productive trees for any given year depends on the mortality rate. This baseline model assumes a flat 5% tree loss rate, as discussed previously for a grove following standard citrus greening management protocol. This assumes that every year 5% of the total trees die and are replaced by resetting. Considering a 225 planting density, after the end of the first year around 11 trees are replaced (figures rounded), leaving 214 one-year old trees and 11 recently planted. By the fourth year, when the grove becomes productive, only 183 are 4 years old (number rounded down, table 6), with small groups of three-, two-, one-year old, and recently planted trees. Since the mortality rate and density planting are kept constant over time, beginning in year 4 we have the same number of productive trees every single year. Operating (caretaking, resetting, harvesting, and hauling) and indirect costs are the average of the two most recent seasons. We assume an average of 50 miles as the distance from the grove to the processor. Table 6. Projected Free Cash Flows for the Baseline Orange Grove Item  Year 0  Y1  Y2  Y3  Y4  Y5  Y6  Y7  Establishment  3,617                Early caretaking    610  670  652          Indirect costs    43  47  47          Reset    286  289  292          Revenues          1,544  1,559  3,150  3,181   Volume (PS/Acre)          737  737  1,475  1,475   Yield (PS/box)          5.76  5.76  5.76  5.76   # boxes per tree          0.70  0.70  1.40  1.40   Productive trees (trees per acre)      183  183  183  183   Price ($/PS)          2.09  2.12  2.14  2.16  Oper. Costs & Expenses        3,096  3,120  3,514  3,542  Caretaking w/o resets          1,652  1,669  1,686  1,702   Spray program          665  671  678  685   Fertilizer program          490  495  500  505   Other caretaking          498  503  508  513  Reset          295  298  301  304  Harvesting          295  298  602  608  Hauling          67  67  136  137  Indirect costs          131  132  134  135  Depreciation          655  655  655  655  Operating Income          −1,552  −1,561  −364  −361  Income taxes          −466  −468  −109  −108  Net Oper. Profit After Taxes        −1,086  −1,092  −255  −253  Opportunity cost (rent)  103  104  105  106  107  108  109  Free Cash Flow  −3,617  −1,042  −1,110  −1,096  −537  −544  292  293  Terminal Value                  FCF + Terminal Value  −3,617  −1,042  −1,110  −1,096  −537  −544  292  293  Item  Y8  Y9  Y10  Y11  Y12  Y13  Y14  Y15  Revenues  3,213  4,404  4,448  4,493  4,538  4,583  5,603  5,659   Volume (PS/Acre)  1,475  2,001  2,001  2,001  2,001  2,001  2,422  2,422   Yield (PS/box)  5.76  5.76  5.76  5.76  5.76  5.76  5.76  5.76   # boxes per tree  1.40  1.90  1.90  1.90  1.90  1.90  2.30  2.30   Productive trees (trees per acre)  183  183  183  183  183  183  183  183   Price ($/PS)  2.18  2.20  2.22  2.25  2.27  2.29  2.31  2.34  Oper. Costs & Expenses  3,571  3,872  3,904  3,937  3,970  4,003  3,609  3,645  Caretaking w/o resets  1,720  1,737  1,754  1,772  1,789  1,807  1,825  1,844   Spray program  692  699  706  713  720  727  734  742   Fertilizer program  510  515  520  525  530  536  541  546   Other caretaking  518  523  529  534  539  545  550  556  Reset  307  310  313  316  319  322  326  329  Harvesting  615  842  851  859  868  877  1,072  1,082  Hauling  139  190  192  194  196  198  242  244  Indirect costs  136  138  139  141  142  143  145  146  Depreciation  655  655  655  655  655  655      Operating Income  −358  532  544  556  568  580  1,994  2,014  Income taxes  −107  160  163  167  170  174  598  604  Net Oper. Profit After Taxes  −251  372  381  389  398  406  1,396  1,410  Opportunity cost (rent)  110  112  113  114  115  116  117  118  Free Cash Flow  294  916  923  931  938  945  1,279  1,291  Terminal Value                18,540  FCF + Terminal Value  294  916  923  931  938  945  1,279  19,832  Item  Year 0  Y1  Y2  Y3  Y4  Y5  Y6  Y7  Establishment  3,617                Early caretaking    610  670  652          Indirect costs    43  47  47          Reset    286  289  292          Revenues          1,544  1,559  3,150  3,181   Volume (PS/Acre)          737  737  1,475  1,475   Yield (PS/box)          5.76  5.76  5.76  5.76   # boxes per tree          0.70  0.70  1.40  1.40   Productive trees (trees per acre)      183  183  183  183   Price ($/PS)          2.09  2.12  2.14  2.16  Oper. Costs & Expenses        3,096  3,120  3,514  3,542  Caretaking w/o resets          1,652  1,669  1,686  1,702   Spray program          665  671  678  685   Fertilizer program          490  495  500  505   Other caretaking          498  503  508  513  Reset          295  298  301  304  Harvesting          295  298  602  608  Hauling          67  67  136  137  Indirect costs          131  132  134  135  Depreciation          655  655  655  655  Operating Income          −1,552  −1,561  −364  −361  Income taxes          −466  −468  −109  −108  Net Oper. Profit After Taxes        −1,086  −1,092  −255  −253  Opportunity cost (rent)  103  104  105  106  107  108  109  Free Cash Flow  −3,617  −1,042  −1,110  −1,096  −537  −544  292  293  Terminal Value                  FCF + Terminal Value  −3,617  −1,042  −1,110  −1,096  −537  −544  292  293  Item  Y8  Y9  Y10  Y11  Y12  Y13  Y14  Y15  Revenues  3,213  4,404  4,448  4,493  4,538  4,583  5,603  5,659   Volume (PS/Acre)  1,475  2,001  2,001  2,001  2,001  2,001  2,422  2,422   Yield (PS/box)  5.76  5.76  5.76  5.76  5.76  5.76  5.76  5.76   # boxes per tree  1.40  1.90  1.90  1.90  1.90  1.90  2.30  2.30   Productive trees (trees per acre)  183  183  183  183  183  183  183  183   Price ($/PS)  2.18  2.20  2.22  2.25  2.27  2.29  2.31  2.34  Oper. Costs & Expenses  3,571  3,872  3,904  3,937  3,970  4,003  3,609  3,645  Caretaking w/o resets  1,720  1,737  1,754  1,772  1,789  1,807  1,825  1,844   Spray program  692  699  706  713  720  727  734  742   Fertilizer program  510  515  520  525  530  536  541  546   Other caretaking  518  523  529  534  539  545  550  556  Reset  307  310  313  316  319  322  326  329  Harvesting  615  842  851  859  868  877  1,072  1,082  Hauling  139  190  192  194  196  198  242  244  Indirect costs  136  138  139  141  142  143  145  146  Depreciation  655  655  655  655  655  655      Operating Income  −358  532  544  556  568  580  1,994  2,014  Income taxes  −107  160  163  167  170  174  598  604  Net Oper. Profit After Taxes  −251  372  381  389  398  406  1,396  1,410  Opportunity cost (rent)  110  112  113  114  115  116  117  118  Free Cash Flow  294  916  923  931  938  945  1,279  1,291  Terminal Value                18,540  FCF + Terminal Value  294  916  923  931  938  945  1,279  19,832  Note: Numbers rounded. Notice that due to projected inflation (1%), prices and costs vary every year. Furthermore, the beginning price at time zero (the average of two last seasons, 2.01 in table 4), is compounded by the inflation rate so that year 4 is 2.09. The same is done for all costs. Life of a Grove (Duration of the Project), Terminal Value and other Financial Assumptions Resetting increases costs and potentially reduces total volume as some infested trees that might continue producing are replaced with unproductive young trees. Resetting is advisable, however, since it increases the life expectancy of the grove. For valuation purposes, resetting gives a “perpetual” life to a citrus grove (Singerman, Burani-Arouca, and Futch 2016; Morris, Muraro, and Castle 2011). When valuing a project on perpetuity it is customary to project free cash flows over a foreseeable horizon (up to year T), and then estimate a terminal value that reflects the present value of all FCFs occurring thereafter (PVT). A common and convenient approach to estimating the terminal value is to use the constant growth model, which assumes that the FCFs grow at a constant growth rate, g, beyond T, known as the steady-stage period. Terminal value (in present value terms, PVT) is estimated by applying the following equation: PVT = FCFT+1 / (WACC-g), where WACC is the weighted average cost of capital or opportunity cost of capital (this equation is the reduced form of an infinite series of FCFs growing at g, and discounted at WACC; refer to Schill 2013). In valuation analysis, g is conventionally assumed to be between 0 to 3%. In general, g should not be higher than the overall growth rate of the economy. Terminal value is usually a large component in a valuation, so sensitivity analysis is recommended. In order for the constant-growth model to be applicable to citrus production, the project is expected to enter a steady stage in the terminal year, implying that all transitional effects are over. This baseline assumes that T is year 15 based on the fact that the investment cost is fully depreciated by then, operating income is stable (table 6), and the grove is already mature (yields have reached a stable level that year). Furthermore, greening, a major transitional effect, should be under control by then. We assume a 0.5% growth rate, g, after year 15. The opportunity cost of capital or WACC is assumed to be 7.5%. The cost of capital in previous studies for citrus varies between 5% to 10% (Muraro, Roka, and Stansly 1999; Spreen and Zansler 2016). The FCFs for the baseline model are in table 6. The Modified Internal Rate of Return (MIRR) is 9.7%, and the Net Present Value (NPV) is $2,597 per acre.8,9 Scenario Analysis and Simulation The previous result is only a point-estimate of the baseline model. Grove care varies across regions and block such that inputs differ from our assumptions based on various factors. Scenario or “What If” analysis, where selected assumptions are expected to move within reasonable ranges, is advisable for capital budgeting evaluation. Graham and Campbell (2001), by surveying Chief Financial Officers in the United States, report that around 52% of companies use scenario analysis as one of their tools when evaluating investment projects. As one of the purposes of this study is to feature a case for teaching purposes, we do not provide scenario analysis results. Students are expected to perform this analysis by incorporating different elements of risks and opportunities in the sector (description below). The baseline model result could be considered as a “most likely” scenario, on which the level of greening severity continues as it is, in the near future. Scenarios on which greening improves and worsens could be considered. Scenario analysis results could be contrasted and complemented with simulation results. Simulation can be performed to incorporate simultaneous changes in assumptions that, presumably, follow a determined statistical distribution. Figure 3 provides an example of Monte Carlo simulation. Students are expected to challenge and discuss these assumptions. Juice quality (e.g., pounds solids per box) and prices are assumed to follow a normal distribution with a mean and standard deviation according to data of the two most recent seasons. Similarly, spray and fertilizer costs, which together account for 70% of caretaking costs, follow a normal distribution. Tree loss rate is assumed to vary uniformly between 2% and 6%. Harvesting costs vary uniformly with minimum and maximum values during the last two seasons, in table 3. Finally, expedited depreciation (more below) has a 50% chance to be approved for use in citrus. Figure 1 shows the distribution of MIRRs when 1,000 simulations are run. MIRR is equal to or higher than the hurdle rate of 7.5%, around 81% times the model is simulated. Figure 3. View largeDownload slide Distribution of modified internal rate of return results for 1,000 Monte Carlo simulations Figure 3. View largeDownload slide Distribution of modified internal rate of return results for 1,000 Monte Carlo simulations Risk and Opportunities The quantitative analysis could be complemented by incorporating elements of risks and opportunities in citrus, featured in this section. Citrus Greening In Florida, greening is caused by the bacterium Candidatus Liberibacter asiaticus, transmitted by Diaphorina citri, an insect known as the Asiatic citrus psyllid (the vector, hereafter).10 Vectors retain the pathogen for life following 15 to 30 minutes access feeding on a diseased plant, and transmit it to other plants after feeding for as little as 15 minutes (low likelihood of transmission) or for one hour or more (Mead and Fasulo 2014). The bacterium causes root dysfunction, and infected oranges generally present an irregular pattern of leaf chlorosis and scattered spots of green. Effects of greening on productivity include fruit drop, fruit deformation, poor juice quality, and general tree decline (Mead and Fasulo 2014; Tansey et al. 2017). Detected in Florida in 2005, greening has been referred to as the most destructive disease of citrus known (Gottwald et al. 2012). Over the course of more than a decade, growers have tried different strategies to contain greening and gained some experience in dealing with the disease. To reduce greening spread, early strategies included aggressive scouting for the disease and removal of greening symptomatic trees. This practice, however, is costly when a large number of trees are infected (Tansey et al. 2017) and nearly all growers do not remove greening-symptomatic trees (Singerman and Burani-Arouca 2012). Aggressive control of the vector and area-wide insecticide spray management programs can be cost effective even when greening incidence is high (Tansey et al. 2017). Although control of the vector is a short-term solution while a cure is sought (Grafton-Cardwell, Stelinski and Stansly 2013), it is likely the most important strategy that growers have to delay and reduce the effects of greening (Tansey et al. 2017). Citrus Health Management Areas (CHMAs), started in 2010 and coordinated by UF-IFAS Extension and FDACS, is a program to fight the vector over a wide geographical area. In addition, foliar nutrition spray programs may reduce trees stress caused by the infection and help tree productivity by allowing foliage to acquire nutrients that are otherwise limited by the root dysfunction caused by the bacterium (Tansey et al. 2017).11 Both foliar nutrition sprays and vector control are currently common practices in Florida for helping growers to contain greening, but have significantly increased production costs, as shown in table 2.12 Some studies have casted doubt, however, on whether costs of these practices individually implemented offset the benefits (Gottwald et al. 2012; Tansey et al. 2017), and propose more integrated practices (Gottwald et al. 2012) such as foliar sprays, area-wide vector management, plus removal of greening symptomatic trees. Horticultural Practices and Planting Density In 2009, a research team at UF-IFAS began APS, an experiment envisioned to help the industry to survive greening and remain competitive until a long-term solution is available (Schumann, Syvertsen, and Morgan 2009).13 A block of trees cultivated under standard growing practices (e.g., granular fertilizer and micro sprinkler irrigation) was compared to blocks with non-standard practices including drip fertigation, open hydroponics, alternative rootstocks, and high plant densities. Schumann et al. (2012) reported the progress of the research when 3-year-old trees were harvested. The integration of non-standard practices, APS, produced early high fruit yields. That is, the normalized production level of the 3-year-old trees is equivalent to what would not have been achieved until year 5 under conventional practices. High planting density was the most significant contributor to higher early yields in the experiment. Blocks planted at 363 trees per acre contributed 57% of normalized gains (measured as soluble solids pounds per acre) compared to a 22% contribution of drip fertigation—open hydroponics, and 21% of rootstock. Planting density affects investment profitability. By choosing a low density, a grower foregoes potential revenue. Planting too many trees, on the other hand, increases costs and may diminish yield per tree since neighboring plants would compete for nutrients and sunlight utilization by the crop canopy. In practice, growers decide the planting density according to their groves’ particular conditions and the planting density within ranges considered best practices. Plants in this experiment were attacked by greening. The incidence of greening was statistically higher and more severe on plants cultivated under conventional practices than under APS. While “[APS] failed to avoid infestation… or to adequately offset the symptoms of greening once trees became infected,” (Gruber et al. 2015), APS components optimize early yields and partially mitigate greening. “Greening-affected trees will remain smaller, with lower yields per tree – conditions which are better dealt with and compensated for with high planting densities and APS than with traditional low densities and conventional citriculture,” (Schumann et al. 2012). Possibly due to APS, orange growers in Florida are adopting high density planting. Prior to greening, orange trees were planted at densities around 150–175 trees per acre. Currently, the density of new plantings by small- and medium-sized growers is estimated to be around 225 trees per acre. Large growers could afford to plant at higher planting densities and APS, which increases establishment and production costs. Best practices on planting density vary over time, and depend upon the prevailing citriculture technology. During the 1950s, for instance, orange groves in Florida were planted at about 70 trees per acre. As freezes in the 1980s devastated many of those groves, new plantings moved further south with tree densities reaching 145 trees per acre with the aid of better technology allowing for higher density (Goldberg and Hogan 2004). Given the perennial nature of citrus cultivars, densities significantly vary during structural industry changes that require new plantings, such as natural disasters or epidemic diseases. Citrus Replanting Incentive Programs Governmental agencies have programs implemented to help citrus growers to reduce the risk of a new or renovated grove investment. Singerman (2016) summarizes these programs. We next highlight the features of the programs that relate to the grove investment model. Private entities have also implemented programs to incentivize citrus replanting. Announced in 2014, the Tree Assistance Program (TAP) of the USDA Farm Service Agency (FSA), reimburses growers for replanting trees lost to the effects of citrus greening. The TAP provides cost-sharing financial assistance after the grove accumulates tree mortality in excess of 18% over a period up to six years. In particular, the program covers 65% of cost per tree and planting cost and 50% of site preparation, subject to eligibility provisions and with capped support. Based on characteristics of the TAP, Spreen and Zansler (2016) note that this program is only available to small- to medium-sized growers because of income limits imposed by the government. The goal of the TAP is to reach a large number of growers in Florida, as its target is to have 6 million new trees planted by 2018. In general, the TAP is a support program limiting resetting costs in case of severe greening attacks. The Citrus Grove Renovation / Re-establishment Support Program (CGRR) is a relatively new program available to Florida growers, announced in August 2016. CGRR is a program implemented by the FDACS. This support is limited to growers planting an entire grove and targets investments in irrigation and nutrient management systems. As discussed previously, one of the strategies currently used by growers against greening precisely involves these investments. CGRR would cover 100% of the cost of engineering and design and 75% of investments that qualify for improvement of irrigation and nutrient management systems. Similar to the TAP, the CGRR is subject to eligibility provisions and pre-established capped amounts. While table 1 provides the investments required to establish a traditional grove, the CGRR program gives room for technology improvement, particularly for technology targeted to contain the negative effects of greening. The Abandoned Grove Abatement Initiative (AGAI) is another support program by the FDACS. AGAI supports growers for the removal and destruction of abandoned groves due to greening, to reduce the spread of the pathogen. Thus, a grower planting a new grove in Florida, eligible for AGAI, would avoid this cost and focus on the establishment costs instead (table 1). In any case, removal costs are considered sunk costs for capital budgeting purposes, as they need to be incurred regardless of the decision to re-plant the grove with citrus or use it for other purposes. An additional benefit of the AGAI for landowners is the fact that it provides tax benefits related to land values if the farmer decides to replant citrus. Private entities also have programs to incentivize replanting of orange groves. However, these programs are not available to a typical grower in Florida, but rather to growers with ties to those firms. Minute Maid, the subsidiary of the Coca-Cola company, has a program consisting of a long-term contract offered to growers (see Spreen and Zansler 2016). In 2014, Florida’s Natural announced major commitments to incentivize citrus plantings in Florida and renewed the program in 2017 (see Trejo-Pech, Spreen, and House 2018). Expedited Depreciation A bill on tax reductions expected to benefit Florida citrus growers was introduced in the U.S. Senate in September 2016. If passed, the Emergency Citrus Disease Response Act of 2016 would allow citrus growers to apply expedited or accelerated depreciation for income tax purposes. That is, instead of accumulating grove establishment costs and early caretaking costs during the non-bearing portion of grove life, costs would be “expensed” or reported in the income statement during the year incurred. Reporting expenses earlier rather than later in the investment horizon alleviates growers’ cash flow needs, particularly during the non-productive grove period. The overall value of a grove improves due to the time value of money. According to the model in this study, the value of a grove would increase about $600 USD per acre by using expedited depreciation instead of normal depreciation, as currently allowed by the IRS. Size of Grove The baseline model in this study is presented on a one-acre basis. While it would be difficult to define small, medium, and large orange growers, for this study a small grower is one with up to 200 acres cultivated, a medium-sized grower has 200 to 500 acres, and a large grower has more than 500 acres. Grower size may capture the scale effects of fixed costs and bargaining power on selected inputs. We mention a few instances where grower size affects profitability. Caretaking costs may be lower for a large grower, as orange farmers typically receive discounts for bulk purchases (Singerman 2015), and small growers may have higher caretaking costs. Financial costs could also be affected. The opportunity cost of capital for a large grower might be lower relative to a small grower as access barriers to capital and interest rates could be lower. The Next-best Alternative to Replanting Oranges The grower may choose to consider alternative crops to plant. Some alternative crops, emerging due to citrus greening mainly, include but are not limited to peaches, olives, and blueberries. An analysis of alternative crops is not covered in this study. The CREC has recently published a profitability study on blueberries (Singerman et al. 2016). Compared to oranges, planting blueberries requires a significantly higher investment of above $35,000 per acre for the first year. According to the study, which presents alternative price and yield scenarios, blueberry cultivation provides positive NPVs at moderate yield and high prices, using 10% as cost of capital. At the same time, blueberry prices have varied year over year, and the infrastructure is still in the developmental phase. Finally, the representative orange grower featured in this study may decide to rent or sell its land. The opportunity cost of renting is already incorporated in the capital budgeting model. The selling option is outside of the scope of this study. Concluding Remarks This study presents a capital budgeting model to evaluate a potential orange grove investment. The study features a representative grower in Southwest Florida with his grove infested by greening to a degree that it makes no economic sense to continue maintaining it. The grower has the choice of replanting the grove or converting the land to other uses. While many Florida growers may have strong incentives to replant an orange grove devastated by greening (such as a long tradition of planting this crop, governmental supports to fight citrus greening, industry knowledge developed through time, etc.), growers need a financial model to make more informed decisions. We provide results of a baseline model, along with Monte Carlo simulation. Users of this case study are expected to challenge the baseline assumptions and replicate the model with alternative scenarios. Ultimately, they should decide whether it is optimal to continue growing oranges in Florida considering both financial metrics and risks and opportunities. Footnotes 1 The Florida citrus harvest and marketing seasons extends from November 1 to October 31 of the following year. 2 The USDA’s National Institute of Food and Agriculture, for instance, awarded about $14 million in grants in 2017 to four research institutions to fight citrus greening (Johnson 2017). 3 The following CBS videos clearly communicate the problem that growers in Florida face due to citrus greening. “Citrus disease attacks Florida's oranges” (https://www.youtube.com/watch?v=T5nqVmliUaM), and “Florida farmers struggling with citrus greening disease” (https://www.youtube.com/watch?v=C8VKwj9y3wc). 4 Early-mid varieties of oranges in Florida include Hamlin, Pineapple, and Mid-Sweet. These varieties are typically harvested between late November and February. Valencia, also known as late orange, is harvested between March and June. Early-mid and late varieties have different production costs, prices and yields. In Florida, during the last two seasons, approximately 47% of total orange production came from early-mid varieties. 5 When reestablishing an entire grove, revenues from commercially productive trees, if any, are foregone. Foregone revenues (and foregone costs) are not considered in this model for project evaluation purposes since it is assumed that the decision to reestablish an entire grove is made by the grower when the grove generates negative Net Present Value. 6 To simplify the estimations in this case study, we ignore bonus depreciation. Under this regime, 50% of the cost of new trees can be written off the year they are expended. 7 Investment in working capital is assumed to be zero, implying that investment in current assets (inventories and account receivables) equal investment in current liabilities (excluding short-term loans). 8 The MIRR provides a more conservative rate of return than the conventional Internal Rate of Return (IRR) since it uses a more realistic reinvestment rate (e.g., the opportunity cost of capital in this instance). In general, the MIRR provides a more accurate metric than the IRR (Kierulff 2008). The MIRR is also less prone to errors when simulation analysis is performed, as in this study. When simulating results, many times there is a possibility that in some cases cash flows change signs more than one time over the investment horizon, thus producing an incorrect IRR or simply producing errors in the spreadsheet. 9 The expected inflation rate of the baseline model is assumed to be 1%, while income taxes are assumed to be 30%. 10 Other species of the bacterium are Candidatus L. africanus, the cause of citrus greening in Africa, and Candidatus L. Americanus, which affects some regions in Brazil (Mead and Fasulo 2014). 11 This includes both macro nutrients (nitrogen, phosphorus, and potassium salts) and micro nutrients (magnesium, boron, and zinc salts). 12 Other control strategies under evaluation include thermal and antimicrobial treatments, not widely used yet due to practicality of implementation or regulatory hurdles (McCollum and Baldwin 2016). 13 The overall APS’s aim was stated as: “…enhance citrus production and reduce abiotic stress and disease pressure by optimizing daily water and nutrient levels for trees growing on sandy soils. This system also promotes rapid canopy development by incorporating high planting densities” (Schumann, Syvertsen, and Morgan 2009). References Court C., Hodges A.W., Rahamani M., Spreen T.H.. 2017. Economic Impacts of the Florida Citrus Industry in 2015–16. Economic Impact Analysis Program, Food & Resource Economics Department. University of Florida. Available at: http://fred.ifas.ufl.edu/pdf/economic-impact-analysis/Economic_Impacts_of_the_Florida_Citrus_Industry_2015_16.pdf . Farnsworth D., Grogan K., van Bruggen A., Moss C.. 2014. The Potential Economic Cost and Response to Greening in Florida Citrus. Choices  29 3: 1– 6. Florida Department of Citrus (FDOC). 2015. Annual Processor's Statistical Report 2014-15. Available at: https://www.floridacitrus.org/grower/resources/processor-reports/ Florida Department of Citrus (FDOC). 2016. Annual Processor's Statistical Report 2015-16. Available at: https://www.floridacitrus.org/grower/resources/processor-reports/ Goldberg R., Hogan H.. 2004. Can Florida Orange Growers Survive Globalization? Harvard Business School Publishing Case  9-904-415: 1– 25. Gottwald T.R., Graham J.H., Irey M.S., McCollum T.G., Wood B.W.. 2012. Inconsequential Effect of Nutritional Treatments on Huanglongbing Control, Fruit Quality, Bacterial Titer and Disease Progress. Crop Protection  36: 73– 82. 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American Journal of Agricultural EconomicsOxford University Press

Published: Mar 1, 2018

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