Many cow/calf producers struggle with what is a fair price to pay for cows or heifers in an up cattle market, the same type of

market that we face now. If the price is too high, the female may not produce enough calves (including her cull value) to pay

for herself and her annual maintenance costs. This is particularly true if the cattle cycle is about to peak and switch

directions, i.e., future calves produced are less valuable and cow maintenance costs are too high.

Many cow/calf producers struggle with what is a fair price to pay for cows or heifers in an up cattle market. This article is

designed to demonstrate the important relationship between profitability and debt serving capacity. With high calf prices,

it is important for each producer to analyze the investment and financial feasibility of purchasing breeding animals.

Only after determining the profitability of the investment can a sound decision be made. Norman L. Dalsted is a Professor

and Extension Farm/Ranch Management Economist, Department of Agricultural and Resource Economics at Colorado

State University, Fort Collins, Colorado. Areas of specialty include financial management, production economics, estate and

tax management, and mediation including financial restructuring and bankruptcy. Rodney L. Sharp is a Management

Economist, Cooperative Extension, Colorado State University, Grand Junction, Colorado. Areas of specialty include farm and

ranch management, cost of production, feasibility analysis, and financial management.

Jeffrey E. Tranel is a Management Economist, Cooperative Extension, Colorado State University, Pueblo, Colorado. Areas of

specialty include tax management, cost of production, labor management, and small farm economics. James Pritchett is an

assistant professor and Extension Farm/Ranch Management Economist in the Department of Agricultural and Resource

Economics at Colorado State University, Fort Collins, Colorado. Areas of specialty include water resource economics,

investment analysis, strategic planning for the farm/ranch business, risk management and agricultural policy issues.

From the manager’s perspective it is important to ask what is a reasonable amount of debt that a female can service in good

times as well as poor market times. It is also important to consider the adaptability of the female to the operating

environment.

The cattle cycle has been evident in the U.S. livestock industry since 1867 - the first year that beef cattle data were

collected. Initially the cycle had longer down cycle movements during which the cow herd contracted, but in the last 30 to 40

years the cycle has remained in a 9 to 11 year cycle with shorter downturns (2-3 years) and lower cow numbers coming out

of the cycle. Figure 1 contains a graphic depiction of the cattle inventory since 1945. As indicated in the figure, cattle

inventory is at a low point in 2003-2004, with the herd beginning to expand in 2005. During an expansionary phase,

replacement heifers are scarce, and have more value, as producers seek to expand.

Given the beef cattle prices observed in 2003 through 2005 there is much interest by producers in expanding cow numbers

or new investors entering the market. In Colorado, this is due in part to the significant number of cows being liquidated due to

the drought of 2000-2003. In some cases, producers with improved forage conditions are considering rebuilding their

herds. Although recent tax legislation has expanded the time period of I.R.S. 1033e to four years, recent high cattle prices

are possibly clouding the decisions to invest in expensive heifer or young cows. Fall 2005 sales data reveal bred heifers are

selling in the $1,200 to $1,400 per head range. Coupled with $1.25-$1.40 per pound yearling heifers, many producers cannot

afford to hold or retain heifers beyond the historical replacement rates for their cow herd.

The purpose of this paper is to provide cow/calf producers with a tool to help analyze their own beef cow investment opportunity.

Investment Analysis

The first step on analyzing any investment decision is to evaluate whether the investment is profitable. Once the investment

is determined to be profitable (if not profitable, the analysis has served its purpose), the producer must address the

financial feasibility of the investment. (1) In other words, does the investment generate sufficient income to cover the

operational costs (cow-costs) as well as service the associated debt? Often cows/heifers are financed over a shorter period

than their productive lives. Certainly debt can be covered from other enterprises within the ranch/farm business, however that

can be construed as subsidization, which can lead to larger financial problems for the overall business over time

(management of debt and financial strengths and weakness of the business are critical to the long run sustainability of any

business).

Steps to the Bottom line

For many breeding livestock investments, a longer term rather than a single production year analysis must be considered

because the net profit stream generated by the asset extends beyond the initial accounting period to end of its useful life.

Thus, the decision to purchase heifers/young cows has an investment horizon of four to twelve years for many cow/calf

producers. There are a number of critical data needs to accomplish this analysis. These are as follows:

1. What are the annual cow costs (estimate the annual operating overhead costs on a per cow basis)? An additional cost

that must be included is the cost of either equity and lender capital (interest cost).

2. What market price will calves and culls sell for over the cow’s productive life?

3. What production levels are reasonable to consider (estimates of death loss, replacement rates, weaning weights, etc.)?

4. What are the annual net returns per cow? [Revenues (calf sales/cull sales) minus cow costs].

5. What is the expected rate of return that is acceptable on this investment?

6. What will be the terminal (salvage/cull) value of the cow once she leaves the herd? Once the values discussed above are

determined then proceed with the new investment analysis. (2) For those interested in the mathematical presentation, the

analysis can be constructed as follows:

return might be four percent given current financial market returns. SV is the cull value of the female at the end of her

productive life. The following example demonstrates this analysis (400 cow unit):

Assumptions

Total females exposed: 400 cows

Conception rate: 95%

Weaning rate: 95%

Average calf weights: 550 lbs.

Yearling heifer weights: 882 lbs.

Expected rate of return: 4%

Replacement heifer retention rate: 15%

Actual cow replacement rate: 12%

Salvage value: $500 per cow

400 cows * 95% conception rate * 95% weaning rate: 361 calves

400 cows * 15% retention rate: 60 heifers

400 cows * 12% replacement rate: 48 heifers

Cow/replacement/heifer death loss: 2 %

Cash Flow Calculations

Annual Revenues:

181 steers * 550 lbs * $1.30: $129,415

120 heifers * 550 lbs * $1.20: 79,200

12 yearling heifers * 882 lbs * $.90: 9,525

Total: $218,140

Annual Operating Profile:

400 cows * $300: ($120,000)

Net Operating Profits: $98,140

Family Living Costs: ($30,000)

Long Term Principal Payment:

(Land, machinery, or livestock payments): ( $15,000)

Net Returns: $53,140

Net Returns Per Cow: $132.85

Present Value Calculations

$132.85 (6.7327) = $894.44 (Net return to the cow without considering her cull value)

$500 (1.048) = $500 (0.7307) = $365.35 (Present value of the cow’s worth when sold eight years from now)

Total $1,260.00

Based on this single analysis, a producer could afford to pay

$1,260 per cow. At this price, a producer would earn a four percent return on the investment.

Financial Feasibility

The next step is to determine if this investment is financially feasible - in other words how much debt are the net returns

capable of serving. Financial feasibility addresses the debt carrying capacity of the female given the production levels,

market prices, and costs identified in the previous analysis. To accomplish this task the following items must be addressed:

1. Interest rate

2. Amortization period

3. Amount borrowed

Continuing the example, bred females were purchased for $1,260 per head. Assuming the financial institution will lend 60

percent of the initial purchase price ($760 per head) for a period of five years at seven percent interest, what debt level can

these animals service? The amortization factor for a five year term and seven percent interest rate is 0.2374, assuming equal

annual payments. The annual payment will be $180.42 per animal ($760 * 0.2374) which exceeds the net return of $132.85

per head. Thus while this investment will return four percent per year it is not financially feasible. Back to the point of

subsidization, this investment (total of $237.85 over the term of the note $180.42 - $132.85 = $47.57 * five years = $237.85)

would need to subsidization from other enterprises. Cash deficits do not mean that the investment is unprofitable or

should not be made. It does mean that servicing the debt could be difficult. These cash deficits can be reduced or eliminated

by extending the term of the debt, increasing the amount of the down payment, reducing the interest rate, or increasing net

cash flow. (Berry, et. al., 1995) From Table 1 one can determine what net receipts must be achieved annually to service the

dept associate with each female. For example, if the debt load is $600 per head with a 5- year note at 6 or 7 percent

interest, one needs to generate $142 to $146 net profit per head to service the debt. Table 2 combines average market

prices, weaning weights, and cow costs to determine the amount one could pay for a replacement. (The analysis uses a 4%

opportunity cost of money as the discount rate). For example, if market prices are $1.00 per pound, coupled with 500 pound

weaning weight and $300 cow costs, one could pay up to $1,061 for a replacement animal. The negative value in Table 2

represent operations that are not covering their cow costs. An Excel spreadsheet has been developed to allow the user to

address a number of variables. An investor may want to estimate the price received for steer and heifer calves over time,

the interest rate (discount rate), salvage value, cow costs, etc. This worksheet will allow the user to evaluate a number of

alternatives. The worksheet entitled “Cow Investment Analysis” is accessible at the following Web site:

http://wwwcoopext.colostate.edu/ABM/Abmndx.html, once at that site go to Section 4 – 4.12 under ABM notes.

This paper is designed to demonstrate the important relationship between profitability and debt serving capability. Even with

high calf prices, it is important for each producer to analyze the investment and financial feasibility of purchasing breeding

animals. Profitability and debt carrying capacity will vary greatly from operation to operation. Only after determining the

profitability of the investment can a sound decision be made. The authors have observed over time that beef cattle in

Colorado can typically service no more than $300 to $400 debt per cow.

References

Peter Berry, Paul Ellinger, John Hopkin and C.R. Becker, Financial Management in Agriculture. 5th Edition. Interstate

Publishing, Danville, Indiana, 1995 pp 299 – 310.

Michael D. Boehllje and Vernon R. Eidman, FarmManagement, John Wiley and Sons, New York, New York, 1984

pp 315 – 334.

James Robb, Livestock Marketing Information Center, Denver,Colorado, 2005.

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Figure 1. January 1 total cattle inventory, U.S., Annual

Source: James Robb, Livestock Marketing Information Center, Denver, Colorado

Table 1. Sensitivity analysis

a) 60% debt to value

b) Equal total annual payments

c) Amortization factors for 6 percent (0.2374) 7 percent (0.2439), and 8 percent (0.2505) for 5 year amortization period.

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Table 2. Sensitivity analysis of beef female purchase price with varying weaning weights, market prices, and annual cow

costs