Agricultural businesses rely on borrowed capital for inputs, machinery, equipment, and land. Debt capital, relative to equity capital, is typically less expensive and can accelerate equity capital growth. However, use of debt capital increases the risk of equity loss and its management is a critical farm business management function. Managing debt capital for a farm is choosing from among multiple financing sources offering differing interest rates, rebates, points, and other non-interest costs. Educational efforts that teach producers how to evaluate financing alternatives are important so the true cost of borrowing is known. Knowing the true cost of debt capital can lead to better decision making because financing sources can be ranked based on cost. In addition, knowing the true cost of debt capital aids in risk management because equity loss only occurs when the farm's rate of return of farm assets drops below the cost of debt capital.
Running the agricultural cost of capital calculator
You will need to have Microsoft Excel on your computer in order to run the Agricultural Cost of Capital Calculator. Clicking on the file "ag cost of capital.xls" will load the model. The model contains imbedded programs called "macros". Because of this, most users will receive a "Security Warning" when they load the model. You must select "Enable macros" or the model will not run. If you receive no "Security Warning" and the model does not run properly, you may have to adjust your security level settings. You can do this under "Tools…Macro…Security".
The "Agricultural Cost of Capital Calculator (Version 1.0)" message box will pop up if the model loads properly. Click on the red X in the upper right hand corner of the message box to start using the model.
The structure of the agricultural cost of capital calculator
The agricultural cost of capital calculator is broken into three modules. These modules are shown as tabs along the bottom of the screen when you are in Excel. You can navigate through the modules by using the arrow icons in the lower left corner or by clicking on the tabs themselves.
In each module you will need to enter data in the yellow-shaded boxes (all of the other cells except those used by the macros are "locked" to protect formulas and formats). After you have entered data in the yellow-shaded boxes, be sure to hit Enter or click on another cell in the worksheet or the macro will not recognize the data. Simply click on the appropriate boxes to run the macro programs.
Instructions for using the individual modules
Short-term financing calculator
This module will help evaluate the cost of short-term financing which is often provided by agribusinesses for the purchase of inputs such as feed, seed, and fertilizer. The terms usually involve the specification of a percentage discount, the period over which the discount can be taken, and the number of days in which full payment is expected if the discount is not taken. An example of this would be '2/10, net 30' which means the purchaser is eligible for a 2% discount if the balance is paid within 10 days or the full amount should be paid by no later than 30 days. In most cases the purchaser should take advantage of the discount provided under trade credit, even if they have to borrow the money. This calculator can also be used to negotiate cash discounts with merchants instead of using a credit card. Merchants pay credit card companies an 'interchange fee' of from 1-6% that the purchaser could evaluate as an 'x%/1, net 30'.
Fill in the yellow-shaded boxes with information relating to your short-term financing alternative. Click on the box labeled "Click to calculate short-term financing costs" to run the calculator. You can change any of the financing parameters and rerun the calculator at any time. If you'd like to clear all information from the calculator, click on "Reset calculation". The output includes calculation of a critical interest rate for a borrowing comparison that shows the effective interest rate charged for payment on the due date and an estimate of the annual cost of not taking the discount. If cash is not available in order to take the discount and money could be borrowed elsewhere at a rate less than this critical rate, it would be to their advantage to do so.
Intermediate-term financing calculator
This module will help you evaluate the cost of intermediate credit like that provided by commercial lenders and automobile and machinery dealerships for cars, trucks, tractors, and equipment. The terms of this type of credit usually involves the specification of the financed amount (which involves negotiation of the purchase price, trade-in value, down payment, and any rebates). Often other costs including document preparation, taxes, title, and license fees are included in the financed amount. One consideration in comparing different financing options is that dealers usually offer either financing or rebates. In some cases it may make more sense to finance the purchase somewhere else at a higher interest rate and take the dealer rebate than it is to take a lower percentage rate from the dealer.
Fill in the yellow-shaded boxes with information relating to your intermediate-term financing alternative. Click on the box labeled "Click to calculate intermediate-term financing costs" to run the calculator. You can change any of the financing parameters and rerun the calculator at any time. If you'd like to clear all information from the calculator, click on "Reset calculation". The output includes calculation of the periodic interest rate, annual percentage rate (APR), annual effective rate, and the loan amortization table.
Long-term financing calculator
This module will help you evaluate the cost of long-term credit like that provided by commercial lenders and Farm Credit for land and buildings. The terms of this type of credit involves the specification of the financed amount, repayment period, and interest rate, along with any points and balloon payment. Often closing costs (including document preparation, title search, appraisals, credit reports, surveys, real estate transfer taxes, and points) are included in the financed amount.
Fill in the yellow-shaded boxes with information relating to your long-term financing alternative. Click on the box labeled "Click to calculate intermediate-term financing costs" to run the calculator. You can change any of the financing parameters and rerun the calculator at any time. If you are borrowing from the Farm Credit System, be sure to select 'Farm Credit System' so that the stock requirements are included in the calculation. Also, make sure to enter an annual expected patronage percentage if considering a FCS loan. If you are considering a loan with points (a loan origination fee charged by lenders often in exchange for a lower interest rate), select the proper number of points from the list (if you are considering a loan with no points, make sure that "no points" has been selected from the list). If you'd like to clear all information from the calculator, click on "Reset calculation" (this also resets the lender type to "Commercial lender" and points to "No points"). The output includes calculation of the periodic interest rate, annual percentage rate (APR), annual effective rate, and the loan amortization table.
Note on the interest rates reported in the calculator:
The periodic rate is the rate of interest per payment period including non-interest costs. The annual percentage rate (APR) is the rate used under the Truth in Lending Act to represent the total financing cost of credit expressed as a percent per annum. In contrast to the APR, the annual effective interest rate also takes into account the impact of non-interest costs (fees, stock requirements) and compounding. It is the best rate to use when making comparisons between financing alternatives.
Calculator and user's guide developed by:
Jeffrey R. Stokes and Jayson K. Harper
Department of Agricultural Economics and Rural Sociology
College of Agricultural Sciences
The Pennsylvania State University
University Park, Pennsylvania