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Current Status On Profits In Recirculating SystemsPatrick
D. O'Rourke IntroductionWhat are called "commercial recirculating aquaculture systems" have drawn a lot of attention in recent years from current aquaculture producers as well as those interested in becoming producers or investors. Why is there this interest in commercial recirculating aquaculture systems (CRAS)? Is it a passing fancy that will fade away like the Edsel or "junk bonds"? Or, is it an appropriate technology for commercial aquaculture production whose time has come or is coming like pen raised salmon, raceway raised trout, and pond raised catfish? What do the proponents of CRAS see as its advantages or potential advantages over other commercial fish production systems and/or the wild capture of fish? Here are some of those suggested advantages or potential advantages: ** has few geographic limitations on location of production ** allows for better quality control of product than other commercial production systems or wild capture fisheries ** allows for better control of diseases and contaminants ** provides much better control of predators than pond systems ** reduces waste management problems through reduced volume of waste water ** through control of the fish production environment, provides opportunity to time production to the market's signals rather than the seasons of the year. What do the protagonists offer as reasons why CRAS are not or will not be successful in large enough numbers to be significant to the aquaculture industry ? Here are some of the suggested disadvantages or potential disadvantages: ** the cost of reconditioning and recirculating the water will be too costly ** the high densities of fish (pounds of fish per volume of water) will cause higher stress and therefore higher incidence of disease ** the cost of supplemental oxygen will be too high ** the cost of special feeds will be too high ** the cost of total energy requirements will be too high ** the cost of removing nitrogen and controlling carbon dioxide will be too high ** the required capital investment is too high ** many have tried and failed. Who is correct? Do we have the technology to design a CRAS that can produce one or several species of fish at a volume, quality and cost that is profitable? I believe the answer is "MAYBE". I believe the scientists, farmers, investors and entrepreneurs who began the pond raised catfish industry over a quarter century ago had the same enthusiasm, similar questions and similar problems to address. Mississippi is the leading catfish producing state today. The first pond built in Mississippi specifically for the commercial production of channel catfish was built in 1965 in Sharkey County. That pond covered 40 acres and produced 10,000 pounds of catfish in January 1966 (Wellborn, 1988). Mississippi had 95,000 acres of commercial catfish ponds in 1991 (USDA, 1991), better than a 9 percent compound annual growth rate over 26 years. In the early years raising catfish in ponds was probably more expensive than dropping a hook and line in the river, however, the catfish raised in ponds were a different product. Fish raised in recirculating systems will similarly be a different product than wild caught or pond raised fish. Commercial Aquaculture Recirculating Systems Cost StudiesThomas M. Losordo, J. E. Easley and Philip Westerman of North Carolina State University, Raleigh, NC, have been conducting research on recirculating systems for commercial production for several years. Utilizing information from a producer survey and their own research experience they developed a "best case" simulation model of catfish (and hybrid striped bass) production in a 9 tank intensive culture system (Losordo, et. al., 1989). The model system was designed for periodic harvesting, year round and was expected to produce approximately 400,000 pounds of fish per year. The capital investment required was estimated to be approximately $345,000 with 50 percent coming from equity and 50 percent coming from debt. That simulation model demonstrated the technical feasibility of raising 6 inch stocker catfish to a harvest weight of 1,25 pounds in 30 weeks (210 days). Overall estimated production costs for the "best case" scenario were $ .95 per pound. (The "best case" scenario for hybrid striped bass was $1.67 per pound.) The breakdown of the costs per pound, as reported in that 1989 study, are shown in the two left most columns in Table 1. The research on commercial recirculating systems at NCSU has continued as they continue to develop "non-biased and non-proprietary studies of the biological, economic and engineering aspects of recirculating systems." (Losordo & Westerman, 1991) This recent report covers an 11 tank system (3 nursery tanks and 8 growout tanks) designed for continuous production and regular periodic harvesting throughout the year. Total annual production is estimated to be over 96,000 pounds of tilapia. The complete production system, including building related costs, required an initial investment of $188,634. The base case simulation (with atmospheric oxygen) indicated that fish production costs were approximately $1.27 per pound. (The authors note that using pure oxygen would increase the estimated costs of production to approximately $1.30 per pound. The two right most columns in Table 1 show the breakdown of the production costs per pound as reported in that 1991 study. Table 1. NCSU Estimated Production Costs From Simulation Models of Recirculating Systems For Catfish (1989) and Tilapia (1991).
ITEM CATFISH (1989) TILAPIA (1991)
% of Cost Cents/lb. % of Cost Cents/lb.
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Feed 32.3 30.7 20.58 26.14
Labor 7.9 7.5 13.33 16.93
Recirculation 3.1 3.0
Heating 15.0 14.3 2.60 3.30
Oxygen 2.7 2.6
Aeration 5.68 7.21
Pumping 5.44 6.91
RBC Energy 1.34 1.70
Elec. Demand .79 1.00
New Water .08 .10
Fingerlings 6.8 6.5 7.57 9.61
Depreciation 9.3 8.8 14.35 18.22
Maintenance 7.9 7.5 7.41 9.41
Operating Interest 2.0 1.9 1.18 1.50
Cost of Borrowed Capital 7.2 6.8 10.96 13.92
Cost of Equity 5.7 5.4 8.68 11.02
TOTAL COST PER POUND $0.95 $1.27
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Research on the viability of commercial recirculating aquaculture systems is also being conducted at Illinois State University. A 1990 report (O'Rourke, 1990) contained production cost estimates based on a simulation model of tilapia production in a recirculating system similar to one located on the ISU Research Farm. That simulation was for a system designed to produce on a batch basis approximately 34,000 pounds of tilapia per year. The complete production system, including building renovation cost, required an initial investment of $78,650. The base case simulation indicated that tilapia production costs were approximately $1.68 per pound. Table 2 shows the breakdown of the production costs per pound for that simulation. Table 2. ISU Estimated Production Costs From Simulation Model of Recirculating System For Tilapia (1990).
ITEM TILAPIA (1990)
% of Cost Cents/lb.
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Feed 17.2 % $ .29
Wages 17.5 .29
Water 0.7 .01
Electricity 6.0 .10
LP Gas 5.7 .10
Liq. Oxygen 11.9 .20
Testing Supplies .6 .01
Insurance 1.7 .03
Fingerlings 6.7 .11
Depreciation 9.5 .16
Maintenance 5.9 .10
Property Tax .6 .01
Operating Interest 5.3 .09
Interest on Investment 8.4 .14
Miscellaneous 2.1 .03
TOTAL COST PER POUND $1.68
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Other Sources of Data For Costs and ProfitsThere are several private companies and groups who have cost of production estimates for commercial recirculating aquaculture systems. In some instances the cost data is based on actual commercial scale production experience with the systems. In other instances the cost of production estimates are based on how the systems are expected to perform when constructed and stocked. In both cases the cost data is generally not available to the general public but is shared with bonafide prospective investors. This lack of publicly available cost data is not unusual . This is the usual situation when new technology applications are emerging in a commercial setting. However, it does suggest that one must carefully and thoroughly evaluate such data to appreciate the applicable risks and uncertainties in a commercial enterprise. Several universities, other than ISU and NCSU, are conducting research related to the commercial viability of recirculating aquaculture systems. These efforts will produce additional data on the biological, engineering and economic aspects of such systems. Some of this data will seem slow in coming to the public because this kind of production system research requires several years to conduct and verify the findings. Until more public, independently derived data is available farmers/investors may find it useful to evaluate investment opportunities in recirculating systems in a capital budgeting framework. The remainder of this paper is dedicated to describing a capital budgeting approach that may be useful, when accompanied by rigorous examination of performance claims, in deciding whether or not to invest in a (any) particular commercial recirculating aquaculture system. The Capital Budgeting Approach To Investment AnalysisWhen one considers investing in assets to expand their current business or to expand into a new product market there are several basic questions they seek answers to. Should I make the investment? Will the investment pay off? Is this the best use of my capital? These questions obviously apply to those considering investing in a commercial recirculating aquaculture system. Answering the questions is complicated by the fact that such investments typically require a substantial initial investment of capital with potential returns on that investment occurring over several years. Those future returns on the investment are uncertain and risky to some degree. The degree of that uncertainty and risk is related to the characteristics of the individual investment opportunity. For example, investing in a 10 year treasury bond is considered to be almost risk free. There is little doubt about the payment of interest on the bond and the return of the original investment when the bond matures. On the other end of the spectrum, investing in a new swine confinement enterprise is considered to be relatively more risky. That is due to the fact that market prices for the pork produced, the operational efficiency of the enterprise and the costs of the inputs over the years are uncertain. The swine confinement investment must offer the investor an opportunity to earn a significantly higher expected return if it is to attract investment capital away from less risky opportunities. An investment in a commercial recirculating aquaculture system has the same general risks and uncertainties as other livestock enterprises; uncertain future market prices, uncertain and risky operational characteristics and uncertain input costs. Further, some of the technology used is relatively new in this type of commercial enterprise so even less is known about its technical performance. Investment in such risky ventures calls for a rigorous analysis and a logical framework within which to make the investment decision. The net present value method of evaluating investments is the preferred framework because it takes into account the time value of money. It explicitly recognizes that a dollar today (present value) is worth more than a dollar to be received at some future time. The present value of that dollar depends on when that dollar will be received (or spent) and the appropriate interest rate representing the time value of money. The net present value method allows one to compare alternative investments of different durations and different levels of risk on a uniform basis. A hypothetical capital budgeting problem will be utilized to illustrate the application of the net present value method in evaluating investment opportunities in commercial recirculating aquaculture systems. Net Present Value Method DemonstratedThe net present value method for evaluating a capital budgeting project can be applied in several steps: 1. Determine the net investment required to initiate the project. 2. Estimate the incremental operating cash flows expected over the life of the project. 3. Estimate the non-operating cash flows expected at the end of the project. 4. Determine the appropriate cost of capital or discount rate of interest. 5. Calculate the net present value of all cash flows. 6. Evaluate the impact of changes in the estimated cash flows on the net present value. 7. Compare this investment with alternative investment opportunities. This approach is applied to a hypothetical commercial recirculating system investment opportunity called the Superfish Recirculating Project. The investment and operating costs are derived from a previously reported simulation model (O'Rourke, 1990) and are not meant to be taken as representative of any specific recirculating system. Tables 3 through 9 contain the data utilized in this illustration. Step OneThe initial capital investment required for the Superfish Recirculating Project is shown in Table 3. An acre of land and an existing building are purchased. The land and building (former swine nursery) are purchased for $10,000 and refurbishing the building costs $10,000. The market value of the land alone is estimated to be $2,000. The equipment for the Superfish system will cost $60,000 installed. It is estimated that an additional $2,000 in net working capital will be required due to an increase in inventory of feed, oxygen and other items. The total initial investment requirement is estimated to be $82,000. This cash outflow is assumed to occur at the beginning of the Superfish project. Table 3.Initial Investment Outlay ( Year 0 ) for Superfish Recirculating Project.Item Outlay ------------------------------------------ Land $2,000 Building $18,000 Equipment $ 60,000 Total Fixed Assets $ 80,000 Change in Net Working Cap. $2,000 Total Investment $82,000 ------------------------------------------ Step TwoEstimating the incremental operating cash flows for the Superfish project begins with estimates of the annual operating expenses of the system. This is usually the most difficult step in the net present value method. It requires making estimates of output level and prices received, quantities and prices of inputs, depreciation schedules for equipment and buildings, and income taxes attributable to the project. Some of these estimates will be uncertain, especially where there is little historic data on which to base them. The estimated cash operating expenses, shown in Table 4, are categorized as fixed or variable. This gives one the opportunity to apply different assumptions on the impact of inflation on these categories of expenses and lets some expenses vary directly with the assumed level of output. Interest expense is not included since the cost of capital is expressed in the discount rate used to calculate net present value. If interest cash expenses were included it would be double counting. The estimated annual cash operating expenses for the Superfish project are $17,000 fixed expenses and $28,000 variable. We will discuss in a later section the impact of changes in these expenses on the evaluation of the project. The allowable depreciation charges on equipment and buildings, while not a cash expense, must also be considered. Depreciation expenses are tax deductible and therefor have an impact on cash flow. An increase in depreciation expenses will reduce the amount of taxes due by an amount equal to the incremental depreciation times the marginal tax rate for the project (or the business initiating the project). Table 5 shows the allowable Modified Accelerated Cost Recovery depreciation rates assumed appropriate for this illustration. The equipment has all been assumed to qualify for the five year asset depreciation category. This is a simplifying assumption. In an actual analysis the depreciation allowed on each major asset should be carefully estimated. Table 4.Estimated Cash Operating Expenses for Superfish Recirculating Project.
ITEM DOLLARS
FIXED VARIABLE
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Feed $10,000
Wages $7,000 3,000
Electricity $2,500 $ 1,000
LP Gas $3,500
Liq. Oxygen $ 7,000
Insurance $1,000
Fingerlings $ 4,000
Maintenance $2,000 $ 2,000
Miscellaneous $1,000 $ 1,000
TOTALS $17,000 $28,000
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Table 5. MACRS Depreciation Rates for Superfish Recirculation Project.Year 1 2 3 4 5 6 ---------------------------------------------------------------------- Building 1.5% 3.0% 3.0% 3.0% 3.0% 3.0% Equipment 20% 32% 19% 12% 11 % 6% ---------------------------------------------------------------------- The net operating cash flows need to be estimated for each year of the projects life. This is another important decision for the person doing the analysis. The life of the project will affect the project net present value either positively or negatively depending on the magnitude of net cash flows in the later years of the project. To simplify this illustration it was assumed that the project would end at the end of the sixth year, This may not be terribly unrealistic given the possibility that technological improvements may lead to the decision to sell the Superfish assets in favor of another system by that time. Table 6 shows the calculation of net operating cash flows for the six years of the project. The basic data comes from Tables 4 and 5. Several assumptions are embodied in the calculations. The sales price is assumed to be at $2.00 per pound in year one and is assumed to increase by 3 percent each year thereafter. Variable expenses, which are 40 percent of sales revenue, and fixed costs also are assumed to increase by 3 percent per year. Earnings are calculated on an accounting basis and taxes, at an assumed rate of 30 percent, are deducted. The net operating income after taxes plus the depreciation represent the net operating cash flow for each year. Table 6. Net Operating Cash Flows For Years 1 Through 6 of Superfish Recirculating Project.
Year 1 Year2 Year 3 Year 4 Year 5 Year 6
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Sales (lb.) 35,000 35,000 35,000 35,000 35,000 35,000
Price $2.00 $2.06 $2.12 $2.18 $2.25 $2.32
Net Sales $70,000 $72,100 $74,263 $76,490 $78,786 $81,149
Variable Cost 28,000 28,840 29,705 30,596 31,514 32,460
Fixed Cost 17,000 17,510 18,035 18,576 19,134 19,708
Depr (build.) 270 540 540 540 540 540
Depr (equip.) 12,000 19,200 11,400 7,200 6,600 3,600
Expense
Subtotal $57,270 $66,090 $59,680 $56,912 $57,788 $56,308
Earnings
Before Tax 12,730 6,010 14,583 19,578 20,998 24,841
Tax (30% ) 3,819 1,803 4,375 5,873 6,299 7,452
Projected Net
Oper. Income 8,911 4,207 10,208 13,705 14,699 17,389
Add back
Depreciation 12,270 19,740 11,940 7,740 7,140 4,140
Cash Flow From
Operations $21,181 $19,947 $22,148 $21,445 $21,839 $21,529
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Step ThreeThere are usually some non-operating cash flows at the end of a project. (Table 7) For the Superfish project, it is assumed that the owner sells the assets of the business at the end of year six. As was mentioned before this is a simplifying assumption but perhaps not an unrealistic one. The land is assumed to have the same value on the market as in the beginning of the project. The building is assumed to have a salvage (market) value of $5,000 significantly below its book value (depreciated value) of $14,490. This results in a calculated loss (non-cash) of $9,490 and a cash savings of $2,847 in taxes. The equipment is assumed to have a salvage value of $10,000 which is above the book value of zero dollars. This is reported as ordinary income whish results in a $3,000 higher tax payment ($10,000 x 30 percent). The net total cash flow from salvage values is the sum of the net salvage values for the land, buildings and equipment. For consistency it is assumed that the increase in net working capital from the beginning of the project is recovered by selling the now unneeded inventory items. The net non-operating cash flow for the end of year six is $18,847. Table 7. Terminal Year Non-operating Cash Flows for Superfish Recirculating Project.
Land Building Equipment
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Salvage (ending market) Value $2,000 $ 5,000 $10,000
Initial Cost $2,000 $18,000 $60,000
Depreciable Basis --- $18,000 $60,000
Book Value (ending) $2,000 $14,490 $ 0.0
Capital Gains Income --- --- ---
Ordinary Income (Loss) $ 0.0 ($9,490) $10,000
Taxes $ 0.0 ($2,847) $ 3,000
Net Salvage Value
(Salvage Value - Taxes) $2,000 $ 7,847 $ 7,000
Net Cash Flow From Salvage Values = $16,847
Net Cash Flow From Working Capital = $2,000
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Step FourDetermining the appropriate cost of capital is the next important step in the net present value method. The cost of capital or discount interest rate used should reflect the cost of capital to the business or the investor and perhaps a risk premium if the project is judged to be riskier than the average project for the business or the investor. If the project is to be financed by both debt and equity capital, the cost of capital rate should reflect the different after tax costs of debt and equity weighted by their proportionate shares. If the debt and equity shares are assumed to be equal (50 percent each) and if the before tax cost of debt is 14 percent and the cost of equity is 20 percent then the appropriate cost of debt would be calculated as follows: (14 x (1.0 - .3 ) x .5 + ( 20 x .5 ) = 14.9 %. The appropriate cost of capital will be related to rates of return on alternative investment opportunities, expected future rates of inflation, the relative riskiness of the project, and the attitude of the investor toward assuming risk. Step FiveIt is now possible to calculate the net present value of the Superfish project. Table 8 shows a consolidated listing of the net annual cash flows for the project. The cash flows are all assumed to occur at the end of the appropriate year with the exception of the initial investment which is assumed to occur at the beginning of year 1 (called time zero). For illustrative purposes a discount rate of 15 percent is used to calculate the net present value of the project. The calculation shows a net present value of $6,639. Accepting the project would be justified because the present value of the future cash inflows is greater than the present value of the initial cash outflow. Table 8.Consolidated Cash Flows for Superfish Recirculating Project.
YEAR CASH FLOW PRESENT VALUE
(@ 15.0%)
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0 ($82,000) ($82,000)
1 $21,181 $18,418
2 $19,947 $15,083
3 $22,148 $14,563
4 $21,445 $12,261
5 $21,839 $10,858
6 $21,529
+$ 2,000
+$16,847
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$40,376 $17,456
NET PRESENT VALUE (15%) = $ 6,639
INTERNAL RATE OF RETURN = 17.7%
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If the appropriate discount rate was 12 percent the net present value of the project would be $15,054. If the appropriate rate was 16 percent the net present value of the project would be $4,086. And, if the appropriate discount rate was 17.7 percent the net present value of the project would be $7.00. The discount rate at which the net present value of the project is zero is called the internal rate of return. While many investors like to see the internal rate of return it is not the most consistent criteria to use in making accept/reject decisions on investments. The net present value method is the preferred criteria. Table 9 contains the present value factors for several interest rates and years. This data can be used to examine the impact of alternative discount rates on the net present value of the Superfish project. Table 9.Present Value of $1 .00 to be Received at the End of n Years.
PVIFk,n = 1/(1 + k)n
(n) DISCOUNT RATE
Years in
The Future 8.0 % 10.0 % 12.0 % 14.0 % 16.0 %
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1 .9259 .9091 .8929 .8772 .8621
2 .8573 .8264 .7972 .7695 .7432
3 .7938 .7513 .7118 .6750 .6407
4 .7350 .6830 .6355 .5921 .5523
5 .6806 .6209 .5674 .5194 .4761
6 .6302 .5645 .5066 .4556 .4104
7 .5835 .5132 .4523 .3996 .3538
8 .5403 .4665 .4039 .3506 .3050
9 .5002 .4241 .3606 .3075 .2630
10 .4632 .3855 .3220 .2697 .2267
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Step SixIt has been mentioned above that the estimates of operating cash flows and terminal cash flows are uncertain. One should examine the impact of reasonable changes in those cash flows on the net present value of the project. One approach to doing this is to develop worst case and best case scenarios and the associated cash flows. Calculate the net present value for each scenario as well as the base case and, if possible assign some (subjective) probability to each. The resulting weighted average net present value may be a better criteria because it now reflect more of the risk and uncertainty of the project (at least on a subjective basis). Step SevenAs a final step one should compare the impact of accepting the project, Superfish in this case, on their opportunities for other investments. An actual investment in a commercial recirculating aquaculture system may tie up capital for long periods of time. In doing this one loses the opportunity to invest in other project or securities. There is also a lose of flexibility in that it may be difficult to reduce the investment in such a system without a lose. Aquaculture enterprises are riskier than many other investment opportunities; therefore one should expect a higher rate of return on such an investment. In calculating the net present value of risky enterprises one should probably use a higher discount rate than normal. ConclusionThe author reported some the limited publicly available economic data on commercial recirculating aquaculture systems. There are indications, not covered in this paper, that technological and biological advances and the expected increased demand for high quality fish products will improve the potential for economically viable recirculating systems. The net present value method of evaluating capital investment opportunities was described and illustrated. It is suggested that it is the preferred criteria for making capital investment decisions. This approach may be helpful for those individuals who are faced with making such decisions now. Caution and rigorous analysis of investment opportunities in commercial recirculating aquaculture systems is suggested. ReferencesLosordo, T. M., J E. Easley and P. W. Westerman. 1989. Preliminary Results of a Survey on the Feasibility of Recirculating Aquaculture Production Systems. Presented paper at the ASAE Winter Meeting, Dec. 12-15, 1989, New Orleans, Louisiana. Losordo, T. M. and P. W. Westerman. 1991. An Analysis of Biological, Economic, and Engineering Factors Effecting the Cost of Fish Production in Recirculating Aquaculture Systems. Presented at Workshop on Design of High Density Recirculating Aquaculture Systems, Sept. 25-27, 1991, Louisiana State University. O'Rourke, P. 0. 1990. Intensive Aquaculture Economics: Can It Be Profitable. Presented at Intensive Aquaculture Workshop, Nov. 2-3, 1990, Illinois State University, Normal, IL. USDA-ERS. Aquaculture Situation and Outlook Report. Wash. DC, Sept, 1991. Wellborn, T. L. 1988. Catfish Farmer's Handbook. Publ. 1549, Mississippi State Univ. Coop. Ext. Svc.
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