## 2. Appraisals and Valuation (Part II)

What is the value of this stand when the seedlings have grown 10 years (i.e., in year 10)? To value this 10-year old seedling stand by replacement cost, we can enter all compounded costs already incurred as positive amounts (since we wish to recover costs with interest). This also includes the value of bare land (SEV) as a positive amount (Table E7). By accumulating forward the SEV (plus planting and pre-commercial thinning costs at a 4% discount rate) this will give us  3,085 €/ha as a cost value of the property as shown in Table E7.

Table E7: Value of a 10-yr old seedling stand used for timber production: appraisal by replacement cost. The expected cash flow is presented in Table E3

 Year Revenue/cost Compounded (positive) value at year 10 (r=0.04) SEV (year 0) 926 1371 Planting (0) -1000 1480 Precommercial thin (6) -200 234 Sum (year 10) 3085

We can also calculate value by using the income approach (Table E8). We can now look forward (from year 10) by entering all future net revenues from thinnings and final cut (including the value of bare land after the final cut). The SEV tells the NPV of all similar future rotations immediately after the first final cut. By discounting all future revenues at a 4% discount rate will give us 3,085 €/ha, which is exactly the same as the appraisal by replacement cost! The trick here is to include the SEV (which has been calculated for the same expected future cash flow in both approaches) in replacement costs. If SEV is not included in replacement costs, the cost value and the net present value of any property will be equal at any point in time only if the interest rate used for compounding and discounting is equal to IRR (implying SEV=0).

Table E8: Value of a 10-year old seedling stand used for timber production: appraisal by capitalized income. Expected cash flow is presented in Table E3.
 Year Revenue/cost Discounted value at year 10 (r=0.04) Sum (year 10) 3085 First thin (30) +800 +365 Second thin (45) +3000 +760 Final cut (60) +13000 +1830 SEV (after final cut) +926 +130

In economics, costs that have been already incurred (sunk costs) are usually considered irrelevant, since buyers and the market look forward to the future.1 One example of the irrelevance of past costs is the German paper mill sold by Stora Enso with a sale price of one euro on August 2006 (reported in several newspapers).

The market prices for forest properties may contain non-timber benefits in addition to benefits from timber production. Under the private property regime, forest owners’ self-consumption of future non-timber benefits is capitalized in forest land prices, but under the right of common access the impact on land prices is more complicated (see Tahvonen 1999, Tahvonen & Salo 1999). On the other hand, private forest owners do not have an incentive to take into account non-timber benefits not accruing for the forest owner (i.e., climate change mitigation by carbon sequestration, biodiversity maintenance). Consequently, such benefits are not capitalized in the market value of forests and can possibly result in market failure and socially non-optimal forestland use.

1. All the investment criteria we have thus far introduced are based on future cash flow excluding (past) sunk costs.

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