Animal health economics - assessing change

Question 1

Commonest methods of assessing change in livestock systems

Answer 1

• partial budget analysis
• investment approasal (referred to as cost-benefit analysis for regional or national assessments)
• other tools incorporate risk (sensitivity analysis and decision tree analysis)

Question 2

Use - partial budgeting

Answer 2

• to assess small changes in farming systems, a livestock sector enterprise or an existing organisation.
• most commonly when considering a new input, enterprse or farm ractice (e.g new medication)
• its conceptual basis is used when introducing time into analysis to assess change

Question 3

What to do if partial budgeting costs/benefits occur in different time periods

Answer 3

• introduce discounting

Question 4

Result of partial budgeting

Answer 4

A marginal analysis not designed to show the profit or loss of the farm as a whole but the net increase or decrease in net farm income resulting from proposed changes. It compares marginal costs versus marginal benefits.

Question 5

What is partial budgeting based on?

Answer 5

expect values

Question 6

4 components of partial budget

Answer 6

COSTS: new costs, revenue foregone
BENEFITS: costs saved, new revenue

Question 7

What is a partial budget not capable of?

Answer 7

• not capable of examining seasonal resource flows

- unsuitable for enterprises that have irregular or lumpy outputs/inputs

Question 8

Why is partial budget restricted?

Answer 8

carried out for a year or a production cycle

Question 9

How do you assess a change inmanagement or investmaent that affects outputs over a number of years?

Answer 9

investment appraisal (known as cost-benefit analysis for regional and national assessments)

Question 10

How is an investment appraisal different to partial budget?

Answer 10

it uses basic framework of partial budgets (costs and benefits of change) but note WHEN these occur (thus adds the concept of the time value of money)

Question 11

What is discounting?

Answer 11

converting future money values into current present value (e.g. something worth £121,000 in 2 years time that is worth £100,000 now if invested with 10% interest.). Discounting requires a rate known as a discount rate. This doesn’t necessarily equate to the rate of interest offered at banks.

Question 12

FOrmula - discounting

Answer 12

a basic principle is that a £ now is worth more than a £ to be received some time in the future because that (present) £ received can be invested at interest to accumulate more than its original value.

Question 13

T/F: when all benefits and costs are converted to present values it is possible to compare them

Answer 13

True - commonly done using three decision-making criteria: net-present value, internal rate of return and the benefit-cost ratio. These have strengths/weaknesses, thus common to present the results of an investment appraisal with all 3 measures of project worth - indicate the economic profitability of an investment

Question 14

When is financial feasibility evaluated?

Answer 14

once economic profitability of various investments have been analysed and alternative chose.

Question 15

Aim - financial feasibility analysis

Answer 15

determine whether/not the investment project witll generate sufficient cash income to make the principal and interest payments on the borrowed funds used to purchase the asset.

Question 16

When is financial feasibility analysis unnecessary?

Answer 16

if the asset is purchased with money that does not need to be borrowed (i.e. equity).

Question 17

Steps - financial feasibilty

Answer 17

• determine the annual net cash flows for the investment. These should be available from the economic feasibility
• determine the annual principal and interest payments based on the loan repayment schedule
• compare the annual cash flow with the annual principal and interest repayments

Question 18

Outcome - the investment produces a cash surplus

Answer 18

it will be able to meet the loan repayments and can be classes as financially and economically feasible

Question 19

What does a cash deficit mean?

Answer 19

the investment is not financially feasible. This does not mean the investment should not take place, it simply means the servicing of the loan will meet with problems

Question 20

When is sensitivity analysis used?

Answer 20

where uncertainty exists about prices of both inputs and outputs and where there is variation in the level of outputs d/t environmental factors. (a range of figures is provided for the parameteres that are uncertain and the worst /best scenarios for the project or activity are used to perform separate gross margin analysis, partial budgets or cost-benefit analyses)

Question 21

What is the output of the sensitivity analysis used for?

Answer 21

to determine how sensitive a project or activity is to changes in the costs and benefits that cannot be given definite values. Thus used to estimate risk of the activity and indicate which prices/production levels have greatest impact on profitability.

Question 22

What is break0even analysis?

Answer 22

a form of sensitivity analysis where the search is for a value of a parameter, be it a price or a level of output, which will produce a zero profit or net present value. This technique can be modified to produce an answer which would produce an output value which is an acceptable threshold

Question 23

What is decision analysis?

Answer 23

for formally analysing complicated decisions which invole a sequential series of actions and chance events. Three aspects within decision are identified:

1. the events which a decision maker can control such as vaccination, treatment of animal or culling of animals
2. probability of occurrence of chance events (virus entry to farm etc)
3. the value of various outcomes, normally but not necessarily expressed in monetray terms
   * once these 3 items are identified, a quantitative analysis is performed, using either pay-off tables and/or decision trees.

Question 24

T/F: all pay-off tables can be presented as decision trees

Answer 24

True

Question 25

Advantage of decision trees

Answer 25

• depict chronology

- evaluate sequence of decisions

Question 26

What are the features of a decision tree?

Answer 26

• DECISION POINTS (NODES) are drawn as squares and lines/branches coming out of such decision nodes represent the complete set of mutually exclusive options being considered
• CIRCLES REPRESENT CHANCE NODES. Branches coming out of chance nodes represent the complete set of mutually exclusive chance events that might occur at that pint
• all branches must be labelled, and branches for chance events have probability values
• the net benefit of each path through the tree is identified at the terminal branch

Question 27

Define opportunity cost

Answer 27

the loss of other alternatives when one alternative is chosen

Question 28

What does the cost-benefit analysis examine?

Answer 28

the economic profitabiluty of a chnage

Question 29

What are the steps in a cost-benefit analysis?

Answer 29

1. ID additional costs (new costs, revenue foregone) and additional benefits (costs saved, new benefits)
2. determine WHEN these additional costs and benefits occur in the future
3. to calculate the present value of the additional costs and benefits using DISCOUNTING and DISCOUNT RATE
4. to calculate the 3 measures of economic profitability (net present value, benefit cost ratio and internal rate of return)

Question 30

Formula - net present value

Answer 30

= present value of additional benefits - present value of additional costs

Question 31

Formula - benefit cost ratio

Answer 31

= present value of additional benefits / present value of additional costs

Question 32

Formula - internal rate of return

Answer 32

= the discount rate which turns the net present value to zero

Question 33

What is the formula for discounting?

Answer 33

Present value (PV) = Xt / (1+r)^t
PV = present vlaue
Xt = amount of money in year t
r = rate of discount (expressed as proportion e.g. 10% = 0.1)
t = number of years from present date

Question 34

Define NPV

Answer 34

= Net present value

= the difference b/w present value of cash inflows and present value of cash outflows

Question 35

Define BCR

Answer 35

= Benefit cost ratio

• always expressed in present values
• higher the better

Question 36

Define IRR

Answer 36

= Internal Rate of Return

• think of this as the rate of growth a project is expected to generate
• the higher the IRR, the more desirable it is to undertake a project
• the IRR is a discount rate that makes the NPV of all cash flows equal to zero.
• aka ERR = economic return rate