Valuation of agricultural property from a wealth creation perspective

Abstract

Shareholders value is created when capital is invested at a return higher than the cost of capital. Adam Smith develop the concept of creating value in 1776 when he wrote in his: An inquiry into the nature and causes of the wealth of nations:” bigger return on capital is required by investors”. The aim of value-based management (VBM) is to create businesses that will be sustainable in the long term. The underlying principles of VBM require that value has to be created consistently over the long-term. The mentioned is contrary to the approach to maximise profits which is more short-term orientated. Based on the assumption that value is created only if the return generated on an investment is bigger than the cost of capital the question arises what is the intrinsic value of an operational efficient asset. In line with the VBM approach the counter question is what amount can be paid for an operational efficient asset? The answer should be that one could pay an amount equal to intrinsic value. In determining purchase amount and based on the fact that intrinsic value is based on required return it is obvious that possible return should at least be equal or bigger than required return. Under consideration in this study is the value of agricultural land in a sheep farming area in the upper Karoo area in South Africa. The aim of the study is to develop a theoretical valuation model based on the above mentioned concepts, to apply the model to determine agricultural land value on “an as is basis”. On an as is basis means that provision is not made for expansion or improvement since these costs will be for the account of the buyer of the land. To develop and test the model - benchmark data both from the business sector, like the Johannesburg Securities Exchange (JSE), property and bond markets and farming data of a study group from the area under consideration were obtained and used as inputs into the model. The results of the study show that three out of the four farms that was bought in the Williston area are over valuated which mean that the farmer (investor) does not received his expected return as compared to the benchmark’s return. Farmers need to generate more income and NOPAT to get the expected return. The only way to do this in the Williston area is to manage the farms more effectively and generate more numbers of lambs per unit. During the study, there is no provision made for compensation for the farmer / shareholder. The study focuses only on the valuation of agricultural property on a production point of view Even though the study and model focus only on NOPAT and cash yield it is important for other studies to investigate more value-based management metrics for the agricultural environment