August 2020 - 32

MANAGEMENT
EMOTIONS
As an investor, it is important to understand
yourself: Are you risk averse? Are you impulsive? Are
you an optimist or a pessimist? How much weight do
you give your emotions when making decisions?
Understanding yourself decreases the likelihood
you will make decisions affected by biases and
heuristics. Biases are preconceived opinions toward
something. Heuristics are mental shortcuts that
increase expediency but also increase risk of error.
Most people are at greater risk of introducing biases
and heuristics into their decision-making during
times of uncertainty. To avoid this, we recommend
discussing your decisions with people who are
objective, believable and may have contrasting views.
TOOLS
Conventional methods used to evaluate investment
decisions include, Internal Rate of Return (IRR),
Accounting Rate of Return (ARR), Payback Period, Net
Present Value (NPV) and Expected Value with Decision
Trees. Two methods we recommend when making
your next capital investment decision are a variation
of NPV and Expected Value with Decision Trees.
Completing these analyses will help you thoroughly
consider the investment.
Net Present Value: This analysis was introduced
in America in 1907 and has been widely adopted by
investment professionals. NPV works by forecasting
cash flows and discounting them to the present.
NPV is an attractive approach because it accounts
for the time value of money and provides a single
number on which to base your decision. The primary
challenge with every NPV analysis is forecasting cash
flows. Variations of the NPV approach seek to control
Contract Grow
5 Acres
$2.2MM
Build 5 Acres
$2.2MM
$3.0MM
+
=
$5MM
x
60%
Increased demand remains: >10 years
Increased demand remains: <=10 years
$(0.8)MM
=
$(2)MM
x
40%
$1.8MM
+
=
$3MM
x
60%
Increased demand remains: >10 years
Increased demand remains: <=10 years
$0.4MM
=
$1MM
x
40%
$2.4MM
Contract Grow
3 Acres
$2.4MM
Build 2 Acres
+
=
$4MM
x
60%
Increased demand remains: >10 years
Increased demand remains: <=10 years
$0.0MM
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32 AUGUST 2020 GPNMAG.COM
for this by running " what-if " analyses, called
Monte Carlo Simulations. By running hundreds,
sometimes thousands, of simulations, you get
a better idea of possible outcomes and the
probability of those outcomes occurring. While
this variation greatly improves the traditional
NPV approach it does not control for the option
value of money.
Expected Value with Decision Trees: While
the NPV approach is binary - to invest or
not to invest - the Expected Value with
Decision Trees considers multiple options.
A classic use-case is buy versus build
scenarios. In our industry, this might be the
decision to fulfill increasing demand with
contract growers versus building additional
acreage. A third option might be to choose
a combination thereof.
This approach accounts for the option value
of money by applying probabilities to the
event of various possible scenarios. In the
previous example, we might determine that
the likelihood of increased demand remaining
for more than 10 years 60% and the
likelihood of it remaining for 10 years or less
is 40%. The analysis might look something
like the figure above.
In this simple example, the expected value
of contract growing versus building is the
=
$0MM
x
40%
same. If these were the only options, either
choice would be justifiable. In this case,
however, the combination of contract growing
and building results in the highest expected
value and should, therefore, be chosen.
CONCLUSION
At our company, Silver Fern Group, we
recently applied these exercises to make
a capital expenditure decision in the heart
of COVID-19 and it saved us 30% on our
up-front cost. By knowing our numbers
(Technicals), understanding ourselves
(Emotions) and using Tools, we were able
to think beyond the pressures caused
by uncertainty and move forward with
our capital expenditure decision. If you
found this helpful, or would like to discuss
further, please connect with us at www.
silverferngroup.com.
Kevin Short, Adam VanWingerden and Stephen
VanWingerden are co-founders of Silver Fern
Group, a firm that provides software, data
analytics and customized technology for growers.
They can be reached at kevin@silverfern.group,
adam@silverfern.group and stephen@silverfern.
group, respectively. For more information, go to
www.silverferngroup.com.
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August 2020

Table of Contents for the Digital Edition of August 2020
