Risk Premia in Tractor and Combine Investments

A farmer planning to use Net Present Value (NPV) analysis on machinery requires estimates of operating benefits over time, an estimate of terminal or salvage values and a risk-adjusted discount rate. Using financial market information and related Root Mean Square Errors on machinery value forecasts, risk premia for combine and tractor investments are estimated for non-diversified investors. These risk premia can be added to the risk free rate in comparable maturity long term bonds to derive an appropriate discount rate for NPV analysis. Where machines are held as single-asset portfolios, risk premia identified for discounting terminal value vary between 5.5% and 8.3% for combines and between 2.4% and 3.6% for tractors, depending on age during the holding period. Where machines are held as parts of multi-asset portfolios, risk premia are usually lower, depending on machinery's weight in the multi-asset portfolio and its covariance with the rest of the portfolio.