Discounted cash flow valuation of conventional and cage-free production investments

Abstract

This study compares profitability and risk of conventional and cage-free egg production in the United States. Evaluating cage-free production is particularly relevant given ongoing consumer driven changes and new cage-free legislation. Results show that while the Modified Internal Rate of Return (MIRR) for conventional production is above an estimated industry opportunity cost of capital, cage-free production’s MIRR does not fully satisfy investors’ expectations. The MIRR of cage-free investment, between 5.6% (deterministic model) and 8.0% (stochastic) per 15-month flock, is below the 9.4% opportunity cost of capital. In addition, the simulations show that there is a 90% probability of conventional production’s MIRR falling between 18.5 and 20.3% per 15-month flock, and cage-free egg production’s MIRR ranging from 6.8 to 9.4%. In order for cage-free to be as equally profitable as conventional production, cage-free egg prices at the farmer gate should be 74% over conventional egg prices. Such high cage-free egg prices are highly unlikely to occur given recent cage-free price premia and consumer willingness to pay estimates from recent research. This study provides a framework egg producers can use to evaluate the potential effects of changes in their portfolio of products (i.e. conventional and cage-free mix) as they accommodate production schedules in this evolving industry.