Step-by-step development of a model simulating returns on farm from investments: the example of hazelnut plantation in Italy

Abstract

Recent literature reviews of empirical models optimizing long-term investments in agriculture see gaps with regard to (i) separating investment and financing decisions, (ii) considering explicitly risk and temporal flexibility, and (iii) accounting for farm-level resource endowments and other constraints. Inspired by real options approaches, this paper therefore stepwise develops a model extending a simple net present value calculation to a farm-scale simulation model based on mathematical programming, which considers time flexibility, different financing options and downside risk aversion. We empirically assess the different model variants by analysing investments into hazelnut orchards in Italy outside of traditional producing regions. The variants suggest quite different optimal results with respect to scale and timing of the investment, its financing and the expected NPV. The stepwise approach reveals which aspects drive these differences and underlines that considering temporal flexibility, different financing options and riskiness can considerably improve traditional NPV analysis.