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ACTA UNIVERSITATIS AGRICULTURAE ET SILVICULTURAE MENDELIANAE BRUNENSIS

Volume 63 150 Number 4, 2015

http://dx.doi.org/10.11118/actaun201563041365

FINANCIAL PROFITABILITY
AND SENSITIVITY ANALYSIS OF PALM
OIL PLANTATION IN INDONESIA

Tereza Svatoňová1, David Herák1, Abraham Kabutey1

1
Department of Mechanical Engineering, Faculty of Engineering, Czech University of Life Sciences Prague,
Kamýcká 129, 165 00 Praha 6-Suchdol, Czech Republic

Abstract

SVATOŇOVÁ TEREZA, HERÁK DAVID, KABUTEY ABRAHAM. 2015. Financial Profitability and
Sensitivity Analysis of Palm Oil Plantation in Indonesia. Acta Universitatis Agriculturae et Silviculturae
Mendelianae Brunensis, 63(4): 1365–1373.

Oil palm cultivation in Indonesia is increasing. This study investigates the financial and economic
aspects of establishing an oil palm plantation using data collected in 2014. The financial case study
is undertaken from the perspective of company in North Sumatra, Indonesia. A spreadsheet model
was used to develop and calculate the net present value (NPV), return of investment (ROI), internal
rate of return (IRR) and payback period (PP). Sensitivity analysis of the NPV to the default discount
rate (10%) was included. A 8,000 ha plantation over 25 years was estimated to result in a positive NPV
of USD 10,670 with a ROI 73.50% and an IRR at 14.83% and payback period of 6.75 years. Establishing
an oil palm plantation seems to be very profitable investment on the basis of the assumptions made.
System is tested on sensitivity in different capital and recurrent costs and in selling price of raw
material, while change in selling price of FFB is more sensitive to NPV than change in investment
and recurrent costs Discount rate is also one of the factors affecting NPV and system is tested between
5–15% change in discount rate.

Keywords: capital cost, fresh fruit bunch (FFB), labour need, plantation, recurrent cost and sensitivity
analysis

INTRODUCTION Compression Ingition engines without regulation

Global population growth, technological develop- (APEC, 2008).
ment and continuous depletion of fossil fuels lead Other vegetable oil sources used for producing
to increasing demand for renewable energy, thus biodiesel include sunflower, rapeseed and soybean
for vegetable oils that are used for the production oil with annual oil yields of 0.47, 0.72 and 0.4,
of biofuels. Production of vegetable oils reached respectively (average value from: Yusoff and Hansen
160 million metric tons in 2014, which has almost 2007; Ong et al., 2012; MPOC, 2012; Mekhilef et al.,
doubled then in 2000 when the value was 90 million 2011; Lim and Teong, 2012). World share of palm
metric tons (Statista, 2015). oil accounts approximately 35%, soybeans 26%,
Palm oil is one of the raw stocks of vegetable oil canola 15%, sunflower 9%, others 15% (Statista,
used for producing biodiesel with annual yields of 2015) The demand for vegetable oils is supposed
3,94 t/ha (average value from: Yusoff and Hansen to be 240 Mt/year in 2020 (Corley 2009 OilWorld,
2007; Ong et al., 2012; MPOC, 2012; Mekhilef 2013). Other non-edible vegetable sources include
et al., 2011; Lim and Teong, 2012). Biodiesel is jantropha oil, waste or recycled oil, and animal fats
a biological non-petroleum diesel derived using (e.g. chicken fat, by-products from fish oil) (APEC,
transesterification process (FAO, 2008; Pahl, 2008; 2008; Lim and Teong, 2012; Fisher et al., 2009; FAO,
Fisher et al., 2009; Yee et al., 2009) and it has similar 2008; World Growth, 2011).
characteristics as petroleum-derived diesel and Indonesia is the largest global producer of palm
when both mixed together it can be used in any oil. Global production of palm oil is expected to

1365
1366 Tereza Svatoňová, David Herák, Abraham Kabutey

increase by 32% to almost 60 Mt by 2020 (World the surface. The population density round about is
Growth, 2011). In Indonesia, 50% of palm oil 190 person/km2 (BPS, 2012). The oil palm company
plantations are owned by huge companies with plantations PT Perkebunan Nusantara IV (Persero)
mills. Small farmers in Indonesia own 40% of were selected, because they are one of the largest
Indonesian plantations. The remaining 10% of plantations owners in North Sumatra.
plantations are owned by Indonesian Government
(Rist et al., 2010; World Growth, 2011; World Growth, Data Collection and Processing
2010; Rianto, 2010). Data were collected during face to face
The global harvested area of oil palm in 2013 was interviews with oil palm plantation managers
approximately 17 Mha, of which 7.08 Mha is in involved in the production process. Data related
Indonesia (FAO, 2014). Production of crude palm to quantities and costs of all inputs and outputs
oil (CPO) in Indonesia reached 28.4 Mt, in Malaysia of the establishment, maintenance, production,
19.2 Mt and 2 Mt in Thailand. Indonesia and harvesting and sales. Future amounts of inputs
Malaysia supply 82% of total demand. and outputs were estimated from past experience.
The aim of this study is to analyse costs and A spreadsheet model, developed in Microso
revenues of establishing palm oil plantation in Excel 2010, was found as appropriate method of
Indonesia. Based on the data collected this study summarising the data and therefore it is necessary to
determines whether the system is more affected specify basic criteria:
by a change in costs or in the selling price of raw • computation unit is one hectar of plantation,
material. The specific objectives are: • the main time scale is one year,
1) To review the factors determining the financial • recognize the impact of discounting the time
profitability of oil palm production (from value of money,
the perspective of a plantation) in Indonesia.
• check the system sensitivity to changes in input
2) To construct a bio-economic model of cultivating values.
oil palm and to compare the sensitivity on
The area of the case study plantation is 8,000 ha.
the effects in different prices.
The typical life cycle production chain is 26 years,
while in first year the pre-nursery and nursery
MATERIAL AND METHODS plantation is planted and the oil palms are removed
in year 25. Concurrently the establishment of
Area Description palm oil field is conducted, but the costs of overall
establishment and nursery costs are summarised
The research was carried out in North Sumatra.
only in year zero. The main costs in each operation
The plantation is located in the eastern part of
relate to labour, machinery, and input materials.
the region Simalungun 19 km east of Pematang
Labour costs are expressed in “person-days” which
Siantar and 147 km southeast of the capital of North
is equal to 8 hours. Cost of worker and master is
Sumatra – Medan at an altitude of 0–369 m. It is
IDR 48,000 and IDR 66,000, resp., and men and
a unit Bah Jambi, which is one of the 40 business
women are equal. The sensitivity analysis compares
units Perkebunan PT Nusantara IV (Persero).
the economics on the effects in different costs and
This business unit is engaged in production and
selling price of raw material.
cultivation of oil palm and processing of palm
fruits. The climate is tropical with a mean daily Technical and Financial Data
temperature of 27 °C and a mean annual rainfall of
around 2,000 mm, which is primarily distributed It was assumed that trees were planted at
from November to March. The relative humidity a triangular spacing of 9×9 m and the density of
is around 85%. The topography is relatively 143 trees.ha−1. The yield of oil palm increased from
bumpy and hilly with a maximum slope of 10°. zero at planting to about 27 t ha−1 at 7 years. It then
The underlying geology is podzolic orange and plateaus before declining aer about 14 years. An
brown soil. The water table is typically 80 cm below area of oil palms is planted at 143 palms per hectare

I: Basic technical data of this case study

System Unit Value
Plantation area ha 8 000
Number of plants in plantation unit/ha 143
Length of access roads and canals km/ha 0.0005
Length of main roads and main drainage km/ha 0.01
Length of collection roads and collection drainage km/ha 0.34
Length of plantation drainage km/ha 0.30
Pre-nursery area ha 3
Nursery area ha 103
 Financial Profitability and Sensitivity Analysis of Palm Oil Plantation in Indonesia 1367

would produce a mean annual yield of 22.1 tonnes CF = R − (C + T). (Equation 1)

FFB per hectare over a 25 year period. Basic
technical data of this case study are shown in Tab. I. The Net present value (NPV) was used to
The price of FFB in the domestic market varies with determine the overall financial performance of
factors such as product availability and market the project (Brent, 1998; Sugden and Williams,
demand. The market price for selling FFB used in 1990). Annual income and returns were estimated
this study was IDR 1,700 per kg and it was used for 25 years, and then discounted to present values.
to conduct this study in July 2014, constant value The NPV of the project was calculated and derived
counts also Ong (2012). FFB price varies directly from the total discounted income and costs. The net
proportional to the price of CPO and is around present value of a system over a period of time (NPV;
20.4% of the CPO price. Aer determining that units: IDR ha−1) was derived using Equation 2, where
percentage the historical price of FFB was derived in cash-flows (CF) are specified for each year (r) over
IDR from the market price of CPO in IDR. a time horizon of R (years), and i is the discount rate:
The USD exchange rate was taken as average value r R
CFr
from 2014 (USD 1 = 11,500 IDR) (World Bank, 2012). NPV   . (Equation 2)
Since 1996, real wages increased by 70%, therefore r 0 (1  i)r
the analysis calculates with the rise of wages levels
by 10% annually. This value was chosen because Internal rate of return (IRR) compares
the statistics indicated a nationwide increase, which the amount of benefits and costs. IRR is the value
are mostly scientific workers, teachers and higher- of the discount rate at which the present value of
ranking employees. In agriculture, there is no such expected investment returns equal to the present
sharp increase in wage increases and we can say that value of investment expenditure. It is interest
wages in this sector are the same. income expected from the investment plan. This
breakthrough discount rate is the value of cash
Financial Analysis and Financial Assesments outflows equal to the value of cash inflows. It is
Cost part of financial analysis uses full production calculated using Equation 3, where: time (r), cash
cost (FPC), which includes not only the personnel flow (CF), internal rate of return (IRR), net present
cost and resources, but also the costs associated with value (NPV).
total production and activities related to the final r R
CFr
product. Therefore it also includes the cost of land NPV   0 . (Equation 3)
and administrative costs. Cost analysis in this work r 0 (1  IRR )r
is based on the distribution and the cost calculation
by activities (ABC). The costs of production taken Return of investment expresses net profit or loss
into account are capital and recurrent costs, both in relation to the initial investment. This indicator
including labour and material costs. simply evaluates the viability and feasibility of
When assessing the benefits of the business the investment. It is the ratio of the money earned to
market with palm oil in Indonesia is first necessary money invested and is given in percent. ROI is used
to determine financial statement of cash-flow, to measure profitability over time, not to measure
which may acquire in income or expense. Then the effectiveness of the project such as in the IRR
following the determination of net cash-flow which or PP. ROI was derived using Equation 4, where
is the balance of net income and expenditure. These total revenue (P), capital costs (C), recurrent costs (T) are
cash flows are discounted yearly over 25 years at specified for each year (r) over a time horizon of R
varying rates of interest: 5%, 10% and 15%, with (years), and i is the discount rate:
a default rate at 10%. The costs and revenues were
calculated on an annual time-step. The result is Pr  Cr Tr 
 
a discounted cash-flow and cumulative discounted (1  i)r  (1  i)r (1  i)r
r R 
.
ROI =  (Equation 4)
cash-flow. For the evaluation of the project is used r 0  Cr Tr 
as indicators of criteria, which are: net present value  (1  i)r  (1  i)r 
 
(NPV), return of investment (ROI), internal rate of
return (IRR) and payback period (PP). It is necessary
Payback period (PP) method is used to define
to take into account all evaluation indicators and
the main time point when it is worth the initial
do not constitute investment decision only on one
investment in the project. PP calculation generally
of them. This analysis is used in order to investigate
represents time (usually years), which is needed
the feasibility and desirability of the system.
to restore the initial costs and the net cash flow
The second objective was to construct
is therefore zero. It is the time required to settle
a spreadsheet model to describe the revenue and
the cumulative income with cumulative costs.
costs associated with oil palm plantation system
The shorter the payback period, the more
over 25 years. It is considered suitable to determine
advantageous because of lower riskiness and of such
the cash-flow. The cash-flow was determined as
earlier possibility to use returned funds for future
the revenue (R; units: IDR ha−1) minus capital costs
investment. PP is calculated as cost of investment
(C; units: IDR ha−1) minus recurrent costs (T; units:
divided by annual cash inflows.
IDR ha−1) (Equation 1):
1368 Tereza Svatoňová, David Herák, Abraham Kabutey

RESULTS AND DISCUSSION The following Fig. 1 is a summary of all capital

This study has sought to estimate the financial costs. The largest capital cost per hectare of
outcome of a new oil palm plantation. Externalities plantation related to the land acquisition, which
are not included in this study and are recommended is shown below. Other studies point to the largest
for future studies. capital costs associated with clearing the land, which
The historic inflation rate peak came in 1998– in this case represents the second largest capital
1999 when inflation was reduced from 80% to cost. This is because other studies do not include
zero (Global Rates, 2013). In the first decade of cost of land acquisition. The total capital cost is USD
the millennium it fluctuated between 20% and 5%. 3,460 per hectare of plantation. Without the cost of
In the last few years it started to go down and is land included the value would be USD 1,960, which
around 5% per annum. Discount rate for this study is almost half of the capital cost.
was determined based on the long-term trend rate of Recurrent Costs
inflation (IMF, 2014) and interest rates of the Central
Bank of Indonesia (Bank Indonesia, 2014). It is not Labour need for individual working activities
expected that the chosen discount rate would be are shown in Tab. II. Labours work 6 days a week,
influenced in future only by inflation value and equivalent to 25 days of the month. Administrative
therefore fixed discount rate of 10% p.a. also takes staff work 5 days a week, equivalent to 22 days of
account of other possible risk, discount rate of 5% is the month. Recurrent costs include costs that occur
calculated without additional risk and 15% discount during the project repeatedly, in different years,
rate involves a greater risk for investment. FFB in however, a number of inputs may vary. Recurrent
Indonesia are not subject to VAT (PWC, 2010). costs include the following activities:
• fertilisation and other maintenance,
Capital and Recurrent Costs • survey,
• maintenance of roads and drainage infrastructure,
Capital Costs • pruning trees,
Capital costs include expenses that occur before • maintenance of buildings and other equipment,
the first harvest and include the cost of: • harvesting and transport of FFB,
• land acquisition, • salaries of administrative staff,
• reconnaissance, • operating costs.
• establishment of pre-nursery and its operation, Costs of variable recurrent costs are shown in
• establishment of nursery and its operation, Fig. 2. These costs include fertilising, harvesting and
• land clearing, pruning. Other recurrent costs belong to activities
• construction of buildings and other facilities, that remain constant during the time period for
• construction of road and drainage infrastructure, the entire duration of the project. This includes
• machinery, road and drainage maintenance survey, salaries
of administrative staff, overheads. Infrastructure
• planting plants in plantation.
maintenance includes the largest share of these

1600 1500
Capitalcosts
1400

1200

1000
USD

800

600 482
456
400 272 285
141 150 175
200
0.13
0

1: Share of capital costs in plantation

 Financial Profitability and Sensitivity Analysis of Palm Oil Plantation in Indonesia 1369

II: Labour and mechanical need for different operations in plantation

Labour need Mechanical work need
Operation Unit
(days) (motohours)
Pre-nursery (4 months) ha of pre-nursery 166 (+8) -
Nursery (8 months) ha of nursery 1097 (+45) 8
Land clearing ha of plantation 61 (+3) 10
Planting trees in plantation ha of plantation 68 (+4) -
Infrastructure and drainage ha of plantation - 9*
Fertilisation and other maintenance (yearly) ha of plantation 37 (+3.5)* -
Maintenance of infrastructure and drainage (yearly) ha of plantation - 1*
Pruning (yearly) ha of plantation 2 -
Survey (yearly) ha of plantation 2 -
Harvest ton of FFB 1.5 -

2: Variable recurrent costs during the lifetime of the plantation

Pruning Recurrentcosts
Harvesting

Fertilising

Operationcosts

Survey

Salariesforadministrativestaff

Infrastructuremaintenance

0.00 5000.00 10000.00 15000.00 20000.00

Salariesfor
Infrastructure Operation
administrativ Survey Fertilising Harvesting Pruning
maintenance costs
estaff
Other 3549.72 0.00 0.00 168.66 8330.61 1033.87 156.52
Workers 0.00 3978.20 480.00 0.00 9506.56 9048.57 450.95

USD

3: Share of recurrent costs in plantation for the lifetime of the project

1370 Tereza Svatoňová, David Herák, Abraham Kabutey

costs. Share of recurrent costs in plantation is shown as USD 10,670. These values suggest that oil palm
in Fig. 3. cultivation is profitable. The derived IRR is 14.83%,
ROI 73.50% and payback period 6.75 years.
Financial Assessments The cash flow for each year and the cumulative
The key factors influencing financial side of cash flow over 25 years have been calculated.
the project are: the cost of inputs (material, labour The biggest difference is visible when the cash flow
and machinery), the market price of selling fruits, benefits became evident. The oil palm plantation
which affect the revenue and profit for company and system is profitable assuming a discount rate of 5%,
discount rate. This part assesses the reasonableness 10% and 15% (Tab. III). Beyond this, it is necessary
of the case study mainly based on criterial indicators. to take into consideration a high risk of establishing
To assess the cost-benefit analysis of a spreadsheet a plantation, because of high establishment costs
model, we used the following indicators: NPV, IRR, and the fact that the plantation will first yield aer
ROI and PP. 3 years from planting. We have to consider the risk
Fig. 4 shows annual cash flow for plantation. of possibility that the forest burns before it starts
Costs are the biggest in the beginning of the project getting profit. System is loaded by negative cash flow
because of the significant capital costs, mainly for for six years and records a rapid growth aer that.
cost of land and clearing. In the next two years, There are three ways of shiing NPV: 1) changing
the annual costs are reduced, but overall costs are the discount rate changes the NPV. Higher discount
still rising and then start to go down. Within the first rate makes minor NPV; 2) higher income amounts
three years there is no income because oil palms heighten the NPV and conversely; 3) formerly profits
still not yield. Revenue begins to growth sharply elevate the NPV and later profits reduce the NPV.
during the fourth year, when oil palms begin to All evaluation indicators, namely IRR and ROI
produce FFB. Subsequently, income starts to vary show that at the discount rate of 26% the project
but stays stable up to Year 15 and begins to decline. becomes financially disadvantageous investment.
The NPV suggest the total financial achievement of However that high discount rate is very unlikely to
investment. For this cost-benefit analysis the annual expect. Inflation in 2008 climbed to 58%, which was
income and costs are calculated for 25 years, and caused by the Asian financial crisis. Inflation started
then discounted. Discounted cumulative net margin to fall immediately and in the period since 1980 has
is the NPV of this investment. Using the discount been fluctuating mostly below 10%. For this reason,
rate at 10%, the NPV of the project, the discounted it would not be realistic to determine discount rate
total revenue is USD 25,188 and the present value higher 15%.
of total costs is USD 14,518. The NPV was calculated

4000

3000

2000

1000
USD

0
1 5 9 13 17 21 25
Ͳ1000

Ͳ2000

Ͳ3000 DiscountedincomeUSD/ha DiscountedcostUSD/ha

Discountedefects(CF)USD/ha
Ͳ4000
Year
4: Annual cash flow for plantation

III: Financial indicators for different discount rates

Discount rate NPV (USD.ha−1) ROI IRR PP (years)
5% 20,775 92.92% 20.3% 6.06
10% 10,670 73.50% 14.83% 6.75
15% 5,304 49.82% 9.84% 7.69
 Financial Profitability and Sensitivity Analysis of Palm Oil Plantation in Indonesia 1371

5: Sensitivity analysis

Sensitivity Analysis USD 3,461. A 5% change in these costs is equal to

Sensitivity analysis facilitates us to assess the amount of USD 173. By increasing capital costs
the economic risks. We explore how strong the oil by 5% the NPV reaches USD 10,506 and vice versa
palm cultivation from the financial perspective while reducing capital costs the NPV is USD 10,843.
may appear within shiing marketplace conditions. The difference in NPV when changing capital costs
All financial indicators are affected by: income, is 1.6% compared to original NPV of the project
costs and discount rate. The analysis was done by USD 10,670. Recurrent costs are represented by
changing financial indicators for different possible the amount of USD 36,704 and 5% change in these
changes in supposed circumstances. Results show costs is equal to USD 1,835. When these costs
how sensitive is the analysis to change in some increase by 5% the NPV is reduced to USD 10,117.
of the factors. Sensitivity can be determined with and vice versa reduction of these costs will increase
distinction between the highest and lowest value for NPV to USD 11,223. The difference in NPV when
each scenario. changing recurrent costs is 5.2%.
We test the sensitivity of the system to changes There have been several economic studies looking
in FFB selling price, change in capital costs and at profitability of oil palm plantation (e.g. Belcher
change in recurrent costs (Fig. 5). Setting of NPV (2004), Latif et al (2003), Noormahayu et al. (2009).
at a discount rate of 10%, the model was used to Study by Noormahayu et al. (2009) is using the same
determine the sensitivity of the system. The system discount rate at 4%. Results in their study show
is being tested on a change in the purchase price of higher profitability in oil palm production with
FFB. In case of reducing this price by 5%, from USD IRR of 63%. Lower costs in their study are probably
147.8 of USD 7.4 to USD 140.4 revenues from selling affected by exclusion of building costs, recurrent
FFB are reduced from USD 25,188.to USD 23,928. maintenance costs and very low investment costs
Difference is USD 1,260 and in case of increase in compared to our study. If they include all proper
the selling price of FFB revenues increases to USD costs, the study would be more relevant and IRR
26,447. In terms of NPV the value is USD 9,411 with will be similar to ours. Malaysian study by Latif et al.
reduction in the selling price and USD 11,929 with (2003) is using interest rate at 10%. They found that
increase in selling price compared to USD 10,670. increasing the density up to 200 palms.ha−1 increase
The difference in NPV is 11.8%. Another testing the NPV. The IRR varies between 21–27% (120–200
change is in capital costs, which are represented by palms.ha−1). This is more likely as our result.

CONCLUSION
In this study the economic analysis of oil palm plantation was developed. The practical part calculates
the NPV for the system during 25 years long period in Indonesian agriculture production. With
incorporation of 10% discount rate the discounted total revenue is USD 25,188 and the present value
of total costs is USD 14,518.
The NPV of the system is positive at USD 10,670 and indicates that this investment is good and
profitable. The ROI of 73.50% ensures a considerable return per hectare. This is obtainable due to
1372 Tereza Svatoňová, David Herák, Abraham Kabutey

inexpensive labour in oil palm plantation. The IRR of 14.83% forecasts high returns and payback
period is 6.75 years. Sensitivity to change in discount rate indicates positive investment opportunity
up to 26% of discount rate. In general, the higher discount rate, the lower NPV and investment
attractiveness. The sensitivity analysis also shows that change in selling price of FFB is more sensitive
than change in investment and recurrent costs This study presents that 5% change in selling price of
FFB causes change in NPV by USD 1,259 whereas 5% change in capital costs make USD 173 change and
5% change in recurrent costs make USD 553 in NPV difference. Discount rate is also one of the factors
affecting NPV. When the discount rate increases to 15% the NPV is reduced by USD 5,366 to USD
5304. Conversely with lowering the discount tare the NPV increased by USD 10,670 to USD 20,775.

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Tereza Svatoňová: [email protected]

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