The Farm's Water Buyback Decision
Kellerman & Daughters is a third-generation citrus farm of 240 hectares in a drought-prone region. It holds a water entitlement of 1,800 megalitres per year. A government buyback scheme offers $4,200 per megalitre for permanent entitlement, and a neighbouring almond grower has offered a five-year lease of 400 megalitres at $950 per megalitre per year. Last season the farm used 1,650 megalitres and produced 9,400 tonnes of fruit at an average price of $610 per tonne. Production costs were $4.1 million. The daughter who now runs operations, Ana, wants to sell 500 megalitres permanently and use the cash to replace two ageing harvesters. Her father argues the entitlement is the farm's inheritance and should never be sold. The bank has flagged that the farm's debt-to-asset ratio is creeping toward its covenant limit.
1. Assess the financial consequences of selling 500 megalitres permanently versus leasing out 400 megalitres for five years, given the farm's current water use and debt position.
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Start with what the farm actually uses: 1,650 ML against an entitlement of 1,800 ML, leaving a 150 ML buffer. Any sale or lease must come out of that buffer plus reduced use, or the farm must buy water back on the temporary market.
Permanent sale of 500 ML: raises 500 × $4,200 = $2.1 million, a one-off cash injection that materially improves the debt-to-asset ratio and funds the harvesters without new borrowing. But it leaves 1,300 ML of entitlement against a 1,650 ML historical need - a 350 ML annual shortfall that must be bought on the temporary market every year, at unpredictable prices. The farm permanently converts a productive asset into a depreciating machine.
Lease of 400 ML for five years: raises 400 × $950 = $380,000 per year, or $1.9 million over five years - comparable total cash to the sale, but spread out and reversible. It still leaves a 250 ML shortfall against historical use, though the lease expires and the water returns.
Judgement: the lease is the better risk-adjusted choice for a farm near its debt covenant. It delivers similar cash over the horizon, does not permanently shrink the productive base, and preserves the option to sell later if drought persists. The father's 'never sell' position is emotionally understandable but too absolute; the real argument is timing, not principle. Ana should lease, use the first two years' income to service debt, and revisit a partial sale only if the covenant pressure continues.
2. The bank is pressing for a decision within the month. Explain how Ana should weigh the short-term liquidity need against the long-term productive capacity of the farm.
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The two pressures pull in opposite directions and the answer must hold both at once.
Short-term liquidity: a covenant breach is not a slow problem. If the ratio crosses the limit, the bank can reprice or call the loan, which could force a distressed sale of land or water at the worst possible time. The lease's $380,000 arrives annually, which may be too slow if the covenant is tested quarterly; the sale's $2.1 million arrives at once. So liquidity argues for speed and size.
Long-term capacity: water entitlement is the farm's core earning asset. Selling 500 ML permanently removes the ability to return to full production when prices or rainfall recover, and the harvesters it buys will depreciate while the water would not have. The lease preserves that option.
Reconciling them: Ana can meet the bank's deadline without the permanent sale by leasing the 400 ML, using the first year's payment plus a short-term facility to satisfy the covenant test, and presenting the bank with a written plan showing the ratio improving over three years. This treats the deadline as a financing problem rather than a reason to liquidate the inheritance. The father's objection should be reframed: the question is not whether to ever sell water, but whether a covenant deadline is the right moment to do it. It is not.