...Ocean Carriers Analysis Date: 8/29/2007 TO: MS MARY LINN CC: PROF. TOM MILLER FROM: RYAN DALE SEELKE RE: DECISION ON CAPE SIZE CARRIER PRIORITY: Ms Mary Linn, After careful cash flow analysis and a discount rate (WACC) of 9%, commissioning a capsize carrier for 25 years is the only appropriate option for our firm. However, if the discount were instead 10%, both options would fail the NPV test by yielding negative results. I make this recommendation after thorough analysis of estimated cash flow and with the desire that our required 15-year life span will be amended. With the expected 9% discount rate, commissioning a capsize carrier for 15 years and then scrapping it as is company policy would ultimately yield a NPV of (1,252,916). However, if Ocean Carriers decided to commission its ship for 25 years, then the NPV would be a positive 368,557. Since current company policy is to scrap ships after 15 years, management should look at these numbers in detail and consider revising its dated policy. As mentioned above, this recommendation hinges on a 9% discount rate. If our cost of debt or cost of equity would change, then this would change our WACC and thus our discount rate. Therefore, if either the cost of equity or debt increases and our subsequent discount rate were to be 10% rather than the expected 9%, then both options would yield a negative NPV and neither should be undertaken. If the opposite happened, and the discount rate was 8%...
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...Case Ocean Carriers Investment calculations If we make calculations assuming that Ocean Carriers is a U.S. firm subject to 35% taxation, net present value for the 39 million dollar investment is approximately -5,55 million dollars. Therefore on the basis of my calculation, the investment appears to be unprofitable. Obviously the conditions are far better if Ocean Carrier resides in Hong Kong and does not pay taxes for its overseas profits. In that scenario the investment has approximately net present value of 2,73 million dollars. A sensitivity analysis reveals that the investment decision will remain profitable even if the future conditions are slightly (but not much) worse than what the firm currently anticipates. If the firm uses 10,1% discount rate (compared to the current 9%), the investment will approximately break even. Relevance of the already occurred expenses The firm should not include the already occurred expenses to its investment calculations. The occurred costs are sunken costs that the firm has to cover whether it decides to make the investment or not. APPENDIX 1. Investment calculation with 35% tax 2. Investment calculation with 0% tax OC is a U.S. firm with 35% tax (1/3) Purchase price 39 000 000 Discount rate 9,00 % Inflation 3,00 % Operating cost increase 4,03 % Tax rate 35,00 % Age of ship 1 2 3 4 5 6 7 Event year 0 1 2 3 4 5 6 7 8 9 Calendar year 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 Days in year 365 365 365 365 365 365...
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...Ocean Carriers Inc. was approached in January of 2001 with a contract proposal for the leasing of one of their ships for a term of 3 years beginning in 2003. Ocean Carriers currently has no ship to accommodate the customer. To commission the construction of a new vessel would take 2 years from start to completion. The average rate in the spot market is $22,000 per day. Ocean Carriers deployed a younger fleet than average carriers and generally earned a 15% premium over the average daily rate placing them in position to capitalize in strong economies. However, the industry is volatile and suseptable to extremes both low and high. Many ship owners sought to sign contracts with time charters in order to shield themselves from the swings in the market. The age of the vessel is another key variable in the rate an owner can demand. Younger ships, as mentioned before, generally take in 15% higher rates than the industry average. However, the older ships, roughly 25 years or over, demanded a 35% discount off of the industry average. Location is also a key factor in determining the demand for dry bulk capsizes. The distance between the US and the EU is relatively short requiring a smaller fleet of ships. Whereas, an upturn in demand in the Asian Pacific would require a greater fleet of capsizes in order to accommodate the time required to ship such distances. Ocean Carriers had to concern themselves especially closely on the global economy because demand for dry bulk capsizes...
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...Ocean Carriers Ocean Carriers Inc. was approached in January of 2001 with a contract proposal for the leasing of one of their ships for a term of 3 years beginning in 2003. Ocean Carriers currently has no ship to accommodate the customer. To commission the construction of a new vessel would take 2 years from start to completion. The average rate in the spot market is $22,000 per day. Ocean Carriers deployed a younger fleet than average carriers and generally earned a 15% premium over the average daily rate placing them in position to capitalize in strong economies. However, the industry is volatile and suseptable to extremes both low and high. Many ship owners sought to sign contracts with time charters in order to shield themselves from the swings in the market. The age of the vessel is another key variable in the rate an owner can demand. Younger ships, as mentioned before, generally take in 15% higher rates than the industry average. However, the older ships, roughly 25 years or over, demanded a 35% discount off of the industry average. Location is also a key factor in determining the demand for dry bulk capsizes. The distance between the US and the EU is relatively short requiring a smaller fleet of ships. Whereas, an upturn in demand in the Asian Pacific would require a greater fleet of capsizes in order to accommodate the time required to ship such distances. Ocean Carriers had to concern themselves especially closely on the global economy because demand for dry bulk capsizes...
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...Michael Depersia Ocean Carriers needs to evaluate the decision to commission a new capesize carrier. Mary Linn, Vice President of Finance, needs to decide if this is a profitable decision for the company. In determining whether Ocean Carriers should purchase the new capesize carrier for the potential customer, we completed a net present value analysis of the project. In order to do this we need to take many things into account including, but not limited to, depreciation, opportunity costs and networking capital. To begin, we calculated the revenue given expected daily hire rate that could be expected over the lifetime of the vessel. We chose to use the expected daily hire rate because it most accurately represents Ocean Carrier’s cash flows. The initial investment was 10% of the purchase price in first year, which amounted to $3,900,000 paid in the beginning and the end of the first year. Beginning in 2003, the operating costs for the vessel were $1,460,000 ($4,000 per day), growing at a rate of 1% per year. For the 15 year analysis, we first subtracted the $5,000,000 salvage value and used straight-line depreciation over 15 years, which was $2,667,667 per year. Depreciation is important for this calculation because it allows the firm to recognize the wear and tear on the vessel by decreasing the worth of the asset. The straight-line depreciation method allows firms to allocate fixed reductions in the asset's value over its useful life. It is calculated by the acquisition cost...
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...Ocean carriers has been approached by a customer who is offering attractive terms for a three year ship lease. However, there is no existing ship that meets the customer’s needs, so Mary Linn, Vice President of Finance, must decide if we should purchase a new ship that will meet the customer’s demands for $39 million. Since the lease is only for three years we need to analyze if by continuing to operate the ship for other charterers will be a profitable project for Ocean Carriers. It is the company’s policy not to operate a ship older than 15 years. At the end of the 15 year period the scrap value of the ship is estimated to be $5 million. Ocean Carriers charges a daily higher rate for the ships and usually earns a 15% premium to the industry, due to younger and larger ships. However, the availability of capsize ships is increasing so it is likely that the daily higher rate will decrease. The cost of operating a capsize ship is currently $4000 per day and is expected to increase at 1% above inflation. With increasing operation costs and a decreasing daily hire rate we must be cautious about the investments we make in new ships. I have explored four cases of analyzing the Net Present Value of the project. Case 1 The first case explores commissioning a United States based ship for fifteen years. In the case we assume the first 3 years are a guaranteed lease to the customer we are building the ship for, where we will receive a $20,000 daily higher rate that will increase...
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...Ocean Carriers According to Exhibit 3, the number of vessels is set to increase from 2001 to 2004. The iron ore shipment imports stay relatively the same amount, so we expect the daily spot rates to decrease over the next few years. The daily hire rates are driven by supply and demand. The historical changes in these rates have been related to the change of the bulk shipments. The supply is equal to the currents vessels plus new ships minus scrapings. Demand for dry bulk capesize is determined by the economy. A strong economy will increase the demand. The long-term prospects of the capesize dry bulk industry are connected to the volume of vessel shipments of iron ore and coal. We expect the long-term prospects to grow. Over 85% of the cargo carried by capsizes was iron ore and coal. The amount in tons of iron ore shipments is expected to grow consistently each year. The cost of a new vessel in present value terms is $33,738,397. Ocean Carriers will pay the $39 million over three installments: 10% immediately, 10% in a year and the rest in two years. The $33,738,397 is roughly 87% of the $39 million price. The installments are a good financing decision for Ocean Carriers since it is less than the $39 million. If the ship is going to be sold for scrap after 15 years, we should calculate the NPV from 2000 to 2017. There are mainly three steps to calculate NPV. First, we work out EBIT, then calculate free cash flow, and finally use the free cash...
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...Case 1: Ocean Carriers We think that daily spot hire rate will likely decrease next year. There are two reasons. First, there are 63 new vessels scheduled for delivery in 2001 to increase the supply of vessel and only few old vessels need to be retired, while the demand will not increase because imports of iron ore and coal would remain stagnant over next two years. Second, exhibit 5 shows that avg. spot rate of 2000 was higher than the rate of previous years and avg. 3-yr charter rate. In addition, the market will seemingly go up after two years. Therefore, ship owners should hope to sign short-term contract through using lower daily spot hire rate rather than locking low daily high rate for a long period. Average daily rates are influenced by two factors. First, market condition decides the rate. A change in the supply of vessels or a change in the demand of iron ore will make the rate fluctuate. The trade pattern also influences the average daily rate because different countries have unique policies. Second, the condition of vessel would have effect on the rate. The newer and more efficient the ship is, the higher the rate is, and vice versa. Market conditions, which include price and competition, imply that the cash flows are susceptible to changes. In this case, the free cash flow will gradually decline with time. The cost of a new vessel in present value (January 2001) terms is $33,738,397.44(Cost Analysis), compared to a book value of $39 million (Cost Analysis). The...
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...Analysis In order to make a recommendation to Mary Linn as to whether Ocean Carriers, Inc. should purchase a new ship we must first look at the net present value of the ship. In order to do this our team used the provided expected daily hire rates to calculate revenue which we expect to be for the lifetime of this vessel. The expected daily hire rate is the most accurate measure to determine future cash flows for the company. By using the annual operating days over the life of the new vessel we were able to determine the annual daily hire revenue. The daily operating cost for the vessel was provided for year 2 at $4,160. For the remaining years of the ship, we increased the operating costs at 1% over the inflation rate of 3%. We used the market year of 360 days per year to determine operating costs incurred, which lead us to annual operating costs of $1,497,600 in year 2, and $1,557,504 in year 3. The company incurred only two survey costs due to the company policy of scrapping a vessel after 15 years. These costs incurred a straight-line depreciation over 5 years. Appendix A shows an annual vessel depreciation expense of $1,560,000 beginning in year 1. Taxes were determined by using the given rate of 35% which did not change over the life of the project. Our analysis includes a down payment of $3,900,000 in years 0 and 1; followed by the remaining $31,200,000 of the cost in year 2. All net working capital will be complete after year 15, and cash flows were calculated by using...
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...Memo OCEAN CARRIERS Date: January 2, 2001 To: Mary Linn, Vice President of Finance From: Thomas Harper Subject: Investment in New Capesize Bulk Ship After analyzing the commissioning of a new capsize ship for a three-year lease, my team has come to the conclusion that Ocean Carriers should move forward with the investment only if it is built and registered in our Hong Kong office. There were key assumption my team and I made in our analysis and they are as follows: 1. We assumed a discount rate of 9% throughout the life of the new capsize. 2. Secondly, we assumed a tax rate of 35% in the United States and a 0% tax rate in Hong Kong. 3. The company policy of only 15 years of service would be upheld with the new capsize. 4. The given spot rates are reasonably accurate throughout the life of the capesize. 5. The charterer offered rate and annual escalation for years 1 through 3 are set in stone. After considering our assumptions we analyzed the data to calculate the free cash flows of the project and were able to come up with the Net Present Value, Profitability Index, and the Internal Rate of Return for the new project. Our calculations are in the attached Excel Workbook under the Investment tab. As you will see in the Excel tab the NWC gained from building the capesize in Hong Kong was $7,149,883, while the NWC from building the capesize in United States created a loss of $1,207,088 for the company. Exhibit 2 it shows the...
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...Ocean Carriers Case Study Q1. a). we expect the daily spot hire rates to decrease in 2001 and 2002 according to the forecast in exhibit 5. This decline in daily spot rates is also supported by the forecast in Exhibit 3 showing a decline in ordering bulk capsizes from 63 in 2001 to 33 in 2002. Spot hire rates tend to fluctuate depending on the highs and lows trading volumes in the market. So since according to the forecast the demand for Iron ore had a poor market outlook in 2001, the spot hire rates were expected to remain stagnant or low. Exhibit 3 Current order book for dry bulk capesizes by delivery date | | | | | | | | 2001 | 2002 | 2003 | 2004 | | | | | | | | Number of vessels | 63 | 33 | 21 | 9 | | | | | | | | b). Market conditions dictated by demand and supply of basic industrial products drive average daily rates. For instance in 2001 the poor market demand for Iron ore drove the daily rates low because Iron ore trading countries would cut costs by trading within nearby trading partners. However, the optimistic Iron market conditions in 2003 between Australia and India increased the demand for capsizes to accommodate trading patterns dictated by distance between world Iron ore trading countries. c). Increase in daily rates is also a function of the age and size of the ship. According to the Ocean estimates in Exhibit 4, Ocean newer vessels tended to earn 15% average daily rates whereas older vessels gave 35% discount from the industry...
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...Budgeting In Practice Ocean Carriers These questions relate to the Ocean Carriers case in your course packet. You can find the data for this case on the course website in a spreadsheet named: Ocean Carriers Exhibits.xls. This case provides the opportunity to make a capital budgeting decision by using discounted cash flow analysis to make an investment and corporate policy decision. Ocean Carriers is a shipping company evaluating a proposed lease of a ship for a three-year period beginning in 2003. The proposed leasing contract offers very attractive terms, but no ship in Ocean Carrier’s current fleet meets the customer’s requirements. The firm must decide if future expected cash flows warrant the considerable investment in a new ship. 1. Do you expect daily spot hire rates to increase or decrease next year? Give the reasons for your choice. Which are the factors that drive average daily rates? What does this imply in terms of your cash flow projections? 2. How much is the cost of a new vessel in present value terms? What is the book value of the ship? 3. Should Ms Linn purchase the capesize carrier? Assume that it is going to be sold for scrap after 15 years. [Hint: Construct the Free Cash Flows of the project!] Explain the reason for constructing the free cash flow rather than some other type of cash flow? Assume that the relevant corporate tax rate is 35%. 4. Ms Linn is considering trying to argue that the firm should operate carriers for more than 15 years...
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...Ocean Carriers: Case Study MBA 540 Fall 204 Janelle Roche King Quaidoo Suzanne Ekstrom Net Present Value: 15 Year Evaluation if the United States with a 35% Taxation Net present value is used in order to determine the present value of an investment by the discounted sum of all cash flows received from a project. In this case this would be the calculation of the single project capital budgeting for Ocean Carriers Inc. and a purchase of 15 year operation vessel. This 15 year time span would begin in 2000 and continue until 2017. Ocean Carries Inc. in this scenario would be subject to the United States 35% taxation. In order to calculate the net present value the free cash flow had to be calculated. Using the formula; EBIAT + depreciation – capital expenditure - change in net revenue + after tax proceeds from the sale of a ship (Year 17: $645,899 + $1,630,000 - 0 - ($756,295) + $8,710,000 = $11,742,193.61) the free cash flow was calculated. Using that calculation the present value of the free cash flow was calculated using the formula; Free cash flow / (1 + 9%) ^ Event year. After summing the total of the present value free cash flow the conclusion was the net present value. After fully comprising the single project capital budget it can be concluded that the Net Present Value would equal -$7,805,694. The net present value rule states that an investment should be accepted if its net present value is greater than zero and should be rejected if it is less than zero. Following...
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...Case Study 1 – Ocean Carriers 1. The Capital Budgeting Decision Should Ms. Linn purchase the Capesize vessel? Assume that Ocean Carriers is a U.S. firm and is subject to 35% taxation. (Please see excel sheets) From our analysis it appears that Ms. Linn should not buy the Capesize vessel. The Net Present Value on the Ocean Carrier is not a positive number, a clear indicator that buying the vessels is not a good idea. The tax rate of 35% makes a lot of difference in determining this NPV. In our calculations we did assume a tax rate on the final sale of the vessel. If it were possible, or known, the tax rate on the salvage it might be more feasible to buy the vessel, and end up with a positive NPV. The effect of taxes on EBIT and thereby NPV is easily seen in our analysis numbers. As taxes remain steady and profits from operations falls, the prudence of the investment becomes apparent. Assume that Ocean Carriers in based in Hong Kong, where owners of Hong Kong ships are not required to pay any tax on profits made overseas and also are exempt from paying any tax on profit made on cargo uplifted from Hong Kong. (Please see excel sheets) If the tax rate were a non-issue it would make sense to buy the vessel. Running our analysis with a zero tax rate gave a positive NPV. This is due to the effects of taxes on EBIT. While it is more realistic to expect a tax rate, draw of having a zero tax rate would make this project more attractive to management, and possible. It may...
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...Answer to Question #1: The daily spot rate for 2002 will likely decrease despite the 2% forecasted growth in worldwide iron ore shipments as 63 new dry bulk capesizes are expected to be delivered in 2001, and 33 in 2002, thereby increasing worldwide supply of capesizes by 11% and 5.4%, respectively. Furthermore the worldwide capesize fleet is relatively young – only 8 capesizes are at least 20 years old – there should be relatively few scrappings. For example Exhibit 5 of the Ocean Carriers case study shows the direct correlation between the number of shipments of iron ore and the average daily spot rate. From 1995-1996, the average spot rate fell from $20,149 to $11,730 and from 1997-1999, the average spot rate fell from $14,794 to $9,427. Consequently, the iron ore shipments effectuated from 1995 through 1996 and from 1997 to 1999 were stagnant. Based on the foregoing historical data and trends, one could expect the same result for the time period from 2001 through 2003. One could expect cash flows for the company to decline as a result. As such, it is economically preferable for ship owners to enter into short term spot market contracts rather than signing long term time charters which would lock them at a low daily rate for an extended time period. Answer to Question #2: Average daily hire rates are determined by supply and demand for capsizes and market conditions. Supply is affected by the number of ships available, plus new ships...
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