Ocean Carriers Case Study

Group 9

1155081008     CHEN, Zhijiang

1155081510     ZHUANG, Huihui

1155086572     SHENG, Xia

1155081267     ZHANG, Qianyun

1155084778     JI, Yuan

September 28, 2016

1. The daily spot hire rates in next year are decided by the market.

1) The demand should remain steady because the imports of iron ore and coal would likely remain stagnant in the next year.

2) According to the equation of the supply quantity, which is: N1 = N0+ new vessels delivery – scrapping, we can know that the supply of vessels should increase a little. There are two reasons for this. First, there is already a 63 order size for new vessels in the industry this year. Second, the current operating vessels are quite young, which means the number of scrappings should be quite small.

Based on the predictive changes of the quantity of both demand and supply, we believe the daily spot hire rates should be slightly lower.

1. 1) Daily hire rates of a specific ship are decided by its own age and size. Ships with younger and larger fleet size can load more shipments and transport in longer distance with higher efficiency, so that they can earn premiums over the industry-wide hire rates.

2) Daily hire rates of the whole industry are decided by the supply-demand relationship in market. If supply for ships increases while demand remains stagnant or decreases, the daily hire rates will decrease as a result of supply exceeding demand. And vice versa.

In terms of supply,

a) Quantity: larger amount of ships in service, more new ships delivered, fewer ships scrapped and sunk will increase the number of ships available and increase supply.

b) Efficiency: larger fleet size, faster shipping speed, higher fuel efficiency will increase the loading capacity per ship, thus decreasing the ships needed for the same shipments and leaving ships vacant for rent. In other words, higher efficiency will increase supply in a disguised way.

As for demand,

c) Strong economy will have a positive impact on dry bulk industry production and active export and import activities, thus resulting in increasingly active worldwide shipments. With active shipments, the demand for hiring ships will increase, driving the daily hire rates up.

1. Changes in trade patterns, such as the changes from short distance shipments to

long ones, will have a positive impact on developing the demand.

1. I am optimistic about the long-term prospects of the industry.                                                            

1. The Australian production in iron ore was expected to be strong and Indian iron ore

exports were anticipated to take off, so there would be large trading volumes which leaded to high demand of vessels beginning from 2003, and the prices should also boost.

1. There were no sufficiently large capesizes available in the second-hand market, and the

ships already leased were too small to meet the customer’s needs. So I expected that there was a large market for bigger-size caepsizes which had not been developed. The company seized the opportunities would benefit much from that.

1. At the same time, we should consider the fact that the supply will also influenced by

the market conditions. For example, the companies will keep the vessels in operation longer and they will reduce the number of scrappings. Also, with a much higher barrier to exist due to the high production costs, the industry of leasing ships would have a serious competition problem.

1. This is a stand-alone project of whether to commission a new capsize carrier or not.

Therefore, we conducted the NPV calculation to see whether it turns out to be positive or negative. The NPV calculation is conducted separately under 2 different taxation assumptions. Under each assumption, the company can choose either to sell the vessel into the secondhand market, or to scrap it in the 15th year. Therefore, 4 scenarios will be considered as below:

(*Following assumptions are made in our NPV calculation:

a)   If the ship is sold into the secondhand market, it can be sold at the price of net book value;

1. The company will collect back the investment in net working capital at the end of the

project (15th year)

1. Regarding the depreciation, the salvage value of the carrier is zero.)

1. The company operates in the U.S. with 35% of tax rate, and chooses to scrap the ship

to receive $5 million.

Appendix A: The NPV of the project is $-7.8 million. So the project should be rejected.

1. The company operates in the U.S. with 35% of tax rate, and plans to sell the ship into

the secondhand market

Appendix B: The NPV of the project is $-6.2 million. So the project should be rejected.

1. The company operates in Hong Kong with 0% of tax rate, and will scrap the ship to

receive $5 million.

Appendix C: The NPV of the project is $-1.2 million. So the project should be rejected.

1. The company operates in Hong Kong with 0% of tax rate, and will sell the ship into the

secondhand market.

Appendix D: The NPV of the project is $1.2 million. So the project is acceptable under this scenario.

1. To comment on the companies’ current depreciation policy, we need to compare the NPV

of the 2 mutually exclusive projects:  1) not operate ships over 15 years old; 2) continue to use the ships till the full depreciation period of 25 years. The reason why the company prefer not to operate ships over 15 years old is that the maintenance expenditures for older ships to comply with special surveys is very costly. But we also need to check whether the future revenues generated from continuing use can cover the increasing operating costs and special survey expenditures. Therefore, we conducted the discounted cash flow of continuing the ship till end of the 25th year, and see which of the 2 projects gives us a higher NPV (Appendix E).