Ocean

DePaul University

The Charles H. Kellstadt Graduate School of Business

FIN 555-102

Financial Management

FALL 2016

Ocean Carriers

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?

It would be expected for the daily spot hire rates to decrease slightly from 2001 to 2002.  This is based on the historical data in exhibit 5, which shows a positive correlation between iron ore vessel shipments and the average spot rate. The demand for spot rates would fluctuate mainly based on the worldwide demand for iron ore and coal. During the time when the market is strong, demand for capesize vessels would increase and thus increase the spot price. This also means that the opposite will happen with the market conditions and demand is not ideal.

Ocean Carriers relies on the shipments of iron ore and coal because it makes up 85% of its current business. In this case study, the mention of strong production of ore in Australia and India over the long term will increase trading volumes and require large capesize vessels. This means that in the long term, the outlook for daily spot rates would be strong and should increase. However, in the short run the daily spot hire rates are expected to decline.

According to the case, 63 new vessels are expected to be delivered and only 3 ships to be scrapped. Therefore, will there will be an increase of 60 ships which would increase supply. In addition, it is mentioned that imports of iron ore and coal will remain stagnant over the next two years. As a result, it should be expected that the daily spot hire rate will decrease next year. Australian iron production and Indian iron will increase supplies and would increase trading volumes. Since higher trading volumes, the demand will increase and daily spot hire rates will rise after the two-year timeframe the daily spot hire rates will increase starting in 2003.  

Average daily rates are influenced by two factors:

• Market Condition - A change in the supply of vessels or the demand of iron ore will cause the rate to fluctuate. The various trade patterns may also cause the rate to fluctuate as countries may have different requirements and policies.
• Condition of the Vessel - A newer and more effective vessel would allow for a more efficient ship.

With daily spot hire rates projected to decrease for the next two years, revenue and accounts receivable would also decrease which indicates that cash flows would decline.  

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2. How much is the cost of a new vessel in present value terms? What is the book value of the ship?

The cost of a new vessel in present value terms is $33,738,397. [3.9M + (3.9/1.09) +(31.2/1.09^2)]

NPV at 15 years (Ship scrapped for $5million assuming 35% tax) = -$8,052,304.61 (Exhibit 8)

NPV at 15 years (Ship sold for FMV assuming 35% tax) = -$4,909,709.40 (Exhibit 9)

NPV at 15 years (Ship scrapped for $5million assuming 0% tax) = $404,007.27 (Exhibit 10)

NPV at 15 years (Ship sold for FMV assuming 0% tax) = $3,546,602.48 (Exhibit 11)

NPV at 25 years (Ship scrapped for $5million assuming 35% tax) = -$4,300,727.38

NPV at 25 years (Ship sold for FMV assuming 35% tax) = -$1,047,874.71

NPV at 25 years (Ship scrapped for $5million assuming 0% tax) = $5,253,181.66

NPV at 25 years (Ship sold for FMV assuming 0% tax) = $8,395,776.86

Ship Book Value Calculations (Exhibit 7)

Year End Book Value of the Ship at Year 1= $37,640,000.00

Year End Book Value of the Ship at Year 15= $18,600,000.00

Year End Book Value of the Ship at Year 25= $5,000,000

Total Book Value of the Ship at Year 1 of Commision = $37,140,000

Total Book Value of the Ship at Year 15 of Commision = $18,727,972

Total Book Value of the Ship at Year 25 of Commision = $5,000,000

Note: Total Book value includes year-end book value - change in working capital + accumulated capital expenditure related to special survey costs.

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3. Should Ms Linn purchase the capesize carrier? Assume that it is going to be sold for scrap after 15 years. 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%.  

Investment with a positive NPV should be accepted, while investments with a negative NPV should be rejected. Assuming Ocean Carriers purchases the ship and sells it for scrap after 15 years, the NPV will be negative.  In this scenario, Ocean Carriers should not purchase the ship. With the expected 9% discount rate, commissioning a capesize carrier for 15 years and then scrapping it as is company policy would ultimately yield a negative NPV. Ms. Linn should not purchase the capesize carrier if the 35% tax rate is applied.  However, if Ms. Linn can register the ship in a different country with a 0% tax rate, she should purchase the ship and will net a positive NPV after only 15 years.