Ocean Carriers Solution

0. Introduction

The following case study is based on the attached excel sheet, which has been set up in a dynamic approach. This means that the four underlying scenarios (25 years with and without tax and 15 years with and without tax) are linked to separate sheets, which enables the user of the model to calculate the net present value (NPV) for the different scenarios with ease. This is why we refrain from explaining every single step of the underlying calculation. In order to get a more detailed understanding of the various calculations, the reader of this analysis is welcome to have a closer look at our model.

1. Do you expect the daily spot hire rates to increase or decrease next year?

Although we expect the iron ore exports to take off in the next few years, our expectation as to next year`s spot rate is rather pessimistic. This is mainly due to the decrease of the demand in iron ore vessel shipments highlighted in exhibit 5. Meanwhile there will be a delivery of 63 new vessels next year, which are bigger and more efficient, leading to lower costs generated from the perspective of the shipping company as fewer ships are needed to deliver the same amount of cargo.

2. What factors drive average daily hire rates?

As the daily hire rates are mainly driven by supply and demand of shipments, the economic outlook plays a key role in determining the prices charged. The demand for iron ore and coal markets takes up over 85% of the cargo carried by capsizes. The higher the demand for those products, the higher the daily hire rates could be charged. As the demand for capsizes is influenced by the distance between the supplier and demander, another factor influencing the daily hire rates is the change in trade patterns. The last factor influencing the daily hire rate is the age of the vessels because the newer the ships are, the more efficient and less costly they will be.

3. How would you characterise the long-term prospects of the industry?

We would characterise the long term prospects of the capsize dry bulk industry rather positive. Judging from exhibit 6, overall the demand will be growing at 1.5% in the future. Also there is an expected increase in demand for capsize vessels considering the probable exports arising from Australia and India starting in 2003. From the shipment company`s perspective, even though the daily hire rates may be unstable, the growing demand in shipments will lead to an increase in the trading volume, which would ultimately give rise to the total revenue. In terms of economy, such features as globalization and the development of emerging markets will lead to a further demand for larger, more efficient vessels, presenting new requirement for capsizes. Taken these prospects into account, the capesize dry bulk industry looks promising in the long term.

4. Should Ms. Linn purchase the $39M capesize?

In order to decide whether the company should implement the project or not the net present value approach (NPV) has been applied. Rather than explain each single step of our estimations, we will provide an overview of the underlying assumptions for the calculation of the NPV. This will ease the understanding of the attached excel sheet, where all steps can be back tested. 1 Step) Calculate revenues and expenses by making assumptions about the growth rates, depreciation methods, capital expenditures and changes in net working capital; 2 Step) Use the information and calculate the free cash flow for both scenarios (with and without taxes) in order to come up with the NPV; 3 Step) Compare the NPV and make a decision.

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Assuming the company is a US firm subject to a tax rate of 35%, Ms. Linn should reject the project, as the NPV is negative. Although the company is facing tax advantages (zero tax payment) in Hong Kong, Ms. Linn should not purchase the capesize since it is a negative NPV project.

5. What do you think of the company’s policy of not operating ships over 15 years old?

In order to come up with an appropriate recommendation of whether the company should change its current policy, we have to change our previous assumption about the length of the project. The calculation of the NPV for 25 years will enable us to make a judgment about the current efficiency of the current policy. A relatively higher NPV for the 25 years project would imply that the current policy is not maximizing the shareholder value. This is why we think that the company should change its policy, because wherever it operates, the NPV is higher if the company adopts the 25-year project than that of 15-year (see the table in section 4 and see also the Excel file for details). To be more precise the only scenario in our analysis that would allow accepting the project is the operation in Hong Kong for 25 years, leading to the conclusion that the company might decline positive NPV projects in the long run due to its current policy.