Lecture-Note-6-(Case-Ocean-Carrier)

LectureNote6Casestudy“OceanCarriers”IntroductionInJanuary2001,MaryLinn,VicePresidentofFinanceofOceanCarriers,ashippingcompanywithofficesinNewYorkandHongKong,wasevaluatingaproposedleaseofashipforathreeyearperiod,beginninginearly2003.Thecustomerwaseagertofinalizethecontracttomeethisowncommitmentsandofferedaveryattractiveterms.NextPageNoshipinOceanCarrier’scurrentfleetmetthecustomer’srequirements.Linn,therefore,hadtodecidewhetherOceanCarriersshouldimmediatelypurchaseanewcapesizecarrier(alargecargoship)thatwouldbecompletedtwoyearshenceandcouldbeleasedtothecustomers.NextPageHowever,theproposedcontractwiththecustomerisonlyforthreeyears.Therefore,afterthethreeyears,theshipwillhavetobeleasedforothercustomers.ItisLinn’sresponsibilitytodecideiffuturemarketconditionswarrantedaconsiderableinvestmentinthenewship.Theobjectiveofthiscasestudyistoestimatethenetpresentvalueoftheinvestmentinthenewcapesizecarrier.Thecasepresentsnecessaryinformationforyoutocomputethenetpresentvalueoftheproject.However,beforecomputingthenetpresentvalueoftheproject,letuslookatthefollowingtwoitems1.HowtheCapesizeCarriers’businessisconducted.2.Thefutureprospectofthemarket.HowtheOceanCarrier’sbusinessisconducted.AcapesizecarrierisalargeshiptoolargetogothroughthePanamaCanal,thushastogothroughtheCapeHorntotravelbetweentheAtlanticandPacificoceans.OceanCarriers’vesselsweremostlychartedona“timehire”basisforaperiodsuchasoneyear,threeyearorfiveyears.However,spotchartermarketisalsoavailable.HowtheOceanCarrier’sbusinessisconducted.(Contd)ThecustomerofOceanCarrierswhochartersavesselpayadailyhireratefortheentirelengthofthecontract.Thus,thedailyhirerateaswellasthenumberofdaystheshipischartereddeterminetherevenuefromtheship.Toexaminetheviabilityoftheinvestment,itisimportanttoconsiderthepossibledailyhirerateaswellasthedemandforsuchvessels.Futureprospectofthemarket-Supplyofthecapesizevessels(Contd)Sincethedailyhirerateisdeterminedbythesupplyandthedemandforsuchservices,wefirsttakealookatthesupplyofCapesizevessels.Futuresupplyofthecapesizevesselsisthesumofcurrentvessels,minusthevesselsthatwillbescraped,plusnewshipsdelivered.Exhibit2showstheexistingcapesizecarriersintermsofthesumoftheloadingcapacity.(SeeExhibit2ofyourcasestudynote)Futureprospectofthemarket-Supplyofthecapesizecarriers(Contd)Thereare2milliontonesofcapesizewiththeageover24years.Wecanexpectthattheseoldvesselswouldbesoonscrapped,whichinturnwouldreducethesupplyofthecapesizevessels.However,sucholdvesselsweresmallportionofthetotalexistingvessels.Sowewouldnotexpectalargereductioninsupplyduetothescrapingofoldvessels.Futureprospectofthemarket-Supplyofthecapesizecarriers(Contd)-Exhibit3showsthecurrentorderofnewcapesizevesselsdeliveredinthecoming4years.Ascanbeseen,therewillbealargesupplyofnewcapesizevesselsin20012002and2003.Thiswillincreasethesupplyofcapesizevesselinthenearfuture.Futureprospectofthemarket-Supplyofthecapesizecarriers(Contd)-Insummary,1.Existingcapesizevesselsarerelativelynew,thuswedonotexpectalargereductionincapesizevesselsduetothescrapingofoldvessel.2.Alargenumberofnewshipswillbedeliveredinthecoming3years.3.Thus,weexpectasubstantialincreaseinthesupplyofcapesizevesselsinthecoming3years.Futureprospectofthemarket-Demandforthecapesizevessels-Over85%ofthecapesizevesselsareusedforshippingironoreandcoal.Linntookalookatthemarketforironore.ShefoundthatAustralianproductioninironorewillbestrong,andthatIndianironoreexportsareexpectedtotakeoffsoon.FutureprospectofthemarketInsummary,thesupplyofvesselmayincreasesubstantiallyinthecoming3years,whichmaydecreasethedailyhirerateintheshortterm.However,consideringafavorableforecastofAustralianandIndianproduction,wecanexpectafavorabledemandforcapesizevesselserviceinthelongrun.FutureprospectofthemarketLinnusedashippingindustryconsultingfirmtohelpherforecastdailyhireratesforanewcapesize.Exhibit6showstheestimateofthedailyhirerateinthecoming25years.ComputingtheNetPresentValueoftheinvestmentinnewcapesizecarrier.ShouldMsLinnpurchasethe$39millioncapesize?Thecompanyplanstooperatetheshipfor25years.Makethefollowingtwoalternativeassumptions.First,assumethatOceanCarriersisaU.S.firmsubjectto35%taxation.Second,assumethatOceanCarriersislocatedinHongKong,whereownersofHongKongshipsarenotrequiredtopayanytaxonprofitsmadeoverseasandarealsoexemptedfrompayinganytaxonprofitmadeoncargoupliftedfromHongKong.Thecompany’sappropriatecostofcapital(discountrateis9%).CashflowofinvestmentFirst,figureoutthecashflowofinvestment.Exercise:CollectalltheinformationnecessarytocomputethecashflowofinvestmentCashflowofinvestment(contd)Tocomputethecashflowofinvestment,notethefollowing.1.Theshipwouldcost$39million,with10%ofthepurchasepricepayableimmediatelyand10%dueinayear’stime.Thebalancewouldbedueondelivery.(p5)2.Linnexpecttomakea$500,000initialinvestmentinnetworkingcapital,whichwouldgrowwithinflation.(p5)3.Expectedrateofinflationis3%(p4)4.Anewshipwouldbedepreciatedonastraight-linebasisover25years.(p5)5.Everyfiveyears,internationalregulationsmandatedthataspecialsurveybeundertakentoensureseaworthinessasdefinedby