Ocean Carriers Case Study

Ocean Carriers Case Study

Overview

Ocean Carriers, Inc. is a shipping company with offices in Hong Kong and New York. In January 2001, Mary Linn, Vice President of Finance must make a decision on a proposed contract in which Ocean Carriers would lease one ship to a client for three years and the customer would begin utilizing the ship in 2003. However, Ocean Carriers does not currently have a ship to meet the requirements of the customer. So as the VP of Finance, Mary Linn must decide whether to purchase a new capsize carrier to meet the requirements of the customer, and whether this decision will be profitable in the future.

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 the discount rate of 9%. We determined the net present value of the ship to be -$8,575,156.

Recommendation

Our team decided that we would not recommend entering a contract with the client. We determined the net present value for this project, with a salvage value of the full $5,000,000 due to their being no tax implications in foreign countries as stated in the case study, and still we did not find a positive present value. Another way to look at the proposal is to consider other venues to invest this money, such as a safe investment in T-Bills.

Conclusion

In 2001 Ocean Carriers had the opportunity to sign a contract to lease a new vessel for 3 years.