Case Study: Ocean Carriers Essay

Executive summaryOcean Carriers is contemplating the opportunity of stipulating a 3-year leasing contract that would require commissioning the construction of a parvenu vessel. In the short marches applied hire rank are decreasing, just as they should be on the recovery side starting 2003. While signing a impertinent client and therefore expanding the business, the aforementioned investment should be undertaken in Hong Kong. Further more(prenominal), a 15year project is preferable, thus scrapping the vessel at an estimated price of $5M in order to reinvest that pith and avoid facing heavier upcoming costs.Although the longer lasting project (25 years) guarantees a higher net present order and forecasted rates bring outm to be increasing, less(prenominal) agility on future market occasions, increasing hire rates volatility and risks to bear for the corporation must be considered. Moreover, the alleged strong coefficient of correlation between number of cargos and hire rates i s being questioned.Summary of factsProvided that Ocean carriers fleet doesnt present a ship which meets the new customers requirements and that a fairly long clipping is needed to build a new one, the management has to decide in 2001 whether to commission a vessel for a 3-year time charter beginning in 2003 at an initial daily hire rate of $20,000 growing at a footstep of $200per year of contract.Statement of the problemMany factors are to be considered such as the daily hire rate and operational cost trends, the yield and occupy of iron ore and steel which form the 85% of capesize dry bulk carriers shipments. The headquarter location, on which the taxation regime depends, is too acritical decision epoch in Hong Kong the operations would be exempt from tax, they would account for 35% on profit in New York.AnalysisFor a better comprehension of the problem, we offset printing focused on some possible outcomes depending on supply and demand tendency. In the short term, an exces s of supply (63 new vessels) and no major forces influencing the demand will cause the hire rates to drop. Also, if the consulting group is to be fully trusted, a sharp decrease in iron ore vessel shipments will gross out down prices as well. Looking at a longer horizon, supply and demand drivers are mainly, for the latter, the world economy as a whole and hatful patterns i.e. the longer distance the more demand, and for the former the efficiency and size of vessels (negative correlation), the demand for shipping capacity and the age of the ships. These factors reveal unconditional long-term effects. Due to Australian ad Indian demand rocketing, exports will expand along with higher trading volume.Moreover, Ocean carriers presents an advantage with regards to their ships they are bigger and newer thus deserving a plus 15% factor over standard prices. Nevertheless, adverse aspects should be taken into account as well, such as the inefficiency in building a new vessel (2 years) whi ch could lead to a growing demand for net working capital in order to strengthen the companys fiscal position and make it able to face sudden cash outflows. In addition, given their better growth pattern, Ocean Carriers should favour the spot and not the time daily hire rates instead of locking themselves up in long term, less flexible contracts.Our view for the long run is definitely positive though not outstanding, with future growth resembling the inflation level. Considering the mentioned facts as well as all the assumptions, the choice that has to be made will be in the main influenced by the daily hire rates. These factors are the mostvolatile and difficult to predict and influence income, profit and finally cash-flows. MsLinns decision should assess different and unpleasant outcomes before taking a decision ground only on cash-flows NPV. Firstly, when comparing Hong Kongs and new Yorks NPV, the no tax zone is clearly the better choice (see table 3 and 4 for calculations), with the 35% straight-line american taxation killing most of the profits from the investments first years. Even if we consider an accelerated depreciation system (MACRS) and compare equivalent profits, annuity figures are still worse for taxed areas (graph 3).From this calculation we begin to see how actual cash-flow equivalent annuities are not markedly different between the 15 and 25-year no-tax projects. If accurately analysed, inter-period NPVs show an unexpected picture (table and graph 1). If the reinvestment of the scrap value could guarantee a real rate of return similar to the discount used (discount rate=9%,inflation rate=3%,real discount=5,83%), the two NPVs conk closer. This partially explains why, of the two, the shorter investment is the best a substantial chunk of the 25-year projects NPV (74%) is created in the latter period of the investment (2017-2027) when prices are hardly predictable, more volatile and easily influenced by present expectations. $610.159,93 sup plementary cash income are not worth 10 more years of holding period operating and survey costs become too heavy to sustain the additional period of investment.We carried on our analysis by looking at the hire rates and their expected value. The strong correlation between charter rates and shipments reported by the consulting firm is now being took into consideration (table and graph 2). The outsourced analysis states that when shipment numbers rise so should the same charter rates. Unfortunately this is wrong under a statistical point of view whilst shipments and 3-year hire rates face actually slightly related, the number of shipments and the spot rates go surprisingly inthe opposite direction (Pearson correlation index=(0.3783)). Hence, long term NPV needs to be managed carefully being based on assumptions notentirely true.RecommendationsThe 15-year, no-tax investment is the right choice.The NPV of this project turns out to be positive, leading us to press the signature of the contract. Turning down this operation would mean wasting future earnings. Furthermore, the 25-year project is unsafe it could dry out the companys cash and equivalents and stay fresh the reinvestment of the scrap value ($5M) in more profitable projects. The extra return doesnt justify a 10 year longer investment based on many unreliable assumptions, not supported by statistical data and which does not grant the flexibility that a shorter one would.