Ocean Carriers

Ocean Carriers

Executive Summary Industry Overview Capesize dry bulk carriers provide shipping services worldwide. Due to their size, Capesize carriers must sail around Cape Horn in order to travel between the Atlantic and Pacifica Oceans – the ships are too large to utilize the Panama Canal. In January 2001, there were 553 capesize vessels in service throughout the world. Demand for dry bulk carriers is determined by the world economy. Over 85% of the capesize vessels are used for shipping iron ore and coal.

In a strong economy, production and demand for iron ore and coal increases. In the next few years, Australian production of iron ore is expected to be strong and Indian iron ore exports are expected to grow. These sources of new iron ore supply will increase trading volumes and therefore demand for capesize ships is likely to increase. There are 63 new vessels that are scheduled for delivery in 2001. Therefore, the supply of capesize vessels will increase substantially which may decrease the daily hire rate in the short term.

However, considering a favorable forecast of Australian and Indian production, there is expected to be favorable demand for capesize vessel service in the long run. Customers for capesize carriers charter the vessels for a specific time period. Customers determine what cargo is carried and control where the vessel is loaded and unloaded. Most carriers are charted on a “time charter” basis for period of one to five years. Occasionally, spot charters are negotiated due to market conditions. The customers, called the “charterer”, agree to pay a daily hire rate for the entire length of the contract.

New ships generally earn a 15% premium in daily hire rates. Ships over 25 years old typically receive a 35% percent discount from the industry average. Company Overview Ocean Carriers Inc. owns and operates capesize dry bulk carriers worldwide. The company provides seaworthy vessels staffed with a fully qualified and certified crew. The company also ensures compliance with international shipping regulations. Because Ocean Carriers vessels are relatively new and larger than the industry average, they are able to earn a premium in the market

Challenges and Options After evaluating discount rates of 8%, 9% and 10%, we figured 9% to be the appropriate hurdle rate for this case. A 10% discount rate would generate a negative NPV for either a 15 year (current Oceans policy) or a 25 year investment (-$3,076,460 and -$1,793,116 respectively), so this would not work in either scenario. If Ocean Carriers chooses to adhere to their policy of selling ships at market value after 15 years, they will incur a net loss of -$1,252,916 on the investment assuming they are based in Japan and pay 0% taxes.

Using the 9% discount rate, total expected revenue in the 25 year model is $148,006,843 with $60,803. 026 in operating expenses with $43,500,000 in EBIT while the 15 year model yields total expected revenues of $95,938,486 with $29,237,437 operating expenses and an EBIT of $41,704,438. The 15 year scenario in this case certainly seems more attractive before you look at the other factors. Total depreciation in the 25 year model is considerably more at $43,500,000 versus the 15 year model which caps out at $25,000,000 and still offers a salvage value.

However, the difference in discounted net income between the two is very small yielding $21,277,456 in the 25 year model and $20,837,403 in the 15 year model. Recommendations Assuming the 9% discount rate and assuming forecasted hire rates and estimated costs are accurate over the long-term, Ocean Carriers should commission the construction of a new capesize carrier in the event they are operating with no corporate tax and chartering the ship for its entire 25 year life. Holding the ship for longer presents more value ecause the discounted earnings outweigh the discounted costs as time goes on. Cap Ex between the two scenarios is only slightly different with a $41,250,00 cost in the 25 year model and $39,650,000 in the 15 year model. This shows the 25 year model as the most desirable scenario as it produces an NPV of $368,557 (using the 9% discount rate). If an 8% discount rate were used, the NPV on the 25 year model increased to $2,865,297. This again is more preferable in the 25 year model than $815,580 for the 15 year model with a salvage value.

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