Ocean Carriers is a shipping company with offices based in the US and Hong Kong. In 2001, the company's Vice President for Finance received a proposal for a leasing agreement of a ship for three years. While the customer was ready and wants to enter into the contract immediately, the company was in a dilemma as it had no available ship that meets the customer's requirement. The company was looking into commissioning a new carrier to be built in two years, after which it may be rented to the customer.
Erik Stafford, Angela Chao, Kathleen S. Luchs
Harvard Business Review (202027-PDF-ENG)
September 13, 2001
Case questions answered:
Case study questions answered in the first solution:
- Based on your analysis, would you advise Ms. Linn, Vice President for Finance of Ocean Carriers, to buy the new vessel?
- Discuss the following questions (no calculations required)
a.) What factors drive the average daily hire rate?
b.) Do you expect daily spot hire rates to increase or decrease next year?
c.) What are the long-term prospects of the capsize dry bulk industry? - Should the firm scrap the ship after 15 years? Why? Why not? (no calculations required)
Case study questions answered in the second solution:
- Compute CFs and NPV twice by making the following two separate assumptions:
a.) First, Ocean Carriers is a US firm subject to 35% taxation.
b.) Second, Ocean Carriers is an HK firm subject to a 0% tax rate.
c.) Compare and contrast CFs and NPVs and discuss the implications of tax rate differences. - Based on your analysis, would you advise Ms. Linn to buy the new vessel?
- Discuss the following questions (no calculations required)
a.) What factors drive the average daily hire rate?
b.) Do you expect daily spot hire rates to increase or decrease next year?
c.) What are the long-term prospects of the capsize dry bulk industry? - Should the firm scrap the ship after 15 years? Why? Why not? (no calculations required)
Case study questions answered in the third solution:
- Discuss the characteristics of the Capsize Dry Bulk Industry. What are the demand and supply tensions in the market, both in the shipping industry and in the global iron ore and metals segment? Do you expect daily spot hire rates to increase or decrease next year?
- Determine the Cost of the new vessel.
- Build and discuss your forecasted expected cash flow model. What are the line items in your model?
- Evaluate the corporate policy of not operating ships over 15 years old. What is the implication of your terminal value calculations of this policy?
- Should Carol purchase the $39 Million vessel? Is this a value-adding proposition?
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Ocean Carriers Case Answers
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SITUATION & ANALYSIS – Ocean Carriers
A proposal for commissioning a new capsize carrier needs to be evaluated by Linn, the Vice President at Ocean Carriers shipping company.
The decision needs to be made by evaluating the benefits of the new carrier vs. the investments. We should also consider the costs that need to be incurred.
The benefits would include the gains from the three-year contract with the new client initially from 2003 to 2006 and, after that, the gains from the regular demand for iron ore and coal, which is subject to market conditions.
RECOMMENDATIONS FOR DECISION MAKING
The details of the future daily rates adjusted for the demand for iron ore, as well as the condition of the carrier for 25 years, are available from the consulting report commissioned by Ocean Carriers.
This report uses those figures to determine the stream of potential cash flows from 2001 to 2027, which can then be used to calculate the Net Present Value of the project.
By doing this, we will be able to arrive at a conclusion about the attractiveness of the investment and suggest whether Ms. Linn should invest in the new project or not.
Based on the NPV analysis, the decision to buy the new capsize carrier depends majorly on:
- The taxation rate, which Ocean Carriers is subject to
- The decision of when to scrap the new carrier
The following table elucidates the NPV for different conditions of the project as listed above:
Table: NPV for project decisions for different countries
From the NPV results summarized in the table above, we propose that Ms. Linn should not invest in the new capsize carrier for any of the alternatives.
The NPV for using the carrier for 25 years if Ocean Carriers is an HK-based firm is positive. This NPV creates value for the firm. However, the value of the NPV is very small compared to the investment that is being made.
Moreover, the NPV calculations have been done using certain assumptions such as – the discount rate of 9% for all 25 years, which consists of a 3% risk premium, and the fact that the market conditions and demand would follow the pattern presented by the consulting report.
It is important to note here that the market conditions for such a long duration may…
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MBA student, Boston
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