Ocean Carriers
In January 2001, Mary Linn, who was a Vice President of Finance for Ocean Carriers, was
evaluating a potential lease of a ship for three years, starting in early 2003. She had to make a
big decision on whether Ocean Carrier would commission the new capsize carrier to be leased
to a prospective client. The current ship they have can only carry 80,000 to 210,000 deadweight
tons, which makes it impossible for them to get through the Panama Canal. There is a total of
553 vessels in service of this fleet around the world. It is way too small to help the customer
they are working with, and Ocean Carrier’s wants to capitalize on the opportunity to create
more revenue. To be able to commission a new vessel like a time charter, Ocean Carriers are
faced with challenges. This would be an immediate investment, they must worry about
operation costs, market conditions, future cash flow, taxation, and future vessel demands. This
report determines whether Ocean carriers should commission this ship.
Whether Linn invests $39 million in a new ship that is projected to be delivered depends on
many things. She must figure out the financial viability of the ship throughout its lifetime after
the initial three-year contract. The company has a strict policy that makes them scrap the ship
after 15 years. After 15 years, they are hard to upkeep, which would increase the maintenance
cost tremendously. Linn’s decision is solely based on the market conditions for these vessels
after 2003. Due to the continuously growing fleet size and changing iron ore demand, it has
impacted the market. To help aid her decision because of these problems, we will evaluate the
expected future cash flows from the lease, operating cost, capital expenditures, salvage value,
and performing a net present value. Net present value will let Linn consider both the time value
of money and the risk associated with projected cash flows.
The prospective client wants to lease this vessel for three years beginning in 2003, and Mary
Linn must decide whether this lease will generate enough cash flow. The cost of the vessel is
relatively expensive. Constructing the new capsize carrier would cost $39 million. Depending on
market conditions, the company’s daily rates for a capsized vessel would be $20,000 a day for
three years. The annual revenue for this would translate to $7.3 million. Operating costs are
approximately $4,000 a day escalating by 1% annually above inflation, which results in $1.46
million a year. When considering this, you must consider the tax implications. The company
operates with a 35% tax rate in the U.S. and no tax requirement in Hong Kong. That said, it
would be advantageous if the vessel was operated in Hong Kong. The vessel would only have a
useful life span of 25 years and depreciate after 15 years, providing tax benefits for the
company. We assume a 9% percent discount rate, reflecting the company’s cost of capital and
industry risk. Considering all of these market overviews, the vessel’s resale value would be $5
million after 15 total years out on the water.
The shipping industry tends to fluctuate widely in response to economic changes, and capesize
vessels are known to be volatile. The daily rate of this lease is $20,000 escalating by $200
annually, which falls in the lower-middle range compared to the market history. Testing the
investment under different market conditions could be critical because the shipping industry
tends to fluctuate with economic changes. The shipping market is cyclical and capsize rates are
affected by global demand for commodities like iron ore, from countries like China and India. To
determine whether it is a financially sound decision for Ocean Carriers to commission this to be
leased, calculating the projected cash flows over the next 15 years, considering revenue and
operating costs, and eventually, what the resale value of the ship would be. Assuming the ship
only operates 357 days a year, allotting for maintenance days on 8 days of the year.
Annual Revenue = Dailey Hire Rate x Operational Days
Annual Revenue (2003) = 20,000 x 357 = 7,140,000
Annual Revenue (2004)= 20,200 x 357 = $7,211,400
Annual Revenue (2005)= 20,400 x 357 = $7,282,800
Total Revenue for the first 3 years: $21,634,200
Operating costs for the new vessel are expected to start at 4,000 dollars per day and increase at
a rate of 1 percent above inflation annually. This includes all crew wages, maintenance, fuel,
and insurance. This ship is expected to spend eight total each year in maintenance for the first
five years, then gradually increasing to 6-10 days in years 6-10 and 16 days after the ship is 10
years old. Since the company has a policy to scrap the ships after 15 years, a vessel will not gain
revenue anytime after this period.
Year 1: $4,000/day × 365 = $1,460,000
Year 2: ($4,000 × 1.03) × 365 = $1,503,800
Year 3: ($4,000 × 1.03^2) × 365 = $1,548,914
Total Operating Costs (First 3 Years): $4,512,714
Net Cash Flow Analysis:
Year 1: Revenue ($7,140,000) – Operating Costs ($1,460,000) – Depreciation ($1.56
million) = $4,120,000
Year 2: Revenue ($7,211,400) – Operating Costs ($1,503,800) – Depreciation ($1.56
million) = $4,147,600
Year 3: Revenue ($7,282,800) – Operating Costs ($1,548,914) – Depreciation ($1.56
million) = $4,173,886
Total Net Cash Flow (First 3 Years): $12,441,486
Based on the data found, it is very evident that the total revenues do not suggest that the
investment in the new ship is beneficial, considering the total net cash of $12.44 million
compared to the initial cost of $39 million. This uncertainty of long-term charter rates after
these three years pose a high risk to the profitability of investing in this new vessel. Ocean
Carriers’ policy of scrapping ships after 15 years further limits the potential for long-term
revenue generation. The expected scrap value of $5 million at the end of the ship’s life only
partially offsets this risk. After analyzing this, I recommend not to go forward with
commissioning this ship. The risks outweigh the benefits based on current projections. While
the proposal for a three-year charter at an attractive daily hire rate offers short-term revenue
opportunities, the overall investment in a new vessel does not appear to be financially viable
when considering Ocean Carriers’ long-term operational strategy and market risks. Ocean
Carriers should either explore alternative ways to meet the client’s needs or consider the timing
of new investments in the capesize fleet when market conditions are more favorable.
