Ocean Carriers Case Study

Executive Summary
Ocean Carriers Inc. is a shipping company with offices located in New York (USA) and
Hong Kong with a mission of owning and operating capesize dry bulk vessels carrying iron ore
and coal worldwide. The company receives an offer with attractive terms, however, Ocean
Carriers is not in possession of a ship that fulfils the customer’s requirements in their fleet.
Hence, the Vice President of the company Mary Linn is considering whether ordering a new
vessel - delivered in two years if ordered immediately- for the aforementioned customer would
be profitable or not.
Summary of Facts
It is important to keep in mind that Ocean Carriers is a company dealing exclusively with
the transportation of iron ore and coal. Due to a company policy to maintain their ships in line
with regulations, they only operate vessels younger than 15 years and scrap or sell their vessels
which are older than this. For the new delivery capesize, the initial investment amounts to
$39’000’000 of which 10% they plan on paying immediately, 10% in a year’s time and the rest
remains to be paid upon delivery. In 2017 they decide on a selling price of $5’000’000 per
vessel, working with a daily operating cost of $4’000 that increases by a rate equal to 1.04 (the
inflation rate plus the rate of growth, as given). There also exists an increasing capital
expenditures every five years for the vessel which must be accounted for. Depreciation is done
on a straight-line basis, scrapping the vessel after 15 years with an estimated residual value of
$5’000’000 over a period of 25 years. To conclude, Ocean Carriers is looking to come to an
agreement with a charterer for a deal of $20’000 rising $200 each day. They have a working
capital investment of $500’000, which increases by the rate of inflation. Additional key
components in the study include the expected rate of inflation and discount rate which are 3 and
9 percent, respectively.
Statement of Problem
The main problem Ms. Linn is currently facing is if it is worth investing in a new carrier
or not. To tackle this issue, an analysis on the future daily spot rates and the factors affecting
them is necessary. The tax exemption in Hong Kong and the 35% tax paid in US have to be
taken into account while doing this analysis. Data of the company from the past 15 years as well
as 25 years should be examined and compared with each other while revising the previsions
made about future conditions.
Analysis
Daily spot hire rates are firstly determined by supply and demand. Spot rate is negatively
correlated with the capesize fleet size and positively correlated with the demand for iron ore and
coal. Although they are expected to increase in the long-term, they will decrease next year due to
the increase in number of vessels and the import remaining stagnant for the next two years.
Furthermore, daily hire rates are driven by the supply of capesizes and production of iron ore and
coal, as they account for more than 85% of the cargo carried by capesizes.
The number of ships available are calculated by the number of vessels in service the
previous year plus the new ships delivered minus the scraps and sunk ships. If the demand is
high, an owner of the vessel would keep the ship in service as long as it could last. If demands
decrease, an owner of the ship would prefer scrapping to avoid maintenance costs. Since the fleet
is mostly constituted of young vessels, there has been a fairly low amount of scraps in the past
few years.
Additionally, market conditions are the other key element determining spot rates. These
conditions are affected by the economic state all around the globe. For instance, a big majority of
the cargo carried by capesizes was iron ore and coal; and production and demand of these
materials would decrease if there was an economic crisis going on. Trade patterns and
destinations also have a big impact on the demand of capesize vessels: for instance, the distance
between destinations have a positive correlation with the spot prices.
Considering that there were 63 new vessels to be delivered in 2001 and iron ore import
were expected to remain stable for the next two years; daily spot rates would likely to decrease in
2001 and 2002. However, from 2003 onwards, ore imports from Australia and India would begin
and consequently lead to an increase in the trade volume. Therefore, spot rates are likely to
increase in the long-term. Thanks to the forecast prepared for Ms. Linn, annual growth rate for
iron ore vessels around the world was known to be 2% between 2002-2005 and 1.5% thereafter.
Looking at Exhibit F and assuming the scrap value would not change, the highest NPV is
given by scrapping the vessel at the end of 25 years and locating the company in Hong Kong. In
the case of the company being located in the U.S and having to pay taxes, the company should
reduce the depreciation period to 15 years, as demonstrated by Exhibits A and B, since the
depreciation costs would increase ( instead of 1,560,000 $, it becomes 2,600,000$) and therefore
decrease the taxes payable that in the end increase profit after tax.
Recommendations
Assuming current market conditions, Ms. Linn should purchase the 39M capesize only in
the case that Ocean Carriers being located in Hong Kong, where owners are not required to pay
any taxes on profits made overseas and are also exempted from paying taxes on profits made on
cargo uplifted. This is because the NPV value is positive and relatively higher than the NPV
under the assumption of Ocean Carries being a U.S firm and thus subject to 35% taxation. This
result can be influenced by the company policy of not operating ships over 15 years: holding all
other variables equal and assuming a depreciation period of 25 years, if they sell the vessel at the
end of the 15th year, they lose about 10,600,000 million $. Therefore, a change in the policy is
suggested.
Exhibits and Tables
Exhibit A: Calculations of USA for 15 years

Exhibit B: Calculations of USA for 25 years
Exhibit C: Calculations of Hong Kong for 15 years

Exhibit D: Calculations of Hong Kong for 25 years
Exhibit E: NPV of USA
Exhibit F: NPV of Hong Kong

Ocean Carriers Case Study

Uploaded by

Copyright:

Available Formats

Ocean Carriers Case Study

Uploaded by

Document Information

Original Description:

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Ocean Carriers Case Study

Uploaded by

Copyright:

Available Formats

What factors determine daily spot hire rates for capesize vessels?

How do market conditions impact daily spot hire rates?

Executive Summary

$5’000’000 over a period of 25 years. To conclude, Ocean Carriers is looking to come to an

made about future conditions.

between destinations have a positive correlation with the spot prices.

Exhibits and Tables

Exhibit A: Calculations of USA for 15 years

Exhibit C: Calculations of Hong Kong for 15 years

Exhibit E: NPV of USA

Exhibit F: NPV of Hong Kong

You might also like