Mary Linn Is the Vice President of Finance for Ocean Carriers

Ocean Carriers: Case study 1

Jordan Reed

Michael Patino II

Dinesh Shrestha

Joseph Cook

Executive Summary

In 2001, Mary Linn is the Vice President of Finance for Ocean Carriers and she is evaluating a lease project for a ship for three years starting 2003. Unfortunately, Ocean Carries does not have a ship big enough for the lease proposal, so Mary has to decide whether or not to build the new ship and how long to hold on to the asset for.

Mary Linn should only approve of build a new ship if they are located in Hong Kong, because both Hong Kong estimates showed that the Ocean Carries would have a positive NPV. If they held on to the asset for 15 years they would have an NPV of $1,820,971.48 and if they held the asset for 25 years $4,424,145.32. This is assuming that the scrap value was 5,000,000 in year 15 and 0 in year 25. Otherwise if she is located in the U.S. and subject to the 35 percent tax when she commission the ship, they would experience a negative NPV, if they held on to the asset for 15 years their NPV would be -5,645,904.29 and if they held the asset for 25 years their NPV would be -$4,126,677.86. Therefore, the only situation where they could obtain a positive NPV is in Hong Kong, because owners are not required to pay any tax on profits made overseas.

As well, in evaluating their policy of not operating ships over 15 years old, we found that it was actually harmful to their profit. For example, in the Hong Kong scenario, they would have made an additional 2,603,173.84 dollars if they kept their ships running the full 25 years. Even in the U.S. scenario, their NPV for holding on to the asset for 25 years was 1,519,226.43 less than is was if they held the asset until the 15th year.

Analysis

The assumption we had to make when doing the analysis were that the expected discount rate was 9% and the expected inflation is 3%. We assumed that operation cost would grow at 1 percent over inflation and the capital expenditure would grow at the inflation level. We then calculated the payments due, which were 10% due in 2001, 10% due in 2002, and 80% due upon delivery in 2003.

After we made our initial assumption we began calculating the revenue for each of the 4 scenarios, using the payment rate schedule given to us by the Ocean Carries company. From here we calculated the fixed cost, taking in to account the annually growth of the operation expense by 4%. Then multiplying it by the number of days billed in the calendar year to get the total operation cost. From the total revenue of each year we subtract the corresponding operating cost to arrive at EBITDA.

Next we had to calculate depreciation, there was the depreciation for the ship, which costed 39 million, which was paid in 3 separate payments. Depending on the scenario, we either used 5 million for the salvage value for the ship that were held until the 15th year. For the scenario where we held the ship until 25 years, we used 0 as salvage value. But regardless of the scenario, we deprecated the ship for 25 years. Which came out to be 1,360,000 for the ships held until 15th year, and 1,560,000 for the ships held until the 25th year. Additionally, we had to include the capital expenditure for the years, 2007, 2012, 2017, 2022, and 2027, that were necessary for the inspection. Each of which were deprecated over 5 years. Subtracting the corresponding deprecation with EBITDA gave us EBIT which then we used to find the  NOPLAT. Although for the Hong Kong scenario we didn’t have to multiple EBIT by the tax rate, so NOPLAT for Hong Kong examples equals the EBIT for that year.