Ocean Carriers

Case Study: Ocean Carriers

February 28, 2012

Michael Depersia

Jessica Gingerelli

Robert Vaughan

Ocean Carriers needs to evaluate the decision to commission a new capesize carrier. Mary Linn, Vice President of Finance, needs to decide if this is a profitable decision for the company. In determining whether Ocean Carriers should purchase the new capesize carrier for the potential customer, we completed a net present value analysis of the project. In order to do this we need to take many things into account including, but not limited to, depreciation, opportunity costs and networking capital.

To begin, we calculated the revenue given expected daily hire rate that could be expected over the lifetime of the vessel. We chose to use the expected daily hire rate because it most accurately represents Ocean Carrier’s cash flows. The initial investment was 10% of the purchase price in first year, which amounted to $3,900,000 paid in the beginning and the end of the first year. Beginning in 2003, the operating costs for the vessel were $1,460,000 ($4,000 per day), growing at a rate of 1% per year. For the 15 year analysis, we first subtracted the $5,000,000 salvage value and used straight-line depreciation over 15 years, which was $2,667,667 per year.

Depreciation is important for this calculation because it allows the firm to recognize the wear and tear on the vessel by decreasing the worth of the asset. The straight-line depreciation method allows firms to allocate fixed reductions in the asset's value over its useful life. It is calculated by the acquisition cost of the asset less any possible salvage value divided by the asset's useful life. More importantly, although depreciation does not directly affect cash flow, it indirectly affects cash flow because it reduces the amount of tax (which is paid in cash) the company must pay. Depreciation is a non-cash expense, but it is tax-deductible on the income statement. A reduction in taxes that would otherwise be paid is the same thing as a cash inflow, so the effects of the depreciation tax shield must be added in to get the total incremental after-tax cash flows.

In this case, depreciation is only relevant if the company headquarters are in the US. Each year that the capesize is in use, it depreciates by $2,266,667 (including a $5 mil salvage value). This figure gets deducted from the firm’s earnings before they are taxed. For example, in 2005, the firm would have paid $2,317,381 in taxes as opposed to $1,410,715 with the depreciation tax shield. Additionally, every 5 years there is a capital expenditure for maintenance, which is depreciated straight line for