Oc Paper

2. The cost of a new vessel is $37,095,400 (39,000+39,000*1.03+31,200,000*1.03^2). This represents taking the cost of the ship and bringing each of the payments into the dollar value at the time of the decision. By discounting the installments, we realize an effective 5% ((37,095,400 – 39,000,000)/ 39,000,000) deduction from the price of the ship if Linn sets aside the present value amount today.

3. Ms. Linn should not make the investment on the ship to secure the lease agreement. The present value of future revenue streams over 15 years total $23,980,255. By netting the present value of the investment, Linn will incur a loss of over $13 million today. The reason is because of the diminishing marginal return over 15 years as result of high ship operations, depreciation and maintenance. In the final year, these expenses make up 80% of her revenue before taxes. Additionally, the $5 million received from scrapping the ship 15 years in the future is only worth $3 million today. Net loss is still about $10 million.

Operating costs for a new ship are $4,000 per day and will increase annually at a rate of 1% above inflation. Eight days out of each year of the contract will be allotted for repairs and maintenance- these days will not be charged to the customer. The new ship will be depreciated on a straight-line basis over 25 years. The average prevailing daily spot market rate is $22,000 per day. Ocean Carriers uses a discount rate of 9% and US tax rate of 35%.

Under the assumption that Ocean Carriers will be subject to a US tax rate of 35%, using a 9% discount rate and the expected daily hire rates forecasted by the analysts, the proposed lease does not seem to be profitable due to the large amount of the initial investment.