Ocean Carriers

Ocean Carriers Analysis

Date:

TO: MS. MARY LINN

CC: PROF. CARROLL

FROM:

RE: DECISION ON CAPE SIZE CARRIER

PRIORITY:

Ms. Linn,

In regards to the spot hire rates, we have determined that they will decrease over the next two years. This is due to two main factors that contribute to average daily rates, iron ore vessel shipments and fleet size. As you indicated in 2001, there will be an increase of 63 new vessels, while at the same time iron ore and coal imports will remain stagnant. Your consulting group also confirmed that worldwide iron ore shipments and charter rates have historically been strongly associated and this would continue in the future. Therefore, there will be an increase in supply of vessels without an increase in demand for imports, causing rates to decrease next year. This information is important for you to consider because it will directly impact your cash flows. A decrease in spot hire rates will decrease cash flows for Ocean Carriers in the short term. In the long term, rates are expected to increase again by 2003 due to Australian and Indian exports. This means that your cash flows will start to increase at the same time the new ship will be leased to the customer.

The cost of this new vessel in present value terms is $33,738,397, using a 9% discount rate. Using straight line depreciation over 25 years with no salvage value, the vessel would depreciate at a rate of $1.5 million a year. With this expense, the book value after 1 year is $37,440,000, after 15 years it will be $15,600,000 and after 25 years it will be fully depreciated.

Based on the current scrap policy, we do not recommend that Ocean Carriers commission the new capsize carrier. There are a number of assumptions we used to form this recommendation, including a 9% discount rate, 35% corporate tax rate and a policy of scrapping the vessel after 15 years for $5M. Based on these assumptions, the discounted free cash flow for this project yielded...