Case Study: Ocean Carriers Write-up and Analysis

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answerhappygod
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Case Study: Ocean Carriers Write-up and Analysis

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Overview and Approach:
Ocean Carriers is a shipping company that operates from New York and Hong Kong. Mary Linn, the company’s Vice President of Finance, is considering purchasing a Capesize carrier for $39 million to meet the demands of its customers. The market is forecasted to grow steadily in the future due to the increased shipping of coal from Australian and Indian markets. The daily income is expected to rise from $20,000 to $20,400 during the first three years of operation before declining steadily to less than $15,000 in the 25th year. Because Ocean Carriers does not operate Capesizes older than 15 years, the new Capesize will be sold in the secondhand market for $16 million after 15 years. The company will incur hefty costs every five years to align with international shipping regulations. By selling the ship at the end of the 15th year, Ocean Carriers will avoid incurring the third special survey costs. Our approach to advising Ms. Linn is to analyze the company’s cash flows and assumptions for this investment and provide a net present value evaluation to demonstrate if Ocean Carriers should proceed with the plan to purchase the Capesize for $39 million and resell it at the end of the 15th year for $16 million.
Evaluation:
Our investment analysis took into account the following key considerations:
• The assumption that the ship can realistically be sold in the secondhand market for $16 million in 15 years.
• Ocean Carriers is based in the U.S. and is therefore subject to a corporate tax rate of 35%
• The net working capital can be recovered when the vehicle is sold or scrapped
• A cost of capital of 9%
Our group began by evaluating the ship’s operational days starting in 2003 which is when the lease is proposed to begin. From there, we calculated the yearly revenue, yearly operating costs, depreciation, earnings before income taxes, and the U.S. income tax to come to a yearly net income for a total of 15 years. Once we found the net income we incorporated the initial investment in net working capital, factored in the potential resale value of $16 million in year 15, and included Ocean Carriers $500,000 initial investment in net working capital with inflation year over year. Finally, we factored in the internationally mandated special survey costs associated with ensuring seaworthiness of the vessel as defined by international regulations. This special survey cost would be incurred every five years as a capital expenditure which would each be depreciated on a straight-line basis over a 5 year period. Since the strategy would be to sell the vessel by year 15, Ocean Carriers would avoid the larger expenditures starting after year 15.
After we factored in all assumptions and key considerations, we then utilized the cost of capital of 9% to calculate the net present value (NPV) and we also analyzed the internal rate of return (IRR). The NPV is negative $2.6 million and the IRR is 7.61%.
Recommendation:
With the IRR being lower than the opportunity cost of the project and the NPV being less than zero, we do not recommend moving forward with Ms. Linn’s strategy to purchase the capsize for Ocean Carriers with the intention of selling it after 15 years.
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