Question: Write a Memorandum
TO: Mary Linn, VP Finance, Ocean Carriers
FROM: The outside consultant
DATE: February 13, 2018
SUBJECT: Whether or not to commission a new capezise carrier to lease to the customer.
With best interests of Ocean Carriers in mind, there are a few things that have been considered in the analysis as below.
1. Expected behaviour of daily spot hire rates in future: In years 2001 and 2002, spot rates would be expected to decline because while 63 dry bulk capesizes were to be delivered in 2001 and 33 further in 2002, there would be no growth in import of iron ore and coal during these years. From 2003, trading volumes are expected to be better based on the expected initiation of Australian and Indian ore exports, thereby boosting the demand for the vessels, and in turn providing a fillip to spot rates.
2. Determinants of average daily hire rates: These rates are normally a function of prevailing economic conditions, patterns of trade, shipping requirements, supply of vessels, efficiency of the vessels, and age of the vessels.
3. Capesize dry bulk industry outlook: In 2003, Australia is expected to post strong iron ore production numbers. Besides, India in the same year is expected to do well in iron ore exports. Therefore, trading volumes will rise and so will vessel demand. This is expected to bring about an increase in spot rates.
4. Whether or not to buy the $39 million vessel: See within the accompanying spreadsheet the worksheet titled “Sheet1” which shows workings under two assumptions – the first assumption being that 35% tax rate applies in the U.S. and the second one being of zero tax rate in Hong Kong. Also note that it is Ocean Carriers’ policy to not operate capesizes over 15 years old. Net present values (NPVs) have been computed for both the tax situations (i.e. for 35% tax rate and for no tax situation). The NPVs are negative, regardless of taxes being there or not, when the vessels are operated for 15 years and scrapped. With a policy in place, where the vessels will be scrapped when they are 15 years old, buying the vessels and ending up with negative NPVs would be sheer financial imprudence.
5. Opinion on company policy on scrapping ships over 15 years old: The company policy clearly shows that the company is not going to be able to recover its investment in the capesize in terms of the discounted cash flows. See within the accompanying spreadsheet the worksheet titled “Sheet2” which shows workings under the two tax assumptions. Note that NPV calculation now assumes that Ocean Carriers’ policy is changed so as to operate capesizes till they are 25 years old. Observe that with 25 years of operation of the vessels, the NPV is still negative (-$7,360,958.20) for U.S. where the company is subjected to 35% tax but becomes positive ($883,458.45) for Hong Kong where there are no taxes.
Thus, the recommendation is that the company should change its policy so as to scrap the vessels when they are done with 25 years of operation and choose Hong Kong as the area of operation.
While calculations, notes and formulae used in the NPV analysis are highlighted in the spreadsheet, please revert if there are questions.
Consultant, Shipping-industry consulting firm
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