Assignment # 1

Ocean Carriers

Submitted By:

Fahad Ashraf (13E00003)Atif Raza (13E00088)

Rana Sohail (13E00075)

Sara Samdani (13E00097)Nadia Virk (13E00096)Maira Taj (11E00132)

Submitted To: Dr. Nawazish MirzaCase Facts: Following are some critical facts about the case:1. Ocean carriers a shipping company provides capesize ships for the transportation of iron and coal (Note that they are not the manufacturer of the ships)2. Their offices are located in New York & Hong Kong

3. They were offered attractive rates by a customer who is supposed to lease their ship for a period of Three Years.4. None of their existing ship meets the requirement of this customer & in order to serve this NEW customer, they have to take a capital budgeting decision for the manufacturing of the new ship that costs 39 Millions USD.5. Ocean carriers prefer to charter the ships on time charter basis such as one year, three year, or five year. They didnt prefer the spot charter rates.

6. For this ship to operate, an operating cost of 4000 USD per day is to be born by ocean carriers for 365 days. This cost is supposed to grow by 1% over the inflation rate of 3% i.e 4% in total every year.

7. Maintenance days are 8 for first five years, 12 for next five years & then 16 for the ships older then ten years.

8. A Survey Cost (Treated as Capital Expenditure) is to be born by Ocean Carriers from 2007 to onward, which is to be depreciated by SL method. (Exhibit # 1).

9. Ocean carriers provide ships to the customers with full operation and maintenance10. . Customer is charged a per day rate based on:

a. Spot rate, rate charged to customers with out contracts.

b. Contractual rate, rates charged to the customers that have a proper contract with the Ocean Carriers.

11. Ships with different years (life) earn either premium rate or discount rate as mentioned in exhibit # 412. In 2001, 63 new vessels will be added to the over all fleet world wide.Exhibits:

Case Analysis:Firm / Industry Analysis:

1. The industry in which Ocean Carriers operates is highly dependent upon global economic conditions.2. Stronger the economy, more the demand of iron ore & coal. 3. More the demand of iron ore & coal, more the need of ships for transportation of material. 4. The demand is dependent on trade pattern. 5. Spot charter rates were more fluctuating as compared with the contractual rates. 6. Companies would prefer to have contractual rates while charters would like to follow the spot rates.

7. As seen from Exhibit # 3, we can see that 63 ships will be delivered, that might reduce the spot rates, resulting in reduction in revenue of the company (ocean carriers).

8. If the demand of Ore from Australia & India increases more then what is being fulfilled by the addition of the new 63 ships, the spot rates will increase.9. There is always risk associated, as termination of contract is possible. In this particular case the risk anticipated by VP of Finance is low.

10. One of the major risks associated with this special ship is that, after the termination of contract with the existing Charter, there is a strong possibility that might be NO other Charter seeks for such a special ship. In that case, Ocean Carriers might have to bear a loss on daily rates.Business Analysis:We made financials of the said project with different assumptions based on different scenarios to find out the best possible financial results to choose the best option in the end at the time of decision. While company has offices in cities of Hong Kong and New York so we assume that company has a chance to register this ship in New York or Hong Kong.

Scenario No. 1: New York

Assumptions:

Registration of Ship in New York

Corporate Tax Rate in US: 35%

Required Rate of Return: 12%

Input Values:

Revues: Daily Charter Rate x (365 Days of Maintenance)

Operating Expenses: Daily Expenses x 365

(Expenses increase at 4% annual rate)

Survey Cost is Capital expenditures and to depreciate in 5 years with SL.

Depreciation is taken in 25 Years with Straight line Method.

Loss in the sale of equipment is taken with the difference in Net Book value and the Scrap Value.

Net Income is formulated by difference of Revenues and Costs.

Survey Depreciation and Ship Depreciations are added Back.

Capital Cost of Ship, Capital expenditure of Survey and Injection of NWC is subtracted.

Disposal of NWC and Disposal of Scrap Ship is added back in year 15.

Results:

NPV is Negative i.e. - 10,911,334 USD

IRR: 3.8%

NPV is negative and IRR is very low compared to required rate of return so Miss Mary Linn should reject this Business option based on financials and Market analysis.

Scenario No. 2: Hong Kong

Assumptions:

Registration of Ship in New York

Corporate Tax Rate in US: 16.5%

Required Rate of Return: 12%

Input Values:

Revues: Daily Charter Rate x (365 Days of Maintenance)

Operating Expenses: Daily Expenses x 365

(Expenses increase at 4% annual rate)

Survey Cost is Capital expenditures and to depreciate in 5 years with SL.

Depreciation is taken in 25 Years with Straight line Method.

Loss in the sale of equipment is taken with the difference in Net Book value and the Scrap Value.

Net Income is formulated by difference of Revenues and Costs.

Survey Depreciation and Ship Depreciations are added back.

Capital Cost of Ship, Capital expenditure of Survey and Injection of NWC is subtracted.

Disposal of NWC and Disposal of Scrap Ship is added back in year 15.

Results:

NPV is Negative i.e. 7,627,615 USD

IRR: 6.1%

NPV is negative and IRR is very low compared to required rate of return so Miss Mary Linn should reject this Business option based on financials and Market analysis.

Results are better than US scenario but still the figures are still not suitable enough to take different decision.