CFIN Ocean Carriers Section J J12 PDF

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Market Outlook The case presents the business model of Ocean carriers, market dynamics of Iron ore shipments, and expected market condition in the future. There exist two kinds of rates - spot rate and time rate. Spot rate has more fluctuations as per demand and thus is preferred more by charters, whereas time rate is more preferred by capsize owners. The current market condition suggests the increasing trading volume of iron ore shipments post 2003 due to the involvement of iron ore trade with India & Australia, while the shipments will be stagnant for 2001 and 2002. But surprisingly we see the number of new ships in the order book is high for 2000-2001 as compared to new ship order for 2002 and 2003. This can be tried to justify in the sense of less scrapping of older ships in coming years. But looking at the number of ships in different age group, a maximum number of scrapped ships in coming one year can be 20. Hence, this move of holding fewer ships can be mainly because of increased ship capacity. Thus, the hire rate would depend on the upcoming iron-ore shipment, the average age of the carrier (since newer carrier extracts a premium and older one attracts an extra discount), along with the number of operating vessels. Charter rate is dependent heavily on iron-ore shipments. We see in Exhibit 1, a 7.3% increase in iron ore shipment in 2001, led to a 140% increase in average spot rate and a 21.5 % increase in avg charter rate. Thus, we see that spot rate are much more sensitive to demand fluctuations than the average charter rate. Hence, as the iron ore shipment is expected to be constant in 2000 and 2001 with number of newer fleets going high, the spot rate is expected to decrease in 2001 and continue to remain low till 2002, but again 2003 onwards the spot rate is expected to increase with the growing involvement of India and Australia in Iron ore shipments. Business Model and Investment Decision Analysis On evaluating the Ocean carrier’s new business decision, we come up with four scenarios which can help Linn take investment decision and see a need for change in the modification of current business model in terms of usage life of a carrier. The scenarios are listed as: 1. Scenario 1: Ocean carrier is an Indian company, subject to 35% taxation, and going ahead with the current strategy of scrapping off a carrier in 15 years Exhibit 5 2. Scenario 2: Ocean carrier is an Indian company, subject to 35% taxation, and going ahead with a changed strategy of using the carrier for 25 years Exhibit 3 3. Scenario 3: Ocean carrier is an Hong-Kong company, subject to 0% taxation, and going ahead with the current strategy of scrapping off a carrier in 15 years Exhibit 4 4. Scenario 4: Ocean carrier is an Hong-Kong company, subject to 0% taxation, and going ahead with a changed strategy of using the carrier for 25 years. Exhibit 2

In order to decide whether Ocean carrier should go ahead with investment in each of the four scenarios, we calculated the Net present value of all cash flows across the number of years in which carrier operates. The Net present value can be tabulated as:

Scenario

The Indian firm, 15

The Indian firm, 25

Hong Kong based

Hong Kong based

NPV (in million $)

years (5.4)

years (4.98)

firm, 15 years 1.7

firm, 25 years 3.25

We can conclude that the current plan of using the carrier for only 15 years is hurting the company’s profitability and instead operating the carrier for 25 years fetched better value to the company. From the above table, we can conclude the following 1. Operating as an Indian company, Ocean carrier should not invest in the new ship – Calculated net present value of the cash flows suggest that Ocean carrier has a negative NPV of $5.4 million, in case they go ahead with the investment and operate the carrier for 15 years. If, they consider operating the carrier for 25 years, it results in the negative NPV of 4.98 million dollars, suggesting that Ocean carriers will still lose money. Hence, no matter the number of years the carrier operates, Ocean carrier will incur losses from this investment and thus should not opt for it. 2. Operating as an Hong Kong based company, Ocean carrier should invest in the new ship - Calculated net present value of the cash flows suggest that Ocean carrier has a positive NPV of $1.7 million, in case they go ahead with the investment and operates the carrier for 15 years. If, they consider operating the carrier for 25 years, it results in the positive NPV of 3.25 million dollars, suggesting that Ocean carriers will run in profit. Hence, no matter the number of years the carrier operates, Ocean carrier will incur gains from this investment and thus should opt for it

We conclude that Ocean Carriers should revaluate their company policy of operating the vessel for only15 years, as even after discounting, the vessel continues to generate positive gross profit, throughout the operating cycle. Ocean carriers should take up the project, if it based out of Hong Kong, as it enjoys tax free regimen, as compare to India where that tax liabilities are very high and generate negative net present cash flow for the project.

Assumptions: 1. 2. 3. 4.

Initial investment of $500000 starts from the year 2003, when the carrier is leased to the charterer. The savage value of the carrier at the end of 25 years is 0. The investment decision point is Jan 2001, and the financial cycle is from Jan, 2001 to Dec, 2001. The payment made for the carrier is at Jan 1 2001, Jan 1, 2002 and Jan 1 2003, respectively, and the carrier starts generating revenue, from the exact date of delivery of Jan 1 2003. 5. Average daily hire rate has been taken for a 1 year lock-in period, and has been based on the consultant’s rate forecast in Exhibit 6. 6. A year is considered for 365 days 7. The working capital infused at the time of beginning the operation would be extracted out of the project a year after the completion of the project, example: extracted in 2018 when the operation cycle is of 15years

Exhibit 1

Year 1997 1998 1999 2000 2001 2002 2003

Number of new ships 63 33 21 9

Iron ore shipments 424 420 410 440 436 445 454

Avg daily charter rate 16063 13076 12626 15344 14747 15072 15403

Avg spot rate

Fleet size

14794 10105 9427 22574 -

540 523 523 552 612

Revenue Days -

-

CapEx, Survey ($ Millions) $ CapEx, Equipment($ Millions)

(3.90)$

(3.90) $ $

Net Working Capital ($ Millions)-

-

8

8

8

357

357

357

357

-

-

8

8

357 (31.20)

0.52 $

0.50 $

$

-

-

$

7.14

$

7.21 $

Operating costs

-

-

$

(1.46) $

(1.52)$

Gross Profit

-

-

$

5.68 $

5.69 $

Depreciation

-

-

$

(1.56) $

(1.56)$

EBIT

-

-

$

4.12 $

4.13 $

Income Tax (35%)

-

-

$

Unlevered Net Income

-

-

$

4.12

-

$

$

4.13 $

$

Free Cash Flows -

-

Plus: Depreciation

(3.90) $

$

Minus: Increase in Working Capital $

(3.90) $

9%

Discount Factor $

3.25

-

1.56 $

$ (3.90)$

(31.20)

1.56 $

$

(0.50)$

(0.02)$

(26.02)$

5.68 $

12

12

12

16

16

353

353

353

353

353

349

349

0.67 $

$ 0.73 $

0.71 $

0.69 $

-

(0.75)$

$

0.78 $

0.76 $

-

$

-

0.80 $

-

$

$

(0.85) $

-

0.88 $

0.85 $

0.83 $

-

$

-

-

-

-

-

-

-

-

-

-

-

-

-

-

-

0.65 $

0.63 $

0.61 $

0.60 $

0.58 $

(0.35) -

-

-

-

$

-

-

-

-

0.90 $

-

$

-

$

$

-

0.93 $

0.96 $

(1.25)$

0.99 $

-

-

-

-

-

349

349

349

349

349

349

349

349

349

349

349

349

349

349

-

16

16

16

16

16

16

16

16

16

16

16

16

16

16

-

1.02 $

Ocean Carrier's Incremental Earning's Forecast ($ Millions) 7.28 $

6.68 $

6.17 $

6.17 $

6.24 $

6.31 $

6.39 $

6.15 $

6.15 $

6.22 $

6.29 $

6.37 $

5.15 $

5.21 $

5.27 $

5.33 $

5.39 $

5.11 $

5.17 $

5.23 $

5.29 $

5.35 $

4.69 $

-

(1.58)$

(1.64)$

(1.71)$

(1.78)$

(1.85)$

(1.92)$

(2.00)$

(2.08)$

(2.16)$

(2.25)$

(2.34)$

(2.43)$

(2.53)$

(2.63)$

(2.73)$

(2.84)$

(2.96)$

(3.08)$

(3.20)$

(3.33)$

(3.46)$

(3.60) $

(3.74)$

-

5.70 $

5.04 $

4.46 $

4.39 $

4.39 $

4.39 $

4.39 $

4.07 $

3.99 $

3.98 $

3.96 $

3.94 $

2.62 $

2.58 $

2.54 $

2.49 $

2.44 $

2.04 $

1.97 $

1.91 $

1.83 $

1.76 $

0.95 $

-

(1.56)$

(1.56)$

(1.56)$

(1.62)$

(1.62)$

(1.62)$

(1.62)$

(1.62)$

(1.63)$

(1.63)$

(1.63)$

(1.63)$

(1.63)$

(1.71)$

(1.71)$

(1.71)$

(1.71)$

(1.71)$

(1.73)$

(1.73) $

(1.73)$

(1.73)$

(1.73)$

-

4.14 $

3.48 $

2.90 $

2.77 $

2.77 $

2.77 $

2.77 $

2.45 $

2.36 $

2.35 $

2.33 $

2.31 $

0.99 $

0.87 $

0.83 $

0.78 $

0.73 $

0.33 $

0.24 $

0.18 $

0.10 $

0.03 $

(0.78)$

-

-

$

-

4.14 $

$

-

(0.30)

-

$

-

$

$

1.62 $

1.62 $ -

$

-

$

$

$

-

$

$

-

$

0.87 $

0.99 $

1.71 $

1.63 $

1.63 $ $

(0.75)$

-

-

$

-

$

0.83 $

1.71 $

$

-

$

-

-

-

$

0.24 $

1.73 $

1.71 $ -

-

$

$

0.33 $

1.71 $

1.71 $ -

-

$

0.73 $

0.78 $

-

-

-

-

-

-

-

$

2.31 $

1.63 $ -

-

-

-

2.33 $

1.63 $

1.63 $ -

(0.35)

-

2.35 $

2.36 $

1.62 $ -

-

-

-

2.45 $

2.77 $

2.77 $

1.62 $ -

-

-

2.77 $

1.62 $ -

$

$

2.77 $

1.56 $

1.56 $ -

-

$

2.90 $

3.48 $

1.56 $

-

(3.90)$

12

0.56 $

0.55 $

0.53 $

12

-

(0.30) -

-

-

-

-

-

-

Minus: CapEx, Survey

$

-

-

-

Annual Revenue

NPV

Exhibit 2: Table denoting NPV calculation for Ocean carrier as Hong-kong company, operating carrier for 25 years

Maintainence Days

Free Cash Flow

2028

2027

2026

2025

2024

2023

2022

2021

2020

2019

2018

2017

2016

2015

2014

2013

15,166.00$15,341.00$ 13,448.00$ $20,000.00 $ 20,200.00$ 20,400.00$ 18,714.00$ 17,283.00$ 17,481.00$ 17,682.00$ 17,886.00$ 18,092.00$ 17,428.00$ 17,628.00$ 17,831.00$ 18,036.00$ 18,243.00$ 14,762.00$ 14,932.00$15,104.00$15,278.00$15,454.00$14,654.00$14,823.00$14,993.00$ $ $(10,253.22) $ (9,858.86) $(8,427.40)$(8,764.49)$(9,115.07)$(9,479.68) $ (7,491.92) $ (8,103.27) $ (7,203.77) $ (7,791.60) $ (6,926.71) $ (6,660.29) $ (6,404.13) $ (6,157.82) $ (5,920.98) $ (5,693.25) $ (5,474.28) $ (5,263.73) $ (5,061.28) $ (4,866.61) $ (4,679.43) $ (4,499.46) $ (4,326.40) $ (4,000.00)$ (4,160.00)

Operating Costs (Per day)

Minus: CapEx, Asset

India: 25yrs of operations 2012

2011

2010

2009

2008

2007

2006

2005

2004

2003

2002

2001 Avg. Daily Hire Rate

$

(0.85) $

-

$

-

-

$

0.18 $

$

0.10 $

1.73 $

1.73 $

-

-

$

-

$

-

-

1.73 $

1.73 $ -

-

$

(0.78)$

$

0.03 $

-

$

(1.25)$

-

(0.02)$

(0.02)$

(0.02)$

(0.02)$

(0.02)$

(0.02)$

(0.02)$

(0.02)$

(0.02)$

(0.02)$

(0.02)$

(0.02)$

(0.02)$

(0.02)$

(0.02)$

(0.02)$

(0.02)$

(0.03)$

(0.03)$

(0.03) $

(0.03)$

(0.03)$

(0.03)$

1.02

5.69 $

5.02 $

4.15 $

4.38 $

4.38 $

4.37 $

4.37 $

3.71 $

3.97 $

3.96 $

3.94 $

3.91 $

1.85 $

2.56 $

2.51 $

2.46 $

2.41 $

1.16 $

1.95 $

1.88 $

1.80 $

1.73 $

(0.33)$

1.02

Maintainence Days Revenue Days CapEx, Survey ($ Millions)

-

-

$ (3.90) $ CapEx, Equipment($ Millions) Net Working Capital ($ Millions) -

357

357

357

-

-

-

(31.20)

(3.90)$

$

-

0.52 $

0.50 $

$

-

-

$

7.14

$

7.21 $

Operating costs

-

-

$

(1.46) $

(1.52)$

Gross Profit

-

-

$

5.68 $

5.69 $

-

-

Annual Revenue

(1.56) $

-

$

EBIT

-

-

$

4.12 $

4.13 $

Income Tax (35%)

-

-

$

(1.44) $

(1.45)$

$

2.68

$

2.69 $

-

Depreciation

-

-

Unlevered Net Income

(1.56)$

Free Cash Flows

Minus: Increase in Working Capital $

NPV

(3.90) $

9%

Discount Factor $

(4.98)

(31.20)

-

1.56 $

India: 25yrs of operations 2006

2008

2007

2009

2010

2025

2024

2023

2022

2021

2020

2019

2018

2017

2016

2015

2014

2013

2012

2011

2028

2027

2026

(0.50)$

(0.02)$

(3.90)$

(27.46)$

4.23 $

-

(0.30)

-

-

-

-

-

-

-

-

-

0.58 $

0.56 $

0.55 $

(0.35) -

0.63 $

0.61$

0.60 $

$

-

-

-

-

-

-

-

0.71 $

0.69 $

0.67 $

0.65 $

-

$ (0.75)

$

-

-

0.80 $

-

$

$

0.83 $

0.85 $

0.88 $

-

-

$