Case Report 1: Ocean Carriers

Refer to the HBS case “Ocean Carriers” and answer the questions below.

Note: You should complete the related textbook chapters (RWJJ Chapters 7 & 8) before attempting this

case. In particular, you need to study the Baldwin Case first (Chapter 8.2).

Start by constructing a spreadsheet showing 25-year projections for these items (use attached template):

a) Age of Ship

b) Event Year

c) Calendar Year

d) E[Iron Ore Shipments]

e) E[Daily Charter Rate]

f) Adjustment Factor

g) E[Daily Hire Rate]

h) Daily Operating Cost

i) Days Hired (per year)

j) Revenue ($M)

k) Operating Costs ($M)

l) Depreciation

m) Taxable Income

n) Tax Paid

o) After-Tax Income

p) Operating Cash Flow

q) Capital Expenditures (CAPEX)

r) Change in Net Working Capital ( NWC)

s) Asset Sales (after tax)

t) Free Cash Flow (FCF)

u) PV Factor: 1/(1+r)t

v) PV of Cash Flow (PV[CF])

w) Net Working Capital

x) Book Value ($M)

y) Scrap Value ($M)

Notes and Assumptions:

1) Ocean Carriers uses a 9% discount rate.

2) Scrap value changes at the rate of inflation (relative to the year-15 projection).

3) Depreciation is fiscal depreciation, not accounting depreciation.

4) No special survey is conducted in the year the ship will be scrapped.

5) Net working capital is only needed when the ship is operating.

6) Any difference between scrap value and book value, at the time of scrapping, gives rise to a

taxable gain or loss (@ corporate income tax rate) and that any resulting tax credits can be used.

Questions:

1) Should Ms Linn purchase the $39M capesize? Make two different assumptions. First, assume

that Ocean Carriers is a U.S. firm subject to a 35% statutory (and effective) marginal tax rate.

Second, assume that Ocean Carriers is domiciled in Hong Kong for tax purposes, where ship

owners are not required to pay any tax on profits made overseas and are also exempted from

paying any tax on profit made on cargo uplifted from Hong Kong, i.e., assume a zero tax rate.

2) What do you think of the company’s policy of not operating ships over 15 years old? Assume

that Ocean Carriers can fully utilize any tax benefit it derives from asset sales. Support your

answer by a spreadsheet analysis.

3) Suppose Ocean Carriers pays fixed annual dues of $500,000 to an association of ship owners that

provides services to its members such as light houses, lobbying efforts, etc. Should a portion of

these dues be included in the NPV calculation for the capesize? If so, what portion seems right?

4) Suppose that, two years ago, Ocean Carriers lost a large lawsuit related to a maritime accident

where it allegedly caused a competitor’s ship to sustain extensive damage. As a result, Ocean

Carriers was fined $10,000,000, which it settled to pay over 10 years. Should the balance of this

fine (now standing at $8,000,000) be included in the NPV calculation for the capesize?