Ocean Carriers is a shipping company evaluating a proposed lease of a ship for a three-year period to a customer, beginning in 2003. The proposed leasing contract offers very attractive terms, but no ship in Ocean Carrier’s current fleet meets the customer’s requirements. The firm must decide if future expected cash flows warrant the considerable investment in a new ship. Objective of Case Assignment To provide your team an opportunity to make a capital budgeting decision.
That is, to develop an understanding of how discounted cash flow analysis can be used to make investment and corporate policy decisions.
- Do you expect daily spot hire rates to increase or decrease next year, and why? (This question should also address what factors appear to drive average daily hire rates. )
- What is the cost of the new ship in present value terms? The company’s cost of capital (i. e. , discount rate) is 9%.
- What are the expected cash flows for each year? (You are expected to setup an Excel spreadsheet to answer this question.
- What is the net present value (i. e. , net cash flow overall) for the investment in the ship?
- Should Ms. Linn purchase the $39MM ship?
- What do you think of the company’s policy of not operating ships over 15 years old?
Additional Notes to Finance Project
- A. Event Year 0 (on the Excel template) equals the year 2000. This means 2000 is the current year of the case, also stated as period (n) = 0.
- B. Based on the above, next year in Question 1 would then be the year 2001.
- C. When calculating days in the year, use 365 (i. e. , ignore leap years).
- D. The initial investment in net working capital of $500,000 (p. 5 of case) occurs at the end of 2002—right before the ship is ready for use at the start of 2003. Net working capital defined: current assets minus current liabilities; the net amount of a company’s liquid resources (i. e. , operational buffer). cont’d
- E. Capital Expenditures (Exhibit I, p. 2 of case) extend the life and/or productivity of an asset–they are not a tax deductible expense in the year they occur. Therefore, they become part of the asset’s cost and must be depreciated over their estimated useful life (5 years). Assume the capital expenditures occur at the end of the years noted in Exhibit I. For example, $300,000 cash outflow in 2007. This means you cannot include the cost of the capital expenditure in your annual depreciation expense calculation until the next year (2008).
- F. Your annual Depreciation expense calculation should be as follows: Original cost of Ship – Salvage value + Cost of Capital Expenditure__ Estimated useful life of Ship Estimated useful life of Capital Expenditure
- G. Salvage value of the ship at the end of 15 years is noted in the case. Salvage value is zero at the end of 25 years.
- H. Tax rate = 35%
- I. After-tax proceeds from sale of asset = Selling Price – [Tax Rate x (Selling Price – Book Value)]
- J. Round all calculations to the nearest dollar.
- K. If you need to make any assumptions, clearly state your assumptions in your paper.