OCEAN CARRIERS

CASE STUDY
BIEM Class 15

Elisa Baj-Macario, N. Berk Yoleri, Aida M. Loggiodice

Team 7
Executive Summary

Ocean Carriers Inc. is a shipping company with offices located in New York (USA) and

Hong Kong with a mission of owning and operating capesize dry bulk vessels carrying iron ore

and coal worldwide. The company receives an offer with attractive terms, however, Ocean Carriers

is not in possession of a ship that fulfils the customer’s requirements in their fleet. Hence, the Vice

President of the company Mary Linn is considering whether ordering a new vessel - delivered in

two years if ordered immediately- for the aforementioned customer would be profitable or not.

Summary of Facts

It is important to keep in mind that Ocean Carriers is a company dealing exclusively with

the transportation of iron ore and coal. Due to a company policy to maintain their ships in line with

regulations, they only operate vessels younger than 15 years and scrap or sell their vessels which

are older than this. For the new delivery capesize, the initial investment amounts to $39’000’000

of which 10% they plan on paying immediately, 10% in a year’s time and the rest remains to be

paid upon delivery. In 2017 they decide on a selling price of $5’000’000 per vessel, working with

a daily operating cost of $4’000 that increases by a rate equal to 1.04 (the inflation rate plus the

rate of growth, as given). There also exists an increasing capital expenditures every five years for

the vessel which must be accounted for. Depreciation is done on a straight-line basis, scrapping

the vessel after 15 years with an estimated residual value of $5’000’000 over a period of 25 years.

To conclude, Ocean Carriers is looking to come to an agreement with a charterer for a deal of

$20’000 rising $200 each day. They have a working capital investment of $500’000, which

increases by the rate of inflation. Additional key components in the study include the expected rate

of inflation and discount rate which are 3 and 9 percent, respectively.

Statement of Problem

The main problem Ms. Linn is currently facing is if it is worth investing in a new carrier

or not. To tackle this issue, an analysis on the future daily spot rates and the factors affecting them

is necessary. The tax exemption in Hong Kong and the 35% tax paid in US have to be taken into

account while doing this analysis. Data of the company from the past 15 years as well as 25 years

should be examined and compared with each other while revising the previsions made about future

conditions.

Analysis

Daily spot hire rates are firstly determined by supply and demand. Spot rate is negatively

correlated with the capesize fleet size and positively correlated with the demand for iron ore and

coal. Although they are expected to increase in the long-term, they will decrease next year due to

the increase in number of vessels and the import remaining stagnant for the next two years.

Furthermore, daily hire rates are driven by the supply of capesizes and production of iron ore and

coal, as they account for more than 85% of the cargo carried by capesizes.

The number of ships available are calculated by the number of vessels in service the

previous year plus the new ships delivered minus the scraps and sunk ships. If the demand is high,

an owner of the vessel would keep the ship in service as long as it could last. If demands decrease,

an owner of the ship would prefer scrapping to avoid maintenance costs. Since the fleet is mostly

constituted of young vessels, there has been a fairly low amount of scraps in the past few years.

Additionally, market conditions are the other key element determining spot rates. These

conditions are affected by the economic state all around the globe. For instance, a big majority of

the cargo carried by capesizes was iron ore and coal; and production and demand of these materials

would decrease if there was an economic crisis going on. Trade patterns and destinations also have
a big impact on the demand of capesize vessels: for instance, the distance between destinations

have a positive correlation with the spot prices.

Considering that there were 63 new vessels to be delivered in 2001 and iron ore import

were expected to remain stable for the next two years; daily spot rates would likely to decrease in

2001 and 2002. However, from 2003 onwards, ore imports from Australia and India would begin

and consequently lead to an increase in the trade volume. Therefore, spot rates are likely to increase

in the long-term. Thanks to the forecast prepared for Ms. Linn, annual growth rate for iron ore

vessels around the world was known to be 2% between 2002-2005 and 1.5% thereafter.

Looking at Exhibit F and assuming the scrap value would not change, the highest NPV is

given by scrapping the vessel at the end of 25 years and locating the company in Hong Kong. In

the case of the company being located in the U.S and having to pay taxes, the company should

reduce the depreciation period to 15 years, as demonstrated by Exhibits A and B, since the

depreciation costs would increase ( instead of 1,560,000 $, it becomes 2,600,000$) and therefore

decrease the taxes payable that in the end increase profit after tax.

Recommendations

Assuming current market conditions, Ms. Linn should purchase the 39M capesize only in

the case that Ocean Carriers being located in Hong Kong, where owners are not required to pay

any taxes on profits made overseas and are also exempted from paying taxes on profits made on

cargo uplifted. This is because the NPV value is positive and relatively higher than the NPV

under the assumption of Ocean Carries being a U.S firm and thus subject to 35% taxation. This

result can be influenced by the company policy of not operating ships over 15 years: holding all

other variables equal and assuming a depreciation period of 25 years, if they sell the vessel at the

end of the 15th year, they lose about 10,600,000 million $. Therefore, a change in the policy is

suggested.
Exhibits and Tables

Exhibit A: Calculations of USA for 15 years

Exhibit B: Calculations of USA for 25 years

Exhibit C: Calculations of Hong Kong for 15 years

Exhibit D: Calculations of Hong Kong for 25 years

Exhibit E: NPV of USA

Exhibit F: NPV of Hong Kong