Ocean Carriers

Case Summary

Mary Linn, the VP of Finance of Ocean Carriers has to make a decision regarding purchase of a new
capsize carrier to meet the demand of a customer. She has to decide whether to accept leasing
contract for a period of 3 years. She has to analyse several factors such as the market conditions,
operating costs, depreciation & inflation in order to make her decision.

Analysis

Since the leasing period is short, the company has to analyse whether the investment will be
profitable even after the closure of the contract. To decide this, we use two methods –

1. Net Present Value Method

2. IRR Method

Assumptions

1. Tax rate in US – 35%

2. Tax rate in Hong Kong – 0%
3. Discount rate – 10% ( 2% Fed rate+ 3%inflation +5% risk premium)

Option 1 (Operations in the US)

After calculating the net cash flow, we calculated the Net Present Value for 15 years (- 1796678)
and for 25 years (-5667712). Since Net Present Value is negative in both cases, this project is not
feasible possibly due to the high tax rate in the US. IRR Value is calculated to be 9 % which is related
to the assumptions that we made on the discount rate. Hence, in this case NPV is a better standard
for judgement.

Option2 (Operations in Hong Kong)

In this case, the Net Present Value for 15 years (12915255) and 25 years ( 2048382) is positive given
the tax rate is zero in Hong Kong – this makes the project feasible. We also note that the net present
value at the end of 15 yrs is higher than the scrap rate. Hence it is advisable to not scrap the vessel
post 15 years. Here , the IRR is ( ) which is clearly higher than the discount rate proving that the
project is profitable.

Conclusion

Despite the the negative market conditions in the next two years, the overall long term prospects
look promising. With new players such as India and Australia joining the market, charter rates will
probably rise given the heightened demand.

From the above calculations on NPV, we find that investment in Hong Kong is the recommended
course as NPV is positive.
The firm should also revise its 15 yr scrapping plan and NPV after 15 yrs seem to be higher than the
Scrap value.