The Charles H.

Kellstadt Graduate School of Business

DePaul University

FIN 555: Financial Management

Prof. Bjorn Johnson

Case Study Questions: Ocean Carriers

These questions relate to the Ocean Carriers case in your course packet. You can find the data
for this case on the course website in a spreadsheet named: Ocean Carriers Exhibits.xls.

This case provides the opportunity to make a capital budgeting decision by using discounted
cash flow analysis to make an investment and corporate policy decision. Ocean Carriers is a
shipping company evaluating a proposed lease of a ship for a three-year period 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. For the questions below, assume that
Ocean Carriers uses a 9% discount rate.

1. Do you expect daily spot hire rates to increase or decrease over the next few years? Give
the reasons for your assessment. What factors drive average daily rates? What do you think
of the long-term prospects of the capesize dry bulk industry?

2. How much is the cost of a new vessel in present value terms? Compared to the book value
of the ship of $39M, what can you conclude about the effect of the installment payments?

3. Should Ms. Linn purchase the capesize carrier? Assume that it is going to be sold for scrap
after 15 years. [Hint: Construct the Free Cash Flows of the project.]

4. Does your conclusion in (3) change if you instead assume that Ocean Carriers operates the
capesize for the full life of 25 years before selling it for scrap value (grown by inflation)?

Assumptions on Tax Rates:

For questions (3) and (4) make two different assumptions. First, assume that Ocean Carriers is
a U.S. firm subject to a 35% corporate taxation rate. Second, repeat the same exercise assuming
that Ocean Carriers is located in Hong Kong, where owners of Hong Kong ships 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. How are your results affected? What do you
conclude?

1
Useful Hints:

a. You need to be consistent in the treatment of the timing of the cash flows in your analysis.
To accomplish this, you should assume that all cash flows occur at the end of the year
closest to the actual date of the cash flow, so for example if the case states that a cash flow
occur in “January” or “early” in a specific year, you should assume that it occurs on Dec-31
of the previous year. This is what makes most sense from a financial perspective, as the
Present Value of a cash flow will be almost exactly the same whether it occurred on Dec-31
in one particular year, or Jan-1 the following year, as those two dates are just one day apart.
(When there is no mentioning in the case of when within a certain year a cash flow occurs,
assume that it occurs at the end of the year.)

b. As stated in the case, you should assume that operating costs will grow annually at 1% in
real terms. You should however be consistently using nominal cash flows while making the
cash flow projections.

c. Assume that Ocean Carriers has a sufficiently high taxable income in each year so that any
tax shields can be used immediately.

d. Assume that the ship is depreciated straight-line for 25 years to a remaining book value of
zero.