Ocean Carriers

CASE 4

FIN 434
Spring, 2013

Group Member:
Chad Qualley
David Thomas
Kun Liu
Yifang Fan
Zhe Tang
1. Do you expect the daily spot rate to increase or decrease next year?

I expect the daily spot rate to decrease next year. Daily hire rates were

determined by supply and demand. As Linn anticipated, the daily spot rate would fall

in 2001 and 2002, for 63 new vessels were scheduled for delivery in 2001 and the

imports of iron ore and coal would probably remain stagnant over the next two years.

A similar trend can be seen from1997 to 1998 and 1995 to 1996. In both instances,

iron ore vessel shipments almost remained steady while the average spot rates sharply

decreased.

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 2. What factors drive average daily hire rates?

Daily hire rates are determined by supply and demand. For example, when

demand goes up, owners’ are likely to keep vessels as long as possible. Consequently,

daily hire rates increase. Conversely, when demand goes down, owners’ are likely to

scrap the vessels and daily hire rates decrease. Additionally, as ships got bigger, faster,

and more fuel efficient, fewer ships were needed to carry the same amount of cargo,

and thus, supply goes down. However, increases in size and efficiency offered by the

newer ships offers a 15% premium in daily hire rates as opposed to ships over 25

years old which carry a 35% discount.

3. How would you characterize the long-term prospects of the capesize dry bulk

industry?

Charter rates are forecast based on the forecast for worldwide iron ore shipments.

The demand for dry bulk carriers is highly dependent on the demand for these two

goods. Over 85% of the goods shipped by dry bulk carriers were coal and iron ore.

Production and demand for these goods are based on world economic conditions. In

recent years the demand for these goods has dropped dramatically but is expected to

bounce back. Australia and India are expected to increase production of iron ore and

coal. This will increase the supply and shipping of these goods in the next few years.

We can see that increases in the amount of iron ore shipped are directly correlated

with the price of charter. As the amount of dry goods increases that charter price

increases. Long term prospects for the bulk dry goods industry are very good. By

2027 iron ore shipments are expected to increase 67%. The charter rate for shipping

these goods is expected to increase 74%. Demand is growing with superior trading

capacity in the long run even though the daily hire rate may be downward in the

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 subsequent 3 years owing to the mounting supply. Nevertheless, with less suppliers in

the market and extended turnaround from order to delivery of new vessel (2 years

average), the long term market will be growing with inflation.

4. Should Ms. Linn purchase the $39M capsize? Make two different assumptions.

First, assume that Ocean Carriers is a US firm subject to 35% taxation. Second,

assume 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.

According to our analysis, Linn should not purchase the Capsize. After 15 years,

Linn will suffer a loss on in both the U.S and Hong Kong. After 20 years, Linn will

still lose money in both locations, albeit less money. Finally, in the 25-year analysis,

Linn will be able to turn a small profit in Hong Kong while still suffering a loss in the

U.S. Although the 25-year time frame allows for a gain in Hong Kong, such a gain is

highly contingent on the salvage rate which may be volatile subject to new

technology, ship defects, etc. Thus, the profits gained by the keeping the ship longer

are not worth the risks inherent in the unpredictable scrap value.

Based on the spreadsheet in the last page:

No with the assumption 1: Tax applied. Negative NPV of $6M

Yes with the assumption 2: No tax applied. Positive NPV of $4.6M

5. What do you think of the company’s policy of not operating ships over 15 years

old?

The company’s policy of not operating ships over 15 years old is not a good

policy because (1) For US Firm, sum of all present values of operating the ship from

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 Year 16 to Year 25 at the end of Year 15 equals $12,114,083, which is much bigger

than the scrap value of $5M. (2) For HK Firm, sum of all present values of operating

the ship from Year 16 to Year 25 at the end of Year 15 equals $13,117,807, which is

also much bigger than the scrap value of $5M. In this case, the scrap value of $5M at

the end of Year 15 is much smaller than the present value of operating the ship from

Year 16 to 25 at the end of Year 15, regardless of location.

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