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Ocean Carriers Lease Analysis Assignment

This document provides instructions for an assignment analyzing the case study "Ocean Carriers". Students are asked to: 1) Estimate annual cash flows over 25 years for a proposed $39 million ship lease and calculate its net present value. 2) Determine whether the ship should be scrapped after 15 or 25 years based on salvage values. 3) Advise whether Ocean Carriers should purchase the ship, considering scenarios where it is located in the US or Hong Kong. The assignment requires a maximum 1,000 word report with any excel analyses attached. Assumptions must be clearly stated. Grades will depend on analysis quality and clarity rather than length.

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Zhenyi Zhu
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20 views2 pages

Ocean Carriers Lease Analysis Assignment

This document provides instructions for an assignment analyzing the case study "Ocean Carriers". Students are asked to: 1) Estimate annual cash flows over 25 years for a proposed $39 million ship lease and calculate its net present value. 2) Determine whether the ship should be scrapped after 15 or 25 years based on salvage values. 3) Advise whether Ocean Carriers should purchase the ship, considering scenarios where it is located in the US or Hong Kong. The assignment requires a maximum 1,000 word report with any excel analyses attached. Assumptions must be clearly stated. Grades will depend on analysis quality and clarity rather than length.

Uploaded by

Zhenyi Zhu
Copyright
© All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd

Imperial Business School

Corporate Finance
Assignment 1

The assignment is based on the Harvard Business School case study “Ocean Carriers”. Please
read the case study as well as the below instructions carefully before proceeding with your
analysis.

Summarize your responses in a report of maximum 1,000 words and attach any accompanying
excel spreadsheets. Clearly state any additional assumptions you think may be necessary in
your analysis. Your answers need to be succinct and to the point. Your grade will depend on
the quality of the analysis and the clarity of the report rather than its length.

Setting

In January 2001, Ocean Carriers, a shipping company, is evaluating a proposed lease of a ship
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.

Questions

Assume that Ocean Carriers uses a 9% discount rate.

1. Estimate the expected annual cash flows for the 25 years of the ship’s useful life.
Assume that Ocean Carriers is a U.S. firm subject to 35% taxation.

2. Do you think that the ship should be scrapped after 15 years as per the company’s policy
or continue to operate through the entire 25-year period? Assume that the company
estimated the scrap value (salvage value) to be $5 million if the ship is scrapped in year
15 and $6.72 million if the ship is scrapped in year 25. Any cash received when the ship
is scrapped that is in excess of (less than) the ship’s carrying value at that time will be
reported as a capital gain (loss) and will affect the cash flows.

3. Should Ms Linn purchase the $39 million capesize? What if 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? Consider both scenarios of 15 and 25 years.

Suggestions
The new ship will be delivered in early 2003 and the contract will begin immediately, so the
first operating cash flow will be in 2003. The first investment cash flow is in 2001. You may
assume that cash flows arrive at the end of the year, except for the initial expenditure, which
occurs immediately. Hence, cash flows occur in Jan 2001, Dec 2001, Dec 2002, Dec 2003, etc.
up to Dec 2027.
Assume that the first investment in working capital is made in 2002 (e.g., due to supplies that
need to be on board before the ship starts operating). The working capital is fully recovered in
the final year of operation of the ship.

Note that periodic special survey costs are also considered as capital expenditures (see p.2 of
the case) and are depreciated on a straight-line base over a five-year period beginning the year
after the survey and ending the year of the next survey. You may assume that the vessel does
not undergo the special survey in year 25, so the final capital expenditure is not required.

Common questions

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Key factors Ocean Carriers should consider include the comparison of operating profits and cash flows generated during the additional 10 years of operation versus the benefits of scrapping after 15 years, such as the salvage value and tax implications. They should also evaluate market conditions and demand forecasts for shipping services as well as maintenance and operational costs increasing with the ship's age .

The timing of the initial cash outflow in 2001 directly impacts the overall financial valuation by influencing when the cash flows start contributing to returns. This early outlay requires precise discounting to accurately reflect future net cash flows’ present value, critically affecting the investment decision's attractiveness .

Ocean Carriers should project expected annual cash flows by accounting for revenue from shipping contracts, operating expenses, tax obligations, and investment costs. Discount these cash flows back to present value using a 9% discount rate to determine their contribution to the firm's profitability and inform the lease decision .

Ocean Carriers must consider the tradeoff between immediate revenue from scrapping at 15 years and the potential profit from operating the ship for an additional 10 years. Evaluating market conditions, possible shipping rates, operational costs, and depreciation benefits against the projected scrap value and considering capital gains or losses from the sale are crucial .

The company should analyze the net cash flow effects of different tax regimes on profits, considering the absence of taxes in Hong Kong could substantially raise net returns compared to the U.S. By leveraging these differences, Ocean Carriers can optimize its financial planning and enhance overall shareholder value .

The economic and financial considerations include the expected cash flow from lease contracts, interest rates affecting discount rate calculations, and potential tax savings or liabilities in different jurisdictions. Evaluating long-term forecasts of shipping rates against the purchase cost and expected depreciation over the useful life also play critical roles .

Capital expenditures on special surveys, which are spread over a five-year period, represent significant periodic costs affecting overall cash flow projections and net profit calculations. These expenses must be factored into the ship’s investment analysis to ensure accurate forecasting of financial performance over the ship's lifespan .

Changes in the discount rate alter the present value calculations of future cash flows, impacting the perceived profitability of the ship lease. A higher rate reduces the present value of future cash flows, potentially making the investment seem less attractive, while a lower rate does the opposite, emphasizing the importance of accurate rate predictions .

The potential risks include increased maintenance and repair costs as the ship ages, potential downtime impacting revenue, and market risks of fluctuating shipping demand. Additionally, depreciation benefits may diminish over time, and operational efficiencies could decrease, affecting profitability .

The tax environment significantly influences Ocean Carriers' decision-making. In Hong Kong, the absence of taxes on profits derived from overseas operations may lead to a favorable financial outlook, enhancing cash flows and net present value compared to the U.S., where there is a 35% taxation . This difference impacts the decision on investment locations and strategic financial planning .

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