Background

OceanCarriersInc.isashippingcompanyspecializingintheoperationofcapsizesbulkdry
carriers.InJanuary2001,MaryLinn,thevicePresidentofFinanceforOceanCarrierswas
evaluatingthepurchaseofanewcapsizecarrierforathreeyearsleaseproposedbya
motivatedcustomer.Theleasingcontractoffersveryattractiveterms,butnoshipinOcean
Carrierscurrentfleetmetthecustomersrequirements.Inaddition,thisproposedcontractis
onlyforthreeyears.Therefore,afterthreeyears,thenewcapsizecarrierwillhavetobe
leasedtoothercustomers.Soconsideringinthelongrun,LinnhadtodecidewhetherOcean
Carriersshouldimmediatelycommissionanewshipwhichcouldbecompletedintwoyears.
Inthesametime,shewouldhavetoconsiderifthecompanyshouldstillfollowthepolicyof
scrappingavesselafter15years,eventhoughsuchvesselhasaproductlifeof25years

Analysis
Therearetwomainfactorswouldaffectthedailyspothirerateswhicharethenumberof
availablevesselsandimportsofironoreandcoal.FromtheExhibit3ofthiscase,weknow
that63newvesselswerescheduledfordeliveryin2001.Thisnumberdecreasesto33in2002
and21in2003.Sowecaninferthatthedemandofnewvesselsissaturatedtemporary.
Besides,withAustralianproductioninironoreexpectedtobestrongandIndianironore
exportsexpectedtotakeoffinthenextfewyears,wecaninferthelongtermmarketdemand
forcapsizeswillbeoptimistic,buttheimportsofironoreandcoalwillremainstagnantover
thenexttwoyears.Sodailyspothireratesareexpectedtodecreasenextyear.
Theworldeconomywilldeterminethedemandfordrybulkcapsizes,specificallytheironore
andcoalmarkets,sincetheytakeupover85%ofthecargocarriedbycapsizes.Thehigher
thedemandfortheseproducts,thehigherthedailyhireratescouldbecharged.Tradepatterns
willalsoaffectthedemandforcapsizes,liketheincreaseofdistancebetweenthesupplierand
demanderwillrisethedemandforcapsizesandthedailyhireratesaswell.Consideringof
thatAustralianandIndianoreexportsmaybeginin2003,thesenewsupplieswilldriveahigh
demandforcapsizes.Intheviewoflongterm,globalizationbooststhedevelopmentof
economysothatthedemandforcapsizeswillincrease.
Moreover,theincreaseddemandforsizeandefficiencyofshipspresentanewrequirement
fornewcapsizes.Sothelongtermprospectsofcapsizedrybulkindustryarepotentialand
promising.Thelargeamountofdemandforcapsizeswillstrengthenthisindustry.
Fromabove,wecanseethatforthedevelopmentofcompanyandcustomerneed,itis
necessaryforOceanCarrierscommissionanewcapsizecarrier.ButthedilemmaforMs.
LinniswhetherOceanCarriersshouldpurchasenewcapsizednoworpushitback.Thereare
twoassumptions.Firstscenario,assumethatOceanCarriersisaU.S.firmsubjectto35%
taxation.Thenetpresentvaluewillbecalculatedbasedongivendataincludingannual
operatingdays,dailyoperatingcosts,dailyhirerates,inflationrateanddiscountrate.The
newcapsizewillbedepreciatedonastraightlinebasisover25yearsandoutofbeing
chartered15yearslaterin2017.Underthisscenario,theNPViscalculatedat
$7,811,354.92.Seeexhibit1.
Secondscenario,assumethatOceanCarriersislocatedinHongKong,whereownersofHong
Kongshipsarenotrequiredtopayanytaxonprofits.Hereweusethesamedatabut
exemptedthetax,andNPViscalculatedat$1,252,915.52.Seeexhibit2.
Fromthosetwoscenarios,werealizedthatbothNPVsarenegativeandLinnwilldefinitely
makeneitherinvestment.Sincethenewcapsizeshave25yearslife,whatifweextendits

servicelifefrom15yearsto25years.Soweusesamedata.TheNPVis$7,273,79.78ifthe
firmlocatedintheU.S.whileitis$368,557.29whenthefirmlocatedinHongKong.See
exhibit3&4.Clearly,operatingthenewcapsizefor25yearswithouttax,makesitapositive
investment.SoOceanCarriersshouldconstructanewcapsizewithoncorporatetaxand
charteringthecapsizeforitsentire25yearslife.IfOceanCarrierschoosestoadheretotheir
policywitha15yearsservicelife,theresultwillturnouttobeanetlossontheinvestment.

Recommendation
MyrecommendationforOceanCarriersisnottoacceptthiscontractwiththecustomer.From
theanalysisofexhibit1&2,bothofthenetpresentvaluesarenegative,sothiscontractwill
notbeinthebestinterestofthefirm.Evenextendthecharteringlifeofcapsize,thenet
presentvaluewillstillbenegativeifchargetax.Onlywhenexemptingtax,itispositive.But
sincethedevelopmentofeconomyandcustomersneeds,itisnecessaryforOceanCarriersto
commissionnewcapsizeswithbiggersizeandfasterspeedtodevelopthefirmwell.Sothe
firmshouldconsiderextendingshipscharteringlife.Underthiscondition,thefirmcould
purchaseanewcapsizewithalowerpriceandadjustthecontractwithanincreasedexpected
hirerateformorethan3years.