Ocean Carrier Case Study
Case Background··························3 Dilemma································3 Scenarios under different tax rates and years ····························3 Alternative································5 Decision summary··························5 Appendix
Ocean Carrier Case Study * Case Background
Mary Linn of Ocean Carriers is evaluating the purchase of a new capesize carrier for a 3-year lease proposed by a motivated customer. The leasing contract offers very attractive terms, but no ship in Ocean Carrier’s current fleet meets the customer’s needs. In addition, the proposed contract with the customer is only for three years. Therefore, after three years, the …show more content…
The first scenario assumes that Ocean Carriers is a U.S. based firm subject to a 35% corporate income tax. Under this scenario, the ship depreciates straight-line over 25 years and is sold, after 15 years, for an after-tax value of $385,831.92. In this case, the NPV is calculated at -$5,781,968.64.
If this project is operated by the office in New York, the company would be subject to a 35% corporate income tax. Under this circumstance, regardless of whether Ocean Carriers decided to operate the vessel for 15 years or 25 years, neither option would result in a positive NPV. The NPV at year 2017 would be $-5,781,968.64; the NPV at year 2027 is calculated as $-4,666,724.23. As a result, Linn would definitely make neither investment.
Assuming Ocean Carriers has no tax burden if the project operates in Hong Kong, the NPV after 15 years and after 25 years is positive. However, operating the vessel for 25 years would have a NPV of $3,780,965.33, which is almost three times larger than the NPV after 15 years, $1,339,629.17. Thus, Linn could make a decision to buy the new ship and to operate the vessel as long as possible.
The second scenario supposes that Ocean Carriers holds the ship for 25 years. The same tax rate assumptions used in the first scenario are
When the discount rate increases from 15% to 40%, the company faces a 37.3% drop in its total value. The loss will be $5,609,132. the largest difference rate comes from the silver segment. Firstly, the silver segment has the most significant amount of customers. The requirement of being a silver customer is small ( fly with the Northern Aero at least one time). Secondly, each year some of the customers will degrade from the platinum or gold segment to the silver segment. Due to the
1.3. In order to estimate the peso discount rate, assume that the International Fisher Effect (IFE) holds. Groupe Ariel's Euro hurdle rate for a project of this type was 8%. Assume that inflation rates are expected to be 7% in Mexico and 3% in France.
Free cash flows of the project for next five years can be calculated by adding depreciation values and subtracting changes in working capital from net income. In 2010, there will be a cash outflow of $2.2 million as capital expenditure. In 2011, there will be an additional one time cash outflow of $300,000 as an advertising expense. Using net free cash flow values for next five years and discount rate for discounting, NPV for the project comes out to be $2907, 100. The rate of return at which net present value becomes zero i.e.
Finally, in order to complete a more accurate comparison between the two projects, we utilized the EANPV as the deciding factor. Under current accepted financial practice, NPV is generally considered the most accurate method of predicting the performance of a potential project. The duration of the projects is different, one lasts four years and one lasts six years. To account for the variation in time frames for the projects and to further refine our selection we calculated the EANPV to compare performance on a yearly basis.
2. Suppose a customer buys an iPhone from Apple for $500 on January 1, 2010. The cost of the iPhone to Apple is $350. Assume that the customer is entitled to upgrades over the next two years. Use the following financial statement effects template (FSET) to illustrate the financial statement impacts for Apple of the customer's iPhone purchase on the date of the initial purchase and at the end of each of the two years following the initial purchase under generally accepted accounting principles (GAAP).
Based off a financial analysis using the data Ocean Carriers has provided, the final recommendation is that Ocean Carriers should build a new ship out of its Hong Kong base where the tax rate is 0% and scrap the ship when it is 25 years old. Following this recommendation would be the only scenario where Ocean Carriers sees a positive net present value
By using the 7.2% after tax rate and assuming the equipment will be sold at the beginning of the 5th year for its book value, if Agro-Chem bought the equipment the company would achieve a project NPV of ($1,043,500.23). In contrast, if Agro-Chem decided to lease the equipment with the same assumptions they would obtain a project NPV of ($1,030,205). Given these assumptions and based off our calculated NPV we recommend that Agro-Chem lease the equipment rather than buy because of the $13,295.23 savings. This $13,295.23 savings is the NAL.
* Taxation and salvage: Tax regulation in every country is different, so the company should consider it when calculating NPV. Also, it should clarify the depreciation expense and interest expense to
Relationship between Age and Ship Price: From the regression, we find that as the ship ages by one year, the price of the ship drops by $ 4.54 mln. This makes sense because as with any other vehicle or asset, the efficiency of the ship drops with age. As it gets older, the carrying value of the ship lowers due to depreciation.
If the company is incorporated in the U.S., the NPV will be $-7,836,500.07(US25) after 25 years and will be $-6,395,945.22(US30) after 30 years. Therefore, the U.S. company should not purchase the vessel. If the company is established in Hong Kong, the NPV will be $1,522,472.92(25HK) after 25 years and will be $3,402,293.81(30HK) after 30 years. Therefore the 30 years should be the optimal number of years to operate the carrier before scrapping it after 30 years. In this situation, if the 15-year-selling policy is changed, the company should buy the carrier. For years 26-30, we assume that average daily charter rate is increased by $200 per year. The expected daily hire rate is calculated by multiplying Avg. Daily Charter Rate by adjustment factor for hire rate of 65%.
It follows that the NPV at t=0 can be found by discounting the above number three years at 12% -- doing so you get a value of $0.2669 million – which is an estimate of what you pay for the sequel right at t=0.
Financial risks include the short payback period. A 3-year payback period would not allow Hansson the opportunity to breakeven. With a negative NPV in the first 3 years Hansson’s decision to invest in the project would be based on his ability to negotiate a longer contract time. The Net Present Value (NPV) would have to be examined in tandem with the other non-financial variables.
The present value of the net incremental cash flows, totaling $5,740K, is added to the present value of the Capital Cost Allowance (CCA) tax shield, provided by the Plant and Equipment of $599K, to arrive at the project’s NPV of $6,339K. (Please refer to Exhibit 4 and 5 for assumptions and detailed NPV calculations.) This high positive NPV means that the project will add a significant amount of value to FMI. In addition, using the incremental cash flows (excluding CCA) generated by the NPV calculation, we calculated the project’s IRR to be 28%. This means that the project will generate a higher rate of return than the company’s cost of capital of 10.05%. This is also a positive indication that the company should undertake the project.