Ocean Carriers Case Solutions

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1994

1995

1996

1997

1998

1999

2000

Iron ore vessel shipments

375

397

385

424

420

410

440

Growth rate

/

5.87%

-3.02%

10.13%

-0.94%

-2.38%

7.32%

Avg. 3-yr charter rate

18,250

18,544

14,079

16,063

13,076

12,626

15,344

Growth rate

/

1.61%

-24.08%

14.09%

-18.60%

-3.44%

21.53%

Although the amount of iron ore vessel shipments fluctuated from 1994 to 2000, due to the strong supply and demand in the future, the trend was still growing in the long run. We can see from the exhibit that the iron ore vessel shipments were 375 millions of tons in 1994 and 440 millions of tons in 2000, there was a 17.3% increase. However, the average 3-year charter rate was $18,250 in 1994 and $15,344 in 2000, there was a 15.6% decrease in the long run.

We can therefore conclude that we can’t only base the forecasts of charter rates off of long-term forecasts for worldwide iron ore vessel shipments. That is to say, the charter rate and iron ore vessel shipments seemed to change in a similar trend, but it was the supply and demand that really determined the charter rate. Whether the supply was balanced with demand would have a large impact on the charter rate.

For example, although we can see from the Exhibit 6 that the iron ore vessel shipments increased from 479 millions of tons in 2007 to 486 millions of tons in 2008, we can’t conclude that the charter rate increased from 2007 to 2008 because we haven’t analyzed the supply and demand during this time period.

Next we will analyze the trend of supply and demand to see the long-term prospects of capesize dry bulk industry.

In terms of supply, number of vessels in service the previous year, new ships delivered and improvements of new capesize carriers are three main factors affecting supply. When there is a strong demand for shipping capacity, the shipping company would increase its supply of capesize carriers. And the technology would undoubtedly develop at a very fast rate. So we can believe in the increase in size and efficiency of news ships in the future, which would increase supply for dry bulk capesizes.

In terms of demand, the world economy determines the demand for dry bulk capesizes.

As we all know, the world economy grows cyclically. Also, from the case, we know that Australian production in iron ore expected to be strong and Indian iron ore exports expected to take off in the next few years. As over 85% of the cargo carried by dry bulk capesizes was iron ore and coal, the demand for dry bulk capesizes would increase with more production of iron ore and higher trading volumes, which would boost prices.

We can therefore conclude that the long-term prospects of the capesizes dry bulk industry is promising and we take an optimistic attitude towards its future performance.

4. Should Ms. Linn purchase the $39M capesize?

Usually, there are several measures to evaluate whether to accept the project, such as IRR, price indices and NPV. In this case, we use the NPV to evaluate this project. If NPV>0, we accept this project. The discount rate for Ocean Carriers is 9%. We evaluate whether Ms. Linn should purchase this ship using the assumptions below:

1)After 2005, the ship will continue to be rent at the expected daily hire rate. In Q3, we are optimistic about the long-term prospect of the capesize dry bulk industry so we assume that the ship can be rent at the expected daily hire rate.

2)The ship is depreciated on a straight-line basis over 25 years. The salvage value on the 25th year is zero. The period of depreciation is usually fixed and is estimated by the industry regulator. In this case, it is said in the last page that a new ship would depreciated on a straight-line basis of 25 years. The company estimated the scrap value to be $5M at the end of the 15th year. We are not sure about the value in the 25th year. To conservatively evaluate this project, we assume the salvage value to be zero at the end of the 25th year.

3)The operation cost is initially $4,000 per day and increases at 4% annually.

4)There are 365 days per year.

5)The $500,000 initial investment in net working capital happens in the end of 2002 and increases at 3% annually. In the end of the 15th year, NWC is zero. In early 2003, this ship would be used in delivery. There should be enough operating capital for the company to maintain the daily operation for this ship. So the net working capital should be injected at the end of 2002. In the end of the15th year, there is no need for net working capital since this ship would be scraped, so the net working capital is zero at that time.

6)When scrap ship on the special surveys year, the company do not need to pay for the capital expenditures anticipated in preparation for special surveys.

7)There is no default risk.

Ocean Carriers is an U.S. firm subject to 35% taxation and the company