Stone Business

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Investment decision: Hong Kong

Main assumption for this question: the $500,000 initial investment in net working capital was made in 2001

First, assume that Ocean Carriers in a U.S. firm subject to 35% taxation, NPV of this company would be -$5,247,000, which means Ms. Linn should not purchase the $39M capesize.

TABLE 1: FORECAST IN USA

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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 exempt from paying any tax on profit made on cargo uplifted from Hong Kong. NPV of this company would be $1,298,710, which means Ms. Linn should purchase the $39M capesize.

TABLE 2: FORECAST IN HONG KONG

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Operating ships over 15 years old: NOT WISE

We disagree with the company’s policy of not operating ships over 15 years old. To justify our opinion, we compute the NPV of continuing to operate ships after 15 years old. First, we assume the ship in this test is the new capesize under Question 4. In this case, the NPV is calculated at the end of 2017, so the initial purchase cost for the ship, $39 million, will be a sunk cost. In 2017, it is worth to note that an opportunity cost of $5 million will occur if the company chooses to continue to operate the ship over 15 years old instead of selling it in the secondhand market. Second, it is known form the case that the ship is expected to be depreciated over 25 years, hence we assume the ship will have an estimated life from 2003 to 2027. The anticipated capital expenditure for special survey in 2027 will not occur, since we assume the ship will only operate until 2027. Moreover, by looking at the income statement from Question 4, we notice the EBIT in 2027 is a negative number, thus tax expense will not be considered in 2027 for computing NPV. Lastly, we compute the NPV under two scenarios: 1. Ocean Carriers is incorporated in U.S., it will be subject to a tax rate of 35%; 2. Ocean Carriers is incorporated in HK subject to no taxation. The TABLE 3 shows our calculation for NPV. The NPVs for both U.S. and HK cases are positive numbers: $10,288,761 and $9,949,176 respectively. Therefore, Ocean Carriers should change its policy to continue operating ships over 15 years old, given its decision to purchase the $39M capesize in 2001.

TABLE3: FORECAST OVER 15 YEARS

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