The Charles H. Kellstadt Graduate School of Business

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Carrier vessels are often registered in a different country than the actual shipping company. This is done to avoid taxes and lower labor costs. Antigua & Barbuda is number one on the list of with the Bahamas a close second. Panama operates what is known as an open registry. Its flag offers the advantages of easier registration (often online) and the ability to employ cheaper foreign labor. Furthermore, the foreign owners pay no income taxes.

The US corporate tax rate of 35% will negatively impact the free cash flow as it represents after tax dollars. The Hong Kong or Bahama’s corporate tax rate of 0% will positively impact the free cash flow as taxes are not needed and therefore don’t reduce NPV.

A free cash flow represents the cash that a company is able to generate after spending the money required to maintain or expand its asset base. Constructing a free cash flow allows for a more accurate representation of the actual cost of the ship investment, as it accounts for capital expenditures.

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4. Ms Linn is considering trying to argue that the firm should operate carriers for more than 15 years before selling them for scrap. What would be the optimal number of years to operate the capesize carrier before scrapping it? Assume that the capesize carrier must be scrapped after 30 years. If the policy is changed should they go ahead and purchase the carrier?

The reason behind ceasing operation before 25 years is to avoid paying the additional special survey fee of $1.25 Million in 2027. To make the investment worthwhile, Ocean Carriers must:

- Register the ship as a foreign ship and hence incur 0% tax, as the 35% tax in the United States would result in a longer time than reasonable for NPV to be positive and therefore it would not be a smart investment decision.

- Sell the ship at a fair market value instead of a scrap value of $5 million, as the fair market value of selling the ship in a second hand market may be more than $5 million.

Here are the possible outcomes:

- Keeping a scrap value of $5 million with 35% tax, NPV would take a longer time than advisable or reasonable to be positive.

- Scrapping the vessel for the Fair Market Value with 35% tax, NPV will become positive at year 34.

- Keeping a scrap value of $5 million with 0% tax, NPV will be positive at year 15

- Scrapping the vessel for the Fair Market Value with 0% tax, NPV will become positive at year 15.

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5. Suppose that Ms Linn is unable to convince the company to change its policy. How much could Ocean Carriers sell the capesize for on the second hand market (as opposed to selling it for scrap) after 15 years?

If Ms. Linn cannot convince the company to change the policy, assuming the second hand market could get similar daily rates and have identical operating costs, as well as an ability to scrap, Ocean Carriers try to get approximately $18,727,972 in the second hand market after 15 years. This is based on the calculation completed in exhibit 7, which calculated the total book value of the asset.

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6. In the quantitative analysis you have done for questions (3.), (4.) and (5.) you used a 9% discount rate. From a qualitative point of view, how is your Free Cash Flows affected if the financing of the project comes from issuing debt in the capital market? If it comes partially from issuing debt and from cash infusion from the owners? Explain clearly and briefly the reason(s) for your answer.

Based on the time value of money concept, money at this moment is worth more today than it is in the future. By using debt, the money is available today and can be invested, whereas a capital injection is more periodic and worth less as time goes on. Using debt will cause a very minor positive impact to NPV. Free cash flows would be positively impacted through the payment of debt prior to increasing stockholder equity.

If the financing of the project comes from issuing debt in the capital market, the firm also gains the benefit of a tax deduction from interest and obligates the company to make payments on time. The company increases their probability of incurring bankruptcy as there are now more debtors which need to be satisfied prior to stockholders.

On the other hand, if part of the financing comes from both issuing debt and cash infusion from the owners, this will lower the probability of bankruptcy and with a lower debt amount and lower the tax benefit from the interest on the debt while having a somewhat positive impact on NPV given the infusion from debt at the start of the project.