Dark Star Enterprises (DSE), which you work for as CFO has decided to diversify its transportation operations.

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Question:

Dark Star Enterprises (DSE), which you work for as CFO has decided to diversify its transportation operations. Currently, the company is active in leasing box and tank cars to US-based railroads. The company has 10,000 railroad cars under lease contracts (a railroad car costs about $100,000 to purchase). An investment opportunity has recently come up, which involves the purchase of a shipping company that owns four (4) ships. Each vessel is 100,000 deadweight (dwt) tons and all will serve the route between Abu Dhabi and Tokyo for Shell on a 20-year contract basis. The ship type is referred to as an Aframax tanker and is about 240 to 245 yards in length and can carry about 600,000 to 800,000 barrels of crude oil. You have been asked to do a valuation of two of the tankers, the Jahre Viking and the Mariner. Based on your analysis, the following data is available.

1. Daily running costs for each oil tanker: $6,000 per day.

2. While the oil tanker is expected to operate every day of the year, Shell will not pay for downtime such as maintenance. Based on industry information, you determine that in the first 10 years of operation, 10 days per year will be required to perform necessary maintenance and repairs. In the second five years of operation, this will increase to 20 days per year. For the remaining life of the ship, non-revenue days will increase to 30 days per year. Note that the company has a policy of not operating ships older than 15 years. The scrap value is estimated to be $3 million at the end of 25 years.

3. Shell had offered to pay $16,000 per day but this will be subject to adjustments based on the age of the ships. Shell wants to portray themselves as an environmentally friendly company and requested the following adjustments to the daily rate (generally, the younger the ship the higher the rate). Daily hire rate adjustment factor: a) 4 years and younger: 1.15 5 to 9 years: 1.05 10 to 15 years: .85 16 to 25 years: .70

4. A new ship would cost $45 million.

5. The ship would be depreciated straight-line over 25 years (assuming the ship would be in use for 25 years).

6. An additional investment in working capital of $500,000 will be required, all of which is “returnable” at the end of the life of the ship or at the end of the contract, as appropriate. The Corporate tax rate is zero since the ship will be registered in Panama.

7. The discount rate is 9 percent.

8. The market value of the ship at the end of year 15 would be $7 million.

9. The age of the Mariner (ship 1) is 10 years; the age of the Namib and the Hamburg (ship 2 and 3) is the same, 5 years; and the 4th ship, the Jahre Viking, is brand new.

10. Cash Flow to value on a per-share basis for similar firms is 9. This is similar to the p/e ratio but it is based on cash flow rather than earnings. Price to earnings ratio for similar firms is 12.

Required: Using the present value method (DCF), what is the value of Jahre Viking? What is the value of the Mariner? Please note that you will need to replace the Mariner in your calculation by purchasing another ship after 10 years. This is necessary since your investment horizon is 20 years. For the second ship, assume that it is sold when the contract is completed in 20 years. Show your supporting calculations and document your assumptions. The difficulties, in this case, are: (1) coming up with a defensible cash flow forecast based on realistic assumptions, (2) dealing with some technical issues (3) making assumptions that will hold when the auditor scrutinizes your valuation, and (4) how to deal with the volatility in shipping prices and daily shipping rates. Please provide a list of decisions you have to make in bullet point format. Note that you must perform the discounted cash flow analysis (PV) and all calculations and formulas should be done in an Excel sheet. If you feel that some information is missing, please make reasonable assumptions and provide an explanation and motivation for each assumption. List any sources you use to arrive at your assumptions and conclusions if any. What conclusions can you draw from your analysis?

Other Information (source: Clarkson’s):

Price/Values Brand New 5 Years Old 10 Years Old 20 Years old

AFRAMAX $45 million $30 million $19 million $7 million

New Production 2018 2019 2020 Total

AFRAMAX 17 58 23 98