The charterer currently in negotiations with Ocean Carriers for a three-year time charter starting in 2003 had
Question:
The charterer currently in negotiations with Ocean Carriers for a three-year time charter starting in 2003 had offered a rate of $20,000 per day with an annual escalation of $200 per day. The expected rate of inflation was 3%.
The vessels in Ocean Carriers’ current fleet could not be committed to a time charter beginning in 2003 because the ships were either already leased during that period or were too small to meet the customer’s needs. Moreover, there were no sufficiently large capesizes available in the second-hand market. Ocean Carriers had to decide immediately if it should commission a new 180,000 deadweight ton ship for delivery in early 2003. The ship would cost $39 million, with 10% of the purchase price payable immediately and 10% due in a year’s time. The balance would be due on delivery. A new ship would be depreciated on a straight-line basis over 25 years. In addition, Linn expected to make a $500,000 initial investment in net working capital, which she anticipated would grow with inflation.
Linn was also confident that the charterer would honor his proposed contract with Ocean Carriers if the company agreed to the terms. While there is always a risk that the charterer would stop paying before the end of the contract or terminate the contract early, Linn considered that the risk was small. Ocean Carriers had long established relationships with its charterers and only contracted with reputable charterers.
The proposed contract, though, was only for three years, and it was Linn’s responsibility to decide if future market conditions warranted the considerable investment in a new ship.
It is your job to evaluate the commisioning of a new capesize carrier by ocean carriers in response to a lease, as described in the case study write up. In answering the below questions, assume ocean carrier's discount rate is 9%.
1. Should Ms. Linn purchase the $39M capesize? Make 2 different assumptions. First assume that Ocean Carriers is a U.S. firm subject to 35% taxation. Second assume that Ocean Carriers is located in Hong Kong, where owners oh Hong Kong ships are not required to pay any tax on profits made overseas and are also exempted from paying any tax on profit made on cargo uplifted from Hong Kong. Show Calculations & explanation