May have help with A-F? Savannah Merchant Marine Co. (henceforth "SMM" or the firm/company) is a cargo shipping company based in Savannah, Georgia, that operates freight vessels in various sizes. In December 2050, the firm is reviewing the proposal for a new dry bulk carrier in an attempt to capture a potential increase in the global demand for freight shipping. The CFO has asked you to estimate cash flows expected from the new ship over its asset life. To aid the analysis, the CFO and the SMM Finance team have collected data from various sources, as summarized below. a) Discount rate, inflation, tax, and other information CFO has made the following baseline assumptions: ? The discount rate is assumed to be 12%, p.a. (per annum) ? For simplicity, the CFO has decided to use an expected inflation rate of 3%, p.a., over the next three decades. ? SMM is expected to face a marginal tax rate of 20%. b) Investments requirements The purchase price of the new vessel is $44 million. If ordered before the end of 2050, the ship will be ready by the end of 2052. If SMM decides to purchase the ship, 10% of the price is due at the end of 2050, another 10% is due at the end of 2051, and the balance is payable at the end of 2052 when the ship is delivered. It will then begin operating from the beginning of 2053. The useful life of the ship is 25 years with no salvage value. The project life is assumed to be equal to the ship life. The depreciation is on a straight-line basis. The CFO also assumes that the firm will liquidate the vessel at the end of its life. Based on your industry survey, the market value of the ship at the end of its life is estimated at $8 million c) Additional capital expenditures required To enhance the performance and the cost efficiency of its vessels, the firm makes additional investments in its fleet on a regular basis, typically every five years. Given the liquidation expected at the end of its 25th year, the new ship will undergo four installments of these capital expenditures, with the first one taking place at the end of its 5th year (i.e., 2057 if the ship is ready by the end of 2052). Factoring in additional costs required for old vessels and the overall inflation, these expenditures are estimated as follows: $300,000 (1st); $350,000 (2nd); $650,000 (3rd); and $1,200,000 (4th) The firm is allowed to capitalize these four expenditures, and each will be depreciated over five years on a straight-line basis, with no remaining book value at the end. d) Workingcapitalrequirements The CFO expects that the operation of the new ship requires an initial working capital investment of $500,000 by the beginning of 2053 (equivalently, "the end of 2052"). From then on, the working capital balance requirement will grow each year at a rate of inflation (provided in subsection a). The working capital balance will be recovered at the end of the project life. e) Assumptions for forecasting daily hire rates and revenues The annual revenues are determined by daily ship hire rates (prices) prevailing in the market and the number of days the ship is expected to be hired in a given year. The market price is the function of the demand for shipments and the supply of shipment capacity. The CFO has obtained from Clarksons the industry experts' forecast for these factors on an annual basis, as summarized in the spreadsheet. In addition, the CFO has come up with the following econometric model for forecasting the rates at which the average daily prices will change each year: ? = 0.007 + 1.4?? ? 1.6?? where y = % change in ship hire rate; x1 = % change in demand; x2 = % change in supply, all on an annual basis. For example, suppose that in 2051, the expected growth in the demand for shipments is 0.0217 and the expected growth in the supply of shipping capacity is 0.0213 (note that these figures are taken from the spreadsheet). Then, based on these forecasts and the CFO's model, the % change in daily ship hire rate is estimated at 0.007 + 1.4(0.0217) - 1.6(0.0213) = 0.0032 (0.32%). Given the hire rate $50,000 (given) in 2050, the rate in 2051 is then estimated at $50,000*(1.0032) = $50,160 per day. See the spreadsheet for detailed forecasts for the demand and supply and the % changes in these variables. The number of days hired is assumed to be equal to 365 days less the number of days required to complete the annual mandatory maintenance. The company's assumption is that it takes 14 days to complete the annual maintenance. f) Assumptions for operating costs The CFO assumes that the operating costs are incurred throughout the year, including the mandatory maintenance period. The annual operating costs therefore can be calculated as the estimated daily operating costs, multiplied by 365 days. In addition, daily operating costs are assumed to grow at a rate that is slightly higher than the expected inflation. The CFO suggests the following equation: ????? ?????? = ????? ???????1(1 + ?)(1.01), where subscript t indexes year, and h is the expected inflation rate, provided in subsection a. For example, given the average daily cost in 2050 estimated at $14,000 (given), the daily cost in 2051 is then estimated at $14,000*(1.03)(1.01) = $14,564 (per day)

 

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Daily hire rate forecasting Calendar year 2050 2051 2052 2053 2054 2056 2057 2058 2060 1 2062 3 2064 2065 2066 2068 2070 2071 2 2073 2074 2075 2076 2077 Ship year (SY) SYO SY1 SY2 SY3 SY4 SY5 SY6 SY7 SY8 SY9 SY10 SY11 SY12 SY13 SY14 SY15 SY16 SY17 SY18 SY19 SY20 SY21 SY22 SY23 SY24 SY25 Industry forecast for shipment demand Estimated annual shipments (millions of tons) 3,415 3,489 3,559 3,634 3,703 3,773 3,833 3,887 3,946 4,007 4,061 4,129 4,191 4,258 4,319 4,381 4,449 4,511 4,586 4,647 4,717 4,793 4,863 4,938 5,007 5,085 5,161 5,239 *1 (% change in demand) 0.022 0.020 0.021 0.019 0.016 0.014 5 0.015 0.013 3 0.017 0.015 6 0.014 0.014 6 0.014 0.017 3 0.015 0.016 0.015 0.015 0.014 0.016 0.015 0.015 Industry forecast for the ship supply Estimated net capacity (new order - scrap) 3,375 3,44 3,519 3,591 3,663 3,744 3,933 4,140 4,248 4,356 4,509 4,815 4,968 5,049 5,157 5,211 5,193 5,139 5,139 5,220 5,283 5,301 5,310 5,499 5,751 6,057 6,165 5 6,237 X2 (% change in supply) 0.021 0.021 0.020 0.020 0.022 0.050 0.053 0.026 0.025 0.035 0.068 0.032 0.016 0.021 0.010 -0.003 -0.010 0.000 0.016 0.012 0.003 0.002 2 0.036 0.046 50.053 0.018 0.012 Daily hire rate forecast "Model: y = 0.007 + 1.4*x; - 1.6*X2 y (% change in daily hire rate) 0.003 Estimated daily hire rates ($000s) 50.0 50.160 "Avg. daily hire rate in 2050 = $50 thousand (given) Project DCF valuation Valuation summary Discount rate : 12.0% Tax rate : 20.0% Inflation : 3.0% Project NPV ($000s) = v estimation ($000s) Time-line (t = 0 : end of 2050) -....-> 0 10 12 19 20 21 22 23 24 25 26 27 Calendar year 2050 2051 2052 205 2054 2055 205 205 205 2059 206 206 206 2063 206 2067 207 2071 207 207 2074 2075 2076 2077 Ship year (SY) SY SY1 SY2 SY3 SY5 SY6 206 SY7 SY8 SY9 SY10 SY1 SY14 SY15 2068 Y1 SY18 SY19 SY20 SY21 SY2 SY23 SY24 SY25 Daily hire rate growth assumption 0.32% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% Est. daily hire rates, $000s 50.00 Est. days of operation (14 days to subtract) 351 351 351 351 351 35 351 351 351 351 351 351 351 351 351 351 351 351 351 351 351 351 351 351 351 Est. daily oper. costs, $000s, growing @(1+ infl)*1.01 14.00 Revenues (= daily hire rate x days of oper) - Costs (= daily cost x 365) OOO Gross profits Oo - Depr -- acquisition cost ($44 min /25 years) - Depr -- additional capex SY5, SY10, SY15, SY20 (each capex/5 years) - Depr total EBIT - Income taxes Unlevered net income ($000s) [+] Depr add back "WC balance (to be recovered at the end) 500 [-] Changes in WC (incr. = outflow) *Ship acquisition cost (10%, 10% & 80% of $44 min) *Add'l capex (0.3 min; 0.35 min; 0.65 min; 1.2 min) [-] Investment costs total (sum of the above two) [+] CF from liquidation "Liquidation at the end of SY25 (cash flow, net of tax) -> -.---- Liquidation at the end of SY25 (cash flow, net of tax) -> Unlevered CF ($000s) DCF Discounted (Unlevered) CF (i.e., PV) 0 0 0 0 NPV (sum of all discounted cash flows) =