Assignment 1

Ocean Carriers

MScEcon 2014 Spring

RC. LI (SID: ********)

I
Should Ms Linn purchase the $39M capsize? Make two different assumptions. First,
assume that Ocean Carriers is a U.S. firm subject to a 35% statutory (and effective)
marginal tax rate. Second, assume that Ocean Carriers is domiciled in Hong Kong for
tax purposes, where ship owners 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, i.e., assume a zero tax rate.

Assumptions:
1 Use constant discount rate of 9%.
2 New ships depreciate on a straight-line basis over 25 years with a salvage value of
zero.
3 The market value of the ship in the second-hand market is the same to book value
including capital expenditure for maintenance.
4 After the year 2005, the new ship would continue operate at E[Daily Hire Rate]
adjusted.
5 Operation cost is initially 4,000 per day, and grows at the rate 4%.
6 Net Working Capital is initially 500,000 and grows with inflation.
7 Scrap value at 2017 is $5M, and adjusted by inflation rate when scrapping in other
years.
8 There is no default risk.
9 There is no side effect such as erosion and synergy.
10 When scrapping the ship at special survey year, the firm does not spend money on
maintenance. At year 2027 the firm does not sell it in second-hand market and only
scrap it.
11 The firm would recover Net Working Capital before selling or scrapping the ship.
12 Calculate one year as 365 days.

1.1 Assume that the firm is a U.S. firm subject to a 35% marginal tax rate and scrap
the ship after 15 years operation.

0.00
0.00
0.00
3.69
3.70
3.71
3.28
2.90
2.86
2.86
2.86
2.85
2.65
2.59
2.58
2.57
2.56
1.71

3.90
3.90
31.20
0.00
0.00
0.00
0.00
0.30
0.00
0.00
0.00
0.00
0.35
0.00
0.00
0.00
0.00
(8.71)

0.00
0.00
0.50
0.015
0.0155
0.0159
0.0164
0.0169
0.0174
0.0179
0.0184
0.019
0.0196
0.0202
0.0208
0.0214
0.022
(0.76)

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
8.71

(3.90)
(3.90)
(31.70)
3.68
3.69
3.69
3.26
2.58
2.84
2.84
2.84
2.83
2.28
2.57
2.56
2.55
2.54
11.17

1.00
0.92
0.84
0.77
0.71
0.65
0.60
0.55
0.50
0.46
0.42
0.39
0.36
0.33
0.30
0.27
0.25
0.23
NPV

(3.90)
(3.58)
(26.68)
2.84
2.61
2.40
1.94
1.41
1.42
1.31
1.20
1.10
0.81
0.84
0.77
0.70
0.64
2.58
(11.59)

Scrap Value ($M)

0.00
0.00
0.00
3.69
3.70
3.71
3.28
2.90
2.86
2.86
2.86
2.85
2.65
2.59
2.58
2.57
2.56
1.71

Book Value ($M)

0.00
0.00
0.00
1.99
1.99
2.00
1.76
1.56
1.54
1.54
1.54
1.54
1.43
1.40
1.39
1.39
1.38
0.92

Net Working
Capital($M)

Operating Cash
Flow($M)

0.00
0.00
0.00
5.68
5.69
5.70
5.04
4.46
4.40
4.39
4.39
4.39
4.07
3.99
3.98
3.96
3.94
2.62

PV of Cash Flow
(PV[CF])($M)

After-Tax Income($M)

0.00
0.00
0.00
1.56
1.56
1.56
1.56
1.56
1.62
1.62
1.62
1.62
1.62
1.63
1.63
1.63
1.63
1.63

PV Factor: 1/(1+r) t

Tax Paid($M)

0.00
0.00
0.00
1.46
1.52
1.58
1.64
1.71
1.78
1.85
1.92
2.00
2.08
2.16
2.25
2.34
2.43
2.53

Free Cash Flow

(FCF)($M)

Taxable Income($M)

0.00
0.00
0.00
7.14
7.21
7.28
6.68
6.17
6.17
6.24
6.31
6.39
6.15
6.15
6.22
6.29
6.37
5.15

Asset Sales (after

tax)($M)

Depreciation($M)

0.00
0.00
0.00
357
357
357
357
357
353
353
353
353
353
349
349
349
349
349

Change in Net Working

Capital (D NWC)($M)

Operating Costs ($M)

0.00
0.00
0.00
4,000
4,160
4,326
4,499
4,679
4,867
5,061
5,264
5,474
5,693
5,921
6,158
6,404
6,660
6,927

Capital Expenditures
(CAPEX)($M)

Revenue ($M)

20,000
20,200
20,400
18,714
17,283
17,483
17,683
17,887
18,093
17,429
17,629
17,832
18,037
18,245
14,763

Days Hired (per year)

1.15
1.15
1.15
1.15
1.05
1.05
1.05
1.05
1.05
1.00
1.00
1.00
1.00
1.00
0.80

E[Daily Hire Rate]

15,344
14,747
15,072
15,403
15,742
16,088
16,273
16,460
16,650
16,841
17,035
17,231
17,429
17,629
17,832
18,037
18,245
18,454

Adjustment Factor

400
436
444.72
453.61
462.69
471.94
479.02
486.2
493.5
500.9
508.41
516.04
523.78
531.64
539.61
547.71
555.92
564.26

39 ($M)
4.00% Straight-line amortization over 25 years
35%
3.00%
9.00%
the ship until scrapping it at year25)

Daily Operating Cost

1
2
3
4
5
6
7
8
9
10
11
12
13
14
15

2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017

E[Daily Charter Rate]

0
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17

E[Iron Ore Shipments]

Calender Year

Event Year

Age of Ship

Base Parameters & Assumptions

Acquisition Cost of Ship
Annual Depreciation Rate
Tax Rate
Expected Inflation Rate
Discount Rate
1)if operate ships over 15 years(do not sell

0.00
0.00
0.50
0.52
0.53
0.55
0.56
0.58
0.60
0.61
0.63
0.65
0.67
0.69
0.71
0.73
0.76
0.00

39.00
37.44
35.88
34.32
32.76
31.50
29.88
28.26
26.64
25.02
23.75
22.12
20.49
18.86
17.23
15.60

3.31
3.40
3.51
3.61
3.72
3.83
3.95
4.07
4.19
4.31
4.44
4.58
4.71
4.85
5.00

The Net Present Value is $-11.59M. So reject the project.

1.2 Assume that the firm is a U.S. firm subject to a 35% marginal tax rate and sell the
ship in the second-hand market after 15 years operation.
Base Parameters & Assumptions
Acquisition Cost of Ship
39 ($M)
Annual Depreciation Rate
4.00% Straight-line amortization over 25 years
Tax Rate
35%
Expected Inflation Rate
3.00%
Discount Rate

9.00%

1.00
0.92
0.84
0.77
0.71
0.65
0.60
0.55
0.50
0.46
0.42
0.39
0.36
0.33
0.30
0.27
0.25
0.23
NPV

PV of Cash Flow
(PV[CF])($M)

1/(1+r)t

PV Factor:

Free Cash Flow

(FCF)($M)
(3.90)
(3.90)
(31.70)
3.68
3.69
3.69
3.26
2.58
2.84
2.84
2.84
2.83
2.28
2.57
2.56
2.55
2.54
18.06

(3.90)
(3.58)
(26.68)
2.84
2.61
2.40
1.94
1.41
1.42
1.31
1.20
1.10
0.81
0.84
0.77
0.70
0.64
4.17
(10.00)

Scrap Value
($M)

0.00
0.00
0.00
0.00
0.50
0.00
0.015 0.00
0.01545 0.00
0.01591 0.00
0.01639 0.00
0.01688 0.00
0.01739 0.00
0.01791 0.00
0.01845 0.00
0.019 0.00
0.01957 0.00
0.02016 0.00
0.02076 0.00
0.02139 0.00
0.02203 0.00
(0.76) 16.35

Book Value ($M)

3.90
3.90
31.20
0.00
0.00
0.00
0.00
0.30
0.00
0.00
0.00
0.00
0.35
0.00
0.00
0.00
0.00
(15.60)

Asset Sales
(after tax)($M)

0.00
0.00
0.00
3.69
3.70
3.71
3.28
2.90
2.86
2.86
2.86
2.85
2.65
2.59
2.58
2.57
2.56
1.71

Change in Net
Working Capital
(D NWC)($M)

0.00
0.00
0.00
3.69
3.70
3.71
3.28
2.90
2.86
2.86
2.86
2.85
2.65
2.59
2.58
2.57
2.56
1.71

Capital
Expenditures
(CAPEX)($M)

0.00
0.00
0.00
1.99
1.99
2.00
1.76
1.56
1.54
1.54
1.54
1.54
1.43
1.40
1.39
1.39
1.38
0.92

Net Working
Capital($M)

0.00
0.00
0.00
5.68
5.69
5.70
5.04
4.46
4.40
4.39
4.39
4.39
4.07
3.99
3.98
3.96
3.94
2.62

Operating Cash
Flow($M)

0.00
0.00
0.00
1.56
1.56
1.56
1.56
1.56
1.62
1.62
1.62
1.62
1.62
1.63
1.63
1.63
1.63
1.63

After-Tax
Income($M)

0.00
0.00
0.00
1.46
1.52
1.58
1.64
1.71
1.78
1.85
1.92
2.00
2.08
2.16
2.25
2.34
2.43
2.53

Tax Paid($M)

0.00
0.00
0.00
7.14
7.21
7.28
6.68
6.17
6.17
6.24
6.31
6.39
6.15
6.15
6.22
6.29
6.37
5.15

Taxable
Income($M)

Depreciation($M
)

Days Hired (per

year)

20,000
20,200
20,400
18,714
17,283
17,483
17,683
17,887
18,093
17,429
17,629
17,832
18,037
18,245
14,763

Operating Costs
($M)

1.15
1.15
1.15
1.15
1.05
1.05
1.05
1.05
1.05
1.00
1.00
1.00
1.00
1.00
0.80

0.00 0.00
0.00 0.00
0.00 0.00
4,000 357
4,160 357
4,326 357
4,499 357
4,679 357
4,867 353
5,061 353
5,264 353
5,474 353
5,693 353
5,921 349
6,158 349
6,404 349
6,660 349
6,927 349

Revenue ($M)

15,344
14,747
15,072
15,403
15,742
16,088
16,273
16,460
16,650
16,841
17,035
17,231
17,429
17,629
17,832
18,037
18,245
18,454

Daily Operating
Cost

E[Iron Ore
Shipments]
400
436
445
454
463
472
479
486
493
501
508
516
524
532
540
548
556
564

E[Daily Hire
Rate]

Calender Year
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017

Adjustment
Factor

Event Year

1
2
3
4
5
6
7
8
9
10
11
12
13
14
15

0
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17

E[Daily Charter
Rate]

Age of Ship

1)if operate ships over 15 years(do not sell the ship until scrapping it at year25)

0.00
0.00
0.50
0.52
0.53
0.55
0.56
0.58
0.60
0.61
0.63
0.65
0.67
0.69
0.71
0.73
0.76
0.00

39.00
37.44
35.88
34.32
32.76
31.50
29.88
28.26
26.64
25.02
23.75
22.12
20.49
18.86
17.23
16.35

3.31
3.40
3.51
3.61
3.72
3.83
3.95
4.07
4.19
4.31
4.44
4.58
4.71
4.85
5.00

The Net Present Value is $-10M. So reject the project.

1.3 Assume that the firm is domiciled in Hong Kong enjoying a zero tax rate and
scrap the ship after 15 years operation.

0.00
0.00
0.00
5.68
5.69
5.70
5.04
4.46
4.40
4.39
4.39
4.39
4.07
3.99
3.98
3.96
3.94
2.62

3.90
3.90
31.20
0.00
0.00
0.00
0.00
0.30
0.00
0.00
0.00
0.00
0.35
0.00
0.00
0.00
0.00
(5.00)

0.00
0.00
0.50
0.015
0.0155
0.0159
0.0164
0.0169
0.0174
0.0179
0.0184
0.019
0.0196
0.0202
0.0208
0.0214
0.022
(0.76)

0.00 (3.90)
0.00 (3.90)
0.00 (31.70)
0.00
5.67
0.00
5.68
0.00
5.69
0.00
5.02
0.00
4.15
0.00
4.38
0.00
4.38
0.00
4.37
0.00
4.37
0.00
3.70
0.00
3.97
0.00
3.96
0.00
3.94
0.00
3.91
5.00
8.38

1.00 (3.90)
0.92 (3.58)
0.84 (26.68)
0.77
4.37
0.71
4.02
0.65
3.70
0.60
2.99
0.55
2.27
0.50
2.20
0.46
2.02
0.42
1.85
0.39
1.69
0.36
1.32
0.33
1.30
0.30
1.18
0.27
1.08
0.25
0.99
0.23
1.94
NPV
(1.25)

Scrap Value ($M)

0.00
0.00
0.00
5.68
5.69
5.70
5.04
4.46
4.40
4.39
4.39
4.39
4.07
3.99
3.98
3.96
3.94
2.62

Book Value ($M)

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

Net Working
Capital($M)

0.00
0.00
0.00
5.68
5.69
5.70
5.04
4.46
4.40
4.39
4.39
4.39
4.07
3.99
3.98
3.96
3.94
2.62

PV of Cash Flow
(PV[CF])($M)

Operating Cash
Flow($M)

0.00
0.00
0.00
1.56
1.56
1.56
1.56
1.56
1.62
1.62
1.62
1.62
1.62
1.63
1.63
1.63
1.63
1.63

PV Factor: 1/(1+r) t

After-Tax Income($M)

0.00
0.00
0.00
1.46
1.52
1.58
1.64
1.71
1.78
1.85
1.92
2.00
2.08
2.16
2.25
2.34
2.43
2.53

Free Cash Flow

(FCF)($M)

Tax Paid($M)

0.00
0.00
0.00
7.14
7.21
7.28
6.68
6.17
6.17
6.24
6.31
6.39
6.15
6.15
6.22
6.29
6.37
5.15

Asset Sales (after

tax)($M)

Taxable Income($M)

0.00
0.00
0.00
357
357
357
357
357
353
353
353
353
353
349
349
349
349
349

Change in Net Working

Capital (D NWC)($M)

Depreciation($M)

0.00
0.00
0.00
4,000
4,160
4,326
4,499
4,679
4,867
5,061
5,264
5,474
5,693
5,921
6,158
6,404
6,660
6,927

Capital Expenditures
(CAPEX)($M)

Operating Costs ($M)

20,000
20,200
20,400
18,714
17,283
17,483
17,683
17,887
18,093
17,429
17,629
17,832
18,037
18,245
14,763

Revenue ($M)

1.15
1.15
1.15
1.15
1.05
1.05
1.05
1.05
1.05
1.00
1.00
1.00
1.00
1.00
0.80

Days Hired (per year)

E[Daily Hire Rate]

15,344
14,747
15,072
15,403
15,742
16,088
16,273
16,460
16,650
16,841
17,035
17,231
17,429
17,629
17,832
18,037
18,245
18,454

Adjustment Factor

400
436
444.72
453.61
462.69
471.94
479.02
486.2
493.5
500.9
508.41
516.04
523.78
531.64
539.61
547.71
555.92
564.26

39 ($M)
4.00% Straight-line amortization over 25 years
0%
3.00%
9.00%
the ship until scrapping it at year25)

Daily Operating Cost

1
2
3
4
5
6
7
8
9
10
11
12
13
14
15

2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017

E[Daily Charter Rate]

0
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17

E[Iron Ore Shipments]

Calender Year

Event Year

Age of Ship

Base Parameters & Assumptions

Acquisition Cost of Ship
Annual Depreciation Rate
Tax Rate
Expected Inflation Rate
Discount Rate
1)if operate ships over 15 years(do not sell

0.00
0.00
0.50
0.52
0.53
0.55
0.56
0.58
0.60
0.61
0.63
0.65
0.67
0.69
0.71
0.73
0.76
0.00

39.00
37.44
35.88
34.32
32.76
31.50
29.88
28.26
26.64
25.02
23.75
22.12
20.49
18.86
17.23
15.60

3.31
3.40
3.51
3.61
3.72
3.83
3.95
4.07
4.19
4.31
4.44
4.58
4.71
4.85
5.00

The Net Present Value is $-1.25M. So reject the project.

1.4 Assume that the firm is domiciled in Hong Kong enjoying a zero tax rate and sell
the ship in the second-hand market after 15 years operation.

0.00
0.00
0.00
5.68
5.69
5.70
5.04
4.46
4.40
4.39
4.39
4.39
4.07
3.99
3.98
3.96
3.94
2.62

0.00
0.00
0.00
5.68
5.69
5.70
5.04
4.46
4.40
4.39
4.39
4.39
4.07
3.99
3.98
3.96
3.94
2.62

3.90
3.90
31.20
0.00
0.00
0.00
0.00
0.30
0.00
0.00
0.00
0.00
0.35
0.00
0.00
0.00
0.00
(15.60)

0.00
0.00
0.00
0.00
0.50
0.00
0.015 0.00
0.0155 0.00
0.0159 0.00
0.0164 0.00
0.0169 0.00
0.0174 0.00
0.0179 0.00
0.0184 0.00
0.019 0.00
0.0196 0.00
0.0202 0.00
0.0208 0.00
0.0214 0.00
0.022 0.00
(0.76) 16.35

(3.90)
(3.90)
(31.70)
5.67
5.68
5.69
5.02
4.15
4.38
4.38
4.37
4.37
3.70
3.97
3.96
3.94
3.91
18.98

1.00
(3.90)
0.92
(3.58)
0.84 (26.68)
0.77
4.37
0.71
4.02
0.65
3.70
0.60
2.99
0.55
2.27
0.50
2.20
0.46
2.02
0.42
1.85
0.39
1.69
0.36
1.32
0.33
1.30
0.30
1.18
0.27
1.08
0.25
0.99
0.23
4.39
NPV
1.20

Scrap Value ($M)

Capital Expenditures
(CAPEX)($M)

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

Book Value ($M)

Operating Cash
Flow($M)

0.00
0.00
0.00
5.68
5.69
5.70
5.04
4.46
4.40
4.39
4.39
4.39
4.07
3.99
3.98
3.96
3.94
2.62

Net Working
Capital($M)

After-Tax Income($M)

0.00
0.00
0.00
1.56
1.56
1.56
1.56
1.56
1.62
1.62
1.62
1.62
1.62
1.63
1.63
1.63
1.63
1.63

PV of Cash Flow
(PV[CF])($M)

Tax Paid($M)

0.00
0.00
0.00
1.46
1.52
1.58
1.64
1.71
1.78
1.85
1.92
2.00
2.08
2.16
2.25
2.34
2.43
2.53

PV Factor: 1/(1+r) t

Taxable Income($M)

0.00
0.00
0.00
7.14
7.21
7.28
6.68
6.17
6.17
6.24
6.31
6.39
6.15
6.15
6.22
6.29
6.37
5.15

Free Cash Flow

(FCF)($M)

Depreciation($M)

0.00
0.00
0.00
357
357
357
357
357
353
353
353
353
353
349
349
349
349
349

Asset Sales (after

tax)($M)

Operating Costs ($M)

0.00
0.00
0.00
4,000
4,160
4,326
4,499
4,679
4,867
5,061
5,264
5,474
5,693
5,921
6,158
6,404
6,660
6,927

Change in Net Working

Capital (D NWC)($M)

Revenue ($M)

20,000
20,200
20,400
18,714
17,283
17,483
17,683
17,887
18,093
17,429
17,629
17,832
18,037
18,245
14,763

Days Hired (per year)

1.15
1.15
1.15
1.15
1.05
1.05
1.05
1.05
1.05
1.00
1.00
1.00
1.00
1.00
0.80

E[Daily Hire Rate]

15,344
14,747
15,072
15,403
15,742
16,088
16,273
16,460
16,650
16,841
17,035
17,231
17,429
17,629
17,832
18,037
18,245
18,454

Adjustment Factor

400
436
444.72
453.61
462.69
471.94
479.02
486.2
493.5
500.9
508.41
516.04
523.78
531.64
539.61
547.71
555.92
564.26

39 ($M)
4.00% Straight-line amortization over 25 years
0%
3.00%
9.00%
the ship until scrapping it at year25)

Daily Operating Cost

2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017

E[Daily Charter Rate]

1
2
3
4
5
6
7
8
9
10
11
12
13
14
15

0
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17

E[Iron Ore Shipments]

Calender Year

Event Year

Age of Ship

Base Parameters & Assumptions

Acquisition Cost of Ship
Annual Depreciation Rate
Tax Rate
Expected Inflation Rate
Discount Rate
1)if operate ships over 15 years(do not sell

0.00
0.00
0.50
0.52
0.53
0.55
0.56
0.58
0.60
0.61
0.63
0.65
0.67
0.69
0.71
0.73
0.76
0.00

39.00
37.44
35.88
34.32
32.76
31.50
29.88
28.26
26.64
25.02
23.75
22.12
20.49
18.86
17.23
16.35

3.31
3.40
3.51
3.61
3.72
3.83
3.95
4.07
4.19
4.31
4.44
4.58
4.71
4.85
5.00

The Net Present Value is $1.20M. So accept the project.

Summary: If the firm is domiciled in Hong Kong enjoying a zero tax rate and sell the
ship in the second-hand market after 15 years operation, Ms Linn should purchase
the $39M capesize.

II

What do you think of the companys policy of not operating ships over 15 years old?
Assume that Ocean Carriers can fully utilize any tax benefit it derives from asset
sales.
Keep the assumptions in part I.
2.1 Assume that the firm is a U.S. firm subject to a 35% marginal tax rate and scrap
the ship after 25 years operation.

Operating Cash
Flow($M)

Capital Expenditures
(CAPEX)($M)

Change in Net Working

Capital (D NWC)($M)

Asset Sales (after

tax)($M)

0.00
0.00
0.00
1.99
1.99
2.00
1.76
1.56
1.54
1.54
1.54
1.54
1.43
1.40
1.39
1.39
1.38
0.92
0.90
0.89
0.87
0.85
0.71
0.69
0.67
0.64
0.61
0.33

0.00
0.00
0.00
3.69
3.70
3.71
3.28
2.90
2.86
2.86
2.86
2.85
2.65
2.59
2.58
2.57
2.56
1.71
1.68
1.65
1.62
1.58
1.33
1.28
1.24
1.19
1.14
0.62

0.00
0.00
0.00
3.69
3.70
3.71
3.28
2.90
2.86
2.86
2.86
2.85
2.65
2.59
2.58
2.57
2.56
1.71
1.68
1.65
1.62
1.58
1.33
1.28
1.24
1.19
1.14
0.62

3.90
3.90
31.20
0.00
0.00
0.00
0.00
0.30
0.00
0.00
0.00
0.00
0.35
0.00
0.00
0.00
0.00
0.75
0.00
0.00
0.00
0.00
0.85
0.00
0.00
0.00
0.00
(4.37)

0.00
0.00
0.50
0.015
0.0155
0.0159
0.0164
0.0169
0.0174
0.0179
0.0184
0.019
0.0196
0.0202
0.0208
0.0214
0.022
0.0227
0.0234
0.0241
0.0248
0.0255
0.0263
0.0271
0.0279
0.0287
0.0296
(1.02)

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
0.00
4.37

(3.90)
(3.90)
(31.70)
3.68
3.69
3.69
3.26
2.58
2.84
2.84
2.84
2.83
2.28
2.57
2.56
2.55
2.54
0.93
1.66
1.62
1.59
1.56
0.45
1.26
1.21
1.16
1.11
6.00

1.00
(3.90)
0.92
(3.58)
0.84 (26.68)
0.77
2.84
0.71
2.61
0.65
2.40
0.60
1.94
0.55
1.41
0.50
1.42
0.46
1.31
0.42
1.20
0.39
1.10
0.36
0.81
0.33
0.84
0.30
0.77
0.27
0.70
0.25
0.64
0.23
0.22
0.21
0.35
0.19
0.32
0.18
0.28
0.16
0.26
0.15
0.07
0.14
0.17
0.13
0.15
0.12
0.13
0.11
0.12
0.10
0.59
NPV (11.52)

0.00
0.00
0.50
0.52
0.53
0.55
0.56
0.58
0.60
0.61
0.63
0.65
0.67
0.69
0.71
0.73
0.76
0.78
0.80
0.83
0.85
0.88
0.90
0.93
0.96
0.99
1.02
0.00

Scrap Value ($M)

After-Tax Income($M)

0.00
0.00
0.00
5.68
5.69
5.70
5.04
4.46
4.40
4.39
4.39
4.39
4.07
3.99
3.98
3.96
3.94
2.62
2.58
2.54
2.49
2.44
2.04
1.97
1.91
1.83
1.76
0.95

Book Value ($M)

Tax Paid($M)

0.00
0.00
0.00
1.56
1.56
1.56
1.56
1.56
1.62
1.62
1.62
1.62
1.62
1.63
1.63
1.63
1.63
1.63
1.71
1.71
1.71
1.71
1.71
1.73
1.73
1.73
1.73
1.73

Net Working
Capital($M)

Taxable Income($M)

0.00
0.00
0.00
1.46
1.52
1.58
1.64
1.71
1.78
1.85
1.92
2.00
2.08
2.16
2.25
2.34
2.43
2.53
2.63
2.73
2.84
2.96
3.08
3.20
3.33
3.46
3.60
3.74

PV of Cash Flow
(PV[CF])($M)

Depreciation($M)

0.00
0.00
0.00
7.14
7.21
7.28
6.68
6.17
6.17
6.24
6.31
6.39
6.15
6.15
6.22
6.29
6.37
5.15
5.21
5.27
5.33
5.39
5.11
5.17
5.23
5.29
5.35
4.69

PV Factor: 1/(1+r) t

Operating Costs ($M)

0.00
0.00
0.00
357
357
357
357
357
353
353
353
353
353
349
349
349
349
349
349
349
349
349
349
349
349
349
349
349

Free Cash Flow

(FCF)($M)

Revenue ($M)

20,000
20,200
20,400
18,714
17,283
17,483
17,683
17,887
18,093
17,429
17,629
17,832
18,037
18,245
14,763
14,934
15,105
15,278
15,455
14,655
14,824
14,994
15,167
15,341
13,449

0.00
0.00
0.00
4,000
4,160
4,326
4,499
4,679
4,867
5,061
5,264
5,474
5,693
5,921
6,158
6,404
6,660
6,927
7,204
7,492
7,792
8,103
8,427
8,764
9,115
9,480
9,859
10,253

Days Hired (per year)

1.15
1.15
1.15
1.15
1.05
1.05
1.05
1.05
1.05
1.00
1.00
1.00
1.00
1.00
0.80
0.80
0.80
0.80
0.80
0.75
0.75
0.75
0.75
0.75
0.65

Daily Operating Cost

15,344
14,747
15,072
15,403
15,742
16,088
16,273
16,460
16,650
16,841
17,035
17,231
17,429
17,629
17,832
18,037
18,245
18,454
18,667
18,881
19,098
19,319
19,540
19,765
19,992
20,222
20,455
20,690

Adjustment Factor

400
436
444.72
453.61
462.69
471.94
479.02
486.2
493.5
500.9
508.41
516.04
523.78
531.64
539.61
547.71
555.92
564.26
572.72
581.32
590.04
598.89
607.87
616.99
626.24
635.64
645.17
654.85

39 ($M)
4.00% Straight-line amortization over 25 years
35%
3.00%
9.00%
the ship until scrapping it at year25)

E[Daily Hire Rate]

2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
2020
2021
2022
2023
2024
2025
2026
2027

E[Daily Charter Rate]

1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25

0
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
26
27

E[Iron Ore Shipments]

Calender Year

Event Year

Age of Ship

Base Parameters & Assumptions

Acquisition Cost of Ship
Annual Depreciation Rate
Tax Rate
Expected Inflation Rate
Discount Rate
1)if operate ships over 15 years(do not sell

39.00
37.44
35.88
34.32
32.76
31.50
29.88
28.26
26.64
25.02
23.75
22.12
20.49
18.86
17.23
16.35
14.64
12.93
11.22
9.51
8.65
7.26
5.87
4.48
3.09
1.70

3.31
3.40
3.51
3.61
3.72
3.83
3.95
4.07
4.19
4.31
4.44
4.58
4.71
4.85
5.00
5.15
5.30
5.46
5.63
5.80
5.97
6.15
6.33
6.52
6.72

The Net Present Value is $-11.52M. So reject the project.

2.2 Assume that the firm is domiciled in Hong Kong enjoying a zero tax rate and
scrap the ship after 25 years operation.

Operating Cash
Flow($M)

Capital Expenditures
(CAPEX)($M)

Change in Net Working

Capital (D NWC)($M)

Asset Sales (after

tax)($M)

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
0.00
0.00

0.00
0.00
0.00
5.68
5.69
5.70
5.04
4.46
4.40
4.39
4.39
4.39
4.07
3.99
3.98
3.96
3.94
2.62
2.58
2.54
2.49
2.44
2.04
1.97
1.91
1.83
1.76
0.95

0.00
0.00
0.00
5.68
5.69
5.70
5.04
4.46
4.40
4.39
4.39
4.39
4.07
3.99
3.98
3.96
3.94
2.62
2.58
2.54
2.49
2.44
2.04
1.97
1.91
1.83
1.76
0.95

3.90
3.90
31.20
0.00
0.00
0.00
0.00
0.30
0.00
0.00
0.00
0.00
0.35
0.00
0.00
0.00
0.00
0.75
0.00
0.00
0.00
0.00
0.85
0.00
0.00
0.00
0.00
(6.72)

0.00
0.00
0.50
0.015
0.0155
0.0159
0.0164
0.0169
0.0174
0.0179
0.0184
0.019
0.0196
0.0202
0.0208
0.0214
0.022
0.0227
0.0234
0.0241
0.0248
0.0255
0.0263
0.0271
0.0279
0.0287
0.0296
(1.02)

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
0.00
6.72

Scrap Value ($M)

After-Tax Income($M)

0.00
0.00
0.00
5.68
5.69
5.70
5.04
4.46
4.40
4.39
4.39
4.39
4.07
3.99
3.98
3.96
3.94
2.62
2.58
2.54
2.49
2.44
2.04
1.97
1.91
1.83
1.76
0.95

Book Value ($M)

Tax Paid($M)

0.00
0.00
0.00
1.56
1.56
1.56
1.56
1.56
1.62
1.62
1.62
1.62
1.62
1.63
1.63
1.63
1.63
1.63
1.71
1.71
1.71
1.71
1.71
1.73
1.73
1.73
1.73
1.73

Net Working
Capital($M)

Taxable Income($M)

0.00
0.00
0.00
1.46
1.52
1.58
1.64
1.71
1.78
1.85
1.92
2.00
2.08
2.16
2.25
2.34
2.43
2.53
2.63
2.73
2.84
2.96
3.08
3.20
3.33
3.46
3.60
3.74

PV of Cash Flow
(PV[CF])($M)

Depreciation($M)

0.00
0.00
0.00
7.14
7.21
7.28
6.68
6.17
6.17
6.24
6.31
6.39
6.15
6.15
6.22
6.29
6.37
5.15
5.21
5.27
5.33
5.39
5.11
5.17
5.23
5.29
5.35
4.69

PV Factor: 1/(1+r) t

Operating Costs ($M)

0.00
0.00
0.00
357
357
357
357
357
353
353
353
353
353
349
349
349
349
349
349
349
349
349
349
349
349
349
349
349

Free Cash Flow

(FCF)($M)

Revenue ($M)

20,000
20,200
20,400
18,714
17,283
17,483
17,683
17,887
18,093
17,429
17,629
17,832
18,037
18,245
14,763
14,934
15,105
15,278
15,455
14,655
14,824
14,994
15,167
15,341
13,449

0.00
0.00
0.00
4,000
4,160
4,326
4,499
4,679
4,867
5,061
5,264
5,474
5,693
5,921
6,158
6,404
6,660
6,927
7,204
7,492
7,792
8,103
8,427
8,764
9,115
9,480
9,859
10,253

Days Hired (per year)

Daily Operating Cost

15,344
14,747
15,072
15,403
15,742
16,088
16,273
16,460
16,650
16,841
17,035
17,231
17,429
17,629
17,832
18,037
18,245
18,454
18,667
18,881
19,098
19,319
19,540
19,765
19,992
20,222
20,455
20,690

39 ($M)
4.00% Straight-line amortization over 25 years
0%
3.00%
9.00%
the ship until scrapping it at year25)

E[Daily Hire Rate]

E[Daily Charter Rate]

400
436
444.72
453.61
462.69
471.94
479.02
486.2
493.5
500.9
508.41
516.04
523.78
531.64
539.61
547.71
555.92
564.26
572.72
581.32
590.04
598.89
607.87
616.99
626.24
635.64
645.17
654.85

Adjustment Factor

E[Iron Ore Shipments]

Calender Year

Event Year

Age of Ship

Base Parameters & Assumptions

Acquisition Cost of Ship
Annual Depreciation Rate
Tax Rate
Expected Inflation Rate
Discount Rate
1)if operate ships over 15 years(do not sell

1.56

1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25

0
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
26
27

2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
2020
2021
2022
2023
2024
2025
2026
2027

1.15
1.15
1.15
1.15
1.05
1.05
1.05
1.05
1.05
1.00
1.00
1.00
1.00
1.00
0.80
0.80
0.80
0.80
0.80
0.75
0.75
0.75
0.75
0.75
0.65

(3.90)
(3.90)
(31.70)
5.67
5.68
5.69
5.02
4.15
4.38
4.38
4.37
4.37
3.70
3.97
3.96
3.94
3.91
1.85
2.56
2.51
2.46
2.41
1.16
1.95
1.88
1.80
1.73
8.69

1.00
0.92
0.84
0.77
0.71
0.65
0.60
0.55
0.50
0.46
0.42
0.39
0.36
0.33
0.30
0.27
0.25
0.23
0.21
0.19
0.18
0.16
0.15
0.14
0.13
0.12
0.11
0.10
NPV

(3.90)
(3.58)
(26.68)
4.37
4.02
3.70
2.99
2.27
2.20
2.02
1.85
1.69
1.32
1.30
1.18
1.08
0.99
0.43
0.54
0.49
0.44
0.39
0.17
0.27
0.24
0.21
0.18
0.85
1.03

0.00
0.00
0.50
0.52
0.53
0.55
0.56
0.58
0.60
0.61
0.63
0.65
0.67
0.69
0.71
0.73
0.76
0.78
0.80
0.83
0.85
0.88
0.90
0.93
0.96
0.99
1.02
0.00

39.00
37.44
35.88
34.32
32.76
31.50
29.88
28.26
26.64
25.02
23.75
22.12
20.49
18.86
17.23
16.35
14.64
12.93
11.22
9.51
8.65
7.26
5.87
4.48
3.09
1.70

3.31
3.40
3.51
3.61
3.72
3.83
3.95
4.07
4.19
4.31
4.44
4.58
4.71
4.85
5.00
5.15
5.30
5.46
5.63
5.80
5.97
6.15
6.33
6.52
6.72

The Net Present Value is $1.03M. But this value is lower than $1.20M of selling after
15 years. So the 15-year policy is better than 25-year policy.
2.3 Real Option Analysis
Now we consider which year is the best to sell the ship given the above assumptions.
Suppose the firm could sell the ship in the second-hand market at book value at any
year after the charter contract, by the assumptions made in part I, the results are as
follows:

This graph shows that as the ship ages, the NPV of selling it after operation is
increasing from age 6 on, reach a peak at age 14, and decrease thereafter. This result
implies that the firm should sell it at age 14 rather than age 15.
III
Suppose Ocean Carriers pays fixed annual dues of $500,000 to an association of ship
owners that provides services to its members such as light houses, lobbying efforts,
etc. Should a portion of these dues be included in the NPV calculation for the capesize?
If so, what portion seems right?
Answer:
The annual due paid to an association of ship owners is a fixed cost which should be
accounted to administrative expense of the firm but not the project. This is irrelevant
to the decision so we should not include it in the NPV calculation for the capesize.
IV
Suppose that, two years ago, Ocean Carriers lost a large lawsuit related to a maritime
accident where it allegedly caused a competitors ship to sustain extensive damage.
As a result, Ocean Carriers was fined $10,000,000, which it settled to pay over 10
years. Should the balance of this fine (now standing at $8,000,000) be included in the
NPV calculation for the capesize?
Answer:
The balance of this fine is irrelevant to the project so we should not include it in the
NPV calculation for the capesize.