Essay About Next Year And Daily Hire Rate

Capesize Dry Bulk Industry
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Capesize dry bulk industryCapesize dry bulk industry mainly operated vessel-renting business. Carriers normally ranged in size from 80,000 deadweight tons to 210,000 deadweight tons of cargo carrying capacity. The company who owned and operated this type of vessels chartered the ship to another company, i.e., the charterer, who had the requirement of carrying cargos. The charterer should pay daily hire rate to the company while the company provides seaworthy vessel and manned the vessel with a certified crew.Daily hire rates were determined by supply and demand. Both the number of current and potential operating vessels in the market jointly determined daily hire rate. The supply was mainly affected by the market demand and the increases in size and efficiency of the newer ships offered. The demand was related to the worldwide economic. When the worldwide economic condition became strong, economic entities would require more ore and coal, leading the increasing of demand for mineral transportation and skyrocketing of the daily hire rates. Besides, changes in trade patterns, for example, the switch of supply of iron ore from United States to Australia, would affect the demand for capsizes because of different sailing distance.Considering the following reasons, we anticipated daily spot hire rates to decrease in 2002. First, as shown in the current order book of new capsize vessels, 63 new vessels were scheduled for delivery in 2001, compared with 33 in 2002, 21 in 2003 and 9 in 2004. It suggested that an increasing number of ships would be in service next year. While the quantity of ships keep increasing, the quality of ships remains in a relatively high level. As of December 2000, most of the worldwide fleet of capsizes was fairly young and there had been very few scrappings in recent years. In sum, both quantity and quality of ship indicated that the supply of capsizes would be sufficient next year. As for the demand side, imports of iron ore and coal would probably remain stagnant over the next two years due to the stability of world economy. As a result, companies may demand less transporting, leading the deceasing of daily hire rates. Besides, from the 1999 to 2000, average spot charter rates experienced a dramatically increase and almost doubled to 22,575 in 2000 compared to 9427 in 1999. This spot rate in 2000 was far higher than the average 3-year charter rate. Thus the charterers would prefer to trade in the time charter market to avoid paying high daily rates next year. Therefore, the spot rates would stand a high probability to fall in 2001 and 2002.However, in the long run we hold an optimistic view on the prospects of the capsize dry bulk industry. The strong perspective of overall economic condition drove our conclusion. Iron ore demand always indicated future worldwide economic condition. With Australian production in iron ore expected to be strong and Indian iron ore exports expected to take off in the next few years, the long-term macro economy would be bright, causing market demand for capsizes to increase. Given the positive correlation between iron ore shipments and charters historically, the chartering price would be boosted. According to the case material, the long-term forecast for worldwide iron ore vessel shipments was for 2% annual growth during 2002 to 2005, and then dropping to 1.5% thereafter.

Ocean Carriers’ investment decisionOcean Carriers was one of the main capesize carriers companies who operated several kinds of charter modes. In January 2001, a charterer wanted to make a deal with Ocean Carriers for a three-year time charter starting in 2003 with a rate of 20,000 per day and an annual escalation of 200. However, no ship in Ocean Carrier’s current fleet met the customer’s requirements. Ms. Linn, Vice President of Finance or Ocean Carriers, had to decide whether Ocean Carriers should immediately commission a new capsize carrier lease to the customer. We highly recommended Ms. Linn to use NPV approach to evaluate new ship investment. The company had a policy of not operating vessels older than 15 years, so the time span is 15 years from 2003 to 2017. Since the ship still needs two years to prepare, we start our calculation at the end of 2000 (year 0). The actual time span was 17 years. First of all, we begin by reviewing the revenue and cost of Ocean Carriers. There were only cash outflows in the initial 3 years (2000 to 2002) since the new ship needs to be prepared in these years. Specifically, Linn expected to make 500,000 in net working capital as initial investment. The increase in NWC which reduced free cash flow would be included in year 2 (2002). Although Linn enlisted the services of a shipping-industry consulting firm, this expenditure was regarded as a sunk cost since it was belonged to past research and development expenditures. Then we started to analyze the earnings from 2003(year 3) when the new ship began to be in service. For a three-year time charter starting in 2003, the company would obtain 20,000 per day in 2003 with an annual escalation of 200 per day in the new two years. After that, we calculated the revenue of the following years by the forecast of daily hire rates of the consulting group. Because the charterers were not charged a daily rate for the time the vessel spent in maintenance and repair, the revenue of these days must be deducted. Then we tried to find out the operation cost of this new ship. For a new ship coming on line in early 2003, operating costs were expected to initially average 4000 per day, and to increase annually at a rate of 4% (1% above 3% inflation rate). Second, we computed the capital expenditure and depreciation. Since a new ship would be depreciated on a straight-line basis over 25 years, the depreciation amount every year is 1,560,000. Besides, every five years, a special survey would be undertaken to ensure seaworthiness. Special surveys were considered capital expenditures, which would each be depreciated on a straight-line basis over a 5-year period. For example, in 2007, the capital expenditure was 300,000 as a cash outflow and depreciated at a rate of 60,000 per year from 2008 to 2012. With estimated revenues, costs and depreciations, we can calculate EBIT. Third, we needed to get the tax rate to calculate net income. Because the interest expense associated with debt was not included in the project, the net income is unlevered. We made 2 different assumptions to decide the tax rate. Ocean Carriers in a U.S. firm subject to 35% taxation while in Hong Kong, the taxation was 0%. Thus the unleveled net income equals EBIT * (1 – tax rate). Finally, after estimating the earnings, we could determine the project’s free cash flow and NPV. According to the formula, Free Cash Flow = (Revenues – Costs – Depreciation) * (1 – tax rate ) + Depreciation – CapEx -∆ NWC, the depreciation of tangible asset (the ship) and intangible asset (the special survey) was added back and the capital expenditure (the cost of new ship and special survey) was deducted. What’s more, the increase in net working capital per year should be deducted. The initial investment of 500,000 in NWC was expected to grow with the 3% inflation rate every year. And in the last year, we got the investment back and the NWC became zero and ∆ NWC became negative. The invested NWC was eventually added back when the project was over. Still we could not forget that the scrapping value of vessel should be added back to FCF in the last year. Then to compute the NPV, we used the 9% discount rate. The NPV of the project is the sum of the present values of each free cash flow. We can see that when the company bought this new ship and operated 15 years, the NPVs under the discount rate of 9% were negative in both scenarios as reported in Exhibit 1. In this case, this investment had to be refused.