Ocean Carriers

Objectives

• Forecast pro-forma cash flows

for a project

• Estimate project values using

Net Present Value (NPV)

• Conduct sensitivity analysis for

the forecast inputs
 Setting

• January 2001

• Customer offering attractive

terms on 3-year lease for a
capesize carrier

• Would require purchase of new

carrier since existing fleet does
not fulfill customer needs

• Should it be purchased?
 Industry Dynamics
• Revenue Drivers?
– Market for iron ore and coal
– Supply and demand
– Pro-cycle

• Outlook in the:
– Short run
– Next couple of years
– Long run

– S>D or D>S?
 Short run?

• Supply is “fixed”

• Spot price is $22K/day

• 3-yr contract price is $20K/day

• Prices likely to fall in the short

run
 LT Supply Factors

Capesize fleet by age category as of December 2000

35
29
Millions of Deadweight Tons

30

25 23
20
20 17
15
11
10
6
5 2

0
Over 24 20 to 24 15 to 19 10 to 14 5 to 9 Under 5 On Order
Years Years Years Years Years Years for 2001

Current worldwide fleet is rather new!

LT Supply factors

Very little forecasted scrapping!

 LT Supply Factors
Number of Vessels Ordered

70
63
60

50

40
33
30
21
20
9
10

0
2001 2002 2003 2004
Year

~20% increase in shipping capacity in

next four years

~10% in 2001 only

 Demand factor

• Forecast from consultants

• LT forecast for iron ore

– 2% in 2002-2005
– 1.5% after

• Supply is increasing more than

demand

→ LT Prices are likely to fall

 Project Evaluation

• Net Present Value (NPV)

examines the present value of
the cash flows net of the
present value of the initial
investment

• Value of the investment

• Estimates of the cash flows

 Initial Investment

• $39M vessel

• 10% due immediately

• 10% due in one year

• Remaining due at delivery in two

years

$3.9M $31.2M
PV = $3.9M + + = $33.74M
(1 + 9%) (1 + 9%) 2
Project Free Cash Flow
Operating Revenue
- Cost of Goods Sold
Gross Profit
- Depreciation
- Other Expenses
Operating Profit Before Interest and Taxes
- Taxes
Net Operating Profit After Taxes
+ Depreciation
- Capital Expenditures
- Increase in Working Capital
- Increase in Other Assets
Free Cash Flow
 Revenue

• Contract Revenues

• Estimated Charter Rates

• Adjustment for Vessel Age

• Expected Daily Rate

• Number of Operating Days

 Revenue
Exhibit 6
Age of Event Calendar Avg Daily Adjust- Expected Operating Revenue
Ship Year Year Charter ment Daily Hire Days
Rate Factor Rate
for Hire
Rate
0 2000 15,344
1 2001 14,747
2 2002 15,072
1 3 2003 15,403 1.150 20,000 357 $7,140,000
2 4 2004 15,742 1.150 20,200 357 $7,211,400
3 5 2005 16,088 1.150 20,400 357 $7,282,800
4 6 2006 16,273 1.150 18,714 357 $6,680,898
5 7 2007 16,460 1.050 17,283 357 $6,170,031
6 8 2008 16,650 1.050 17,481 353 $6,170,793
7 9 2009 16,841 1.050 17,682 353 $6,241,746
8 10 2010 17,035 1.050 17,886 353 $6,313,758
9 11 2011 17,231 1.050 18,092 353 $6,386,476
10 12 2012 17,429 1.000 17,428 353 $6,152,084
11 13 2013 17,629 1.000 17,628 349 $6,152,172
12 14 2014 17,832 1.000 17,831 349 $6,223,019
13 15 2015 18,037 1.000 18,036 349 $6,294,564
14 16 2016 18,245 1.000 18,243 349 $6,366,807
15 17 2017 18,454 0.800 14,762 349 $5,151,938
16 18 2018 18,667 0.800 14,932 349 $5,211,268
17 19 2019 18,881 0.800 15,104 349 $5,271,296
18 20 2020 19,098 0.800 15,278 349 $5,332,022
19 21 2021 19,318 0.800 15,454 349 $5,393,446
20 22 2022 19,540 0.750 14,654 349 $5,114,246
21 23 2023 19,765 0.750 14,823 349 $5,173,227
22 24 2024 19,992 0.750 14,993 349 $5,232,557
23 25 2025 20,222 0.750 15,166 349 $5,292,934
24 26 2026 20,455 0.750 15,341 349 $5,354,009
25 27 2027 20,690 0.650 13,448 349 $4,693,352
 Operating Costs

• Initial
Age of Event Calendar Costs per Operating
Ship Year Year day Costs

Cost 0
1
2000
2001
Estimate 1
2
3
2002
2003 4,000.0 $ 1,460,000
2 4 2004 4,160.0 $ 1,518,400
3 5 2005 4,326.4 $ 1,579,136
4 6 2006 4,499.5 $ 1,642,301
• Growth in 5
6
7
8
2007
2008
4,679.4
4,866.6
$ 1,707,993
$ 1,776,313
Costs 7
8
9
10
2009
2010
5,061.3
5,263.7
$ 1,847,366
$ 1,921,260
9 11 2011 5,474.3 $ 1,998,111
10 12 2012 5,693.2 $ 2,078,035
11 13 2013 5,921.0 $ 2,161,157
• Number 12 14 2014 6,157.8 $ 2,247,603
13 15 2015 6,404.1 $ 2,337,507
of Days 14 16 2016 6,660.3 $ 2,431,007
15 17 2017 6,926.7 $ 2,528,248
16 18 2018 7,203.8 $ 2,629,378
17 19 2019 7,491.9 $ 2,734,553
18 20 2020 7,791.6 $ 2,843,935
19 21 2021 8,103.3 $ 2,957,692
20 22 2022 8,427.4 $ 3,076,000
21 23 2023 8,764.5 $ 3,199,040
22 24 2024 9,115.1 $ 3,327,001
23 25 2025 9,479.7 $ 3,460,081
24 26 2026 9,858.9 $ 3,598,485
25 27 2027 10,253.2 $ 3,742,424
 Capital Expenditures

• Periodic Special Surveys

– $300K in 2007

– $350K in 2012

– $750K in 2017

– $850K in 2022

– 2027?
 Depreciation

• Initial Expenditure

– Straight-Line over 25 years

• Special Survey Expenditures

– Straight-Line over the next 5

years
 Operating Income and
Taxes
Age of Event Calendar Operating Taxable
Revenue Depr. Taxes NOPAT
Ship Year Year Costs Income

0 2000
1 2001
2 2002
1 3 2003 $ 7,140,000 $ 1,460,000 $ 1,560,000 $ 4,120,000 $ 1,442,000 $ 2,678,000
2 4 2004 $ 7,211,400 $ 1,518,400 $ 1,560,000 $ 4,133,000 $ 1,446,550 $ 2,686,450
3 5 2005 $ 7,282,800 $ 1,579,136 $ 1,560,000 $ 4,143,664 $ 1,450,282 $ 2,693,382
4 6 2006 $ 6,680,898 $ 1,642,301 $ 1,560,000 $ 3,478,597 $ 1,217,509 $ 2,261,088
5 7 2007 $ 6,170,031 $ 1,707,993 $ 1,560,000 $ 2,902,038 $ 1,015,713 $ 1,886,324
6 8 2008 $ 6,170,793 $ 1,776,313 $ 1,620,000 $ 2,774,480 $ 971,068 $ 1,803,412
7 9 2009 $ 6,241,746 $ 1,847,366 $ 1,620,000 $ 2,774,380 $ 971,033 $ 1,803,347
8 10 2010 $ 6,313,758 $ 1,921,260 $ 1,620,000 $ 2,772,498 $ 970,374 $ 1,802,123
9 11 2011 $ 6,386,476 $ 1,998,111 $ 1,620,000 $ 2,768,365 $ 968,928 $ 1,799,437
10 12 2012 $ 6,152,084 $ 2,078,035 $ 1,620,000 $ 2,454,049 $ 858,917 $ 1,595,132
11 13 2013 $ 6,152,172 $ 2,161,157 $ 1,630,000 $ 2,361,015 $ 826,355 $ 1,534,660
12 14 2014 $ 6,223,019 $ 2,247,603 $ 1,630,000 $ 2,345,416 $ 820,896 $ 1,524,520
13 15 2015 $ 6,294,564 $ 2,337,507 $ 1,630,000 $ 2,327,057 $ 814,470 $ 1,512,587
14 16 2016 $ 6,366,807 $ 2,431,007 $ 1,630,000 $ 2,305,800 $ 807,030 $ 1,498,770
15 17 2017 $ 5,151,938 $ 2,528,248 $ 1,630,000 $ 993,690 $ 347,792 $ 645,899
16 18 2018 $ 5,211,268 $ 2,629,378 $ 1,710,000 $ 871,890 $ 305,162 $ 566,729
17 19 2019 $ 5,271,296 $ 2,734,553 $ 1,710,000 $ 826,743 $ 289,360 $ 537,383
18 20 2020 $ 5,332,022 $ 2,843,935 $ 1,710,000 $ 778,087 $ 272,331 $ 505,757
19 21 2021 $ 5,393,446 $ 2,957,692 $ 1,710,000 $ 725,754 $ 254,014 $ 471,740
20 22 2022 $ 5,114,246 $ 3,076,000 $ 1,710,000 $ 328,246 $ 114,886 $ 213,360
21 23 2023 $ 5,173,227 $ 3,199,040 $ 1,730,000 $ 244,187 $ 85,466 $ 158,722
22 24 2024 $ 5,232,557 $ 3,327,001 $ 1,730,000 $ 175,556 $ 61,444 $ 114,111
23 25 2025 $ 5,292,934 $ 3,460,081 $ 1,730,000 $ 102,853 $ 35,998 $ 66,854
24 26 2026 $ 5,354,009 $ 3,598,485 $ 1,730,000 $ 25,524 $ 8,934 $ 16,591
25 27 2027 $ 4,693,352 $ 3,742,424 $ 1,730,000 $ (779,072) $ (272,675) $ (506,397)
 Working Capital
Change in
Calendar Working
Working
Year Capital
Capital
• Initial 2000
Investment 2001
2002 $ 500,000 $ 500,000
2003 $ 515,000 $ 15,000
2004 $ 530,450 $ 15,450
2005 $ 546,364 $ 15,914
• Source of 2006 $ 562,754 $ 16,391
2007 $ 579,637 $ 16,883
Increase 2008 $ 597,026 $ 17,389
2009 $ 614,937 $ 17,911
2010 $ 633,385 $ 18,448
2011 $ 652,387 $ 19,002

• Recovery of 2012
2013
$ 671,958
$ 692,117
$
$
19,572
20,159

Investment 2014
2015
$ 712,880
$ 734,267
$
$
20,764
21,386
2016 $ 756,295 $ 22,028
2017 $ 778,984 $ 22,689
2018 $ 802,353 $ 23,370
• Annual 2019 $ 826,424 $ 24,071
2020 $ 851,217 $ 24,793
Change 2021 $ 876,753 $ 25,536
2022 $ 903,056 $ 26,303
2023 $ 930,147 $ 27,092
2024 $ 958,052 $ 27,904
2025 $ 986,793 $ 28,742
2026 $ 1,016,397 $ 29,604
2027 $ - $ (1,016,397)
 Cash Flow Estimates
Change in
Calendar Survey Taxable
Depr. Taxes Working Free Cash Flow
Year CapEx Income
Capital

2000 $ -
2001 $ -
2002 $ 500,000 $ (500,000)
2003 $ 1,560,000 $ 4,120,000 $ 1,442,000 $ 15,000 $ 4,223,000
2004 $ 1,560,000 $ 4,133,000 $ 1,446,550 $ 15,450 $ 4,231,000
2005 $ 1,560,000 $ 4,143,664 $ 1,450,282 $ 15,914 $ 4,237,468
2006 $ 1,560,000 $ 3,478,597 $ 1,217,509 $ 16,391 $ 3,804,697
2007 $ 300,000 $ 1,560,000 $ 2,902,038 $ 1,015,713 $ 16,883 $ 3,129,442
2008 $ 1,620,000 $ 2,774,480 $ 971,068 $ 17,389 $ 3,406,023
2009 $ 1,620,000 $ 2,774,380 $ 971,033 $ 17,911 $ 3,405,436
2010 $ 1,620,000 $ 2,772,498 $ 970,374 $ 18,448 $ 3,403,675
2011 $ 1,620,000 $ 2,768,365 $ 968,928 $ 19,002 $ 3,400,436
2012 $ 350,000 $ 1,620,000 $ 2,454,049 $ 858,917 $ 19,572 $ 2,845,560
2013 $ 1,630,000 $ 2,361,015 $ 826,355 $ 20,159 $ 3,144,501
2014 $ 1,630,000 $ 2,345,416 $ 820,896 $ 20,764 $ 3,133,757
2015 $ 1,630,000 $ 2,327,057 $ 814,470 $ 21,386 $ 3,121,201
2016 $ 1,630,000 $ 2,305,800 $ 807,030 $ 22,028 $ 3,106,742
2017 $ 750,000 $ 1,630,000 $ 993,690 $ 347,792 $ 22,689 $ 1,503,210
2018 $ 1,710,000 $ 871,890 $ 305,162 $ 23,370 $ 2,253,359
2019 $ 1,710,000 $ 826,743 $ 289,360 $ 24,071 $ 2,223,313
2020 $ 1,710,000 $ 778,087 $ 272,331 $ 24,793 $ 2,190,964
2021 $ 1,710,000 $ 725,754 $ 254,014 $ 25,536 $ 2,156,204
2022 $ 850,000 $ 1,710,000 $ 328,246 $ 114,886 $ 26,303 $ 1,047,057
2023 $ 1,730,000 $ 244,187 $ 85,466 $ 27,092 $ 1,861,630
2024 $ 1,730,000 $ 175,556 $ 61,444 $ 27,904 $ 1,816,207
2025 $ 1,730,000 $ 102,853 $ 35,998 $ 28,742 $ 1,768,113
2026 $ 1,730,000 $ 25,524 $ 8,934 $ 29,604 $ 1,716,987
2027 $ 1,730,000 $ (779,072) $ (272,675) $ (1,016,397) $ 2,240,000
 Optimal Scrap Time
• What do you get by selling the
vessel for scrap?

– Scrap value earlier

– Avoid survey expenditures

• What do you lose by selling the

vessel for scrap?

– Cash flows from years after the

vessel is scrapped
 Optimal Scrap Time
• Year 15 versus Year 25

– Receive $5 million salvage value plus extra

depreciation tax shield in year 15
• $5M + 35%*($15.6M - $5M) = $8.71 million

– Avoid $750K CapEx in year 15

– Recover $779K in working capital in year 15

– Forego cash flows in years 16 thru 25

• PV = $12.56 million

– Forego receiving salvage value in year 25

• PV = $1.4 million

• Result of scrapping in year 15:

– Loss of $3.7 million
 NPV with Taxes

• Initial Investment
– $33.74 million

• Present Value of Cash Flows

– $26.47 million

• Present Value of Scrap Value

– Year 25 CF: $3.25 M
– PV: $317K

• NPV: -$6.95 million

 NPV without Taxes

• Initial Investment
– $33.74 million

• Present Value of Cash Flows

– $34.11 million

• Present Value of Scrap Value

– Year 25 CF: $5 M
– PV: $488K

• NPV: $857 thousand

 Sensitivity Analyses

• Once the template is in place,

we can examine the sensitivity
to any of our assumptions:
– Sales Growth

– Operating Cost changes

– Survey Capital Expenditures

– Working Capital

– Cost of Capital
 Conclusions

• The project generates a huge

loss if it is registered in the U.S.

• Proceed with the purchase if we

can register the ship in Hong
Kong

• Are we comfortable with the

projected charter rates given the
economics of the industry?
 Takeaways

• Discounted Cash Flow models

allow us to incorporate a great deal
of precise forecast data into our
evaluations

• The strength of the result heavily

depends upon the precision of the
inputs

• Once the model is in place, we can

see how sensitive our decision is to
assumption changes