General Comments-Ocean Carriers is a shipping company evaluating

General CommentsOcean Carriers is a shipping company evaluating a proposed lease of a ship for a three year period, beginning in 2003. The proposed leasing agreement offers very attractive terms, but no ship meets the customer’s requirements. The case centers on determining whether the expected cash flow warrant the considerable investment in a new ship. The case is an opportunity to evaluate a capital budgeting decision. The case is designed is have a determination based on the value and net present value of a real asset. It involves distinguishing between book and market values, identifying and forecasting incremental cash flows, understanding initial and ongoing capital expenditures, investment in working capital, and proceeds of asset sales. There are tax consequences of depreciation and asset sales, and you must completely evaluate whether a policy of reselling or scrapping a vessel is most desirable.1. From reviewing the case, do you expect daily spot hire rates to increase or decease next year? Why?2. What factors appear to be the drives for average daily hire rates?3. How would you characterize the long-term prospects of the dry bulk capsize shipping industry?4. Assume that Ocean Carriers uses a 9.0% project cost of capital for investments of this nature and uses straight line depreciation. Should Ms. Linn recommend that Ocean Carriers purchase the $39 million capsize? Make two different assumptions in developing your solution. First, assume that Ocean Carriers is a U.S. firm with income subject to 35% taxation. Second, assume that Ocean Carriers is located in Hong Kong, where owners of Hong Kong ships are not required to pay any taxes on profits make overseas (outside of Hong Kong) and are also exempted to from paying any tax on profits made on cargo uplifted (picked up for shipment) from Hong Kong.5. Does the company’s policy of not operating ships over 15 years old make good financial sense?(The timing of the cash flows with case may be initially confusing. Ocean Carriers is making a decision in January of 2001 with a new ship to be placed in operation in 2003. The payment for the ship is to be made in three installments: 2001, 2002, and 2003. The firm will begin to receive cash inflows from leasing the ship in 2003. However, the final payment for the ship at the beginning of 2003 and the total 2003 cash inflows from the lessee will probably not occur on the same date. The cash inflows will occur over the year, but the final payment at the beginning of the year.There are two alternative approaches for dealing with this using Excel. Using the Excel NPV function, you might define t = 0 as the year 2000 when the initial payment is made when the ship is ordered. Then t = 1 is 2001 with the second payment for the ship, t = 2 is 2002 for the final ship payment, and t = 4 is 2003 when they begin to receive lease payments as per exhibit 6 of the case. Alternatively, you might use the Excel XNPV function. Using this function, you might make a January 2001 as the date for the initial payment (assume 15 January 2001 for example). Then 15 January 2002 and 15 January 2003 for the subsequent ship purchase payments. As they will start receiving net cash inflows in 2003, you might select a midyear date for the recognition of these inflows—maybe 15 July 2003 (six months after placing the ship in service). In subsequent years, these cash inflows would be recognized on 15 July.)Required Case Analysis Computations1) Determining the cost of the new capsize2) Forecast expected cash flows3) Item 2) above entails developing a cash flow recipe that includes revenues, operating expenses, depreciation, operating income (EBIT), taxes, and EBIAT. In addition to these cash flows the analysis must add back the depreciation, account for capital expenditures, changes in net working capital, and after tax proceeds from sale of equipment to complete the cash flow determination.4) Also assume that repair costs grow with inflation and the tax rate in the US is 35%.5) Ocean Carriers uses a 9% discount rate.