The Charles H. Kellstadt Graduate School of Business
DePaul University
FIN 555: Financial Management
Prof. Randy Fisher
Case Study Questions: Ocean Carriers
These questions relate to the Ocean Carriers case in your course packet. You can find the data for this case on the course website in a spreadsheet named: Ocean Carriers Exhibits.xls.
This case provides the opportunity to make a capital budgeting decision by using discounted cash flow analysis to make an investment and corporate policy decision. Ocean Carriers is a shipping company evaluating a proposed lease of a ship for a threeyear period beginning in 2003. The proposed leasing contract offers very attractive terms, but no ship in Ocean Carrier’s current fleet meets the customer’s requirements. The firm must decide if future expected cash flows warrant the considerable investment in a new ship. For the questions below, assume that Ocean Carriers uses a 9% discount rate.
1. Do you expect daily spot hire rates to increase or decrease over the next few years? Give the reasons for your assessment. What factors drive average daily rates? What do you think of the longterm prospects of the capesize dry bulk industry?
2. How much is the cost of a new vessel in present value terms? Compared to the book value of the ship of $39M, what can you conclude about the effect of the installment payments?
3. Should Ms. Linn purchase the capesize carrier? Assume that it is going to be sold for scrap after 15 years. [Hint: Construct the Free Cash Flows of the project.]
4. Does your conclusion in (3) change if you instead assume that Ocean Carriers operates the capesize for the full life of 25 years before selling it for scrap value (grown by inflation)?
Assumptions on Tax Rates:
For questions (3) and (4) make two different assumptions. First, assume that Ocean Carriers is a U.S. firm subject to a 35% corporate taxation rate. Second, repeat the same exercise assuming that Ocean Carriers...
...
FINC5001 Capital Market and Corporate Finance

Workshop 5 – Capital Budgeting II
1. Basic Concepts Review
a) In applying NetPresentValue, what factors do we include, and what factors do we ignore?
Use cash flows not accounting income
Ignore
* sunk costs
* financing costs
Include
* opportunity costs
* side effects
* working capital
* taxation
* inflation
2. Practice Questions
a) After spending $3 million on research, Better Mousetraps has developed a new trap. The project requires an initial investment in plant and equipment of $6 million. This investment will be depreciated straightline over five years to a value of zero, but, when the project comes to an end in five years, the equipment can in fact be sold for $500,000. The firm believes that working capital at each date must be maintained at 10% of next year's forecasted sales. Production costs are estimated at $1.50 per trap and the traps will be sold for $4 each. (There are no marketing expenses.) Sales forecasts are given in the following table. The firm pays tax at 35% and the required return on the project is 12%. What is the NPV?

Figures in 000's  
Year  0  1  2  3  4  5 
Unit Sales   500  600  1,000  1,000  600 
Revenues   2,000  2,400  4,000  4,000  2,400 ...
...Examples Of NetPresentValue (NPV), ROI and
Payback Analysis
Introduction
Terms and Definitions
NetPresentValue  Method of calculating the expected net monetary gain or loss from a project by discounting all expected future cash inflows and outflows to the present point in time.
Discount Rate  Also known as the hurdle rate or required rate of return, is the rate that a project must achieve in order to be accepted rather than rejected.
Return on Investment – Expected income divided by the amount originally invested
Payback Analysis – The number of years needed to recover the initial cash outlay.
Formulas
NetPresentValue = (t=1..n A * (1+r)t OR (t=1..n A/ (1+r)t
Where A = Cash flow
r = Required rate of return
t = year of cash flow
n = the nth year
Return On Investment = (Discounted Benefits – Discounted Costs) / Discounted Costs
Payback Period = Years taken to repay initial outlay .
Eg. Project Z Outlay = $ 4000
Yearly cash flows = $2000...
...Netpresentvalue
In finance, the netpresentvalue (NPV) or netpresent worth (NPW) of a time series of cash flows, both incoming and outgoing, is defined as the sum of the presentvalues (PVs) of the individual cash flows. In case when all future cash flows are incoming (such as coupons and principal of a bond) and the only outflow of cash is the purchase price, the NPV is simply the PV of future cash flows minus the purchase price (which is its own PV). NPV is a central tool in discounted cash flow (DCF) analysis, and is a standard method for using the time value of money to appraise longterm projects. Used for capital budgeting, and widely throughout economics, finance, and accounting, it measures the excess or shortfall of cash flows, in presentvalue terms, once financing charges are met.
The NPV of a sequence of cash flows takes as input the cash flows and a discount rate or discount curve and outputting a price; the converse process in DCF analysis, taking as input a sequence of cash flows and a price and inferring as output a discount rate (the discount rate which would yield the given price as NPV) is called the yield, and is more widely used in bond trading.
Formula
Each cash inflow/outflow is discounted back to its presentvalue (PV). Then they are...
...debt to tangible net worth.
5. A measure of profitability and not shortterm liquidity is the
a. Accounts receivable turnover ratio.
b. Sales to working capital ratio.
c. Total asset turnover ratio.
d. Acidtest ratio.
6. Return on investment (ROI) is a term often used to express income earned on capital invested in a business unit. A company’s ROI would be increased if
a. Sales increased by the same peso amount as express and total assets increased.
b. Sales remained the same and expenses were reduced by the same peso amount that total assets increased.
c. Sales decreased by the same peso amount that expenses increased.
d. Sales and expenses increased by the same percentage that total assets increased.
(CMA adapted)
7. When a balance sheet amount is related to an income statement amount in computing a ration;
a. The balance sheet amount should be converted to an average for the year.
b. The income statement amount should be converted to an average for the year.
c. Both amounts should be converted to market value.
d. Comparisons with industry ratios are not meaningful.
(PhilCPA adapted)
8. Ratios are used for many purposes in financial statement analysis. In order to determine the return on investment for a company, the numerator of the fraction used should be
a. Net income.
b. Income before nonrecurring items.
c. Income before nonrecurring items and before income taxes.
d. Income before...
...restricted current assets policy; company would hold minimal amounts of these items. Current assets are necessary, but there are costs associated with holding them. Therefore, if D&D can manage its current assets more efficiently and thereby operate with smaller investment in working capital; this will increase D&D laundry profitability.
3. Would you suggest that the product be charged for the use of excess production facilities and building? Would this opinion change under the hypothetical assumption that needed production facilities for the current line of powdered detergents were at 55 percent of capacity and expected to grow at a rate 20 percent a year and maximum production capacity was 100 percent? What would be the presentvalue of this cash flow given the fact that the currently proposed new plant would involve cash outflows of $5 million in three years (assuming that acceptance of the Blast project would not affect the size of the proposed outlay, only the timing, and that the new plant and facilities would be operable indefinitely). (Hint: Assume that the introduction of Blast would only move the need for a new plant ahead by one year, that the cash outflow would remain at $5 million regardless of when incurred, and that the plant would operate indefinitely.)
In our opinion, the excess usage of production facilities and building would not be charge into Blast. The reasons of this are:
a) When the machine was bought...
...these two currencies is 1 euro =1.3118 dollars so in order to make easier the case we will use 1.31 to round it up.
The politics of the Group related to the management of the risk of change foresee, as a rule, the coverage of the future commercial flows that you/they will have bookkeeping demonstration within 12 months and of the orders acquired (or committed in progress) to put aside from their expiration. It is reasonable to believe that the relative effect of coverage suspended in the Reserve of cash flow hedge will primarily be in relief to economic account in the following exercise.
The Group is exposed to consequential risks by the variation of the rates of change, that you/they can influence on its economic result and on the value of the clean patrimony. Particularly:
Whereas the societies of the Group sustain costs denominated in different currencies by those of denomination of the respective proceeds, the variation of the rates of change can influence the Result operational of such societies. In 2012, the general amount of the commercial flows directly statements to the risk of change you/he/she has been equivalent to 10% around of the billing. Gives the last budget of Fiat the total billing of 83 billion of euro therefore the figure that we will go to analyze is equal to 830 million of Euro.
CASE STUDY
The Group, which operates in numerous markets worldwide, is naturally exposed to market risks stemming from fluctuations in currency and...
...Tesca team we were able to create a comprehensive capital budget and cash flow analysis for the proposed refrigerator project.
Through our analysis we found that the cost of capital of the project to be 13.487% and a Weighted Average Cost of Capital (WACC) to be at a value of 9.70%. Factoring in the WACC into our projections we found that if the demand maintains at an average rate the project will be at a positive NetPresentValue of $5,997,505.31 with an IRR of 13.21%, a profitability index of 8.84, and an approximate payback period of 6.84 years. Please see Exhibits below for a snapshot of the capital budget and NPV values.
This information seemed to be very promising for the project in general. However, our continued analysis showed the project to be very sensitive to the sales price per unit of the refrigerator. We used the average demand scenario to produce a sensitivity analysis and found that with just a 5% decrease in the sales price of the refrigerator the NPV quickly dipped into a negative value thus showing the project to be extremely sensitive to the sales price of the refrigerator.
Our scenario analysis also exposed a strong probability of the project giving a negative NetPresentValue and giving a probable low Internal Rate of Return of only 4.01%. This is mainly due to the projects sensitivity to the sales price of...
...investment but low rate investment such as Tbills or bonds.
E) Which of the following is true about the NPV and IRR techniques?
1) The NPV and IRR techniques always provide the same ranking of different investment projects.
2) The NPV and IRR techniques explicitly consider the cost of capital and the time value of money.
3) All projects can have only one value for NPV and one value for IRR.
4) The NPV technique cannot provide information on how acquiring the project will contribute to shareholders’ wealth.
Explanation: NPV calculates presentvalue of investment and opportunity cost of capital and IRR takes time value of money and cost of capital into consideration as well.
F) Which of the following is false?
1) The profitability index method explicitly considers the time value of money and the firm’s cost of capital.
2) The payback period is preferred by managers since it is simple, easy to calculate, and estimates how quickly the project cash flows will return the investment in the project.
3) The disadvantages of the payback period method are that it ignores project cash flows which occur after the payback period as well as the time value of money.
4) The profitability index method always ranks all projects in the same way that the IRR method does.
Explanation: In IRR method projects are accepted if the IRR is greater then...
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