Case Study 1 – Ocean Carriers
1. The Capital Budgeting Decision
Should Ms. Linn purchase the Capesize vessel?
Assume that Ocean Carriers is a U.S. firm and is subject to 35% taxation. (Please see excel sheets)
From our analysis it appears that Ms. Linn should not buy the Capesize vessel. The Net Present Value on the Ocean Carrier is not a positive number, a clear indicator that buying the vessels is not a good idea. The tax rate of 35% makes a lot of difference in determining this NPV. In our calculations we did assume a tax rate on the final sale of the vessel. If it were possible, or known, the tax rate on the salvage it might be more feasible to buy the vessel, and end up with a positive NPV. The effect of taxes on EBIT and thereby NPV is easily seen in our analysis numbers. As taxes remain steady and profits from operations falls, the prudence of the investment becomes apparent.
Assume that Ocean Carriers in based in Hong Kong, where owners of Hong Kong ships are not required to pay any tax on profits made overseas and also are exempt from paying any tax on profit made on cargo uplifted from Hong Kong. (Please see excel sheets)
If the tax rate were a non-issue it would make sense to buy the vessel. Running our analysis with a zero tax rate gave a positive NPV. This is due to the effects of taxes on EBIT. While it is more realistic to expect a tax rate, draw of having a zero tax rate would make this project more attractive to management, and possible. It may have also been advantage in the analysis we ran to see the effects a change in the discount rate has on the NPV. Couple with a zero tax rate there could be some definite gains from investing in the vessel.
3. Internal Rate of Return
Calculate the Internal Rate of Return for the investment in this new vessel. According to the IRR, should Ocean Carriers accept the project? Please discuss separately for the U.S. case and Hong Kong case. (Please see excel sheets)
The IRR for the US...
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