TO:MS MARY LINN
CC:PROF. TOM MILLER
FROM:RYAN DALE SEELKE
RE:DECISION ON CAPE SIZE CARRIER
Ms Mary Linn,
After careful cash flow analysis and a discount rate (WACC) of 9%, commissioning a capsize carrier for 25 years is the only appropriate option for our firm. However, if the discount were instead 10%, both options would fail the NPV test by yielding negative results. I make this recommendation after thorough analysis of estimated cash flow and with the desire that our required 15-year life span will be amended. With the expected 9% discount rate, commissioning a capsize carrier for 15 years and then scrapping it as is company policy would ultimately yield a NPV of (1,252,916). However, if Ocean Carriers decided to commission its ship for 25 years, then the NPV would be a positive 368,557. Since current company policy is to scrap ships after 15 years, management should look at these numbers in detail and consider revising its dated policy. As mentioned above, this recommendation hinges on a 9% discount rate. If our cost of debt or cost of equity would change, then this would change our WACC and thus our discount rate. Therefore, if either the cost of equity or debt increases and our subsequent discount rate were to be 10% rather than the expected 9%, then both options would yield a negative NPV and neither should be undertaken. If the opposite happened, and the discount rate was 8%, then both options would yield a positive NPV. In this case, the 25-year option is more profitable due to its NPV being greater. Details are below (Italics showing recommendation at appropriate discount rate).
15 Year$815,580 ($1,252,916)($3,076,460)
25 Year$2,865,297 $368,557 ($1,793,116)
With current projections of cash flow and the estimated 9% discount rate, this project is acceptable only if the company allows the commissioning of 25-year old ships....