TAMU Understanding The Lumpiness Involved During Supply Project

1Project DCF valuation
Valuation summary
Discount rate :
Tax rate :
Inflation :
Project NPV ($000s) =
12,0%
20,0%
3,0%
0
Cash flow estimation ($000s)
Time-line (t = 0 : end of 2050) ——>
Calendar year
Ship year (SY)
1
2051
2
2052
SY0
3
2053
SY1
4
2054
SY2
5
2055
SY3
6
2056
SY4
7
2057
SY5
8
2058
SY6
9
2059
SY7
10
2060
SY8
11
2061
SY9
12
2062
SY10
13
2063
SY11
0,32%
0,00%
0,00%
0,00%
0,00%
0,00%
0,00%
0,00%
0,00%
0,00%
0,00%
0,00%
0,00%
351
351
351
351
351
351
351
351
351
351
351
Revenues (= daily hire rate x days of oper )
– Costs (= daily cost x 365)
Gross profits
– Depr — acquisition cost ($44 mln /25 years)
– Depr — additional capex SY5, SY10, SY15, SY20 (each capex/5 years)
– Depr total
EBIT
– Income taxes
Unlevered net income ($000s)
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
[+] Depr add back
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
Daily hire rate growth assumption
Est. daily hire rates, $000s
Est. days of operation (14 days to subtract)
Est. daily oper. costs, $000s, growing @(1+ infl)*1.01
.
.
0
2050
50,00
14,00
*WC balance (to be recovered at the end)
[-] Changes in WC (incr. = outflow)
*Ship acquisition cost (10%, 10% & 80% of $44 mln)
*Add’l capex (0.3 mln; 0.35 mln; 0.65 mln; 1.2 mln)
[-] Investment costs total (sum of the above two)
500
0
0
[+] CF from liquidation *Liquidation at the end of SY25 (cash flow, net of tax) ——>
.
Unlevered CF ($000s)
DCF Discounted (Unlevered) CF (i.e., PV)
NPV (sum of all discounted cash flows) =
0
0
0
2
Project DCF valuation
Valuation summary
Discount rate :
Tax rate :
Inflation :
Project NPV ($000s) =
12,0%
20,0%
3,0%
0
Cash flow estimation ($000s)
Time-line (t = 0 : end of 2050) ——>
Calendar year
Ship year (SY)
14
2064
SY12
15
2065
SY13
16
2066
SY14
17
2067
SY15
18
2068
SY16
19
2069
SY17
20
2070
SY18
21
2071
SY19
22
2072
SY20
23
2073
SY21
24
2074
SY22
25
2075
SY23
26
2076
SY24
27
2077
SY25
0,00%
0,00%
0,00%
0,00%
0,00%
0,00%
0,00%
0,00%
0,00%
0,00%
0,00%
0,00%
0,00%
0,00%
351
351
351
351
351
351
351
351
351
351
351
351
351
351
Revenues (= daily hire rate x days of oper )
0
– Costs (= daily cost x 365)
0
Gross profits
0
– Depr — acquisition cost ($44 mln /25 years)
– Depr — additional capex SY5, SY10, SY15, SY20 (each capex/5 years)
– Depr total
0
EBIT
– Income taxes
Unlevered net income ($000s)
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
[+] Depr add back
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
Daily hire rate growth assumption
Est. daily hire rates, $000s
Est. days of operation (14 days to subtract)
Est. daily oper. costs, $000s, growing @(1+ infl)*1.01
.
.
*WC balance (to be recovered at the end)
[-] Changes in WC (incr. = outflow)
*Ship acquisition cost (10%, 10% & 80% of $44 mln)
*Add’l capex (0.3 mln; 0.35 mln; 0.65 mln; 1.2 mln)
[-] Investment costs total (sum of the above two)
—— Liquidation at the end of SY25 (cash flow, net of tax) ——>
[+] CF from liquidation *Liquidation at the end of SY25 (cash flow, net of tax) ——>
.
Unlevered CF ($000s)
DCF Discounted (Unlevered) CF (i.e., PV)
NPV (sum of all discounted cash flows) =
0
0
0
0
0
0
0
0
0
0
0
0
0
0
3
Daily hire rate forecasting
Calendar year
2050
2051
2052
2053
2054
2055
2056
2057
2058
2059
2060
2061
2062
2063
2064
SY0
SY1
SY2
SY3
SY4
SY5
SY6
SY7
SY8
SY9
SY10
SY11
SY12
3.489
3.559
3.634
3.703
3.773
3.833
3.887
3.946
4.007
4.061
4.129
4.191
4.258
4.319
0,022
0,020
0,021
0,019
0,019
0,016
0,014
0,015
0,015
0,013
0,017
0,015
0,016
0,014
3.447
3.519
3.591
3.663
3.744
3.933
4.140
4.248
4.356
4.509
4.815
4.968
5.049
5.157
0,021
0,021
0,020
0,020
0,022
0,050
0,053
0,026
0,025
0,035
0,068
0,032
0,016
0,021
Ship year (SY)
Industry forecast for shipment demand
Estimated annual shipments (millions of tons)
3.415
x 1 (% change in demand)
Industry forecast for the ship supply
Estimated net capacity (new order – scrap)
3.375
x 2 (% change in supply)
Daily hire rate forecast
*Model: y = 0.007 + 1.4*x 1 – 1.6*x 2
y (% change in daily hire rate)
Estimated daily hire rates ($000s)
*Avg. daily hire rate in 2050 = $50 thousand (given)
0,003
50,0
50,160
4
Daily hire rate forecasting
Calendar year
2065
2066
2067
2068
2069
2070
2071
2072
2073
2074
2075
2076
2077
Ship year (SY)
SY13
SY14
SY15
SY16
SY17
SY18
SY19
SY20
SY21
SY22
SY23
SY24
SY25
Estimated annual shipments (millions of tons)
4.381
4.449
4.511
4.586
4.647
4.717
4.793
4.863
4.938
5.007
5.085
5.161
5.239
x 1 (% change in demand)
0,014
0,016
0,014
0,017
0,013
0,015
0,016
0,015
0,015
0,014
0,016
0,015
0,015
Industry forecast for shipment demand
Industry forecast for the ship supply
Estimated net capacity (new order – scrap)
5.211
5.193
5.139
5.139
5.220
5.283
5.301
5.310
5.499
5.751
6.057
6.165
6.237
x 2 (% change in supply)
0,010
-0,003
-0,010
0,000
0,016
0,012
0,003
0,002
0,036
0,046
0,053
0,018
0,012
Daily hire rate forecast
*Model: y = 0.007 + 1.4*x 1 – 1.6*x 2
y (% change in daily hire rate)
Estimated daily hire rates ($000s)
*Avg. daily hire rate in 2050 = $50 thousand (given)
Business | Wed Feb 18, 2015 12:08am EST
Second dry-bulk shipper files for bankruptcy as rates tumble
* Worst dry-bulk cargo market since 1980s – ship owner
* Dozens of iron ore and coal carriers idled
* Baltic dry index falls to all-time low
By Keith Wallis and Henning Gloystein
SINGAPORE Feb 18
A second dry cargo shipper has filed for bankruptcy following a collapse in freight
rates that has forced many companies to idle vessels used to haul iron ore, coal and grain rather than hire
out the ships at a loss.
Weaker demand from China and an oversupply of ships has led to the worst industry downturn in 30 years,
pushing the Baltic dry index – the industry benchmark for freight rates – to an all-time low.
China’s Winland Ocean Shipping Corp filed for Chapter 11 bankruptcy protection in the United States on
Feb. 12, court documents show, the second bankruptcy this month.
“Due to current market conditions, the financial position of the company and its subsidiaries has
deteriorated, leading to immediate difficulties,” the document states, adding that it had therefore filed for
Chapter 11 protection.
Privately owned Danish firm Copenship filed for bankruptcy earlier in February after losses in the dry bulk
market.
“The combination of lower steel demand in China and the huge volume of new tonnage coming on line is
what is causing panic and making this the worst bulk market since the mid-1980s,” said Hsu Chih-chien,
chairman of Hong Kong and Singapore-listed dry bulk shipper Courage Marine.
China’s imports tumbled 19.9 percent from a year earlier as its economy grows at its slowest rate in 24
years.
The current freight rate for carrying a cargo of coal in a panamax ship from Indonesia to southern China is
about $3,000 per day, compared with more than $6,000 last year. The Baltic dry index has slumped by
nearly two-thirds in the past 15 months.
Adding to slowing demand is a swelling fleet, with the number of ordered capesize and panamax carriers
for the next three years equal to 39 percent of the existing fleet, according to shipping services firm
Clarkson. Yet dry-bulk seaborne trade rose only 4 percent last year.
As a result, dozens of capesize and panamax vessels have been idle around Singapore, Hong Kong and
off South Africa’s coast, Reuters ship tracking data showed.
Dry-bulkers are not the only shippers in trouble. Over 10 percent of the global liquefied natural gas (LNG)
tanker fleet is currently idled after Asian LNG prices fell almost two-thirds since February 2014.
Fin. Mgt.
1
Data analysis assignment
– The data analysis assignment is part of the AACSB program requirements.
1 Instructions
•
Use the Project Information provided in Section 2 to conduct the required analyses
described in Section 3.
•
The main task of the assignment is preparing cash flow projection in Excel spreadsheets
(use the template “fm-data-worksheet” available in the course shell).
•
For other tasks, prepare your responses in a Word document (no handwriting).
•
Upload both Excel spreadsheet and Word document to the corresponding submission
point.
2 Project information
Savannah Merchant Marine Co. (henceforth “SMM” or the firm/company) is a cargo shipping
company based in Savannah, Georgia, that operates freight vessels in various sizes. In December
2050, the firm is reviewing the proposal for a new dry bulk carrier in an attempt to capture a
potential increase in the global demand for freight shipping. The CFO has asked you to estimate
cash flows expected from the new ship over its asset life. To aid the analysis, the CFO and the SMM
Finance team have collected data from various sources, as summarized below.
a) Discount rate, inflation, tax, and other information
CFO has made the following baseline assumptions:
•
The discount rate is assumed to be 12%, p.a. (per annum)
•
For simplicity, the CFO has decided to use an expected inflation rate of 3%, p.a., over the
next three decades.
•
SMM is expected to face a marginal tax rate of 20%.
b) Investments required
The purchase price of the new vessel is $44 million. If ordered before the end of 2050, the ship will
be ready by the end of 2052. If SMM decides to purchase the ship, 10% of the price is due at the
end of 2050, another 10% is due at the end of 2051, and the balance is payable at the end of 2052
when the ship is delivered. It will then begin operating from the beginning of 2053. The useful life
Fin. Mgt.
2
of the ship is 25 years with no salvage value. The project life is assumed to be equal to the ship life.
The depreciation is on a straight-line basis.
The CFO also assumes that the firm will liquidate the vessel at the end of its life. Based on your
industry survey, the market value of the ship at the end of its life is estimated at $8 million.
c) Additional capital expenditures required
To enhance the performance and the cost efficiency of its vessels, the firm makes additional
investments in its fleet on a regular basis, typically every five years. Given the liquidation expected
at the end of its 25th year, the new ship will undergo four installments of these capital expenditures,
with the first one taking place at the end of its 5th year (i.e., 2057 if the ship is ready by the end of
2052).
Factoring in additional costs required for old vessels and the overall inflation, these
expenditures are estimated as follows:
$300,000 (1st); $350,000 (2nd); $650,000 (3rd); and $1,200,000 (4th)
The firm is allowed to capitalize these four expenditures, and each will be depreciated over five
years on a straight-line basis, with no remaining book value at the end.
d) Working capital requirements
The CFO expects that the operation of the new ship requires an initial working capital investment of
$500,000 by the beginning of 2053 (equivalently, “the end of 2052”). From then on, the working
capital balance requirement will grow each year at a rate of inflation (provided in subsection a).
The working capital balance will be recovered at the end of the project life.
e) Assumptions for forecasting daily hire rates and revenues
The annual revenues are determined by daily ship hire rates (prices) prevailing in the market and
the number of days the ship is expected to be hired in a given year. The market price is the
function of the demand for shipments and the supply of shipment capacity. The CFO has obtained
from Clarksons the industry experts’ forecast for these factors on an annual basis, as summarized in
the spreadsheet. In addition, the CFO has come up with the following econometric model for
forecasting the rates at which the average daily prices will change each year:
𝒚 = 0.007 + 1.4𝒙𝟏 − 1.6𝒙𝟐
where y = % change in ship hire rate; x1 = % change in demand; x2 = % change in supply, all on an
annual basis.
For example, suppose that in 2051, the expected growth in the demand for shipments is 0.0217
and the expected growth in the supply of shipping capacity is 0.0213 (note that these figures are
Fin. Mgt.
3
taken from the spreadsheet). Then, based on these forecasts and the CFO’s model, the % change
in daily ship hire rate is estimated at 0.007 + 1.4(0.0217) – 1.6(0.0213) = 0.0032 (0.32%). Given the
hire rate $50,000 (given) in 2050, the rate in 2051 is then estimated at $50,000*(1.0032) = $50,160
per day. See the spreadsheet for detailed forecasts for the demand and supply and the % changes
in these variables.
The number of days hired is assumed to be equal to 365 days less the number of days required
to complete annual mandatory maintenance. The company’s assumption is that it takes 14 days to
complete the annual maintenance.
f) Assumptions for operating costs
The CFO assumes that the operating costs are incurred throughout the year, including the
mandatory maintenance period. The annual operating costs therefore can be calculated as the
estimated daily operating costs, multiplied by 365 days. In addition, daily operating costs are
assumed to grow at a rate that is slightly higher than the expected inflation. The CFO suggests the
following equation:
𝐷𝑎𝑖𝑙𝑦 𝑐𝑜𝑠𝑡𝑠𝑡 = 𝐷𝑎𝑖𝑙𝑦 𝑐𝑜𝑠𝑡𝑠𝑡−1 (1 + 𝒉)(1.01),
where subscript t indexes year, and h is the expected inflation rate, provided in subsection a.
For example, given the average daily cost in 2050 estimated at $14,000 (given), the daily cost in
2051 is then estimated at $14,000*(1.03)(1.01) = $14,564 (per day).
Fin. Mgt.
4
3 Analysis
For #1, submit an Excel file. For #2 and #3, prepare your responses in a Word document.
#1 [35 points] Cash flow projection.
Using the Excel template “fm-data-worksheet” available in the course shell, prepare the cash flow
projection for the new vessel (submit the completed Excel file). Note that you must first complete
the forecasting of daily hire rates for each year (a separate tab in the file).
•
All necessary information is provided in Section 2 of this document and the Excel spreadsheet. Note
that some of the cells in the spreadsheet are already filled in for you. Additionally, the header
columns contain brief notes that summarize various assumptions and instructions.
•
The Excel worksheets (and pre-filled inputs) are provided to give you an idea about how one can
carry out cash flow projection, rather than making you build something from scratch. It is therefore
your responsibility to find the correct information to enter in the right places, to use the Excel
functions correctly, to check calculated values, etc., etc. Feel free to create your own spreadsheets if
you don’t want to use the provided template.
#2 [10 points] Project NPV and sensitivity analysis.
a) If a discount rate of 12% p.a. is applicable, what is the NPV of the project? What if the
discount rate for the project was 14%? 16%? Provide the NPVs for each scenario (no need to
include spreadsheets for each).
*Note: To perform the sensitivity analysis of this kind, it is recommended that you complete
the baseline case (i.e., with the 12% discount rate), then create a copy of the completed
spreadsheet, and change the parameter value.
b) Select other parameter(s) for which you wish to change the assumptions. Then check—report
to CFO—how the project NPV changes depending on new assumptions you have made for
that parameter. While it is up to you which one to choose and play with (no correct answer),
you are required to provide parameter values used, the NPVs, and brief discussion.
[cont.]
Fin. Mgt.
#3 [5 points] Analytical reasoning: the assumption concerning the supply of ship capacity.
The premise of the CFO’s pricing model is that the market rate for ship hire is in principle the
function of the demand for commercial shipments and the supply (shipping capacity). However,
although the shipping demand, governed by various economic factors, is likely to evolve smoothly,
the supply of shipping capacity may be lumpy due to the time-to-build constraints and
irreversibility of capital investment. That is, if companies order new vessels once they observe the
increased demand for cargo shipping, the new vessels ordered today will be ready in, say, three
years later. Moreover, once new vessels are delivered, they are likely to stay in the market for the
next 20–30 years, resulting in the problem of irreversible investments (i.e., prohibitively costly to
disinvest because of illiquid secondhand markets).
Required: In what way would the described lumpiness in the supply of ship capacity play out in
determining the market rates for ship hire? Provide your thoughts and discuss.
*Note that a short news article has been provided, which can help you understand the demandsupply dynamics in the industry and prepare your responses.
5