REV: APRIL 18, 2002
ERIK STAFFORD KATHLEEN LUCHS ANGELA CHAO
In January 2001, Mary Linn, Vice President of Finance for Ocean Carriers, a shipping company with offices in New York and Hong Kong, was evaluating a proposed lease of a ship for a three-year period, beginning in early 2003. The customer was eager to finalize the contract to meet his own commitments and offered very attractive terms. No ship in Ocean Carrier’s current fleet met the customer’s requirements. Linn, therefore, had to decide whether Ocean Carriers should immediately commission a new capesize carrier that would be completed two years hence and could be leased to the customer.
For a new ship coming on line in early 2003, operating costs were expected to initially average $4,000 per day, and to increase annually at a rate of 1% above inflation. Charterers were not charged a daily rate for the time the vessel spent in maintenance and repair, although operating costs were still incurred. Initially, 8 days a year were scheduled for such work. The time allotted to maintenance and repairs increased to 12 days per year after five years of operation, and to 16 days a year for ships older than ten years.
Angela Chao (HBS MBA 2001) and Research Associate Kathleen Luchs prepared this case under the supervision of Professor Erik Stafford. HBS cases are developed solely as the basis for class discussion. Cases are not intended to serve as endorsements, sources of primary data, or illustrations of effective or ineffective management. Copyright © 2001 President and Fellows of Harvard College. To order copies or request permission to reproduce materials, call 1-800-545-7685, write Harvard Business School Publishing, Boston, MA 02163, or go to http://www.hbsp.harvard.edu. No part of this publication may be reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any means—electronic, mechanical, photocopying, recording, or otherwise—without the permission of Harvard Business School.
The company had a policy of not operating vessels older than 15 years. Every five years, international regulations mandated that a special survey be undertaken to ensure seaworthiness as defined by international regulations. By the fifteenth year, the maintenance required to comply with the special surveys was very costly. Exhibit 1 shows the capital expenditures anticipated in preparation for the special surveys. These outlays were considered capital expenditures, which would each be depreciated on a straight-line basis over a 5-year period. To avoid the larger expenditures for older ships, the company planned to sell the vessel into the secondhand market, or “scrap” the vessel just before the third special survey. When scrapped, the vessel was demolished and its steel was sold to demolition yards. The company estimated the scrap value to be $5M at the end of the fifteenth year. Exhibit 1
Source: Company estimates
Capital Expenditures Anticipated in Preparation for Special Surveys
2012 $350,000 2017 $750,000 2022 $850,000 2027 $1,250,000
Supply of Capesizes
Daily hire rates were determined by supply and demand. The number of ships available equaled the number of vessels in service the previous year plus any new ships delivered minus any scrappings and sinkings. When the market demand for shipping capacity was high, owners would keep a vessel in operation as long as possible. Conversely, when market demand was low, scrapping rose. Supply was also...