9-202-027
REV: APRIL 18, 2002
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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,
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ERIK STAFFORD
KATHLEEN LUCHS
ANGELA CHAO
Ocean Carriers
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.
Ship Operations
Ocean Carriers Inc. owned and operated capesize dry bulk carriers that mainly carried iron
ore worldwide. This type of vessel ranged in size from 80,000 deadweight tons to 210,000
deadweight tons of cargo carrying capacity. Capesize carriers were too large to transit the Panama
Canal and therefore had to sail around Cape Horn to travel between the Atlantic and Pacific Oceans.
In January 2001, there were 553 capesizes in service in the world.
Ocean Carriers’ vessels were mostly chartered on a “time charter” basis for a period such as
one year, three years, or five years, although the spot charter market was used on occasion. The
company that chartered the ship was called the “charterer.” The charterer paid Ocean Carriers a
daily hire rate for the entire length of the contract, determined what cargo the vessel carried, and
controlled where the vessel loaded and unloaded. The company, in turn, supplied a seaworthy
vessel that complied with international regulations and manned the vessel with a fully qualified and
certified crew.
Operations also included ensuring adequate supplies and stores were onboard, supplying
lubricating oils, scheduling repairs, conducting overall maintenance of the vessel, and placing all
insurances for the vessel. 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.
This document is authorized for use only in Professor Prachi Deuskar, Professor Apoorva Javadekar, Professor N R Prabhala and Professor Shashwat Alok’s Corporate Finance I__[PGP] at
Indian School of Business (ISB) from Sep 2021 to Dec 2021.
202-027 Ocean Carriers
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 Capital Expenditures Anticipated in Preparation for Special Surveys
2007 2012 2017 2022 2027
$300,000 $350,000 $750,000 $850,000 $1,250,000
Source: Company estimates
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 affected by the increases in size and efficiency the newer ships offered. As
ships got bigger, faster, and more fuel efficient, fewer ships were needed to carry the same amount of
cargo. Moreover, there had been very few scrappings in recent years, and most of the capacity of the
