Solution for Ocean Drilling Case Study

Ocean Drilling Inc.
Ocean Drilling Inc. was a US based leading company in offshore industry, which was used as outsource by various other companies for drilling related projects. Now Ocean Drilling had to purchase two semisubmersibles drilling rigs, but due to lack of government featured loans. It had to choose between the two foreign bids, one was from Japanese shipyard for $90 Million and the other one was from French shipyard for $96 Million. These bids held great risk in them due to fluctuating exchange rates, as being in the foreign currencies.
Mr. Moore was given the responsibility of making a choice between the two bids by weighting them. He had two possibilities to make decision for choice. Either to sell the US dollars in French or Japanese forward market or to borrow in US at 20% and then convert it to Francs or yen. Now in order to make an efficient decision, both these bids have to be evaluated.
In order to evaluate both the bids we have to weigh the cost of debt. How much Ocean Drilling Inc. has to pay for these bids and also the risk pertaining in every bid.

Evaluation of Bids

French Shipyard

Japanese Shipyard

Principal Amount

 $                   96.00

 $                        90.00

(In millions)

Maturity (Years)

8

10

Payment Schedule

Interest Rate Annual

10.50%

8.75%

Interest Rate Monthly

0.88%

0.73%

Required Down Payment

 $                   24.00

 $                        18.00

Yearly  payments

 $                   13.32

 $                        10.80

(In millions)

yearly Interest payment (1981)

 $                     2.89

 $                          3.63

(In millions)

Total Interest Paid

 $                   23.12

 $                        36.28

 

For year 1981

Earnings before Interest and Tax (1981)

 $                117.00

 $                      117.00

(In millions)

Interest Payments

 $                   32.89

 $                        33.63

(In millions)

Earnings before Tax

 $                   84.11

 $                        83.37

Tax

 $                   42.05

 $                        41.69

Earnings after Tax

 $                   42.05

 $                        41.69

1981

Tax

50%

50%

After Tax cost of Debt

42%

44%

 

Moore should also have to consider the Down Payment which the company has to pay at the start. According to the Financial Statement of Ocean Drilling, it has $8 million in Cash at the end of year 1980, but it has to make Down payment of $24 Millions if accept French Bid or $18 Million if accept Japanese Bid. In order to pay the amount the company has to sell some of the assets as it can’t go for another loan.
By keeping under consideration, all the calculations like that of cost of Debt, Interest Payments and the Net Income after satisfying the tax. This can be declared that Bid from French Shipyard would be more profitable over Japanese Shipyard. Loaning from the French Shipyard would result in greater Net Income, Less after tax cost of debt and hence less risk. There comes the problem of greater down payment in French Shipyard bid, but the financial statements of company shows that the company is in position to pay even the down payment of $24. Furthermore the exchange rate of French Francs is also more favorable (Table 2) as compared to that of Japanese Yen.
The two methods of avoiding the risk of foreign borrowing have their own complications. As if the company sells the US dollars in forward market. It will be able to buy contract in Japan for 5 year but in France not on reasonable price. Further as per the exchange rates table it was forecasted that yen would be appreciated and hence its cost would keep on increasing. Whereas French Francs would be depreciated which means US Dollar would be appreciated hence borrowing it would cost less.
The other way out was to borrow US dollar at 20% which is more than Japanese 8.75% and French 10.5% interest rate. Furthermore the interest rates of long term Debt, in United States are also seemed to be increasing with the years as compared to that of Japanese and French.

 

 

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