Steel Freight Lines Case Study
Suppose that you are the CEO for a small steel freight line operating on the Mississippi River. You have a dozen freight boats that haul steel scrap to the mills. The price for you haul the scrap is $.05 per lb., half the price the railroads charge and one third of the price of the trucking lines (your primary competitors), though you estimate local shipping charges for your inland customers raises their costs another 1-2 cents.
There is one other competing boat line with five boats—but due to the owner’s health problems, there is no fleet expansion planned by that family owned company. You also estimate that you are currently handling about ten percent of all the scrap being shipped in your area. Moreover, there appears to be a back-log in current scrap shipments, and the backlog is expected to grow.
You have four 15-year old boats that need immediate overhaul, the cost for each boat will be $3.3 million, and it will extend their service life by five years. The overhaul for each will take approximately 6 months and they can be done two at a time.
Alternatively, you could purchase four new boats, two of which will be ready in a month. The others will be built per your specification, and will be available in two years. A new freight boat will cost you $5 million, will last 15 years, and it takes one years to build (there is one builder in the area with a limited capacity that can deliver two boats per year; the builder has other commitments for the next year). You can afford either option, since the bank has given you an unused loan commitment for up to $20 million. Your cost of capital (a bank loan) is 12%; assume payment is on delivery for both options.
You estimate that each boat produces $4,000,000 in revenues annually, and has the following costs: $1,400,000 crew salaries/benefits, $970,000 fuel expenses, and $300,000 in maintenance. Your marginal tax rate is 33%, and you use straight-line depreciation for tax reporting.
What should you do? (Hint: review the entire set of economic issues and possibilities, and think outside of the box.)
One page bullet-point report summarizing your recommendations and rational. 2-3 pages of supporting spreadsheets/typewritten calculations should be provided as appropriate.