Northstar Logistics 2020

4^th April 2020

In March 2008, Boris Johansson, aka Bojo, CEO for Northstar Logistics Inc., a trucking company, was evaluating a new proposal that would require substantial investment.This project was of particular importance as it would represent a new source of revenue - one that is badly needed.The investment involves branching out into a new business.Bojo, therefore, had to decide whether his company should immediate start the project.

From trucking to shipping

Northstar Logistics owned a huge fleet of trucks that deliver valuable goods across the UK and Europe.Founded in 1923, the company had grown substantially.In the mid-fifties, it was one of the largest trucking companies in the UK. However, in the 1970s, after the oil crisis when petrol prices went skyrocketed, Northstar Logistics has been on a decline.Severe competition almost drove the company into bankruptcy.Various CEOs had been appointed to revive the company but without much success.But that was until Bojo.He joined the company as the CFO in 2007, having spent his earlier career at one of the largest investment banks.In 2011, he was made the CEO and tasked with restoring the former glory of the company.

Having saved the ailing Northstar Logistics and turned it into one of the most profitable companies within the trucking industry, Bojo ought to have many reasons to be happy.Yet, he was not.This was because he knew that the profit margin for the trucking company would become increasingly razor thin as other non-trucking firms had been entering this market.This worried him.At a meeting with the senior management of the company in November 2015, he put forward such concerns and asked the senior executives to come up with new ways to ensure that Northstar Logistics could remain profitable.

Northstar Shipping

In the follow-up senior management meeting that took place in 2016, Evans Engel, a newly recruited business development executive from a major shipping company, proposed that Northstar Logistics might want to consider moving into a completely new line of business to create a new stream of revenue.Specifically, he suggested that the company could expand into the sea logistics business.

Engel and his team identified a certain number of sea routes that the company could realistically serve in the near future.In order to serve these sea routes, Northstar Shipping, a newly created division within Northstar Logistics, would need to purchase a fleet of vessels.Having done some prior research and relying on his experience, Engel identified that the vessel that could best meet the requirements of Northstar Shipping was a fleet of ships called Prince Diamond, the latest type of transport vessel in the industry of sea logistics.

Project economics

The purchase price tag attached to a fleet of Prince Diamond was 753 million.Since the fleet was custom-made and Northstar Shipping was a new entity, the manufacturer insisted that the purchase ought to be paid in full upfront - the company would have to make this payment in 2017. Once the purchase was made, the fleet would enter service on the first day of 2018. Since each Prince Diamond was constructed with a special material for the body as well as advanced technologies and the latest design for its turbines, the vessel would only have an operational life of 8 years.At the end of the eighth year, it would carry no salvage value. (It is assumed that Northstar Shipping will close down after this time.)

While the price, availability and longevity of the fleet were all indisputable, Engel's team, however, disagreed in the revenue that Northstar Shipping would be able to generate. In the "bull" case, this new service would achieve revenue of 580 million in 2018.After that, revenues would increase by 8% every year.In the "bear" case, it was forecasted that revenues would only grow by 4% a year, with 210 million generated in the first year. It is therefore important to construct a model that is sufficiently flexible to account for these two possible scenarios. Indeed, to help decide whether to go ahead with this project or not, a comprehensive study of 45,000 was commissioned and completed for the purpose beforehand. Both Bojo and Engel wonder how similar or different between the results from the scenarios to be conducted and those estimated in the study.

Each fleet of Prince Diamond had two categories of costs.Operational costs such as fuel, labour and insurance would account for 24% of revenue every year.The use of special material on Prince Diamond meant that maintenance costs (including replacement parts and servicing) differ in the span of its life.As a result, maintenance costs accounted for 6.00% of the annual revenues in the first four years.In the four years that follow, maintenance costs would increase to 9.00% of the annual revenues. Engel calculated that the vessel should be depreciated according to the schedule stated in exhibit 1.

In addition, Engel also prepared a projected working capital required for operating the fleet, which is shown in exhibit 2.The corporate tax of Northstar Shipping was 38%. The project used the same discount rate as its parent company; Northstar Logistics was financed by bank loan, bonds, preferred shares and common shares, the details of their proportions are shown in exhibit 3.The company's bank charged interest of 6.80%. The bond that was issued had a 5 year maturity, with a coupon rate of 11%, a face value of each bond is 410 and the total amount gained from selling each bond was 450. Competitors in the shipping industry had had a beta of about 1.4, with the current riskfree rate of 2.80% and the market risk premium 8.00%.Furthermore, the current trading price of the preferred share is 69 and pays an annual dividend of 9.

In determining the value of this project, Bojo thought it was critical to use the above information to make the necessary assessments.All in all, senior managers were excited about the possibility of expanding into sea transport but they wanted to be sure they would be making a sound investment decision.

Exhibit 1. Depreciation Schedule

Year

1

2

3

4

5

6

7

8

15.00%

25.00%

18.00%

14.00%

9.00%

9.00%

6.00%

4.00%

Exhibit 2.Working Capital projected to incur in the year of operation (in 000s)

Year of operation

First

Second

Third

Fourth

Fifth

Sixth

Seventh

Eighth

20,000

25,000

30,000

35,000

38,000

36,000

34,000

31,000

Exhibit 3.Summary of Financing

Financing

% of total financing

(book value)

% of total financing

(market value)

Bank loan

19.00%

17.00%

Bonds

11.30%

12.10%

Preferred shares

13.70%

17.40%

Common shares

56.00%

53.50%

Total financing

100.00%

100.00%

we need P&L ?