Economic Criteria

Economic Criteria
There was more than 1 way of looking at a particular problem. The factors were as follows:

1. Required rate of return;
2. Freight rate (timecharter rate);
3. Permissible price for ship;
4. Net present value (NPV).

i) NPV (Net Present Value): If the acquisition cost of a ship, the required rate of return on the capital invested (or discount rate), the operating costs each year, the cargo quantity transported each year & the corresponding freight rate (which together determine annual income) are known, the present worth of each item of income & expenditure can be calculated. These items can then be totalled to find the NPV (or Worth). The present worth of each annual cash flow can be calculated for each of the N years of the ship life, often in a tabular form.

One way of regarding NPV is as an instantaneous capital gain, if positive (or loss, if negative) or as a discounted profit. Consequently, designs with the highest NPVs are sought. The term NPV is sometimes called the 'venture worth'.

ii) Required Freight Rate (RFR): The RFR is the calculated freight income needed per unit of cargo to cover all operating costs & to privide the required rate of return on the capital invested in the ship. If the acquisition cost of a ship, the required rate of return, all the operating costs, & the annual cargo quantity transported are known, the level of freight rate which produces equal present worths of income & expenditure can be ascertained, i.e. zero NPV.

The RFR can be regarded as a calculated long-term average freighting cost, which can then be compared with actual freighting prices, i.e. market freight rates. In general, the design with the lowest RFR is the best. RFR is sometimes called a 'shadow price'.

For non-uniform cash flows, an initial freight rate has to be assumed so that an initial NPV can be calculated. As this NPV is unlikely to be exactly zero, an iterative procedure must be used to find the exact freight rate which gives zero NPV.

A rather similar criterion is the Average Annual Cost (AAC), which excludes the denominator Cargo Quantity. For uniform cash flows it is simply expressed as follows:

Annual operating costs + CR (ship first cost)

Minimum AAC can then be used as a criterion where transportation capabilities are equal between alternatives or where no income is generated, e.g., some service vessels.

iii) Yield or DCF Rate of Return: In cases where the freight income is known, the yield (also called Discounted Cash Flow Rate of Return, or Internal Rate of Return, or Equivalent Interest Rate of Return, or Investor's Method) can be calculated; this is the discount rate which gives equal present worths of income & expenditure, i.e. zero NPV.