Question

Question: Case Study: Neptune Shipyard Company History: Neptune Shipyard is a shipyard operating on the Riv...

Case Study: Neptune Shipyard Company History: Neptune Shipyard is a shipyard operating on the River Clyde near Glasgow, Scotland in the form of a private company. It has a workforce of around 300, roughly divided into the following areas: Marketing 8, Accounting 22, Human Resources 12, Purchasing 8, Production 200. Production is divided into two departments: New Construction (shipbuilding) and Ship repair. Neptune Shipyard is a wholly owned subsidiary of regional shipping giant Jupiter Shipping PLC.

The shipyard is considered to be in the “medium” category. For example, it owns and operates one “floating dock” (ship repair berth) and it is also constructing one new ship at present.

The Issues: The company historically (before it was purchased eight years ago by Jupiter Shipping) was primarily known as a medium sized ship repairer. Recently, under the direction of Managing Director, Mr. Angus Young, who is also a director of Jupiter Shipping, the parent company has decided to “allocate” more and more financial capital and human capital (labourers) to New Construction, and away from Ship Repair.

There is presently one vessel being constructed in the company’s yard. It is 12 months into an 18 month estimated construction time. The vessel will be used by the parent company in its shipping business. The parent company has fixed a price so that the ship will generate a 6% profit above budgeted cost. The contract sales price is £1,900,000.

These are the viewpoints of the major departments about the company’s proposed new business direction:

Mr Young and Jupiter Shipping progressively plan to shift more and more financial and human capital to the construction of new vessels to be used in the parent company’s operations. Their argument has been that this business produces a safe, guaranteed fixed return of 6% over the duration of the vessel’s construction life which, although on the low side, it exposes the company to much less risk than if ship repair remained the company’s focus. The ship repair business has become much more competitive globally, and bad debts run at 10%.

The New Construction manager, Philip Rudd, is obviously very pleased with the company’s new direction. He points out that it is easy to shift workers to shipbuilding and away from ship repair because the skills bases required are very similar. The Ship repair Manager, Mr Balakrishnan, known as Bala, is very unhappy about the company’s new business direction and has been attempting to rally supporters from within supposedly neutral departments such as Accounting and Human Resources. He has been known to debate his views in the staff canteen at lunchtimes.

He fears that his department will be down-graded over the longer term to the extent that it might ultimately disappear. He relies upon the company’s long standing tradition as a skilled ship repairer, and argues that ship repair should continue to be the focus. Bala regards it as weak, cowardly and sub-servient to see a great ship yard become just a vehicle for the parent company’s agenda. He fears losing skilled staff to other “yards” (ship repair companies). He is also aware of the general perception among ship repair labourers that shipbuilding yields very low job satisfaction compared to ship repair because often there are few visible signs of progress for long periods.

Bala also argues that because the company has only one floating dock, and is presently operating at full capacity, Neptune should buy a second small floating dock at a cost of £1,000,000, so that the yard has the capacity to repair more than one vessel at once. Typically, the average ship-repair job takes one month, has a profit margin of 20% and sales prices ranging from £120,000-£280,000 (average around £200,000). However, Ship repair also has a bad debts rate of around 10% because it is very difficult to secure payment from a ship-owner based say in Japan for emergency repairs done in Scotland.

Bala has developed an interesting counter-argument recently. This is his prime trump-card, which is he is ready to release at the next staff meeting. He argues that because ship-building occurs on the land, but ship repair in the water, one third of the cost of land rental of £30,000 per month should be borne by New Construction and none by Ship repair. He argues that this is a fairer cost allocation than the present system of not allocating any of it to production departments, because (as he says) if shipbuilding takes up land area, it should bear the cost. New Construction has heard of this argument through the canteen grapevine and strongly opposes it.

Lastly, the Sales Department, led by Sales Manager Belford Scott, tends to side with Ship repair. Primarily Scott is concerned that his two young and motivated salesmen might be lost to competing yards if the company shifts focus to New Construction.

Other information:

(a) Use a useful life figure of 6 years for floating docks taken from the State Administrative & Accounting Manual of the Office of Financial Management, State of Washington, USA (available online, accessed 8 March 2007).

(b) Also assume that the 1/3 land rental allocation would apply for 2 ships being built at once. i.e. expansion of New Construction.

Questions:

1. Compute Return on Assets (ROA) for the second floating dock versus the ROA for building a second new ship, assuming that existing operations (one floating dock and one ship in progress in construction) continue unchanged. Assume no taxation. Assume that the second floating dock will be fully utilized right from the start. Assume that the second new ship will replicate exactly the first new ship and that the second floating dock will replicate exactly the first floating dock (in terms of revenues, costs, and projected job times).

Answer 1

Return on total assets= Ebit/ averagetotal assets profit on second new shio=20%*200000=40000 cost of dock =1000000 so ROA=40000*12/100000=.48, ebit=480000-360000(rental)-20000=100000/1000000=.10 it is net income produced during the period by total assets. if 6%percentage return taken=480000+400=480040 6/100*40000=2400/6==400 every year