Amtrak Case Solution - IIM Indore PGP 2008

7/25/2019 Amtrak Case Solution - IIM Indore PGP 2008

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IIMI/PGP/Finance II/20081

National Railroad PassengerCorporation (Amtrak): Acela Financing

Session 15


Discussion Question

Whether Amtrak should finance the equipmentpurchases using BNCYFs leveraged-leaseproposal or borrow money and purchase the

equipment on its own?


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National Railroad PassengerCorporation (Amtrak): Acela Financing

! Dated: 30 April, 1999

! People:Arlene Friner, CFO, Amtrak

! Review: leveraged-lease proposal from BNY CapitalFunding LLC (BNYCF)

! Adviser: Babcock & Brown Financial Corporation

! Invited: financial institutions to submit lease-financing

proposals for planned purchase of..,! Locomotives

! High-speed train set


National Railroad PassengerCorporation (Amtrak)

! Created in: 1970

! Created by: US congress

! Ensured: modern, efficient intercity passenger-rail service

! Remain as: integral part of the national

transportation system! Govt. mandated: to take over rail-passenger

operations of private railroads


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! Primary provider of passenger-rail service in US

! Provided service to..,! Intercity passengers: > 20 million

! Operated stations: 516

! Operated states: 44

! Received: subsidies from federal govt.

! Three strategic business units..,!

Amtrak Northeast Corridor! Amtrak Intercity

! Amtrak West



! After Amtrak Reform and Accountability Act 1997(ARAA)..,

! Proposed to eliminated its reliance on federal subsidies by 2002

! After 2002; no federal funds could be used for operatingexpenses

! Never been profitable in 30-year history

!

To meet the goal of self sufficiency by 2002! Developed radical business plan

! Center price: high-speed rail service

Projected annual revenues: $180 million by FY2002


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1994 1995 1996 1997 1998

Revenues

Passenger-related and other 1152 1177 1213 1341 1392Commuter 184 213 234 242 260

Reimbursable 77 107 108 91 91

Federal payments 542

Total revenues 1413 1497 1555 1674 2285

Expenses

Salaries, wage and benefits 1330 1241 1236 1299 1448

Train operations 358 321 321 365 356

Facility and office related 153 172 181 187 190

Maintenance-of-way goods and services 45 73 59 46 52

Advertising and sales 91 90 109 98 102

Interest 185 144 149 160 181

Depreciation and amortization 245 230 238 242 294

Other 83 34 25 39 15

One-time charges/(gains) -244

Total expenses 2246 2305 2318 2436 2638

Operating income/(loss) -833 -808 -763 -762 -353

Exclude federal payments and related interest 577

Operating loss restated -833 -808 -763 -762 -930Federal grants

Federal operating grant 352 392 285 223 202

Excess railroad retirement taxes 150 150 120 142 142

Federal capital - interest 42

Federal capital - progressive overhaul and other 36 37 82

Total federal grants 502 542 441 444 426

Net loss -331 -266 -322 -318 -504

Fiscal Year Endin Se t. 0

Income Statement Values in Millions of USD


1994 1995 1996 1997 1998

RevenuesPassenger-related and other 82 79 78 80 61

Commuter 13 14 15 14 11

Reimbursable 5 7 7 5 4Federal payments 24

Total revenues 100 100 100 100 100

Expenses

Salaries, wage and benefits 94 83 79 78 63Train operations 25 21 21 22 1 6


Maintenance-of-way goods and services 3 5 4 3 2Advertising and sales 6 6 7 6 4

Interest 13 10 1 0 10 8

Depreciation and amortization 17 15 15 14 1 3Other 6 2 2 2 1

One-time charges/(gains) -17

Total expenses 159 154 149 146 115Operating income/(loss) -59 -54 -49 -46 -15

Exclude federal payments and related interest 25Operating loss restated -59 -54 -49 -46 -41Federal grants


Excess railroad retirement taxes 11 10 8 8 6Federal capital - interest 3

Federal capital - progressive overhaul and other 2 2 4

Total federal grants 36 36 28 27 19Net loss -23 -18 -21 -19 -22

Income Statement (Values in Millions of USD)Fiscal Year Ending Sept. 30


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1994 1995 1996 1997 1998

Revenues

Passenger-related and other 100 102 105 116 121Commuter 100 116 127 132 141

Reimbursable 100 139 140 118 118

Federal payments

Total revenues 100 106 110 118 162

Expenses

Salaries, wage and benefits 100 93 93 98 109

Train operations 100 90 90 102 99


Maintenance-of-way goods and services 100 162 131 102 116

Advertising and sales 100 99 120 108 112

Interest 100 78 81 86 98

Depreciation and amortization 100 94 97 99 120

Other 100 41 30 47 18

One-time charges/(gains)

Total expenses 100 103 103 108 117

Operating income/(loss) 100 97 92 91 42

Exclude federal payments and related interest

Operating loss restated 100 97 92 91 112Federal grants


Excess railroad retirement taxes 100 100 80 95 95

Federal capital - interest

Federal capital - progressive overhaul and other

Total federal grants 100 108 88 88 85

Net loss 100 80 97 96 152

Income Statement Values in Millions of USD

Fiscal Year Ending Sept. 30


Fy EndingSept 30, 1998

Fy EndingSept 30, 1998

Current Assets

Cash and equivalents 274.7 4

Temporary cash investments 409.7 6

Account receivable, net 88.7 1

Mtaerials and supplies 91.6 1Other current assets 3.4 0

Total current assets 868.1 12

Property, plant and equipment 9456.4 129

Less: Accumulated depreciation -3106.9 -43

Net property, plant and equipment 6349.5 87

Other assets and deffered charges 87.6 1

Total assets 7305.2 100

Balance Sheet (Values in Million of USD)


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Fy Ending

Sept 30, 1998

Fy Ending

Sept 30, 1998

Current liabilities

Accounts payable 270.8 4Accrued expenses and other current liabilities 186.7 3

Deffered ticket revenue 61.4 1

Current maturities of LT debt and capital-lease obligations 102.2 1

Total current liabilities 621.1 9

LT debt and capital lease obligations

Capital lease obligations 1213.1 17

Equipment and other debt 322.5 4

1535.6 21

Other liabilities and deffered credit

Deferred federal payments 457 6

Casuality reserves 136.2 2

Postretirement employee-benefits obligation 118.4 2

Environmental reserve 35.4 0

Advances from railroads and commuter agencies 20.6 0

Other 1.5 0

769.1 11

Total liabilities 2925.8 40

Capitalization

Preffered stock 10939.7 150

Common stock 93.9 1

Other paid-in capital 6471.3 89

Accumulated comprehensive loss -13125.4 -180

4379.5 60

Total liabilities and capitalization 7305.3 100

Balance Sheet (Values in Million of USD)


Acela

! New brand

! New high-speed rail service

! More than high-speed trains

! Designed to: differentiate Amtrak passenger trains andservice in Northeast Corridor from existing service

! To begin: service in late 1999

! To offer: faster trip times and premium service

! Served routes: Virginia to Maine


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Exhibit 1


Acela

! Brand representing new way of doing business

! Designed to: bring high speed and high quality toNortheast Corridor passengers

! Will offer..,! Faster trip times

! Comfortable amenities

! Highly personalized service

! Latest and boldest step to change its rail service into amore..,

! Customer-focused

! Commercially driven

! Premium transportation service


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Acela

! Designed to..,! Operate as fast as 150 miles an hour (241.35 kms an hour)

! Promised to reduce travel time significantly

! Timing between: Washington D.C., to Boston! Current timing: 7 hrs 30 minutes

! High-speed train: 5 hrs 50 minutes

! Late 1999: to begin service between NY city and

Boston! NY Washington leg would be added within a year


Equipment

! Operate the Acela Regional Service as planned

! Needed to purchase..,! 15 dual-cab

! High-horsepower electric locomotives

! 20 high-speed train sets, consists of..,! First-class coach car: 1

! Bistro car: 1

! Coach cars: 3

! End coach car: 1

! Power cars: 2

! Estimated total cost for all equipment: $750 million


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Equipment

No. Cost Aggregate Cost

High-speed locomotives 15 7,161,300 107,419,500

Train sets 20 32,129,050 642,581,000

750,000,500Total


Equipment

! Estimated life: 25 years

! Residual values: ~15% of original equipment cost

! Depreciation as per..,! Accounting purpose: straight-line

! Tax purposes: 7-year MACRS

! Arranged finance for all equipment save ($267.9million) for..,

! Locomotives: 6

! Train sets: 7

! Amount for which considered BNYCF leveraged-leaseproposal: $267.9 million


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Financing Options

! Three options..,! Borrow money to fund the purchase

! Lease the equipment from a financial institution (such asBNCYF)

! Rely on federal sources for funding


Borrow and Buy

! Major bank offered to underwrite a bondissuance for Amtrak..,

! Term: 20-year

! Coupon: 6.75 percent per annum

! Semiannual payments: $12.303 million

! Payment beginning: Dec 1999

! Collateral for the loan: locomotives and trains sets

! Drawback:! Had recently issued debt

! Public market might already be saturated with Amtrakpaper


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Leveraged Lease

! Proposed by: BNCYF

! Wholly owned subsidiary of the Bank of New York

! Lessor: BNCYF! Would provide equity funds needed to finance the purchase

! Sole lender and debt provider: Export DevelopmentCorporation (EDC) of Canada

! Funds to be provided..,! EDC: 80% of required funds! BNCYF: 20% of required funds; would receive lease payments

only after debtor had been paid


Lessee

Equipment Lease Payments

Equity investors put up $53.6

million (20% of equipment value)

in exchange for lease paymentsafter debt service

Owner TrusteeWilmington Trust

Lenders advance $214.3

million (80% of equipmentvalue) in exchange for

first claim on lease

payments on locomotivesand trains ets

Equity InvestorBNY Capital Funding, LLC

Lender

Export DevelopmentCorporation (EDC) of

Canada

BNY Capital Funding LLC's Proposed Leveraged-Lease Strcuture


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Leveraged Lease

! Equity and debt funds on closing would flow throughWilmington Trust..,

! An independent third party to the transaction

! Acted as owner-trustee

! Rental payments would flows through

! Would distribute the payments to either EDC or BNCYF

! Amtrak..,! At the end of lease term, could buy equipment from BNCYF at

higher terminal fair market value! Had an early-buyout option, could acquire the equipment from

BNCYF in 2017 for $126.6 million


Amount

1999 June .

Dec $200,1022000 June $3,761,228

Dec $7,965,652

2001 June $10,022,594Dec $10,316,948

2002 June $8,617,634

Dec $10,360,645

2003 June $9,828,570

Dec $10,367,985

2004 June $8,607,823

Dec $10,418,573

2005 June $9,683,063

Dec $10,435,186

2006 J une $8,580,151

Dec $11,599,993

2007 June $7,338,339

Dec $11,468,2112008 J une $9,475,208

Dec $15,792,709

2009 June $7,765,741

Dec $20,224,322

2010 June $5,067,035

Dec $15,872,556

2011 June $4,121,823

Dec $22,807,129

2012 J une $3,336,587

Dec $23,645,133

2013 June $2,662,913

Dec $24,055,367

2014 J une $1,957,919Dec $20,017,6082015 June $6,067,613

Dec $6,287,652

2016 June $12,292,315

Dec $21,394,788

2017 June $6,551,924

Dec $18,107,167

2018 June $8,612,133

Dec $13,469,295

2019 June $8,864,543

Dec $6,654,238

2020 J une $2,035,748

Dec $1

BNY Capital Funding LLC's ProposedLease-Payment Schedule (in Dollars)

Date Due


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Types of Financial Leases

! Direct leases! Lessor purchased equipment or asset and rented it out to

lessee

! Sale-and-leaseback

! Leveraged leases! Lessor borrowed money to fund part of purchase of assets,

pledging the lease contract as security for the loan


Leveraged Lease

! Treasury staff estimates..,! SD of market-value fluctuations of train sets and

locomotives: 25%

! 17-year risk-free rate: 5.78%

!Amtrak WACC: 11.8%


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Rely on Federal Sources

! Could use federal monies to fund equipmentpurchases

! Congress..,! Mandated not to use federal subsidies for operating

expenses

!Agreed to fund for capital appropriations

! Federal grants considered as premium andprecious commodity


Rely on Federal Sources

! Preferred to use grant money to fund capitalprojects that could not be easily and cost-effectively financed such as..,

! Safety

! Right-of-way

! Infrastructure-related projects

! Major overhauls

! Train sets and other rolling stock, could be veryefficiently financed through capital markets


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Year % Depreciated

1 14.29

2 24.49

3 17.49

4 12.49

5 8.93

6 8.93

7 8.93

8 4.45

Seven-Year MACRS Depreciation

Schedule (in % of DepreciableInvestment)

Because of the half-year convention, seven-

year MACRS involved eight years of

depreciation expenses


Types of Lease

Also called capital leasePurpose: using an assetPurpose: financing an asset

Lessor bears: maintenance,insurance, taxes

Lessee bears: maintenance,insurance, taxes

Cancelable by lessee on noticeIrrevocable by both parties

No fixed future commitmentLease period = life of asset

Total lease rental > asset price

Operating LeaseFinance Lease


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Types of Lease

Similar to mortgage loans

Payout will include; asset cost,cost of financing, lessoroverhead, rate of return

Risk on asset falls on lesseeMin lease rental = rate ~ equalto lessee marginal cost of debt

Operating LeaseFinance Lease


Finance Lease

! Leveraged lease

! Sale and lease back arrangements

! Cross border (international) lease

! Foreign to foreign lease


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Leveraged Lease

! Parties involved..,! Lessor contributes equity (20% to 40%)

! Lesse

! Financier finance by way of term loans

! Used for assets requiring huge capital outlay ,! Airplane

! Satellites

! Ships

! Rails

! Off-shore drinking! Nuclear machines

! Power generation plants

! Large chemical plants

! Gas pipe lines


Leveraged Lease

! Loan is secured by first lien in the equipmentby an assignment of leased equipment andleased rental payments

! Basic documents used..,! Participation agreement signed by all parties

!

Trust agreement! Indenture trust

! Lease agreement for tax shield associated with assetownership and residual value of asset


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Direct Lease

! Hybrid of operating and financial lease

! Payout will not include..,! Repairs

! Maintenance

! Taxes

! Features..,! Duration: 3 or more years

! Lessor holds the title

! At expiration: lessee may renew or purchase

! Full payout


Other Types of Leases

! Master lease: blanket leasing

! Percentage lease: flat rental + additional rental over and above a revenue

! Wet and dry lease used in airline industry

! Triple net lease net of insurance, maintenance, taxes .

! Closed end and open end lease ownership possibilities opened to lessee

! Swap lease exchange assets in need of major repairs

! Full pay-out lease

! True lease fully goes with the local rules and regulations of a country

! Wash lease tax benefit transferred to investor! Upgrade lease used in obsolescence

! Capital lease to transfer ownership to lessee at the end of lease term

! Employee lease transferring employees to Lessor and leasing it back


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Why Leasing?

! Benefits to lessee..,! Leasing 100% financing

! Offers cash flow benefits

! Off balance sheet financing

! Avoidance of loan covenants

! Tax planning

! Creation of working capital

! Hedge against risk of inflation and obsolescence

!

Fast and flexible financing! To over come monopoly act

! Used in non-priority sector and service sector


Why Leasing?

! Benefits to lessor..,!Additional financial product

! Reduces risk

! Increases profitability

!Accelerates sales

! Higher leverage [Max. of 10:1]

! No gestation period! Low cost of operations


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Discussion Question

What is the problem in the case?


Problems in the Case

! To choose among three financing options! Debt

! Lease financing

! US govt. funding

! Use of federal monies is neither preferred nor practical

! Amtrak ..,! Never been profitable

! Should become self sufficient by 2002 (3 years away)

! Acela the key to self sufficiency [investment decisionhas been already made]


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Discussion Question

What is financial lease? How does it work?


Test for Capitalizing Lease

! Ownership test: ownership transferred to lessee at theend of lease

! Alternative ownership test: lessee has right to buyasset at a price substantially below fair market price

! Economic life test: lease term >= 75% of estimatedeconomic life of the asset

! Value test: PV of minimum lease payment >= 90% offair market value of asset at the time of lease


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Discussion Question

Which alternative to choose? What are the keybets in the decision?


Lease vs. Buying

! Lease financing! Increases companys debt capacity

! Public market is saturated with Amtrak debt

! Also includes interest component

! Investors will not recognize a financial lease liability as a form ofdebt?

! Liabilities: PV of financial lease payments

! Assets: PV of financial lease payments

! Possibility of increasing book income buy avoiding depreciationand interest?

! Lease payments includes depreciation and interest

! Possibility of evading capital-expenditures

! To avoid capital-approval procedures


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Discussion Question

Is there really a difference between formallyowning an asset, on the one hand, and being

entitled full use of the asset even without

formal ownership, on the other?


Lease vs. Buying

! In world of no taxes; leasing = borrow-and-buy

! Lease amount higher or lower indifferencepoint would result in value destruction for bothparties


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Difference between Lessor and LesseeCreating More Value for Lease

! Tax rate differences between lessor and lessee

! Realizing depreciation deduction by lessor and lessee

! Asset acquisition and maintenance cost specialization or scale of economies

! Realizing salvage values superiority of propertyknowledge

! Leverage abilities between lessor and lessee difference in interest deductibility


Discussion Question

What, in your view, are the advantages ofleasing over debt and vice versa?

Instances in which leasing makes sense?


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NPV Analysis of Lease

! Cash flows! Outflow: lease payments

! No tax shields on lease payments Amtrak has no taxbenefits

! Not entitled for residual value of $40.2 million

! Discount rate! WACC: 11.8%

! Interest rate: 6.75% - appropriate rate to be used


Discount rate 6.75%

Tax rate 0.00%

After-tax interest rate 6.75%

0 1 2 3 4 5 6 7 8 9 10

Lease payments (0.20) (3.76) (7.97) (10.02) (10.32) (8.62) ( 10.36) (9.83) (10.37) (8.61)

Tax shield on lease payments 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00

After-tax lease payments (0.20) ( 3.76) (7.97) (10.02) (10.32) (8.62) (10.36) (9. 83) (10.37) ( 8.61)

Residual value

Total cash flows (0.20) (3.76) (7.97) (10.02) (10.32) (8.62) (10.36) (9.83) (10.37) (8.61)

Discounted flows @ KD (0. 19) (3.52) ( 7. 21 ) ( 8. 78) (8.74) (7.06) ( 8. 21 ) ( 7. 54 ) (7. 69) (6.18)

11 12 13 14 15 16 17 18 19 20

Lease payments (10.42) (9.68) (10.44) (8.58) (11.60) (7.34) (11.47) (9.48) (15.79) (7.77)


After-tax lease payments (10.42) (9.68) (10.44) (8. 58) ( 11.60) (7.34) (11.47) ( 9. 48) (15.79) (7.77)

Residual value

Total cash flows (10.42) ( 9.68) ( 10.44) (8.58) (11.60) ( 7.34) (11.47) (9.48) ( 15.79) ( 7.77)

Discounted flows @ KD (7. 23) (6.50) ( 6. 78 ) ( 5. 39) ( 7.05) (4.31) ( 6. 52 ) ( 5. 21 ) (8. 41) (4.00)

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Lease payments (20.22) (5.07) (15.87) (4.12) (22.81) (3.34) (23.65) (2.66) (24.06) (1.96)


After-tax lease payments (20.22) (5.07) (15.87) (4. 12) ( 22.81) (3.34) (23.65) ( 2. 66) (24.06) (1.96)

Residual value

Total cash flows (20.22) ( 5.07) ( 15.87) (4.12) (22.81) ( 3.34) (23.65) (2.66) ( 24.06) ( 1.96)


Time Period 31 32 33 34 35 36 37 38 39 40

Lease payments (20.02) (6.07) (6.29) (12.29) (21.39) (6.55) (18.11) (8.61) (13.47) (8.86)


After-tax lease payments (20.02) (6.07) (6.29) ( 12.29) ( 21.39) (6.55) (18.11) ( 8. 61) (13.47) (8.86)

Residual valueTotal cash flows (20.02) ( 6.07) (6.29) (12.29) (21.39) ( 6.55) (18.11) (8.61) ( 13.47) ( 8.86)


Time Period 41 42 43 4 4 4 5 46 47 48 49 50

Lease payments (6.65) (2.04) (0.00)

Tax shield on lease payments 0.00 0.00 0.00

After-tax lease payments (6.65) (2.04) (0.00)

Residual value

Total cash flows (6.65) (2.04) (0.00) 0.00 0.00 0 .00 0.00 0 .00 0.00 0 .00

Discounted flows @ KD (1.71) (0.50) (0.00) 0.00 0.00 0.00 0.00 0.00 0.00 0.00

NPV of Lease Alternative (220.26)

Cash Flow Analysis of Lease Alternative (in Million Dollars)


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NPV Analysis of Borrow-and-Buy

! Cash flows! Inflow: debt proceeds

! Outflow 1: debt proceeds used to finance the equipment

! Outflow 2: interest and principal repayments

! No interest tax shields Amtrak has no tax benefits

! Depreciation tax shield: 0

! Entitled to residual value of equipment


Discount rate 6.75%

Tax rate 0.00%After-tax interest rate 6.75%Useful life of equipment 2 5

0 1 2 3 4 5 6 7 8 9 10 Sums

Debt 267.90Pur chase o f e quip me nt (26 7. 90)

Principal repayment (3.26) (3.37) (3.49) (3.60) (3.72) (3.85) (3.98) (4.11) (4.25) (4.40)Int eres t e xpe nse ( 9.0 4) (8.93) (8.82) (8.70) (8.58) ( 8. 45 ) (8.32) ( 8.19) (8.05 ) ( 7.91)Interest tax shields 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00

Depreciation tax shield 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00Residual valueTotal cash flows (12.30) (12.30) (12.30) (12.30) (12.30) (12.30) (12.30) (12.30) (12.30) (12.30)

Discounted flows @ KD ( 11 .9 0) ( 11 .5 1) ( 11 .14) (10.77) ( 10.42 ) ( 10 .0 8) ( 9. 75) (9.43) ( 9.13 ) (8.83) (102.97)

11 12 13 14 1 5 16 17 1 8 19 20Principal repayment (4.55) (4.70) (4.86) (5.02) (5.19) (5.37) (5.55) (5.73) (5.93) (6.13)Interest expense (7.76) (7.60) (7.45) (7.28) (7.11) (6.94) (6.76) (6.57) (6.38) (6.18)

Interest tax shields 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00Depreciation tax shield 0.00 0.00 0.00 0.00Residual value

Total cash flows (12.30) (12.30) (12.30) (12.30) (12.30) (12.30) (12.30) (12.30) (12.30) (12.30)

Discounted flows @ KD (8.54) (8.26) (7.99) (7.73) (7.48) (7.23) (7.00) (6.77) (6.55) (6.33) (73.88)

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Principal repayment (6.33) (6.55) (6.77) (7.00) (7.23) (7.48) (7.73) (7.99) (8.26) (8.54)Interest expense (5.97) (5.75) (5.53) (5.31) (5.07) (4.83) (4.57) (4.31) (4.04) (3.76)Interest tax shields 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00

Depreciation tax shieldResidual valueTotal cash flows (12.30) (12.30) (12.30) (12.30) (12.30) (12.30) (12.30) (12.30) (12.30) (12.30)


31 32 33 34 35 36 37 38 39 40Principal repayment (8.83) (9.13) (9.43) (9.75) (10.08) (10.42) (10.77) (11.14) (11.51) (11.90)

Interest expense (3.48) (3.18) (2.87) (2.55) (2.22) (1.88) (1.53) (1.17) (0.79) (0.40)Interest tax shields 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00Depreciation tax shield

Residual valueTotal cash flows (12.30) (12.30) (12.30) (12.30) (12.30) (12.30) (12.30) (12.30) (12.30) (12.30)


41 42 43 44 45 46 47 48 49 50Principal repaymentInterest expense

Interest tax shieldsDepreciation tax shieldResidual value 40.19Total cash flows 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 40.19

Discounted flows @ KD 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 7.64 7.64

(260.26)

Cash Flow Analysis of Borrow-and-Buy Alternative (In Million Dollars)

NPV of Borrow-and-Buy


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NPV Analysis of Lease vs. Borrow-and-Buy

! NPV of interest and principal repayment cashflows discounted by cost of debt will result incost of debt

! Difference in NPV

! Residual value claim of Amtrak at the end of 25

years! Leasing is superior cheaper by $40 million


Discussion Question

What happens to the decision on NPV whenAmtrak start making profit and starts claiming

any tax shields?


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! Assumed tax rate: 38%! Tax shields on lease payments are no longer zero

! Interest and depreciation tax shields are also positive

! Discount rate: after tax cost of debt

! NPV advantage on leasing is eliminated when taxesare assumed

! Better to borrow and buy

! Leasing makes sense; when lessor can use tax shieldsmore effectively than lessee



-$171.51 million-$260.26 millionBorrow-and-buy

-$173.90 million-$220.26 millionLease

Tax Rate of 38%No Tax


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Discount rate 6.75%

Tax rate 38.00%

After-tax interest rate 4.19%

0 1 2 3 4 5 6 7 8 9 10

Lease payments (0.20) (3.76) (7.97) (10.02) (10.32) (8.62) ( 10.36) (9.83) (10.37) (8.61)


After-tax lease payments (0.12) ( 2.33) (4.94) (6.21) (6.40) ( 5.34) (6.42) (6.09) (6.43) ( 5.34)

Residual value

Total cash flows (0.12) (2.33) (4.94) (6.21) (6.40) (5.34) (6.42) (6.09) (6.43) (5.34)

Discounted flows @ KD (0. 12) (2.24) ( 4. 64 ) ( 5. 72) (5.77) (4.72) ( 5. 56 ) ( 5. 16 ) (5. 34) (4.34)

11 12 13 14 15 16 17 18 19 20

Lease payments (10.42) (9.68) (10.44) (8.58) (11.60) (7.34) (11.47) (9.48) (15.79) (7.77)


After-tax lease payments (6.46) ( 6.00) (6.47) (5.32) (7.19) ( 4.55) (7.11) (5.87) (9.79) ( 4.81)

Residual value

Total cash flows (6.46) (6.00) (6.47) (5.32) (7.19) (4.55) (7.11) (5.87) (9.79) (4.81)


21 22 23 24 25 26 27 28 29 30

Lease payments (20.22) (5.07) (15.87) (4.12) (22.81) (3.34) (23.65) (2.66) (24.06) (1.96)


After-tax lease payments (12.54) ( 3.14) (9.84) (2. 56) (14.14) (2.07) (14.66) (1. 65) (14.91) ( 1.21)

Residual value

Total cash flows (12.54) (3.14) (9.84) (2.56) (14.14) (2.07) (14.66) (1.65) (14.91) (1.21)


Time Period 31 32 33 34 35 36 37 38 39 40

Lease payments (20.02) (6.07) (6.29) (12.29) (21.39) (6.55) (18.11) (8.61) (13.47) (8.86)


After-tax lease payments (12.41) (3.76) (3.90) (7.62) ( 13.26) (4.06) (11.23) ( 5.34) (8.35) (5.50)

Residual value

Total cash flows (12.41) (3.76) (3.90) (7.62) (13.26) (4.06) (11.23) (5.34) (8.35) (5.50)


Time Period 41 42 43 4 4 4 5 46 47 48 49 50

Lease payments (6.65) (2.04) (0.00)

Tax shield on lease payments 2.53 0.77 0.00

After-tax lease payments (4.13) (1.26) (0.00)

Residual value

Total cash flows (4.13) (1.26) (0.00) 0.00 0.00 0 .00 0.00 0 .00 0.00 0 .00

Discounted flows @ KD (1.76) (0.53) (0.00) 0.00 0.00 0.00 0.00 0.00 0.00 0.00

NPV of Lease Alternative (173.90)

Cash Flow Analysis of Lease Alternative (in Million Dollars)


Discount rate 6.75%

Tax rate 38.00%After-tax interest rate 4.19%Useful life of equipment 25

0 1 2 3 4 5 6 7 8 9 10 Sums

Debt 267.90Purchase of equipment (267.90)

P rinc ipal r ep ay me nt ( 3. 26 ) (3 .3 7) (3 .4 9) (3 .60 ) (3 .7 2) ( 3. 85 ) (3 .98) ( 4. 11 ) (4 .2 5) (4. 40 )Interest expense (9.04) (8.93) (8.82) (8.70) (8.58) (8.45) (8.32) (8.19) (8.05) (7.91)Interest tax shields 3.44 3.39 3.35 3.31 3.26 3.21 3.16 3.11 3.06 3 .00

Depreciation tax shield 7.27 7.27 12.47 12.47 8.90 8.90 6.36 6.36 4.55 4.55Residual valueTotal cas h fl ows (1 .59) (1. 64) 3. 51 3.47 ( 0.14) (0.19) (2.78) (2.83) (4.7 0) (4.75)

Discounted flows @ KD ( 1.56 ) (1.57) 3 .30 3.19 (0.13) (0.17) (2.41) (2.40) (3.90) (3.86) (9.50)

11 12 13 14 15 16 17 18 19 20P rin ci pal r ep ay me nt ( 4. 55 ) ( 4. 70 ) ( 4. 86) (5 .0 2) ( 5. 19 ) (5 .3 7) ( 5. 55 ) (5 .7 3) ( 5. 93 ) (6. 13 )Interest expense (7.76) (7.60) (7.45) (7.28) (7.11) (6.94) (6.76) (6.57) (6.38) (6.18)

Interest tax shields 2.95 2.89 2.83 2.77 2.70 2.64 2.57 2.50 2.42 2.35Depreciation tax shield 4.55 4.55 2.27 2.27Residual value

Total cas h fl ows (4.81) ( 4.87 ) (7 .2 1) ( 7.27 ) (9. 60) ( 9.67) ( 9.74) ( 9. 81) (9.88) ( 9.96)


21 22 23 24 25 26 27 28 29 30

P rin ci pal r ep ay me nt ( 6. 33 ) ( 6. 55 ) (6. 77 ) ( 7. 00 ) (7 .2 3) ( 7. 48) (7 .73 ) (7 .99) ( 8.2 6) ( 8. 54)Interest expense (5. 97) (5 .7 5) ( 5. 53 ) (5 .3 1) (5 .07) (4.83) ( 4. 57 ) ( 4. 31) (4.04) ( 3.76)Interest tax shields 2.27 2.19 2.10 2.02 1.93 1.83 1.74 1.64 1.54 1.43

Depreciation tax shieldResidual valueT otal c ash f lo ws (10.03) (10.12) (10.20) (10.29) (10.38) (10.4 7) (10.57) (10.6 6) (10.77) (10.8 7)


31 32 33 34 35 36 37 38 39 40Princ ipal repayme nt (8.83) (9.13) (9 .4 3) (9 .75) (10.08) (10.4 2) (10.77) (11 .14) (11 .51) (11 .9 0)

Interest expense (3. 48) (3. 18) (2.87 ) (2 .5 5) (2. 22) (1.88) ( 1. 53) ( 1. 17) (0.79) (0.40)Interest tax shields 1.32 1.21 1.09 0.97 0.84 0.71 0.58 0.44 0 .30 0.15Depreciation tax shield

Residual valueT otal c ash f lo ws (10.9 8) (11 .10) (11 .21) (11 .33) (11 .4 6) (11 .59) (11 .72) (11 .8 6) (12.00) (12.15)


41 42 43 44 45 46 47 48 49 50Principal repaymentInterest expense

Interest tax shieldsDepreciation tax shieldResidual value 40.19Total cash flows 0.00 0 .00 0 .00 0 .00 0 .00 0.00 0.00 0.00 0.00 40.19

Discounted flows @ KD 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 14.27 14.27

(171.51)

Cash Flow Analysis of Borrow-and-Buy Alternative (In Million Dollars)

NPV of Borrow-and-Buy


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Value of Early-Buyout Option

! Amtrak would acquire equipment from BNYCF in 2017for $126.6 million

! Type: simple European call option

! Valuation model: BSM

! WACC! Avg yield on 30-year bond: 5.5%

! Assumed market equity weight: 100%

! Assumed beta: 1! Market risk premium: 6%

! Cost of equity: 11.5% [referred in case is 11.8%]

! Option value is highly sensitive to WACC


Underlying asset value $17 Million (Present value of strike price of 126.6 million 18 years from now discounted at WACC 11.8%)

Strike price $126.6 Million Purchase price os asset

Maturity 18.5 years (June 1999 to Dec 2017)

Risk-free rate 6% 5% to 6%

Volatility 25% Footnote 10; volatility estimate of locomotive and train cars

Option Vlaue (BSM) $2.97 Million


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Adjusted NPV

-$171.51 million-$260.26 millionBorrow-and-buy

-$170.93 million-$217.29 millionLease

Tax Rate of 38%No Tax


Discussion Question

What, in your view, are the advantages ofleasing over debt and vice versa?


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Advantages of Leasing Over Debt

! Little options holding significant value

! Lessor can purchase equipment more costeffectively; tax deductions for..,

! Interest

! Depreciation

! Tailored to meet lessors needs heavier

payments in Dec than in June

Amtrak Case Solution - IIM Indore PGP 2008

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