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National Railroad Passenger Corporation (Amtrak): Acela Financing

Session 15

IIMI/PGP/Finance II/2008

Discussion Question

Whether Amtrak should finance the equipment purchases using BNCYFs leveraged-lease proposal or borrow money and purchase the equipment on its own?

IIMI/PGP/Finance II/2008

National Railroad Passenger Corporation (Amtrak): Acela Financing


Dated: 30 April, 1999 People: Arlene Friner, CFO, Amtrak Review: leveraged-lease proposal from BNY Capital Funding LLC (BNYCF) Adviser: Babcock & Brown Financial Corporation Invited: financial institutions to submit lease-financing proposals for planned purchase of..,

Locomotives High-speed train set

IIMI/PGP/Finance II/2008

National Railroad Passenger Corporation (Amtrak)


Created in: 1970 Created by: US congress Ensured: modern, efficient intercity passengerrail service Remain as: integral part of the national transportation system Govt. mandated: to take over rail-passenger operations of private railroads
IIMI/PGP/Finance II/2008

National Railroad Passenger Corporation (Amtrak)


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

IIMI/PGP/Finance II/2008

National Railroad Passenger Corporation (Amtrak)

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 operating expenses

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

IIMI/PGP/Finance II/2008

Income Statement (Values in Millions of USD) Fiscal Year Ending Sept. 30 1994 1995 1996 1997 1998 Revenues Passenger-related and other Commuter Reimbursable Federal payments Total revenues Expenses Salaries, wage and benefits Train operations Facility and office related Maintenance-of-way goods and services Advertising and sales Interest Depreciation and amortization Other One-time charges/(gains) Total expenses Operating income/(loss) Exclude federal payments and related interest Operating loss restated Federal grants Federal operating grant Excess railroad retirement taxes Federal capital - interest Federal capital - progressive overhaul and other Total federal grants Net loss 1152 184 77 1413 1330 358 153 45 91 185 245 83 -244 2246 -833 -833 352 150 1177 213 107 1497 1241 321 172 73 90 144 230 34 2305 -808 -808 392 150 1213 234 108 1555 1236 321 181 59 109 149 238 25 2318 -763 -763 285 120 36 441 -322 1341 242 91 1674 1299 365 187 46 98 160 242 39 2436 -762 -762 223 142 42 37 444 -318 1392 260 91 542 2285 1448 356 190 52 102 181 294 15 2638 -353 577 -930 202 142 82 426 -504

502 -331

542 -266

IIMI/PGP/Finance II/2008

Income Statement (Values in Millions of USD) Fiscal Year Ending Sept. 30 1994 1995 1996 1997 1998 Revenues Passenger-related and other Commuter Reimbursable Federal payments Total revenues Expenses Salaries, wage and benefits Train operations Facility and office related Maintenance-of-way goods and services Advertising and sales Interest Depreciation and amortization Other One-time charges/(gains) Total expenses Operating income/(loss) Exclude federal payments and related interest Operating loss restated Federal grants Federal operating grant Excess railroad retirement taxes Federal capital - interest Federal capital - progressive overhaul and other Total federal grants Net loss 82 13 5 100 94 25 11 3 6 13 17 6 -17 159 -59 -59 25 11 79 14 7 100 83 21 11 5 6 10 15 2 154 -54 -54 26 10 78 15 7 100 79 21 12 4 7 10 15 2 149 -49 -49 18 8 2 28 -21 80 14 5 100 78 22 11 3 6 10 14 2 146 -46 -46 13 8 3 2 27 -19 61 11 4 24 100 63 16 8 2 4 8 13 1 115 -15 25 -41 9 6 4 19 -22

IIMI/PGP/Finance II/2008

36 -23

36 -18

Income Statement (Values in Millions of USD) Fiscal Year Ending Sept. 30 1994 1995 1996 1997 1998 Revenues Passenger-related and other Commuter Reimbursable Federal payments Total revenues Expenses Salaries, wage and benefits Train operations Facility and office related Maintenance-of-way goods and services Advertising and sales Interest Depreciation and amortization Other One-time charges/(gains) Total expenses Operating income/(loss) Exclude federal payments and related interest Operating loss restated Federal grants Federal operating grant Excess railroad retirement taxes Federal capital - interest Federal capital - progressive overhaul and other Total federal grants Net loss 100 100 100 100 100 100 100 100 100 100 100 100 100 100 100 100 100 102 116 139 106 93 90 112 162 99 78 94 41 103 97 97 111 100 105 127 140 110 93 90 118 131 120 81 97 30 103 92 92 81 80 116 132 118 118 98 102 122 102 108 86 99 47 108 91 91 63 95 121 141 118 162 109 99 124 116 112 98 120 18 117 42 112 57 95

IIMI/PGP/Finance II/2008

100 100

108 80

88 97

88 96

85 152

Balance Sheet (Values in Million of USD) Fy Ending Fy Ending Sept 30, 1998 Sept 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 1 Other 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 10 IIMI/PGP/Finance II/2008

Balance Sheet (Values in Million of USD) Fy Ending Fy Ending Sept 30, 1998 Sept 30, 1998 Current liabilities Accounts payable Accrued expenses and other current liabilities Deffered ticket revenue Current maturities of LT debt and capital-lease obligations Total current liabilities LT debt and capital lease obligations Capital lease obligations Equipment and other debt Other liabilities and deffered credit Deferred federal payments Casuality reserves Postretirement employee-benefits obligation Environmental reserve Advances from railroads and commuter agencies Other Total liabilities Capitalization Preffered stock Common stock Other paid-in capital Accumulated comprehensive loss 270.8 186.7 61.4 102.2 621.1 1213.1 322.5 1535.6 457 136.2 118.4 35.4 20.6 1.5 769.1 2925.8 10939.7 93.9 6471.3 -13125.4 4379.5 7305.3 4 3 1 1 9 17 4 21 6 2 2 0 0 0 11 40 150 1 89 -180 60 100

11

Total liabilities and capitalization IIMI/PGP/Finance II/2008

Acela

New brand New high-speed rail service More than high-speed trains Designed to: differentiate Amtrak passenger trains and service 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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IIMI/PGP/Finance II/2008

Exhibit 1

13

IIMI/PGP/Finance II/2008

Acela

Brand representing new way of doing business Designed to: bring high speed and high quality to Northeast Corridor passengers Will offer..,

Faster trip times Comfortable amenities Highly personalized service

Latest and boldest step to change its rail service into a more..,

Customer-focused Commercially driven Premium transportation service


IIMI/PGP/Finance II/2008

14

Acela

Designed to..,

Operate as fast as 150 miles an hour (241.35 kms an hour) Promised to reduce travel time significantly Current timing: 7 hrs 30 minutes High-speed train: 5 hrs 50 minutes

Timing between: Washington D.C., to Boston


Late 1999: to begin service between NY city and Boston NY Washington leg would be added within a year

15

IIMI/PGP/Finance II/2008

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

16

IIMI/PGP/Finance II/2008

Equipment

No. High-speed locomotives 15 Train sets 20

Cost Aggregate Cost 7,161,300 107,419,500 32,129,050 642,581,000 Total 750,000,500

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IIMI/PGP/Finance II/2008

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 ($267.9 million) for..,


Locomotives: 6 Train sets: 7

Amount for which considered BNYCF leveraged-lease proposal: $267.9 million


IIMI/PGP/Finance II/2008

18

Financing Options

Three options..,

Borrow money to fund the purchase Lease the equipment from a financial institution (such as BNCYF) Rely on federal sources for funding

19

IIMI/PGP/Finance II/2008

Borrow and Buy

Major bank offered to underwrite a bond issuance 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 Amtrak paper
IIMI/PGP/Finance II/2008

20

10

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 Development Corporation (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

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IIMI/PGP/Finance II/2008

BNY Capital Funding LLC's Proposed Leveraged-Lease Strcuture

Lessee

Equipment

Lease Payments

Equity investors put up $53.6 million (20% of equipment value) in exchange for lease payments after debt service

Owner Trustee Wilmington Trust

Lenders advance $214.3 million (80% of equipment value) in exchange for first claim on lease payments on locomotives and trains ets

Equity Investor BNY Capital Funding, LLC

Lender Export Development Corporation (EDC) of Canada


IIMI/PGP/Finance II/2008

22

11

Leveraged Lease

Equity and debt funds on closing would flow through Wilmington 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 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

Amtrak..,

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IIMI/PGP/Finance II/2008

24

BNY Capital Funding LLC's Proposed Lease-Payment Schedule (in Dollars) Date Due Amount 1999 June . Dec $200,102 2000 June $3,761,228 Dec $7,965,652 2001 June $10,022,594 Dec $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 June $8,580,151 Dec $11,599,993 2007 June $7,338,339 Dec $11,468,211 2008 June $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 June $3,336,587 Dec $23,645,133 2013 June $2,662,913 Dec $24,055,367 2014 June $1,957,919 Dec $20,017,608 2015 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 June $2,035,748 Dec $1

IIMI/PGP/Finance II/2008

12

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

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IIMI/PGP/Finance II/2008

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%

26

IIMI/PGP/Finance II/2008

13

Rely on Federal Sources


Could use federal monies to fund equipment purchases Congress..,


Mandated not to use federal subsidies for operating expenses Agreed to fund for capital appropriations

Federal grants considered as premium and precious commodity


IIMI/PGP/Finance II/2008

27

Rely on Federal Sources

Preferred to use grant money to fund capital projects that could not be easily and costeffectively financed such as..,

Safety Right-of-way Infrastructure-related projects Major overhauls

Train sets and other rolling stock, could be very efficiently financed through capital markets
IIMI/PGP/Finance II/2008

28

14

Seven-Year MACRS Depreciation Schedule (in % of Depreciable Investment) 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
Because of the half-year convention, sevenyear MACRS involved eight years of depreciation expenses

29

IIMI/PGP/Finance II/2008

Types of Lease
Finance Lease Total lease rental > asset price Lease period = life of asset Irrevocable by both parties Purpose: financing an asset Also called capital lease Lessee bears: maintenance, insurance, taxes Lessor bears: maintenance, insurance, taxes No fixed future commitment Cancelable by lessee on notice Purpose: using an asset Operating Lease

30

IIMI/PGP/Finance II/2008

15

Types of Lease
Finance Lease Operating Lease

Min lease rental = rate ~ equal Risk on asset falls on lessee to lessee marginal cost of debt Payout will include; asset cost, cost of financing, lessor overhead, rate of return Similar to mortgage loans

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IIMI/PGP/Finance II/2008

Finance Lease

Leveraged lease Sale and lease back arrangements Cross border (international) lease Foreign to foreign lease

32

IIMI/PGP/Finance II/2008

16

Leveraged Lease

Parties involved..,

Lessor contributes equity (20% to 40%) Lesse Financier finance by way of term loans Airplane Satellites Ships Rails Off-shore drinking Nuclear machines Power generation plants Large chemical plants Gas pipe lines
IIMI/PGP/Finance II/2008

Used for assets requiring huge capital outlay ,


33

Leveraged Lease

Loan is secured by first lien in the equipment by an assignment of leased equipment and leased rental payments Basic documents used..,

Participation agreement signed by all parties Trust agreement Indenture trust Lease agreement for tax shield associated with asset ownership and residual value of asset
IIMI/PGP/Finance II/2008

34

17

Direct Lease

Hybrid of operating and financial lease Payout will not include..,


Repairs Maintenance Taxes Duration: 3 or more years Lessor holds the title At expiration: lessee may renew or purchase Full payout

Features..,

35

IIMI/PGP/Finance II/2008

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

36

IIMI/PGP/Finance II/2008

18

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

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IIMI/PGP/Finance II/2008

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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IIMI/PGP/Finance II/2008

19

Discussion Question

What is the problem in the case?

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IIMI/PGP/Finance II/2008

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 decision has been already made]
IIMI/PGP/Finance II/2008

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Discussion Question

What is financial lease? How does it work?

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IIMI/PGP/Finance II/2008

Test for Capitalizing Lease


Ownership test: ownership transferred to lessee at the end of lease Alternative ownership test: lessee has right to buy asset at a price substantially below fair market price Economic life test: lease term >= 75% of estimated economic life of the asset Value test: PV of minimum lease payment >= 90% of fair market value of asset at the time of lease

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IIMI/PGP/Finance II/2008

21

Discussion Question

Which alternative to choose? What are the key bets in the decision?

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IIMI/PGP/Finance II/2008

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 of debt?

Liabilities: PV of financial lease payments Assets: PV of financial lease payments

Possibility of increasing book income buy avoiding depreciation and interest?

Lease payments includes depreciation and interest

Possibility of evading capital-expenditures To avoid capital-approval procedures


IIMI/PGP/Finance II/2008

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Discussion Question

Is there really a difference between formally owning an asset, on the one hand, and being entitled full use of the asset even without formal ownership, on the other?

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IIMI/PGP/Finance II/2008

Lease vs. Buying


In world of no taxes; leasing = borrow-and-buy Lease amount higher or lower indifference point would result in value destruction for both parties

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IIMI/PGP/Finance II/2008

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Difference between Lessor and Lessee Creating 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 property knowledge Leverage abilities between lessor and lessee difference in interest deductibility

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IIMI/PGP/Finance II/2008

Discussion Question

What, in your view, are the advantages of leasing over debt and vice versa? Instances in which leasing makes sense?

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IIMI/PGP/Finance II/2008

24

NPV Analysis of Lease

Cash flows

Outflow: lease payments No tax shields on lease payments Amtrak has no tax benefits Not entitled for residual value of $40.2 million WACC: 11.8% Interest rate: 6.75% - appropriate rate to be used

Discount rate

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IIMI/PGP/Finance II/2008

Cash Flow Analysis of Lease Alternative (in Million Dollars) Discount rate Tax rate After-tax interest rate Lease payments Tax shield on lease payments After-tax lease payments Residual value Total cash flows Discounted flows @ K D Lease payments Tax shield on lease payments After-tax lease payments Residual value Total cash flows Discounted flows @ K D Lease payments Tax shield on lease payments After-tax lease payments Residual value Total cash flows Discounted flows @ K D Time Period Lease payments Tax shield on lease payments After-tax lease payments Residual value Total cash flows Discounted flows @ K D Time Period Lease payments Tax shield on lease payments After-tax lease payments Residual value Total cash flows Discounted flows @ K D 6.75% 0.00% 6.75% 0

1 (0.20) 0.00 (0.20) (0.20) (0.19) 11 (10.42) 0.00 (10.42) (10.42) (7.23) 21 (20.22) 0.00 (20.22) (20.22) (10.07) 31 (20.02) 0.00 (20.02) (20.02) (7.15) 41 (6.65) 0.00 (6.65) (6.65) (1.71)

2 (3.76) 0.00 (3.76) (3.76) (3.52) 12 (9.68) 0.00 (9.68) (9.68) (6.50) 22 (5.07) 0.00 (5.07) (5.07) (2.44) 32 (6.07) 0.00 (6.07) (6.07) (2.10) 42 (2.04) 0.00 (2.04) (2.04) (0.50)

3 (7.97) 0.00 (7.97) (7.97) (7.21) 13 (10.44) 0.00 (10.44) (10.44) (6.78) 23 (15.87) 0.00 (15.87) (15.87) (7.40) 33 (6.29) 0.00 (6.29) (6.29) (2.10) 43 (0.00) 0.00 (0.00) (0.00) (0.00)

4 (10.02) 0.00 (10.02) (10.02) (8.78) 14 (8.58) 0.00 (8.58) (8.58) (5.39) 24 (4.12) 0.00 (4.12) (4.12) (1.86) 34 (12.29) 0.00 (12.29) (12.29) (3.98) 44

5 (10.32) 0.00 (10.32) (10.32) (8.74) 15 (11.60) 0.00 (11.60) (11.60) (7.05) 25 (22.81) 0.00 (22.81) (22.81) (9.95) 35 (21.39) 0.00 (21.39) (21.39) (6.70) 45

6 (8.62) 0.00 (8.62) (8.62) (7.06) 16 (7.34) 0.00 (7.34) (7.34) (4.31) 26 (3.34) 0.00 (3.34) (3.34) (1.41) 36 (6.55) 0.00 (6.55) (6.55) (1.98) 46

7 (10.36) 0.00 (10.36) (10.36) (8.21) 17 (11.47) 0.00 (11.47) (11.47) (6.52) 27 (23.65) 0.00 (23.65) (23.65) (9.65) 37 (18.11) 0.00 (18.11) (18.11) (5.30) 47

8 (9.83) 0.00 (9.83) (9.83) (7.54) 18 (9.48) 0.00 (9.48) (9.48) (5.21) 28 (2.66) 0.00 (2.66) (2.66) (1.05) 38 (8.61) 0.00 (8.61) (8.61) (2.44) 48

9 (10.37) 0.00 (10.37) (10.37) (7.69) 19 (15.79) 0.00 (15.79) (15.79) (8.41) 29 (24.06) 0.00 (24.06) (24.06) (9.19) 39 (13.47) 0.00 (13.47) (13.47) (3.69) 49

10 (8.61) 0.00 (8.61) (8.61) (6.18) 20 (7.77) 0.00 (7.77) (7.77) (4.00) 30 (1.96) 0.00 (1.96) (1.96) (0.72) 40 (8.86) 0.00 (8.86) (8.86) (2.35) 50

0.00 0.00

0.00 0.00

0.00 0.00

0.00 0.00

0.00 0.00

0.00 0.00

0.00 0.00

50

NPV of Lease Alternative

(220.26)

IIMI/PGP/Finance II/2008

25

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

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IIMI/PGP/Finance II/2008

Discount rate Tax rate After-tax interest rate Useful life of equipment Debt Purchase of equipment Principal repayment Interest expense Interest tax shields Depreciation tax shield Residual value Total cash flows Discounted flows @ K D Principal repayment Interest expense Interest tax shields Depreciation tax shield Residual value Total cash flows Discounted flows @ K D Principal repayment Interest expense Interest tax shields Depreciation tax shield Residual value Total cash flows Discounted flows @ K D Principal repayment Interest expense Interest tax shields Depreciation tax shield Residual value Total cash flows Discounted flows @ K D Principal repayment Interest expense Interest tax shields Depreciation tax shield Residual value Total cash flows Discounted flows @ K D

Cash Flow Analysis of Borrow-and-Buy Alternative (In Million Dollars) 6.75% 0.00% 6.75% 25 0 1 2 3 4 5 6 7 8 267.90 (267.90) (3.26) (3.37) (3.49) (3.60) (3.72) (3.85) (3.98) (4.11) (9.04) (8.93) (8.82) (8.70) (8.58) (8.45) (8.32) (8.19) 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 (12.30) (12.30) (11.90) (11.51) 11 12 (4.55) (4.70) (7.76) (7.60) 0.00 0.00 0.00 0.00 (12.30) (12.30) (8.54) (8.26) 21 22 (6.33) (6.55) (5.97) (5.75) 0.00 0.00 (12.30) (11.14) 13 (4.86) (7.45) 0.00 0.00 (12.30) (7.99) 23 (6.77) (5.53) 0.00 (12.30) (10.77) 14 (5.02) (7.28) 0.00 0.00 (12.30) (7.73) 24 (7.00) (5.31) 0.00 (12.30) (10.42) 15 (5.19) (7.11) 0.00 (12.30) (12.30) (10.08) (9.75) 16 17 (5.37) (5.55) (6.94) (6.76) 0.00 0.00 (12.30) (9.43) 18 (5.73) (6.57) 0.00

10

Sums

(4.25) (8.05) 0.00 0.00 (12.30) (9.13) 19 (5.93) (6.38) 0.00

(4.40) (7.91) 0.00 0.00 (12.30) (8.83) 20 (6.13) (6.18) 0.00

(102.97)

(12.30) (7.48) 25 (7.23) (5.07) 0.00

(12.30) (12.30) (7.23) (7.00) 26 27 (7.48) (7.73) (4.83) (4.57) 0.00 0.00

(12.30) (6.77) 28 (7.99) (4.31) 0.00

(12.30) (6.55) 29 (8.26) (4.04) 0.00

(12.30) (6.33) 30 (8.54) (3.76) 0.00

(73.88)

(12.30) (12.30) (6.13) (5.93) 31 32 (8.83) (9.13) (3.48) (3.18) 0.00 0.00

(12.30) (5.73) 33 (9.43) (2.87) 0.00

(12.30) (5.55) 34 (9.75) (2.55) 0.00

(12.30) (5.37) 35 (10.08) (2.22) 0.00

(12.30) (12.30) (5.19) (5.02) 36 37 (10.42) (10.77) (1.88) (1.53) 0.00 0.00

(12.30) (4.86) 38 (11.14) (1.17) 0.00

(12.30) (4.70) 39 (11.51) (0.79) 0.00

(12.30) (4.55) 40 (11.90) (0.40) 0.00

(53.01)

(12.30) (4.40) 41

(12.30) (4.25) 42

(12.30) (4.11) 43

(12.30) (3.98) 44

(12.30) (3.85) 45

(12.30) (12.30) (3.72) (3.60) 46 47

(12.30) (3.49) 48

(12.30) (3.37) 49

(12.30) (3.26) 50

(38.04)

0.00 0.00

0.00 0.00

0.00 0.00

0.00 0.00

0.00 0.00

0.00 0.00

0.00 0.00

0.00 0.00

0.00 0.00

40.19 40.19 7.64

7.64

52

NPV of Borrow-and-Buy

(260.26)

IIMI/PGP/Finance II/2008

26

NPV Analysis of Lease vs. Borrowand-Buy

NPV of interest and principal repayment cash flows discounted by cost of debt will result in cost of debt Difference in NPV Residual value claim of Amtrak at the end of 25 years Leasing is superior cheaper by $40 million

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IIMI/PGP/Finance II/2008

Discussion Question

What happens to the decision on NPV when Amtrak start making profit and starts claiming any tax shields?

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27

NPV Analysis of Lease vs. Borrowand-Buy

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 taxes are assumed Better to borrow and buy Leasing makes sense; when lessor can use tax shields more effectively than lessee
IIMI/PGP/Finance II/2008

55

NPV Analysis of Lease vs. Borrowand-Buy

No Tax Lease

Tax Rate of 38%

-$220.26 million -$173.90 million

Borrow-and-buy -$260.26 million -$171.51 million

56

IIMI/PGP/Finance II/2008

28

Cash Flow Analysis of Lease Alternative (in Million Dollars) Discount rate Tax rate After-tax interest rate Lease payments Tax shield on lease payments After-tax lease payments Residual value Total cash flows Discounted flows @ K D Lease payments Tax shield on lease payments After-tax lease payments Residual value Total cash flows Discounted flows @ K D Lease payments Tax shield on lease payments After-tax lease payments Residual value Total cash flows Discounted flows @ K D Time Period Lease payments Tax shield on lease payments After-tax lease payments Residual value Total cash flows Discounted flows @ K D Time Period Lease payments Tax shield on lease payments After-tax lease payments Residual value Total cash flows Discounted flows @ K D 6.75% 38.00% 4.19% 0

1 (0.20) 0.08 (0.12) (0.12) (0.12) 11 (10.42) 3.96 (6.46) (6.46) (5.14) 21 (20.22) 7.69 (12.54) (12.54) (8.12) 31 (20.02) 7.61 (12.41) (12.41) (6.53) 41 (6.65) 2.53 (4.13) (4.13) (1.76)

2 (3.76) 1.43 (2.33) (2.33) (2.24) 12 (9.68) 3.68 (6.00) (6.00) (4.68) 22 (5.07) 1.93 (3.14) (3.14) (1.99) 32 (6.07) 2.31 (3.76) (3.76) (1.94) 42 (2.04) 0.77 (1.26) (1.26) (0.53)

3 (7.97) 3.03 (4.94) (4.94) (4.64) 13 (10.44) 3.97 (6.47) (6.47) (4.94) 23 (15.87) 6.03 (9.84) (9.84) (6.11) 33 (6.29) 2.39 (3.90) (3.90) (1.97) 43 (0.00) 0.00 (0.00) (0.00) (0.00)

4 (10.02) 3.81 (6.21) (6.21) (5.72) 14 (8.58) 3.26 (5.32) (5.32) (3.98) 24 (4.12) 1.57 (2.56) (2.56) (1.55) 34 (12.29) 4.67 (7.62) (7.62) (3.77) 44

5 (10.32) 3.92 (6.40) (6.40) (5.77) 15 (11.60) 4.41 (7.19) (7.19) (5.27) 25 (22.81) 8.67 (14.14) (14.14) (8.43) 35 (21.39) 8.13 (13.26) (13.26) (6.43) 45

6 (8.62) 3.27 (5.34) (5.34) (4.72) 16 (7.34) 2.79 (4.55) (4.55) (3.27) 26 (3.34) 1.27 (2.07) (2.07) (1.21) 36 (6.55) 2.49 (4.06) (4.06) (1.93) 46

7 (10.36) 3.94 (6.42) (6.42) (5.56) 17 (11.47) 4.36 (7.11) (7.11) (5.00) 27 (23.65) 8.99 (14.66) (14.66) (8.38) 37 (18.11) 6.88 (11.23) (11.23) (5.22) 47

8 (9.83) 3.73 (6.09) (6.09) (5.16) 18 (9.48) 3.60 (5.87) (5.87) (4.05) 28 (2.66) 1.01 (1.65) (1.65) (0.92) 38 (8.61) 3.27 (5.34) (5.34) (2.43) 48

9 (10.37) 3.94 (6.43) (6.43) (5.34) 19 (15.79) 6.00 (9.79) (9.79) (6.61) 29 (24.06) 9.14 (14.91) (14.91) (8.18) 39 (13.47) 5.12 (8.35) (8.35) (3.72) 49

10 (8.61) 3.27 (5.34) (5.34) (4.34) 20 (7.77) 2.95 (4.81) (4.81) (3.18) 30 (1.96) 0.74 (1.21) (1.21) (0.65) 40 (8.86) 3.37 (5.50) (5.50) (2.40) 50

0.00 0.00

0.00 0.00

0.00 0.00

0.00 0.00

0.00 0.00

0.00 0.00

0.00 0.00

57

NPV of Lease Alternative

(173.90)

IIMI/PGP/Finance II/2008

Discount rate Tax rate After-tax interest rate Useful life of equipment Debt Purchase of equipment Principal repayment Interest expense Interest tax shields Depreciation tax shield Residual value Total cash flows Discounted flows @ K D Principal repayment Interest expense Interest tax shields Depreciation tax shield Residual value Total cash flows Discounted flows @ K D Principal repayment Interest expense Interest tax shields Depreciation tax shield Residual value Total cash flows Discounted flows @ K D Principal repayment Interest expense Interest tax shields Depreciation tax shield Residual value Total cash flows Discounted flows @ K D Principal repayment Interest expense Interest tax shields Depreciation tax shield Residual value Total cash flows Discounted flows @ K D

Cash Flow Analysis of Borrow-and-Buy Alternative (In Million Dollars) 6.75% 38.00% 4.19% 25 0 1 2 3 4 5 6 7 8 267.90 (267.90) (3.26) (3.37) (3.49) (3.60) (3.72) (3.85) (3.98) (4.11) (9.04) (8.93) (8.82) (8.70) (8.58) (8.45) (8.32) (8.19) 3.44 3.39 3.35 3.31 3.26 3.21 3.16 3.11 7.27 7.27 12.47 12.47 8.90 8.90 6.36 6.36 (1.59) (1.56) 11 (4.55) (7.76) 2.95 4.55 (4.81) (3.83) 21 (6.33) (5.97) 2.27 (1.64) (1.57) 12 (4.70) (7.60) 2.89 4.55 (4.87) (3.80) 22 (6.55) (5.75) 2.19 3.51 3.30 13 (4.86) (7.45) 2.83 2.27 (7.21) (5.51) 23 (6.77) (5.53) 2.10 3.47 3.19 14 (5.02) (7.28) 2.77 2.27 (7.27) (5.44) 24 (7.00) (5.31) 2.02 (0.14) (0.13) 15 (5.19) (7.11) 2.70 (0.19) (0.17) 16 (5.37) (6.94) 2.64 (2.78) (2.41) 17 (5.55) (6.76) 2.57 (2.83) (2.40) 18 (5.73) (6.57) 2.50

10

Sums

(4.25) (8.05) 3.06 4.55 (4.70) (3.90) 19 (5.93) (6.38) 2.42

(4.40) (7.91) 3.00 4.55 (4.75) (3.86) 20 (6.13) (6.18) 2.35

(9.50)

(9.60) (7.04) 25 (7.23) (5.07) 1.93

(9.67) (6.94) 26 (7.48) (4.83) 1.83

(9.74) (6.85) 27 (7.73) (4.57) 1.74

(9.81) (6.76) 28 (7.99) (4.31) 1.64

(9.88) (6.67) 29 (8.26) (4.04) 1.54

(9.96) (6.58) 30 (8.54) (3.76) 1.43

(59.40)

(10.03) (10.12) (10.20) (10.29) (10.38) (10.47) (10.57) (10.66) (6.50) (6.41) (6.33) (6.26) (6.18) (6.11) (6.04) (5.97) 31 32 33 34 35 36 37 38 (8.83) (9.13) (9.43) (9.75) (10.08) (10.42) (10.77) (11.14) (3.48) (3.18) (2.87) (2.55) (2.22) (1.88) (1.53) (1.17) 1.32 1.21 1.09 0.97 0.84 0.71 0.58 0.44

(10.77) (10.87) (5.91) (5.84) 39 40 (11.51) (11.90) (0.79) (0.40) 0.30 0.15

(61.56)

(10.98) (11.10) (5.78) (5.72) 41 42

(11.21) (5.66) 43

(11.33) (5.61) 44

(11.46) (11.59) (5.55) (5.50) 45 46

(11.72) (5.45) 47

(11.86) (12.00) (5.40) (5.35) 48 49

(12.15) (5.31) 50

(55.32)

0.00 0.00

0.00 0.00

0.00 0.00

0.00 0.00

0.00 0.00

0.00 0.00

0.00 0.00

0.00 0.00

0.00 0.00

40.19 40.19 14.27

14.27

58

NPV of Borrow-and-Buy

(171.51)

IIMI/PGP/Finance II/2008

29

Value of Early-Buyout Option


Amtrak would acquire equipment from BNYCF in 2017 for $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


IIMI/PGP/Finance II/2008

59

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

60

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30

Adjusted NPV

No Tax Lease

Tax Rate of 38%

-$217.29 million -$170.93 million

Borrow-and-buy -$260.26 million -$171.51 million

61

IIMI/PGP/Finance II/2008

Discussion Question

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

62

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31

Advantages of Leasing Over Debt


Little options holding significant value Lessor can purchase equipment more cost effectively; tax deductions for..,

Interest Depreciation

Tailored to meet lessors needs heavier payments in Dec than in June

63

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32