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IIMI/PGP/Finance II/20081
National Railroad PassengerCorporation (Amtrak): Acela Financing
Session 15
IIMI/PGP/Finance II/20082
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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IIMI/PGP/Finance II/20083
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
IIMI/PGP/Finance II/20084
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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IIMI/PGP/Finance II/20085
National Railroad PassengerCorporation (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/20086
National Railroad PassengerCorporation (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 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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IIMI/PGP/Finance II/20087
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
IIMI/PGP/Finance II/20088
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
Facility and office related 11 11 12 11 8
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
Federal operating grant 25 26 18 13 9
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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IIMI/PGP/Finance II/20089
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
Facility and office related 100 112 118 122 124
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
Federal operating grant 100 111 81 63 57
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
IIMI/PGP/Finance II/200810
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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IIMI/PGP/Finance II/200811
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)
IIMI/PGP/Finance II/200812
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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IIMI/PGP/Finance II/200813
Exhibit 1
IIMI/PGP/Finance II/200814
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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IIMI/PGP/Finance II/200815
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
IIMI/PGP/Finance II/200816
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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IIMI/PGP/Finance II/200817
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
IIMI/PGP/Finance II/200818
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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IIMI/PGP/Finance II/200819
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
IIMI/PGP/Finance II/200820
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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IIMI/PGP/Finance II/200821
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
IIMI/PGP/Finance II/200822
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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IIMI/PGP/Finance II/200823
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
IIMI/PGP/Finance II/200824
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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IIMI/PGP/Finance II/200825
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
IIMI/PGP/Finance II/200826
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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IIMI/PGP/Finance II/200827
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
IIMI/PGP/Finance II/200828
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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IIMI/PGP/Finance II/200829
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
IIMI/PGP/Finance II/200830
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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IIMI/PGP/Finance II/200831
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
IIMI/PGP/Finance II/200832
Finance Lease
! Leveraged lease
! Sale and lease back arrangements
! Cross border (international) lease
! Foreign to foreign lease
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IIMI/PGP/Finance II/200833
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
IIMI/PGP/Finance II/200834
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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IIMI/PGP/Finance II/200835
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
IIMI/PGP/Finance II/200836
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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IIMI/PGP/Finance II/200837
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
IIMI/PGP/Finance II/200838
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/200839
Discussion Question
What is the problem in the case?
IIMI/PGP/Finance II/200840
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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IIMI/PGP/Finance II/200841
Discussion Question
What is financial lease? How does it work?
IIMI/PGP/Finance II/200842
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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IIMI/PGP/Finance II/200843
Discussion Question
Which alternative to choose? What are the keybets in the decision?
IIMI/PGP/Finance II/200844
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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IIMI/PGP/Finance II/200845
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?
IIMI/PGP/Finance II/200846
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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IIMI/PGP/Finance II/200847
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
IIMI/PGP/Finance II/200848
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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IIMI/PGP/Finance II/200849
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
IIMI/PGP/Finance II/200850
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)
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 (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)
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)
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 (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)
Discounted flows @ KD (10. 07) (2.44) ( 7. 40 ) ( 1. 86) ( 9.95) (1.41) ( 9. 65 ) ( 1. 05 ) (9. 19) (0.72)
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)
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 (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)
Discounted flows @ KD (7. 15) (2.10) ( 2. 10 ) ( 3. 98) ( 6.70) (1.98) ( 5. 30 ) ( 2. 44 ) (3. 69) (2.35)
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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IIMI/PGP/Finance II/200851
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
IIMI/PGP/Finance II/200852
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)
21 22 23 24 25 26 27 28 29 30
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)
Discounted flows @ KD (6.13) (5.93) (5.73) (5.55) (5.37) (5.19) (5.02) (4.86) (4.70) (4.55) (53.01)
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)
Discounted flows @ KD (4.40) (4.25) (4.11) (3.98) (3.85) (3.72) (3.60) (3.49) (3.37) (3.26) (38.04)
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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IIMI/PGP/Finance II/200853
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
IIMI/PGP/Finance II/200854
Discussion Question
What happens to the decision on NPV whenAmtrak start making profit and starts claiming
any tax shields?
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IIMI/PGP/Finance II/200855
NPV Analysis of Lease vs. Borrow-and-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 taxesare assumed
! Better to borrow and buy
! Leasing makes sense; when lessor can use tax shieldsmore effectively than lessee
IIMI/PGP/Finance II/200856
NPV Analysis of Lease vs. Borrow-and-Buy
-$171.51 million-$260.26 millionBorrow-and-buy
-$173.90 million-$220.26 millionLease
Tax Rate of 38%No Tax
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IIMI/PGP/Finance II/200857
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)
Tax shield on lease payments 0.08 1.43 3.03 3.81 3.92 3.27 3.94 3.73 3.94 3.27
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)
Tax shield on lease payments 3.96 3.68 3.97 3.26 4.41 2.79 4.36 3.60 6.00 2.95
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)
Discounted flows @ KD (5. 14) (4.68) ( 4. 94 ) ( 3. 98) ( 5.27) (3.27) ( 5. 00 ) ( 4. 05 ) (6. 61) (3.18)
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)
Tax shield on lease payments 7.69 1.93 6.03 1.57 8.67 1.27 8.99 1.01 9.14 0.74
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)
Discounted flows @ KD (8. 12) (1.99) ( 6. 11 ) ( 1. 55) ( 8.43) (1.21) ( 8. 38 ) ( 0. 92 ) (8. 18) (0.65)
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)
Tax shield on lease payments 7.61 2.31 2.39 4.67 8.13 2.49 6.88 3.27 5.12 3.37
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)
Discounted flows @ KD (6. 53) (1.94) ( 1. 97 ) ( 3. 77) ( 6.43) (1.93) ( 5. 22 ) ( 2. 43 ) (3. 72) (2.40)
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)
IIMI/PGP/Finance II/200858
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)
Discounted flows @ KD (3.83) (3.80) (5.51) (5.44) (7.04) (6.94) (6.85) (6.76) (6.67) (6.58) (59.40)
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)
Discounted flows @ KD (6.50) (6.41) (6.33) (6.26) (6.18) (6.11) (6.04) (5.97) (5.91) (5.84) (61.56)
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)
Discounted flows @ KD (5.78) (5.72) (5.66) (5.61) (5.55) (5.50) (5.45) (5.40) (5.35) (5.31) (55.32)
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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IIMI/PGP/Finance II/200859
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
IIMI/PGP/Finance II/200860
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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IIMI/PGP/Finance II/200861
Adjusted NPV
-$171.51 million-$260.26 millionBorrow-and-buy
-$170.93 million-$217.29 millionLease
Tax Rate of 38%No Tax
IIMI/PGP/Finance II/200862
Discussion Question
What, in your view, are the advantages ofleasing over debt and vice versa?
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IIMI/PGP/Finance II/200863
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