Natioanal Road

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IIMI/PGP/Finance II/20081

National Railroad Passenger Corporation (Amtrak): Acela Financing

Session 15


Discussion Question

Whether Amtrak should finance the equipment purchases using BNCYF’s leveraged-lease proposal or borrow money and purchase the

equipment on its own?

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National Railroad Passenger Corporation (Amtrak): Acela Financing

l Dated: 30 April, 1999l People: Arlene Friner, CFO, Amtrakl Review: leveraged-lease proposal from BNY Capital

Funding LLC (BNYCF)l Adviser: Babcock & Brown Financial Corporationl Invited: financial institutions to submit lease-financing

proposals for planned purchase of..,l Locomotivesl High-speed train set


National Railroad Passenger Corporation (Amtrak)

l Created in: 1970l Created by: US congressl Ensured: modern, efficient intercity passenger-

rail servicel Remain as: integral part of the national

transportation systeml Govt. mandated: to take over rail-passenger

operations of private railroads

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l Primary provider of passenger-rail service in USl Provided service to..,

l Intercity passengers: > 20 millionl Operated stations: 516l Operated states: 44

l Received: subsidies from federal govt.l Three strategic business units..,

l Amtrak Northeast Corridorl Amtrak Intercityl Amtrak West



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

l Proposed to eliminated its reliance on federal subsidies by 2002l After 2002; no federal funds could be used for operating

expenses

l Never been profitable in 30-year historyl To meet the goal of self sufficiency by 2002

l Developed radical business planl Center price: high-speed rail service

– Projected annual revenues: $180 million by FY2002

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1994 1995 1996 1997 1998RevenuesPassenger-related and other 1152 1177 1213 1341 1392Commuter 184 213 234 242 260Reimbursable 77 107 108 91 91Federal payments 542Total revenues 1413 1497 1555 1674 2285ExpensesSalaries, wage and benefits 1330 1241 1236 1299 1448Train operations 358 321 321 365 356Facility and office related 153 172 181 187 190Maintenance-of-way goods and services 45 73 59 46 52Advertising and sales 91 90 109 98 102Interest 185 144 149 160 181Depreciation and amortization 245 230 238 242 294Other 83 34 25 39 15One-time charges/(gains) -244Total expenses 2246 2305 2318 2436 2638Operating income/(loss) -833 -808 -763 -762 -353Exclude federal payments and related interest 577Operating loss restated -833 -808 -763 -762 -930Federal grantsFederal operating grant 352 392 285 223 202Excess railroad retirement taxes 150 150 120 142 142Federal capital - interest 42Federal capital - progressive overhaul and other 36 37 82Total federal grants 502 542 441 444 426Net loss -331 -266 -322 -318 -504

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


1994 1995 1996 1997 1998RevenuesPassenger-related and other 82 79 78 80 61Commuter 13 14 15 14 11Reimbursable 5 7 7 5 4Federal payments 24Total revenues 100 100 100 100 100ExpensesSalaries, wage and benefits 94 83 79 78 63Train operations 25 21 21 22 1 6Facility and office related 11 11 12 11 8Maintenance-of-way goods and services 3 5 4 3 2Advertising and sales 6 6 7 6 4Interest 13 10 1 0 10 8Depreciation and amortization 17 15 15 14 1 3Other 6 2 2 2 1One-time charges/(gains) -17Total expenses 159 154 149 146 115Operating income/(loss) -59 -54 -49 -46 -15Exclude federal payments and related interest 25Operating loss restated -59 -54 -49 -46 -41Federal grantsFederal operating grant 25 26 18 13 9Excess railroad retirement taxes 11 10 8 8 6Federal capital - interest 3Federal capital - progressive overhaul and other 2 2 4Total 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 1998RevenuesPassenger-related and other 100 102 105 116 121Commuter 100 116 127 132 141Reimbursable 100 139 140 118 118Federal paymentsTotal revenues 100 106 110 118 162ExpensesSalaries, wage and benefits 100 93 93 98 109Train operations 100 90 90 102 99Facility and office related 100 112 118 122 124Maintenance-of-way goods and services 100 162 131 102 116Advertising and sales 100 99 120 108 112Interest 100 78 81 86 98Depreciation and amortization 100 94 97 99 120Other 100 41 30 47 18One-time charges/(gains)Total expenses 100 103 103 108 117Operating income/(loss) 100 97 92 91 42Exclude federal payments and related interestOperating loss restated 100 97 92 91 112Federal grantsFederal operating grant 100 111 81 63 57Excess railroad retirement taxes 100 100 80 95 95Federal capital - interestFederal capital - progressive overhaul and otherTotal federal grants 100 108 88 88 85Net loss 100 80 97 96 152

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


Fy Ending Sept 30, 1998


Current AssetsCash and equivalents 274.7 4Temporary cash investments 409.7 6Account receivable, net 88.7 1Mtaerials and supplies 91.6 1Other current assets 3.4 0Total current assets 868.1 12Property, plant and equipment 9456.4 129Less: Accumulated depreciation -3106.9 -43Net property, plant and equipment 6349.5 87Other assets and deffered charges 87.6 1Total assets 7305.2 100

Balance Sheet (Values in Million of USD)

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Current liabilitiesAccounts payable 270.8 4Accrued expenses and other current liabilities 186.7 3Deffered ticket revenue 61.4 1Current maturities of LT debt and capital-lease obligations 102.2 1Total current liabilities 621.1 9LT debt and capital lease obligationsCapital lease obligations 1213.1 17Equipment and other debt 322.5 4

1535.6 21Other liabilities and deffered creditDeferred federal payments 457 6Casuality reserves 136.2 2Postretirement employee-benefits obligation 118.4 2Environmental reserve 35.4 0Advances from railroads and commuter agencies 20.6 0Other 1.5 0

769.1 11Total liabilities 2925.8 40CapitalizationPreffered stock 10939.7 150Common stock 93.9 1Other paid-in capital 6471.3 89Accumulated comprehensive loss -13125.4 -180

4379.5 60Total liabilities and capitalization 7305.3 100

Balance Sheet (Values in Million of USD)


Acela

l New brandl New high-speed rail servicel More than high-speed trainsl Designed to: differentiate Amtrak passenger trains and

service in Northeast Corridor from existing servicel To begin: service in late 1999l To offer: faster trip times and premium servicel Served routes: Virginia to Maine

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Exhibit 1


Acela

l Brand representing new way of doing businessl Designed to: bring high speed and high quality to

Northeast Corridor passengersl Will offer..,

l Faster trip timesl Comfortable amenitiesl Highly personalized service

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

l Customer-focusedl Commercially drivenl Premium transportation service

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Acela

l Designed to..,l Operate as fast as 150 miles an hour (241.35 kms an hour)l Promised to reduce travel time significantly

l Timing between: Washington D.C., to Bostonl Current timing: 7 hrs 30 minutesl High-speed train: 5 hrs 50 minutes

l Late 1999: to begin service between NY city and Boston

l NY – Washington leg would be added within a year


Equipment

l Operate the Acela Regional Service as plannedl Needed to purchase..,

l 15 dual-cabl High-horsepower electric locomotivesl 20 high-speed train sets, consists of..,

l First-class coach car: 1l Bistro car: 1l Coach cars: 3l End coach car: 1l Power cars: 2

l Estimated total cost for all equipment: $750 million

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Equipment

No. Cost Aggregate CostHigh-speed locomotives 15 7,161,300 107,419,500Train sets 20 32,129,050 642,581,000

750,000,500Total


Equipment

l Estimated life: 25 yearsl Residual values: ~15% of original equipment costl Depreciation as per..,

l Accounting purpose: straight-linel Tax purposes: 7-year MACRS

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

l Locomotives: 6l Train sets: 7

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

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Financing Options

l Three options..,l Borrow money to fund the purchasel Lease the equipment from a financial institution (such as

BNCYF)l Rely on federal sources for funding


Borrow and Buy

l Major bank offered to underwrite a bond issuance for Amtrak..,

l Term: 20-yearl Coupon: 6.75 percent per annuml Semiannual payments: $12.303 millionl Payment beginning: Dec 1999l Collateral for the loan: locomotives and trains setsl Drawback:

l Had recently issued debtl Public market might already be saturated with Amtrak

paper

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Leveraged Lease

l Proposed by: BNCYFl Wholly owned subsidiary of the Bank of New Yorkl Lessor: BNCYF

l Would provide equity funds needed to finance the purchase

l Sole lender and debt provider: Export Development Corporation (EDC) of Canada

l Funds to be provided..,l EDC: 80% of required fundsl 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 payments after debt service

Owner TrusteeWilmington Trust

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

Equity InvestorBNY Capital Funding, LLC

LenderExport Development Corporation (EDC) of

Canada

BNY Capital Funding LLC's Proposed Leveraged-Lease Strcuture

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Leveraged Lease

l Equity and debt funds on closing would flow through Wilmington Trust..,

l An independent third party to the transactionl Acted as owner-trusteel Rental payments would flows throughl Would distribute the payments to either EDC or BNCYF

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

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

BNCYF in 2017 for $126.6 million


Amount1999 June ….

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

Dec $7,965,6522001 June $10,022,594

Dec $10,316,9482002 June $8,617,634

Dec $10,360,6452003 June $9,828,570

Dec $10,367,9852004 June $8,607,823

Dec $10,418,5732005 June $9,683,063

Dec $10,435,1862006 June $8,580,151

Dec $11,599,9932007 June $7,338,339

Dec $11,468,2112008 June $9,475,208

Dec $15,792,7092009 June $7,765,741

Dec $20,224,3222010 June $5,067,035

Dec $15,872,5562011 June $4,121,823

Dec $22,807,1292012 June $3,336,587

Dec $23,645,1332013 June $2,662,913

Dec $24,055,3672014 June $1,957,919

Dec $20,017,6082015 June $6,067,613

Dec $6,287,6522016 June $12,292,315

Dec $21,394,7882017 June $6,551,924

Dec $18,107,1672018 June $8,612,133

Dec $13,469,2952019 June $8,864,543

Dec $6,654,2382020 June $2,035,748

Dec $1

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

Date Due

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Types of Financial Leases

l Direct leasesl Lessor purchased equipment or asset and rented it out to

lessee

l Sale-and-leasebackl Leveraged leases

l Lessor borrowed money to fund part of purchase of assets, pledging the lease contract as security for the loan


Leveraged Lease

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

locomotives: 25%l 17-year risk-free rate: 5.78%l Amtrak WACC: 11.8%

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Rely on Federal Sources

l Could use federal monies to fund equipment purchases

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

expensesl Agreed to fund for capital appropriations

l Federal grants considered as premium and precious commodity


Rely on Federal Sources

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

l Safetyl Right-of-wayl Infrastructure-related projectsl Major overhauls

l Train sets and other rolling stock, could be very efficiently financed through capital markets

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Year % Depreciated1 14.292 24.493 17.494 12.495 8.936 8.937 8.938 4.45

Seven-Year MACRS Depreciation Schedule (in % of Depreciable

Investment)

Because of the half-year convention, seven-year MACRS involved eight years of depreciation expenses


Types of Lease

Also called ‘capital lease’

Purpose: 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, lessor overhead, rate of return

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

Operating LeaseFinance Lease


Finance Lease

l Leveraged leasel Sale and lease back arrangementsl Cross border (international) leasel Foreign to foreign lease

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Leveraged Lease

l Parties involved..,l Lessor – contributes equity (20% to 40%)l Lessel Financier – finance by way of term loans

l Used for assets requiring huge capital outlay…,l Airplanel Satellitesl Shipsl Railsl Off-shore drinkingl Nuclear machinesl Power generation plantsl Large chemical plantsl Gas pipe lines


Leveraged Lease

l Loan is secured by first lien in the equipment by an assignment of leased equipment and leased rental payments

l Basic documents used..,l Participation agreement – signed by all partiesl Trust agreementl Indenture trustl Lease agreement – for tax shield associated with asset

ownership and residual value of asset

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Direct Lease

l Hybrid of operating and financial leasel Payout will not include..,

l Repairsl Maintenancel Taxes

l Features..,l Duration: 3 or more yearsl Lessor holds the titlel At expiration: lessee may renew or purchasel Full payout


Other Types of Leases

l Master lease: blanket leasingl Percentage lease: flat rental + additional rental over and above a revenuel Wet and dry lease – used in airline industryl Triple net lease – net of insurance, maintenance, taxes….l Closed end and open end lease – ownership possibilities opened to lesseel Swap lease – exchange assets in need of major repairsl Full pay-out leasel True lease – fully goes with the local rules and regulations of a countryl Wash lease – tax benefit transferred to investorl Upgrade lease – used in obsolescencel Capital lease – to transfer ownership to lessee at the end of lease terml Employee lease – transferring employees to Lessor and leasing it back

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Why Leasing?

l Benefits to lessee..,l Leasing 100% financingl Offers cash flow benefitsl Off balance sheet financingl Avoidance of loan covenantsl Tax planningl Creation of working capitall Hedge against risk of inflation and obsolescencel Fast and flexible financingl To over come monopoly actl Used in non-priority sector and service sector


Why Leasing?

l Benefits to lessor..,l Additional financial productl Reduces riskl Increases profitabilityl Accelerates salesl Higher leverage [Max. of 10:1]l No gestation periodl Low cost of operations

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Discussion Question

What is the problem in the case?


Problems in the Case

l To choose among three financing optionsl Debtl Lease financingl US govt. funding

l Use of federal monies is neither preferred nor practical

l Amtrak ..,l Never been profitablel Should become self sufficient by 2002 (3 years away)

l Acela the key to self sufficiency [investment decision has been already made]

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Discussion Question

What is financial lease? How does it work?


Test for Capitalizing Lease

l Ownership test: ownership transferred to lessee at the end of lease

l Alternative ownership test: lessee has right to buy asset at a price substantially below fair market price

l Economic life test: lease term >= 75% of estimated economic life of the asset

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

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Discussion Question

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


Lease vs. Buying

l Lease financingl Increases company’s debt capacityl Public market is saturated with Amtrak debtl Also includes interest componentl Investors will not recognize a financial lease liability as a form of

debt?l Liabilities: PV of financial lease paymentsl Assets: PV of financial lease payments

l Possibility of increasing book income buy avoiding depreciation and interest?

l Lease payments includes depreciation and interestl Possibility of evading capital-expendituresl To avoid capital-approval procedures

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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?


Lease vs. Buying

l In world of no taxes; leasing = borrow-and-buyl Lease amount higher or lower indifference

point would result in value destruction for both parties

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Difference between Lessor and Lessee Creating More Value for Lease

l Tax rate differences between lessor and lesseel Realizing depreciation deduction by lessor and lesseel Asset acquisition and maintenance cost –

specialization or scale of economiesl Realizing salvage values – superiority of property

knowledgel Leverage abilities between lessor and lessee –

difference in interest deductibility


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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NPV Analysis of Lease

l Cash flowsl Outflow: lease paymentsl No tax shields on lease payments – Amtrak has no tax

benefitsl Not entitled for residual value of $40.2 million

l Discount ratel WACC: 11.8%l 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 10Lease 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 0.00After-tax lease payments (0.20) (3.76) (7.97) (10.02) (10.32) (8.62) (10.36) (9.83) (10.37) (8.61)Residual valueTotal 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 20Lease 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 0.00After-tax lease payments (10.42) (9.68) (10.44) (8.58) (11.60) (7.34) (11.47) (9.48) (15.79) (7.77)Residual valueTotal 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 30Lease 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 0.00After-tax lease payments (20.22) (5.07) (15.87) (4.12) (22.81) (3.34) (23.65) (2.66) (24.06) (1.96)Residual valueTotal 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 40Lease 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 0.00After-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 44 45 46 47 48 49 50Lease payments (6.65) (2.04) (0.00)Tax shield on lease payments 0.00 0.00 0.00After-tax lease payments (6.65) (2.04) (0.00)Residual valueTotal cash flows (6.65) (2.04) (0.00) 0.00 0.00 0.00 0.00 0.00 0.00 0.00Discounted 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

l Cash flowsl Inflow: debt proceedsl Outflow 1: debt proceeds used to finance the equipmentl Outflow 2: interest and principal repaymentsl No interest tax shields – Amtrak has no tax benefitsl Depreciation tax shield: 0l Entitled to residual value of equipment


Discount rate 6.75%Tax rate 0.00%After-tax interest rate 6.75%Useful life of equipment 25

0 1 2 3 4 5 6 7 8 9 1 0 SumsDebt 267.90Purchase of equipment (267.90)Principal repayment (3.26) (3.37) (3.49) (3.60) (3.72) (3.85) (3.98) (4.11) (4.25) (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 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 0.00 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 (11.90) (11.51) (11.14) (10.77) (10.42) (10.08) (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 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 (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 30Principal 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 0.00Depreciation 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)


41 42 43 44 45 46 47 48 49 50Principal repaymentInterest expenseInterest 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 40.19Discounted 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

27


NPV Analysis of Lease vs. Borrow-and-Buy

l NPV of interest and principal repayment cash flows discounted by cost of debt will result in cost of debt

l Difference in NPVl Residual value claim of Amtrak at the end of 25

yearsl Leasing is superior – cheaper by $40 million


Discussion Question

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

any tax shields?

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l Assumed tax rate: 38%l Tax shields on lease payments are no longer zerol Interest and depreciation tax shields are also positive

l Discount rate: after tax cost of debtl NPV advantage on leasing is eliminated when taxes

are assumedl Better to borrow and buyl Leasing makes sense; when lessor can use tax shields

more 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 10Lease 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 3.27After-tax lease payments (0.12) (2.33) (4.94) (6.21) (6.40) (5.34) (6.42) (6.09) (6.43) (5.34)Residual valueTotal 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 20Lease 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 2.95After-tax lease payments (6.46) (6.00) (6.47) (5.32) (7.19) (4.55) (7.11) (5.87) (9.79) (4.81)Residual valueTotal 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 30Lease 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 0.74After-tax lease payments (12.54) (3.14) (9.84) (2.56) (14.14) (2.07) (14.66) (1.65) (14.91) (1.21)Residual valueTotal 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 40Lease 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 3.37After-tax lease payments (12.41) (3.76) (3.90) (7.62) (13.26) (4.06) (11.23) (5.34) (8.35) (5.50)Residual valueTotal 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 44 45 46 47 48 49 50Lease payments (6.65) (2.04) (0.00)Tax shield on lease payments 2.53 0.77 0.00After-tax lease payments (4.13) (1.26) (0.00)Residual valueTotal cash flows (4.13) (1.26) (0.00) 0.00 0.00 0.00 0.00 0.00 0.00 0.00Discounted 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 SumsDebt 267.90Purchase of equipment (267.90)Principal repayment (3.26) (3.37) (3.49) (3.60) (3.72) (3.85) (3.98) (4.11) (4.25) (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 3.00Depreciation tax shield 7.27 7.27 12.47 12.47 8.90 8.90 6.36 6.36 4.55 4.55Residual valueTotal cash flows (1.59) (1.64) 3.51 3.47 (0.14) (0.19) (2.78) (2.83) (4.70) (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 1 6 1 7 18 1 9 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 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 valueTotal cash flows (4.81) (4.87) (7.21) (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)



41 42 43 44 45 46 47 48 49 50Principal repaymentInterest expenseInterest 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 40.19Discounted 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

30


Value of Early-Buyout Option

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

l Type: simple European call optionl Valuation model: BSMl WACC

l Avg yield on 30-year bond: 5.5%l Assumed market equity weight: 100%l Assumed beta: 1l Market risk premium: 6%l Cost of equity: 11.5% [referred in case is 11.8%]

l 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

31


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 of leasing over debt and vice versa?

32


Advantages of Leasing Over Debt

l Little options holding significant valuel Lessor can purchase equipment more cost

effectively; tax deductions for..,l Interestl Depreciation

l Tailored to meet lessor’s needs – heavier payments in Dec than in June

Natioanal Road

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