Some of the assumptions facing this acquiring of the asset are that they will have a useful life of 25 years. The train sets will also have a residual value of 15 percent of the original cost of the equipment. Straight-line depreciation will be used for the purposes of accounting while the seven year MACRS system will be used for tax purposes (Case35). We agreed with the case that national railroad should not pursue the funding through the federal sources. Since they are used to relying on these funds for safety, infrastructure right of way, and major overhauls we felt they should not use these ncase of any emergency need of funds.
These would be the easiest and most readily accessible. The first option we looked at was the option ofa financial lease. A financial lease consists basically ofa rental contract between the lessee and lessor. The person is considered the lessee and is the one with the rights to us the asset and therefore makes payments to the lessor. The payments made by the lessee are considered tax deductable. This is one of the major advantages of the lease. Another important advantage of a lease is that there is less of an initial cash requirement so you are not equired to have a substantial amount up front.
Another option we looked at was the opportunity of issuing bonds for the borrow and buy method. The borrow and buy method has some of its own advantages as well. A tax break can be received by deducting the payments of interest and depreciation. One thing we feel that Amtrak is facing is their eligibility for the tax liability. Since they have not been profitable in the past years, they more or less will not be able to take full advantage of the tax savings. Congress created National Railroad Passenger Corporation in 1970 to provide passenger rail service in the
United States. Currently, they are launching a new line of trains that will revolutionize the passenger train industry, but need to determine the appropriate financing method. Several options are available including a leveraged lease proposed by Bank of New York Capital Funding (BNYCF), to borrow money to fund the purchase, or to rely on government funding (Bruner). After our analysis of these options, we have decided to select the leveraged lease option provided by BNYCF. ernment Funding The first option we looked at was using government funding to finance the project.
This option would be the least expensive, but management felt this grant money would be needed for other projects that might be hard to obtain funding for. Therefore, we decided to reject this financing option. Leasing Next, we looked at several advantages of the lease option. A financial lease is a long- term rental agreement between two parties, a lessee and a lessor. The lessee makes payments and receives the right to use the asset, while the lessor owns the asset and receives rental payments. A major benefit of leasing is that the payments are entirely xpensed on the income statement, which makes them tax deductible.
Another advantage to leasing involves the timing of the lease payments. Lease payments can be adapted to better fit the lease as compared to the fixed payment of a fully amortizing loan. Borrow and Buy There are also some advantages to borrowing and buying an asset, including the tax deductibility of interest and depreciation. By using an accelerated depreciation schedule such as MACRS, these benefits can be increased. A problem facing National Railroad is since they have not been profitable; they are not able to take full dvantage of the depreciation tax shield. This is because they do not have any tax liability.
Analysis Next we conducted a quantitative analysis between these two alternatives. In order to do this we needed to make a few assumptions including a 35% tax rate, a semi- annual discount rate of 3. 4%, 7-year MACRS depreciation, and a salvage value of the equipment equal to 15% of the original cost (Exhibit 1). First we looked at each alternative without tax effects. In this analysis we are making a major underlying assumption that National Railroad will not become profitable in the near future. We looked at this because they have not shown a profit in 30 years (Exhibit 2).
This resulted in a present value (PV) cost of leasing of roughly $220 million and the PV cost of borrowing of $260 million (Exhibits 4 & 5). From this analysis you can see that the leasing alternative dominates the borrow and buy alternative. Since it is possible for National Railroad to become profitable we also looked at these two options with full tax ettects. The results ot these calculations nave the PV cost ot leasing at million and the PV cost of borrowing at $177. 7 million (Exhibits 6 & 7). After this analysis, we are recommending to accept the leasing option provided to us by BNYCF.
Since National Railroad has not been profitable in the past 30 years and has had an increasing net loss the past five years (Exhibit 2), it is highly unlikely for them to regain profitability in the coming year. This gives us reason to choose the analysis excluding taxes, which estimates the cost of leas ing to be $40 million less than the cost of borrowing and buying. With the small chance of them having a profitable year, we feel the difference in cost is not significant compared to the loss e otherwise would incur if we chose the borrow and buy option. nd Executive Summary The National Railroad Passenger Corporation (Amtrak) is the United States leading provider of passenger train travel. Recently, Amtrak has decided to take on a new project that would develop a new line of trains that are much faster and will cut todays commuting times substantially. This new project "Acela" calls for $750 million to create a new high-speed rail and train sets running between Virginia and Maine. These trains offer high-speed transportation and comfort that is incomparable to any thers currently offered.
With financing in the near future, Amtrak hopes to have Acela in full operation by fall of 2000. The CFO has currently arranged for financing of all of the needed equipment except for six locomotives and seven train sets, totaling $267. 9 million. Amtrak has three options available to them to finance the remaining $267. 9 million needed to complete the project. The first is to borrow money and fund the purchase themselves. Secondly, they could lease the equipment from a financial institution using a financial lease.
Their final option would be to use ederal grants to fund the project. First of all, we took out the Federal funding alternative. Although the money is available to them, and would not have to be paid back, their funds are limited in this area. The case states that the staff at Amtrak feels that these grants are a "premium and precious commodity'', and would rather use these funds to pay for other capital projects that are more difficult and less cost- effective to finance, such as safety, right-of-way, and infrastructure-related projects.
Second, we calculated the borrow-and-buy method. The reasons for doing this ption are that rather than leasing the equipment, they would pay a lump sum at the beginning and own it. Another advantage of owning the equipment is the tax yield the company would be receiving from the equipment''s depreciation. There are some negative aspects to this option as well. First of all, the company would have to issue new debt in the market. The problem with issuing this debt, is that Amtrak Just recently issued debt, and they feel this could "flood the market" with their paper.
We also feel that by issuing debt, it will increase their debt-equity ratio - increasing their robability of default. Another aspect they would have to take into account is the maintenance cost of the equipment. From our calculations of the borrow-and-buy method, we concluded that the NPV would be negative, and they should disregard this option as a viable alternativel. The final alternative is the financial lease option. A financial lease, also known as capital lease, is a long term leasing of capital assets - equipment in our case.
To the lessee (Amtrak), this financial lease is viewed the same as owning the asset, and they must account for the lease payments in the company''s alance sneet2 The pros ot the leasing option to Amtrak, are that the lease payments are tax-deductable and the company does not have to worry about disposal of the equipment after its useful life. The cons are that they do not personally own the equipment, and will not benefit from the salvage value at the end of its useful life, and they do not profit from depreciation''s tax yield. There are two alternatives within this option.
First, they can lease the equipment for the full 22 years, making semi-annual payments according to Exhibit 6 in the case. Second, they ave the option to make these semi-annual payments and buyout the lease early in year 2017 for $126. 6 million. From our calculations, we concluded that the Financial Lease without the buyout in year 19 (2017) as the highest NPV, and would be the best option for the company to finance the new equipment3. 3rd Executive Summary National Railroad Passenger Corporation (Amtrak) Acela Financing Decision: Executive Summary project.
This new project "Acela" calls for $750 million to create a new high-speed rail and train sets running between Virginia and Maine. These trains offer high-speed ransportation and comfort that is incomparable to any others currently offered. The trains will reach speeds of 150 miles per hour connecting passengers to their destination quickly and comfortably. With financing in the near future, Amtrak hopes to have Acela in full operation by fall of 2000. Out of the total $750 million needed for the initial cost of the Acela, $267. million will need to be financed from an outside source. Amtrak has not been profitable in its 30-years history; instead they have relied on annual government subsidies to remain operational. Congress passed the Amtrak Reform and Accountability Act, which states that Amtrak must eliminate their reliance on federal subsidies by 2002. Amtrak developed a radically new plan (Acela) to bring in net annual revenues of $180 million by 2002. Amtrak has three different alternatives in which to obtain the $267. 9 million for the Acela project.
The first option is to take on debt to fund the purchase. This would mean borrowing capital from a loaning institution, such as a large bank. The second option is a lease contract with the BNY Capital Funding, with the opportunity to exercise the option of buying the equipment in 2017. The third option is to depend on federal grants for funding. The first option of borrowing and buying the asset has an advantage of being the easiest method for National Railroad, because a major bank has offered to underwrite a bond issuance for Amtrak with a 20-year term at 6. 5 percent per annum with semiannual payments. On the other hand, Amtrak has Just issued debt and the market might be saturated with Amtrak paper. The second option of accepting the financial lease has its advantages; all the responsibilities related to the possession of equipment, which includes maintenance, insurance, and taxes, are wned by the lessor. Also, an advantage over debt is that it is not recorded the same way on the balance sheet.
Instead of being debt, it shows up as a footnote at the bottom of the balance sheet. On the other hand, a financial lease is fully paid over its term and cannot be cancelled. The tinal financing option is to rely on tederal tunds, which is very beneficial being that these funds do not need to be paid back. Since Amtrak has never been profitable on its own, relying on this money may set them up for future failure. Our group recommends Amtrak lease the equipment and do not xercise their option of early-buyout in 2017.
We chose not to advise relying on Federal sources because we believe that source should be seen as an emergency fund and only be used as a last resource. We have taken into consideration the opportunity of first leasing and then buy the asset in 2017, and compared it to the option of borrowing and buying. As a result we found a net advantage to leasing and buying (NAL&B) of $37,616,233. 02 (Exhibit 8). When we compared the option of borrowing and buying with the option of leasing only, we find a net advantage to leasing (NAL) of (Exhibit 5).
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