National Railroad Passenger Corporaton (“amtrak”): Acela Financing

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Option 1: Borrow and Buy

The first option to be evaluated is loan from some bank or financial institution and use of loan funds for financing the purchase of locomotives and train sets. Amtrak had received an offer from a major bank to underwrite a bond issuance for Acela. The terms of the loan are as follows:

Loan term

20 years

Interest rate

6.75% p.a.

Instalment amount

12.303 million

Periodicity of payment

Semi Annual

Payments beginning from

December, 1999

Collateral

Locomotives and Train sets

A few points to be noted:

- WACC of the company has been considered as the discounting rate for NPV calculations. Accordingly, cash flows have been discounted at 11.8% p.a. WACC already considers impact of tax hence the adjustment of the same has not been made separately. Since the instalments are to be paid semi-annually, 6 monthly rate is considered i.e. 11.8/2 = 5.9%

- Since the instalments are to be paid semi-annually, a total of 40 periods are to be considered and they are discounted at 6 monthly discounting rate of 5.9%

- Assuming that the company will be liable to pay tax, tax benefit on interest and depreciation have been given impact to. Alternatively, we can ignore the tax component and calculate the pre-tax cash flows and discount them using the pre-tax discounting rate.

Advantages and Disadvantages of Borrow and Buy option:

- The advantages to this is it is the easiest method for National Railroad. It involves relatively less complications and paper work and is easier to avail.

- Based on the financial statements of National Railroad, they can easily obtain debt from a financial institution in order to make the purchase.

- An issue with borrowing is that Amtrak had recently issued debt in the market and the public market was saturated with Amtrak paper. This would prove to be a disadvantage for Amtrak.

- Another disadvantage is that the liability is recorded in full on the balance sheet, which will affect the debt equity ratio, interest coverage ratio and weighted average cost of capital of the company.

Option 2: Leveraged Lease Structure

The next option is to take the asset on finance lease from BNY Capital Funding LLC, a wholly owned subsidiary of the Bank of New York. The lease will consist of two parts – 80% debt and 20% equity. BNYCF would act as lessor and would provide equity funds to finance the purchase. The debt portion would be fulfilled by EDC of Canada. The entire lease transaction would be routed through Wilmington Trust who would act as the owner-trustee. Lease payments were to be made semi-annually as per the schedule given.

The lease option further had two options:

Option 1: Amtrak had an option to buy the asset at the end of the lease term at higher of terminal value or fair market value.

- In this case, if the terminal value is higher than fair market value, Amtrak will choose to buy the asset from the market rather than buying it from BNYCF. Hence, in this case, option of buying the asset won’t be utilized at all.

- Next scenario would be when fair market value would be higher than terminal value. In this case, Amtrak would be indifferent whether to buy it from BNYCF or from the market.

- Hence, while calculating the net present value, we have considered the fair market value of the asset as on the date of end of the lease term. Due to lack of data, we have considered the fair market value to be the terminal value + 25% (since the standard deviation of market value fluctuations of train sets and locomotives has been given to be 25%).

Option 2: Early buy-out option – Amtrak could acquire the equipment from BNYCF for $126.6 million in 2017.

- This option would be beneficial if the market value at the end of 2017 is higher than the early buyout value. However, due to lack of data, we cannot take a decision on this basis.

The decision as to which option is better in case of leasing has been taken on the basis of present value of future cash outflows in case of both the options.

Advantages and Disadvantages of Leveraged Lease

- Lease payments are tax deductible and would enable Amtrak to claim tax benefits on the same. This benefit is absent in the option of borrow and buy since only interest payments are tax deductible and not the loan repayment part.

- There is no need for any immediate lump-sum payment to be made in case of finance lease. This saves the company from immediate requirement of funds since the company in itself is a heavily loss making company and is completely reliant on federal grants.

- One disadvantage for Amtrak is that Amtrak will not be able to avail tax benefits on depreciation since, in case of leveraged leases, depreciation can be claimed by the lessor and not the lessee.

- In case the equipment is returned to the lessor at the end of lease period, Amtrak will lose out on the salvage value of the asset which it would’ve been able to avail of had it owned the asset.

Option 3: Rely on Federal Sources

- Congress had restricted Amtrak from using federal subsidies only for operational expenses. Capital appropriations could still be Federal funded. Purchase of locomotives and train sets could very well be considered as capital-asset acquisitions and accordingly Amtrak was still eligible for availing benefit of the same.

- However, Friner and her staff were reluctant to use federal monies to fund this acquisition since they considered federal grants to be a premium and precious commodity and preferred to use it to fund capital projects that couldn’t be easily and cost effectively financed.

- External funding is easily available for Acela and Amtrak is already considering two options of borrow and buy and lease financing for the same. Considering the above