Burlington Northern - Lease New Auto Racks

        Burlington Northern has taken up an analysis to lease new Auto Racks that cost $22,067,600 million.  The corporate decision maker taking the lead on this analysis has computed the project as feasible at a 20% required hurdle rate.  In order to present his findings to the CFO, he makes the comparison of the lease cash flows to one in purchasing cash flows at the present time.  His objective is to present leasing as the more value added alternative.

        The lease is a financing decision and not an investment decision.  Since Burlington can assume the 34% tax rate benefit from the lessor, the firm receives a larger tax shield compared to it’s own 20% rate.  When the lease terminates, the company will be able to purchase the equipment, and we assume that they will purchase it to continue operating; therefore, it is relevant to our calculations of the present value of the leasing option.  We also assume that the AMT tax status 20% will remain constant for our calculations when looking at the purchasing horizon.

        Consequently, the tax situation is the basis for our leasing decision since the company is in a position of benefiting by leasing from a company that is not subject to AMT.  With the lessor at a 34% tax rate, the depreciation benefits are passed along to Burlington when leasing the asset. Ultimately, this decision comes down to being a tax play for Burlington.

        The residual value is important to the company since it has the option to buy the equipment - if the market value decreases, the company does not exercise the option - the company can choose to simply go to the market instead of exercising the option in the future.  In case the market that value is higher, the company will exercise the option, which presents a better deal to them on the equipment.  In our analysis, we have assumed that both market and book value (predetermined) are equal in order to calculate the present value and take it into our account in this analysis.  As a result, the estimate of residual value is significant for our NPV calculations on this lease decision.