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Leveraged leasing of railway rolling stock in Canada : a comparative analysis of the equipment leases signed by Canadian Pacific and Canadian National Railways between 1969 and 1974 Norman, Terrance James

Abstract

Leveraged leasing of equipment has become the lowest cost and most readily available source of external funds for transportation companies in North America. This study examines the experience of the principal Canadian railroads with leveraged leasing of rolling-stock. It also examines some recent changes In Canadian government regulations which will significantly affect the future of leveraged leasing in Canada. It is essential to begin with a basic understanding of railway equipment financing. Chapter 2 reviews the background of equipment financing by North American railroads and the types of equipment obiigat ions that have evolved over the years. Chapters 3 and 4 explain how leveraged leasing works and survey the theoretical models that are available ifin financial literature for analyzing the lease-or-buy decision. It is then possible to apply the theory to empirical data. The financial leases signed by Canadian Pacific and Canadian National Railways between 1969 and 1974 are examined to assess their economic merits. Application of two of the most recent theoretical models to the leases signed by CN and CP confirmed that the railways' decisions to lease were correct. However there were significant differences in the ways the lease were analyzed. CN Is a Crown corporation and ft does not pay federal Income tax. It achieves lower financing costs by "selling" the tax shield (principally depreciation which can be deducted from taxable income)which is normally derived from ownership of an asset to a lessor in return for a lower lease rate. On the other hand, CP can use the tax shield but it ts restricted to a depreciation rate of 6% on declining balance annua11y for tax purposes. It achieves lower financing costs by "selling" the tax shield to a lessor which can depreciate the same asset at 20£ on declining balance in Canada or at accelerated depreciation rates coupled with the investment tax credit in the United States. The overall benefits to CN from leasing are comparable to the benefits to CP but they are much more apparent in a before-tax calculation. Analysis of the CP lease-or-buy decision is complicated by incorporattimg the tax shield into an after-tax calculation. The lowest cost external source of capital for both CN and CP was found to be leveraged leasing using U.S. financial sources for equipment to be used in international service between Canada and the United States. The next best alternative is leveraged leasing usiimg Canadian financial sources.

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