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Under what circumstances will a railroad rent or lease locomotives
rather than buy them?
QUESTION:Under what circumstances will a railroad rent or lease locomotives
rather than buy them?
ANSWER: As a guy who actually taught a finance course in heavy equipment leasing
I can give you some answers from a leasing salesman's point of view.
Leasing an asset allows the lessee (the guy who uses the asset) to use
and pay for it without having its cost show up on his balance sheet.
Now depending on the balance sheet, that can be a good or a bad thing.
If the railroad owns the locomotive, the loco is listed on the balance
sheet as an asset, BUT the cost of buying that locomotive has to be
listed somewhere else as a liability. As the loco gets used, the asset
value goes down or depreciates, and the liability goes down or gets
paid off.
The catch is that companies are rated by the contents of their balance
sheets. A company with a high "debt-to-equity" is rated less valuable
than one with a low debt-to-equity. Buying a locomotive incurs a debt
on the balance sheet, but leasing one raises the monthly expenses but
not the debt.
So why does anyone contract to lease? Well, a leased item goes on
somebody ELSE's balance sheet as a debt -- like a finance company or
a bank. A company like General Electric, with big mountains of assets,
can afford to hang some debt on its balance sheet. A company like
Southern Pacific, with a huge investment in track and land, can't.
Hence the load is passed from one balance sheet to another, with the
leasing company taking a profit for keeping the lessee's debt off
its books. The lessor also takes a profit by taking a risk -- that
the lessee won't be able to pay back the entire lease. In practice
that rarely happens with locomotives, because there's a ready
secondhand market.
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