Burlington Northern Santa Fe Railway (BNSF) Comprehensive Capital Budgeting Decision Project
Investment Opportunities
Payback, Net present value, Cash Flow spreadsheet, internal rate of return and Modified Internal Rate of Return methods Berkshire Hathaway, led by CEO Warren Buffett, purchased the Burlington Northern Santa Fe Railway (BNSF) in 2010. BNSF will be spending $3.4B on capital improvements in 2017 to improve their infrastructure. Forecasting demand for rail traffic has become increasingly difficult on BNSF's northern United States rail lines due to the drop in oil prices to $50 a barrel. In addition, President Trump is rolling bag legislation restricting the use of coal. Buffett and his management team have brainstormed new ideas and come up with three potential Northern states rail line expansions to carry BNSF freight. Mr. Buffett would like you to evaluate these three potential capital investments for the railroad. Each is unique in the state the line will travel over and in the freight to be carried. Warren Buffett is a master investor. He is pleased with projects that exceed BNSF's cost of capital. He requires a five year outlook on his investments. The three rail line capital improvements to be analyzed are mutually exclusive.
1. Invest in a new Minnesota Rail Line - After a two year decrease, there is an increasing demand for Frac Sand freight loads to be moved from Wisconsin and Minnesota to the oil fields of North Dakota. Drillers have become more efficient with new Apps, such as the iSteer App, in extracting oil from the North Dakota shale underground. With efficiencies, drillers can now be profitable at $50 a barrel of oil. With a goal of profitability at $40 a barrel, frac sand demand is sure to increase. Currently the frac sand can be moved to St. Paul, MN easily, but there is no direct route to the Fargo, ND railroad hub for this sand. Buffet's team is excited about investing in this line due to the growing number of Frac Sand mines located in Wisconsin and Minnesota and the increased oil extraction efficiencies. The freight loads are expected to increase each year for the next 10 years before leveling off for another 15 years. Buffet forecasts Year 1 revenue at $350,000,000. The 2017 Earnings Before Depreciation and Taxes are forecast at 28% of Revenue each year. In Years 2 - 5, revenue is forecast to increase by 12% each year. Competition from the Union Pacific Railroad is a threat to the forecast, but BNSF has many miles of track in the Northern U.S. already, and should be able to withstand a freight price war with Union Pacific. The St. Paul to Fargo line will require 290 miles of track to be installed. In addition to the track infrastructure installation - land, locomotives, and sand freight cars will have to be purchased. The projected cost per track mile is estimated to be $1.1M. This is an all in cost that includes track, land, and trains. Land represents 10% of the investment amount. The remaining investment amount will be taken over 15 years MACRS. Buffet notes that the Frac Sand industry is posed for big growth and the government has made it a priority for the U.S. to become more self-reliant. That is a great $ign.
2. Invest in a new North Dakota Rail Line - The Bakken Oil Shale Fields in North Dakota have provided Burlington Northern Santa Fe Railway with a golden opportunity to cash in by adding a rail line from Jamestown, ND to Minot, ND to move oil from Minot to the new Jamestown refineries. Buffet estimates that the North Dakota oil fields will produce for the next 75 years. Making an investment in this line has long term potential for a healthy return. There is some concern that the government may halt drilling in the area due to environmental concerns. This seems unlikely since the United States is seeking oil independence. In fact, there are promising geological explorations continuing in the region that could double the current output of oil. Buffet's team is excited about investing in this line that will carry the black gold to Jamestown. The oil tanker loads are expected to increase each year for the next 25 years before leveling off for another 50 years. He forecasts Year 1 oil tanker revenue at $375,000,000. The 2017 Earnings Before Depreciation and Taxes are forecast at 20% of Revenue each year. In Years 2 - 5, revenue is forecast to increase by 10% each year. Track safety is a major concern with building this line due to carrying a hazardous material. The Jamestown to Minot line will require 210 miles of track to be installed. In addition to the track infrastructure installation - land, locomotives, and oil tanker freight cars will have to be purchased. The projected cost per track mile is estimated to be $1.2M. This is an all in cost that includes track, land, and trains. Land represents 10% of the investment amount. The remaining investment amount will be taken over 15 years MACRS. Buffet believes there are other areas in the northern United States that will open Shale Oil fields in the future. Establishing this line would give BNSF an established tanker line to be used as an anchor track for short rail line branches. This project smells of money!
3. Invest in a new Montana Rail Line - Coal is still a heavily used source of energy. With President Trump recently relaxing the coal emissions laws, coal traffic could increase or at least remain level. Montana coal mines have provided Burlington Northern Santa Fe Railway with a steady cash flow for over 60 years. The Montana Coal Mining Corporation has requested a new coal freight line to be added from Havre, Montana to Billings, Montana to move mined coal. Buffet estimates that the Havre Coal Mine will produce for the next 25 years. Making an investment in this is a risk to BNSF. Coal is considered a dirty source of energy and some major energy companies have shuttered their coal powered energy plants or are considering doing so in the future. Buffet's team is worried about the long-term prospects in investing in the Montana Coal Line. On the other hand, if this line makes money, BNSF will consider it a viable investment alternative. The coal freight loads are expected to slightly decrease each year for the next 5 years before leveling off for another 20 years. Warren forecasts Year 1 coal hauling revenue at $225,000,000. The 2017 Earnings Before Depreciation and Taxes are forecast at 33% of Revenue each year. In Years 2 - 5, revenue is forecast to decrease by 1% each year. The Havre to Billings route will require 230 miles of track to be installed. In addition to the track infrastructure installation - land, locomotives, and coal freight cars will have to be purchased. The projected cost per track mile is estimated to be $0.9M. This is an all in cost that includes track, land, and trains. Land represents 10% of the investment amount. The remaining investment amount will be taken over 15 years MACRS. Buffet believes there will always be a steady demand for coal. Coal is cheap and obtainable within the United States. Establishing this line would be a major help to a loyal customer in Montana Coal Mining Corporation. Should we help out a friend?
CEO, Warren Buffett wants to know which rail line he should be investing in for the long-term. He has asked you to analyze the three rail line expansion alternatives identified above. BNSF requires all investments to exceed the Cost of Capital and have a positive Net Present Value. Marketing has adjusted the sales revenue projections for each of the three alternatives presented above to account for risk.
The Revenue for each project are projected as follows:
Minnesota Line N. Dakota Line Montana Line
|
Year
|
EBDT
|
EBDT
|
EBDT
|
|
|
1............
|
$350,000,000
|
$375,000,000
|
$225,000,000
|
|
|
2............
|
|
|
|
|
|
3............
|
|
|
|
|
|
4............
|
|
|
|
|
|
5............
|
|
|
|
|
Depreciation Expenses are projected as follows:
Minnesota Line N. Dakota Line Montana Line
|
Year
|
Deprec.
|
Deprec.
|
Deprec.
|
|
|
1............
|
$
|
$
|
$
|
|
|
2............
|
|
|
|
|
|
3............
|
|
|
|
|
|
4............
|
|
|
|
|
|
5............
|
|
|
|
|
Tips for presentation:
A. Calculate and present the Cash flow spreadsheet, Net Present Value, Internal Rate of Return, MIRR and payback method calculations for evaluating each investment. Each investment scenario should have it's own PowerPoint slide.
B. Show one slide that summarizes each:
Minnesota Line North Dakota Line Montana Line
Payback Period:
Net Present Value:
Internal Rate of Return
Modified Internal Rate of Return
C. Show one slide with your recommendation, noting potential opportunities and risks. Be clear on your recommendation with written supporting analysis.