U.S. Railway Association Case

Table 3-3 gives estimates of real cash flows from liquidating land, structures, and other assets of Penn Central and other bankrupt Eastern railroads. These assets were acquired by Conrail, but proposed compensation is based on the present value of the flows from a hypothetical liquidation. The government (U.S. Railway Association, or USRA) proposed to discount line (a) at 15 percent. Liquidation costs are all allocated to other assets, and the net flows (line (d)) are discounted at 12 percent. USRA calculated a total present value of $757.4 as of January 1, 1976.

1. What do you get? Assume cash flows occur at mid-year. Note: All cash flows have to be discounted for an extra half-year to get a value as of January 1976 rather than mid-1976.

2. How much difference would it make if the rates were 10, and 8 percent instead of 15, and 12?

3. If you discount the liquidation costs at 15 rather than 12 percent, how will that alter your present value calculations.

4. Refer to note 3 in the table. Show that the later a parcel of land is sold, the lower its present value as of January 1976. Does this result make economic sense for undeveloped (vacant) land? Assume that it is optimal during this period of time to leave the land undeveloped.

Table 3-3: USRA's Cash Flow Projections from Liquidating Eastern Railroads
		1979	1980	1981	1982	1983	1984	1985	1986	1987
(a)	Real Estate	0	356.8	396.2	253.3	203.9	111.6	75.6	0	359.7
(b)	Other Assets, Mostly Ferrous Scrap	646.0	398.9	263.9	229.2	171.7	96.8	10.9	0	0
(c)	Liquidation Costs	-436.3	-330.0	-284.6	-234.3	-164.2	-102.6	-37.8	0	-206.5
(d)	Net, (b)+(c)	209.7	68.9	-20.7	-5.1	7.5	-5.8	-26.9	0	-206.5
(e)	Net Proceeds	209.7	425.7	375.5	248.2	211.4	105.8	48.7	0	153.2
Note: Cash flow for real estate was forecasted as follows: 1. USRA started with appraisals as of January 1, 1976. These were accepted as unbiased estimates of the parcels' market values at that time. 2. However, the parcels could not have been sold immediately under the USRA scenario. Some properties would not have been sold until the late 1980's. 3. Future sales prices were forecasted by assuming real estate values would grow at a relatively low rate. Assume 2% per year for this problem, and that this rate gives the values shown in line (a). 4. Much of the real estate was vacant land which would not generate rents or other income before the time of sale. Source: U.S. Railway Association, Final System Plan, Vol. 1, Appendix to Chapter 5, p. 155.