This document provides an analysis of the Canadian Pacific and Norfolk Southern railroad companies and the US railroad industry. It includes an industry analysis covering future growth potential, industry life cycle, barriers to entry, concentration, capacity changes, stability, technology investments, and government regulations. Company backgrounds and financials are presented for Canadian Pacific and Norfolk Southern. A merger recommendation and pro forma financials are provided showing the benefits of a merger between the two companies, with Canadian Pacific advised to continue pursuing a merger deal with Norfolk Southern.

1. MBAD 517
Canadian Pacific & Norfolk Southern Analysis
Jennifer Baker, Mary Johnson, Stephen Page

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Table of Contents:
1. ExecutiveSummary
1.1 Industry
1.2 CompanyAnalysis&Backgrounds
1.3 Mergerof NorfolkSouthern& CanadianPacific
1.4 Recommendation
2. Industry Analysis
2.1 FutureGrowthPotential
2.2 IndustryLife Cycle
2.3 Barriersto Entry
2.4 Concentration
2.5 ChangesinCapacity
2.6 Stability
2.7 Investing inTechnology
2.8 Government&Regulations
3. Company Backgrounds
3.1CanadianPacific
3.1.A Background
3.1.B Equipment
3.1.C Competition
3.1.D PastFinancialPerformance
3.1.E FutureGrowth: ProFormas:SGR -Industry -Time-Trend
3.2NorfolkSouthern
3.2.A Background
3.2.B Competition
3.2.C PastFinancialPerformance
3.2.D FutureGrowth: ProFormas:SGR -Industry -Time-Trend
4. Financial Ratio Analysis
4.1 CanadianPacific
4.2 NorfolkSouthern
5. WACC
5.1CanadianPacific
5.1.A Costof Debt& Equity
5.1.B WeightofDebt & Equity
5.1.C WACC
5.2NorfolkSouthern
5.2.A Costof Debt& Equity
5.2.B WeightofDebt & Equity
5.3.C WACC
6. Firm Valuation

3. 3
6.1 P/ERatios
6.2 EV/EBITDA Ratios
6.3 Free CashFlows
6.4 SummaryofValuationMethods
7. Merger Recommendation &ProFormas
7.1 Overview
7.2 Recommendation&ProFormas
Executive Summary
1.1 Industry
Taking multiple variables into account, such as population increase, oil price
predictions, the US Railroad industry is expected to grow at 2.9%, up to $87.5 billion
by the year 2021. Currently, the US Railroad industry is in a “Growth” phase,
growing at a faster pace than the US Economy. This is due to private investments
($525 billion since 1980) and a mix of cost-efficiencies, fuel-efficiencies, and
convenience. The barriers for entrance into this industry are very high with the top
4 competitors making up 87.4% of the market share. On top of these market share

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barriers, the US government places strict regulations on the railroad industry;
making it that much harder to succeed.
1.2 Company Analysis & Background
Operating out of the United States and a little in Canada, Norfolk Southern operates
on 36,000 miles of track with 4,353 locomotives. NS’s main form of rail business
comes from bulk, intermodal, and merchandise freight. The growth rate of 2.9%
was used in projecting future financials, raising revenue in 2015 of $10.5 billion to
$11.45 billion by 2018. Using financials, WACC was calculated to be 6.10% and
10.68%. Again, using the 2.9% industry growth rate published by IBIS, the share
price was calculated to be $151.06.
Canadian Pacific, operating in US but mainly Canada, operates on 12,500 miles of
track. CP’s main form of revenue comes from bulk. Intermodal, and merchandise
freight. It was decided to focus on the time-trend growth rate of 6.76% from 2011 to
2015. Given this growth rate, there will be a surplus of funds over the coming years.
These funds were used to repurchase shares of stock, increase dividend payouts
and reduce long-term debt. In accordance with the 6.76% time-trend growth, WACC
was calculated at 3.42% and 3.16%. Again, using the 6.76% time-trend growth, CP’s
stock valuation was calculated to be roughly $202.57 per share.
1.3 Merger of Norfolk Southern & Canadian Pacific
If the merger of both Norfolk Southern & Canadian Pacific were to become a reality,
it would create a true transcontinental railroad system from the gulf of mexico and
the way up to the west edges of Canada; the first of its kind. With the merger comes
an increased value of $1.8 billion. The improvements that come along with the
merger are increased fuel-efficiencies, velocity improvements, and better asset
utilization. The synergies created from this merger will the extend reach that was
previously mentioned, increase in market shares, and interline efficiencies. This
merger would increase combined revenues of $15.74 billion in 2015 up to a
combined $19.74 billion in 2020. This takes into account a starting 2.5% growth
increase in 2015 up to 6% in 2020; giving CP & NS ample time to combine cultures
and reach full potential.
1.4 Recommendation

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Given the potential future financials of a successful merger, Canadian Pacific is
advised to continue pushing for a merger deal with Norfolk Southern. CP must
show NS the true benefits of a transcontinental railroad. Should they use these
given financials below, CP will be able to add power to their merger argument.
Outside of attempts with Norfolk Southern, Canadian Pacific must convince the
Surface Transportation Board as well as antitrust agencies that the merger will not
only benefit themselves, but the economy as a whole.
Railroad Industry Analysis
2.1 - FutureGrowth Potential
According to the IBIS report on the US Rail Industry, the industry is expected to
grow at an average annual rate of 2.9%, up to $87.5 billion by 2021. These figures
take into account US population growth projections of approximately 337 million
people by the year 2021. With an increase in the population, the demand for goods
increases, leading to increased demand for transporting those goods, and
therefore aiding in the growth of the rail industry. Furthermore, oil prices are
projected to increase, potentially leading to a shift away from trucks, creating more
business for firms in the rail industry (Exhibit 1). By 2021, the US rail industry is

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projected to hit 599 operators, a 1.2% increase from 2015. With the increase of
operators and overall growth, the industry is expected to expand the number of
jobs to 178,054 by the year 2021.

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World Bank Crude Oil Projections
2.2 - Industry LifeCycle
Currently, the US railroad industry is in a “Growth” phase of its life cycle, growing
even faster than the US Economy. The annual Industry Value Added (IVA) to the
overall economy is expected to grow at 2.7% until 2021. The US railroad system is a
mix of cost-efficiencies, fuel-efficiencies, and convenience. These components play
a major role in the growth of the industry due to society’s desire to be more
environmentally conscious. Another importantfactor in the life-cycle of the industry
is that it is privately funded, rather than depending on US government spending
budgets. Since 1980, US rail has reinvested roughly $525 billion back into growth,
improvements, and maintenance of the rail systems across the country. This
reinvestment of operational revenues is roughly $.40 for every incoming dollar.
Trends & Industry Drivers
2.3 - Barriers to Entry
Developing and creating new rail lines requires a high cost of capital, and extensive
operations connecting large consumer markets. These needs make it difficult for
new companies to enter the industry. Additionally, since railroads are owned and
funded by private investors, new entrants must acquire specific industry knowledge
to be successful at raising capital. Regional and local rail companies also have

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strong barriers to entry because of their reliance on Class 1 firms. However, as
demand for rail services increases over time, more companies are expected to
enter the industry due to the appealing
increase revenues associated with higher
demand.
2.4 - Concentration
In the United States there are 564 railroad
operations, not including sightseeing rail
lines, street or commuter rail lines, or rapid
transit. The top four competitors account
for 87.4% of revenue so far in 2016, leaving
560 other competitors (mostly regional and local) to compete for 12.6% of the
remaining market share.
In addition to the four major players (Exhibit), there are three other large
companies that make up the seven Class 1 operators. These companies include:
Grand Trunk Corporation, Soo Line Railroad Company, and Kansas City Southern. In
order to be a Class 1 operator, a company’s operating revenue must be at least
$433 million. These seven firms make up the largest freight rail organizations, while
the National Railroad Passenger Corporation (better known as Amtrak) is widely
recognized as the largest, government-owned passenger rail operation. The
concentration of railroad companies is expected to increase marginally until 2021.
2.5 - Changes in Capacity
According to the U.S. Department of Transportation, demand for shipments by rail
will increase by 88% over the 2002 levels by 2035, in terms of tonnage. This is due
to the fact that as the U.S. population grows, there will be greater demand for

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imported products.
However, as demand for
rail services expands over
time, the capacity to ship
the influx of goods will be
limited. In order to meet
the anticipated demand,
operators have started to
invest in new equipment
and infrastructure,
enhancing overall productivity, performance, and profitability.
Import & Export Volumes
The U.S. rail industry is sensitive to import and export trade volumes. When
volumes rise, demand for rail transportation increases, leading to a rise in revenue.
Some export goods that are transported using U.S. railways include: coal, minerals,
agricultural goods, and chemicals. International demand for these items is driven
by economic growth in developing nations, global supply of goods, exchange rates,
and global commodity prices. Total trade volumes are expected to rise in 2016.
2.6 - Stability
The three key external drivers that affect industry stability include: the price of
diesel fuel, global price of coal, and demand from the chemical manufacturing
industry.

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Fuel Prices
Maintaining the cost of fuel is the
most critical driver for maintaining
profits. Rail operators impose
surcharges onto their customers in
order to mollify fuel price
fluctuations. If the price of fuel
increases, rail transit becomes
more competitive because lower
fuel surcharges are offered relative
to other modes of transportation.
However, if the price of fuel
decreases, trucking is often preferred over rail for it’s flexibility and customization.
In 2015 oil prices dropped and have continued to stay stagnant at these price levels
into 2016.
Coal Prices
Coal produces the greatest amount of revenue for
freight rail. However, as other energy options become
more and more popular (namely solar, wind, and
hydropower), the price of coal has increased relative to
these alternatives. This has pushed the global price of
coal into a decline in 2016, leading operators to move
away from concentrating their efforts on coal.
Chemical Manufacturing
The chemical manufacturing industry is the second largest producer of revenue for
freight rail. This industry is expected to increase in 2016, leading to increased
demand for the rail industry.
2.7 - Investing in Technology

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Technology will help increase revenue and drive growth for the US rail industry.
More fuel efficient and strong locomotive engines are beginning to take over the
industry as older engines are being phased out. With anticipated freight volumes to
raise above 88% of the 2002 number by 2035, operators must begin investing in
more infrastructure to be able to accommodate such large numbers. Again, this will
be done through investments in tracks, engines, and railcars.
2.8 - Government&Regulations
There are several governmental institutions, as well as environmental agencies, that
regulate the rail industry. The Federal Railroad Administration (FRA) regulates
railroad safety and equipment standards, ranging from rail track maintenance,
handling of hazardous shipments, locomotive and rail car inspection and repair
requirements, operating practices, and crew qualifications. Freight railroads are
also prohibited, by antitrust laws, from forming agreements among one another to
set rates, allocate markets, or unreasonably restrain trade in other ways. An agency
within the US Department of Transportation, the Surface Transportation Board, is
charged with economically regulating the railroads. They have jurisdiction over
market entry and exit, mergers and acquisitions, rail service, and other conduct
including rate structures.
Company Backgrounds
3.1 Canadian Pacific - Background
Incorporated in June 2001, Canadian Pacific (CP) operates a transcontinental railway
system in the United States and Canada. Their rail services include bulk

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commodities, merchandise freight, and intermodal transportation. CP has access to
12,500 miles of rail across Canada and the United States stretching from the
Northeastern United States, through the Midwest, all the way to Vancouver. Of the
12,500 miles of rail, CP owns 9,000 miles and either leases or jointly owns the
remaining 3,500 miles. Approximately 7,600 miles are located in Canada and 4,900
miles are located in the United States. Note: all of the financials referring to CP in
this report are in Canadian dollars unless otherwise noted.
Exhibit 1: Geographic extension of CP’s rail network.
Source: Canadian Pacific. Investor Fact Book 2015 Supplement.
Exhibit 2: Revenue breakdown of CP’s services from 2013-2015
Source: Canadian Pacific. Investor Fact Book 2015 Supplement.
3.1.B Equipment
Canadian Pacific owns a fleet of high-adhesion alternating current locomotives that,
relative to standard direct current locomotives, have enhanced fuel-efficiencies and
hauling capabilities. As of December 2015, CP had 600 locomotives in storage and
does not intend to purchase or acquire new locomotives for several years.

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Exhibit 4: Number of Locomotives Owned and Leased by Canadian Pacific.
Source: Canadian Pacific. CP Works Annual Report 2015.
3.1.C Competition
Canadian Pacific faces competition from alternative
transportation services such as other railroad companies,
trucks and vehicles, ships, air, and pipelines. Customers
choose the cheapest transportation service, so the price of
fuel often determines the type of transportation service
they will use. When fuel prices drop, CP risks losing
customers to lower cost providers, such as trucking fleets.
When fuel prices rise, CP is often able to provide cheaper transportation services.
Within the railroad industry, CP’s primary competitors are Canadian National
Railway Company and
Burlington Northern Santa
Fe. Other rail companies
also run through CP’s
network and exert
pressure on transportation
prices and customer
service.
Exhibit 8. The extension of the
freight rail network across the
United States. The seven Class 1 Railroad companies are listed at right.

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3.1.D -PastFinancial Performance
In 2015, CP was able to produce an operating ratio of 61%, the lowest in the
company’s history. Additionally, they produced a record free cash flow of $1.16
billion, a $430 million increase over 2014. This is result of trains making fewer trips
and pulling more weight, requiring fewer assets overall. Capital expenditures in
2015 were $1.5 billion. This investment back into the company helped update rail
infrastructure, with the goal of creating opportunitiesfor future expansion and
reducing capital expenditures in 2016. Below are Canadian Pacific’s past financial
statements and key performance measures.
Exhibit 9: Canadian Pacific Key Performance Measures, 2011-2015.
Source: Canadian Pacific. CP Works Annual Report 2015.

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3.1.E Future Growth
SustainableGrowth Rate
Canadian Pacific’s sustainable growth rate is 24.23%. This rate seems to be an
aggressive growth forecast, and CP will be unlikely to obtain this rate of growth
within the next three years. The external funding needed is (in millions) $2,821.98,
$3,363.62, and $4,036.51 in 2016, 2017, and 2018 respectively. In order to grow at
this rate, long-term debt was increased each year by the EFN in the pro forma
balance sheet. Considering CP has several locomotives sitting idle in storage, and
infrastructure updates were performed in 2015 to maximize efficiency, it is very
unlikely that CP will need this amount of funding. If they decide to start a new
project(s), they may then need to raise capital to support their growth.

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Exhibit 14: Pro Forma Income Statement, Sustainable Growth Rate, 2015-2018.

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Exhibit 15: Pro Forma Balance Sheet, Sustainable Growth Rate, 2015-2018.
Industry Growth Rate
The predicted industry growth rate is 2.9%. With this amount of growth, CP will
have a surplus of funds and therefore will not need any external funding. In 2016,
CP intends to repurchase up to 6,910,000 common shares (out of 153,059,426 total
shares outstanding), but will not acquire more than 116,562 shares in one trading
day. Given this information, 116,562 shares were repurchased, reflected in the 2016
pro forma statements, at the price of $129.13 (close on 5/20/26), equaling $15.05

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million in share repurchases. Only one day’s worth of shares were repurchased in
the pro forma statements because CP announced that the share repurchase was
not definite, so a moderate amount of repurchased shares were assumed. The
remaining $669.97 million surplus funds were then used to reduce total long-term
debt. For 2017, the extra funds were used to increase the dividend payout ratio
from 14.06% to 15.5%. This new ratio was chosen based on recent payout ratios in
2014 and 2015. The remaining funds were then used to reduce long-term debt.
Lastly, in 2018, the dividend payout ratio was again increased by the same rate as
the last year (a 10.95% increase). The new ratio for 2018 is 17.31%. The remaining
funds were then used to reduce long-term debt.
Exhibit 16: Pro Forma Income Statement, Industry Growth Rate, 2015-2018.

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Exhibit 17: Pro Forma Balance Sheet, Industry Growth Rate, 2015-2018.
Time-trend Growth Rate
The time-trend growth rate from 2011-2015 is 6.76%. With this growth rate CP will
have surplus of funds and will not need any external funding. Given the
information about CP’s intentions to repurchase common stock, 116,562 shares
were repurchased, which is reflected in the 2016 pro forma statements, at the price
of $129.13 (close on 5/20/26), equaling $15.05 million in share repurchases. The
remaining $35.85 million was then used to reduce long-term debt to $8,855.30. The

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same actions were taken in 2017 and 2018 as in the industry growth rate pro
formas. The biggest difference is that there are more surplus funds with the
industry growth rate, resulting in more long-term debt being retired. Of the three
growth rates analyzed, the time-trend growth is what we expect to see in the next
three years. The sustainable growth rate seems very ambitious for any company in
the highly competitive and relatively mature railroad industry, and given CP’s past
financial performance, we predict CP will surpass the expected industry growth
rate.
Exhibit 18: Pro Forma Income Statement, Time-trend Growth Rate, 2015-2018.

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Exhibit 19: Pro Forma Balance Sheet, Time-trend Growth Rate, 2015-2018.

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3.2 Norfolk Southern - Background
Founded in 1982 in Norfolk, Virginia, Norfolk Southern is a Class 1 railroad firm.
Norfolk Southern operates in 22 different states and is directly responsible for over
36,000 miles of railroad track. In addition to the 22 states, the firm has track located
in the District of Columbia as well Canadian routes connecting Albany & Montreal
and Buffalo & Toronto. Norfolk Southern’s main form of income is from the
transportation of coal up and down the east coast as well as through the plain
states. In addition to coal, Norfolk Southern is the largest intermodal freight
transporter on the eastern seaboard. The firm is currently publically traded on the
NYSE with a stock value of
roughly $34.5 billion, as of
October 2014.
Exhibit 20: Norfolk Southern Rail
Map
Source: Wikipedia, Norfolk
Southern Railway, web, 2016
Exhibit 20, 21: Plant and Equipment, Operating Revenue Sources
Source: Norfolk Southern Corp website, Corporate Profile
3.2.B Competition
Norfolk Southern Corporation faces competition from several different subdivisions
of the transportation industry. First and foremost, Norfolk Southern faces

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competition from other railroad companies; including Canadian Pacific, Union
Pacific, and CSX. Depending on conditions in the oil industry, Norfolk Southern
could face competition from the truck industry as well as independent parcel
services, like FedEx and UPS. Norfolk Southern is also susceptible to the Cargo Ship
industry, which can freely operate around the world.
3.2.C PastFinancial Performance
Since 2011, Norfolk Southern’s revenues have been up and down the last five years;
ranging from $10.5 billion just this past year up to $11.6 billion in 2014. The firm’s
stock prices have also been very inconsistent over the last 5 years in terms of
steady growth, as the stock price has ranged anywhere from the highest at $117.64
to a low of $56.05. The only upside to Norfolk Southern’s previous 5 year financial
performance is the steady climb in both Gross Margin % and Dividends. Gross
Margin % has climbed from 63.1% in 2011 to 65.2% in 2015 (Exhibit 22). Dividends
have climbed from 1.66 in 2011 to 2.36 in 2015 (Exhibit 22).
Exhibit
22:
Norfol
k
South
ern
Corp.
2011-
2015
Financ
ial
Perfor
mance
Sourc
e:
Morni
ng
Star,
NSC
Key Ratios, web, 2016
3.2.D FutureGrowth

24. 24
SustainableGrowth Rate
Norfolk Southern’s sustainable growth rate pro forma statements was calculated to
be at 8.2% via previous years financial statement postings. With this growth rate,
Norfolk Southern’s operating revenues should increase from $10.511 billion in 2015
to $11.373 billion in 2016, $12.306 billion in 2017, and $13.316 billion in 2018. Using
an average Dividend Payout of 35.74% from the previous 5 years, Norfolk Southern
should see Retained Earnings increase as well. Retained earnings will hike up from
$996 million in 2015 to $1.321 billion in 2018. (Exhibit 24). With the balance sheet
uneven from 2016-2018,, it is advised to invest in technology and superior
performing locomotives by taking on more long-term debt. This would increase the
LTD account from $9.39 billion in 2015 to $14.3 billion by end of fiscal year 2018
(Exhibit 26). The Sustainable Growth rate of 8.2% is a bit too ambitious considering
Norfolk Southern’s recent negative growth a railroad industry analysis estimate at
2.9%.
Exhibit 24: Norfolk Southern SGR ProForma Income Statement 2015-2018

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Exhibit 26: Norfolk Southern ProForma - B/S - 2015-2018

26. 26
Industry Growth Rate
The US railroad industry is estimated to be an average of 2.9% until
2021, according to IBISWorld industry report (2.7% → 3.3%). If this
estimation were to come to fruition, Norfolk Southern stands to
increase their revenues from $10.5 billion in 2015 to $10.8 billion
in 2016, $11.1 billion in 2017, and $11.45 billion in 2018 (Exhibit
27). By keeping the dividend payout ratio constant at 35.74% (5-year
previous average), Norfolk Southern will see an increase in the
firm’s retained earnings account. Retained Earnings will steadily
grow from $996 million in 2015 to $1.1 billion by end of fiscal year
2018 (Exhibit 29). With a surplus of funds coming into the picture
from 2016-2018, it is advised to try and payoff as much long-term
debt that Norfolk Southern may have. The estimated industry growth
rate of 2.9% seems to right on target, as Norfolk Southern’s Chief
Financial Analyst, has been quoted as saying “Norfolk expects $2.5%
annual volume growth”.

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Exhibit 27: Norfolk Southern Industry Growth Pro Forma - Income Statement - 2015-2018

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Exhibit 29: Norfolk Southern Industry Growth ProForma - B/S - Liab. and Equity - 2015-2018

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Time-trend Growth Rate
Norfolk Southern’s previous 5-year growth has been calculated to an average of -
1.38%. If this trend were to continue the company would see operating revenues
decline from $10.5 billion in 2015 to $10.36 billion in 2016, $10.2 billion in 2017, and
$10.08 billion by the end of fiscal year 2018 (Exhibit 30). By keeping the dividend
growth at a previous 5-year average of 35.74%, Norfolk Southern would also see a
decline in their Retained Earnings account. Retained Earnings would fall from $996
million in 2015 to $940 million by 2018 (Exhibit 30). Despite Norfolk Southern’s
average negative growth rate of -1.38% over the previous 5 years, this would give
the firm a surplus of funds. This can be handled in several different ways, such as
repurchasing stock from holders or trying to payoff long-term debt. With the
potential of Norfolk Southern to continue a downward slide it is advised to try and
payoff as much debt as possible. This can be seen in Exhibit 32, where LTD can be
lowered from $9.3 billion in 2015 to $5.23 billion by 2018. The continued negative
growth rate is very pessimistic; Norfolk Southern should expect to see a turnaround
in revenues via the 2.9% average annual growth IBISWorld has predicted.

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Exhibit 30: Norfolk Southern Company Growth ProForma - Income Statement - 2015-2018

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Exhibit 32: Norfolk Southern Company Growth ProForma - B/S - Liab & Equity - 2015-2018

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Financial Ratio Analysis
4.1 Canadian Pacific
When Canadian Pacific’s growth is projected at the time-trend rate of 6.76%, a boost
can be seen in their interest coverage ratio in a 3-year forecast, indicating that their
debt expenses are less of a burden to the company. This is important for CP in the
future, as potential investors will want to make sure that they are able to pay
interest on future debts. This improving ratio will prevent CP from having to use
their cash or borrow even more, which will allow them to better use their cash to
invest in the capital assets that are so critical to this industry.
A 3-year forecast also shows CP’s debt/equity ratio dropping by about 45%, down to
1.677. While such a large decrease may suggest that CP’s current debt/equity mix is
probably too high, the cost of their current debt financing is healthy, as it is reaping
great enough earnings to still benefit their shareholders. Given that the rail industry
is very capital-intensive, this is not uncommon for a firm like CP to have a seemingly
high debt/equity ratio.
In terms of profitability, CP should be able to continue to leverage their cost
advantages and scale efficiencies against competitors (ships, barges, aircraft, and
trucks), in order to generate positive profits. Time-trend growth forecasts predict
that CP’s profit margin will see a 8.9% increase by 2018. This may be accepted by
some investors as somewhat of a conservative prediction, given that today railroads
are claiming to quadruple the fuel efficiency of trucking per ton mile of freight, and
they have economically greater railcar capacity, with minimal manpower required.
Next, a 9% increase in ROA over the three years is a useful teller of how efficient
CP’s management is at using their assets to generate earnings. Although CP actually
lost a significant amount of revenues in 2015, due to some of their major
commodities delivering negative currency-adjusted revenue growth compared with
years past, their operating metrics have consistently improved. When revenues
from some categories declined by as much as 25%, (US grain, crude, metals,
minerals), CP compensated for the loss by improving their terminal dwell, network

33. 33
speed, and fuel efficiency, which they are believed to have improved by more than
double the average annual improvement rate of the industry. In short, this rise in
ROA shows investors how effective they are at converting money from invested
capital into net income.
4.2 NorfolkSouthern
Norfolk Southern’s strength is in their financial stability over years past, as well as
looking into the future, using the industry growth rate to predict their future
financials. When investors are assessing the company’s short-term health in order
to identify opportunities, Norfolk’s historical interest coverage ratio and their
equally steady future projections provide a favorable view for a positive investment
decision.
Norfolk’s network of assets is vastly dense across the country, with tracks
expanding all across the US to capture about half of rail volume in many regions.
This requires strict asset management and constant renewal, yielding historical
annual capital investments averaging 15%-20%, with the majority being applied
towards maintenance of capital expenditures and less than a quarter for driving
growth and productivity. Given this information, although forecasts show Norfolk’s
ROE as decreasing over the next several years, this should not be a major red flag,
as comparing the ROE of companies in a capital-intensive sector can sometimes not
be the most telling of profitability. Therefore, ROCE, return on capital employed, is a
better and more useful indicator of financial performance, because unlike ROE,
which only analyzes profitability related to a company’s common equity, ROCE
considers debt and other liabilities as well. For investors, Norfolk’s stable ROCE over
the years is a very favorable trend, especially when compared with companies
whose returns on capital employed are volatile and inconsistent.

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Company Weight Average Cost of
Capital
(WACC)
5.1
Canadia
n Pacific WACC
5.1.A Costof Debt&Equity
Canadian Pacific’s beta was given as 1.07 on Morningstar, the risk-free rate is the
current rate of three month t-bills, and the market risk premium of 6% was given.
Using these numbers we were able to find a CAPM of 6.74%. The cost of debt was
found using CP’s Components of Long-term Debt portion of their 10K. We matched
the coupon rate and maturity rate of their outstanding bonds to bonds of similar
companies in the industry (mainly CSX and Norfolk Southern). We then weighted
each bond with the total amount of debt in order to come up with a cost of debt.
5.1.B Weight of Debt& Equity

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CP’s total debt, equity, and assets were found using the SMF Function in Excel. We
weighted both debt and equity to Total Assets in order to come up with the weight
of each.
5.1.C WACC
Using the weights of debt and equity,
the CAPM, and the cost of debt, we
were able to come up with a WACC of
3.42% (left). Using the DGM (right) we
came up with a WACC of 3.16%.
5.2
Norfolk Southern WACC
5.2.A Costof Debt&Equity
Norfolk Southern’s CAPM was
computed the same way as CP,
using a beta of 1.28 from
Morningstar, a market risk
premium of 6%, and the current
yield on 3-month treasury bills.
The cost of debt was found by
calculating the weighted average
YTM of the bonds listed for
Norfolk Southern on

36. 36
Morningstar.
5.2.B Weight of Debt& Equity
Norfolk Southern’s total debt was calculated by a
summing the amounts of each of their bonds.
The value of equity is the market capitalization.
Both amounts have been weighted according to
their values relative to total assets.
5.3.C WACC
To conclude, these measurements of
debt and equity ultimately yield a WACC
of 6.10%. However, a WACC of 10.68%
is the result when using DGM.
Firm Valuation
6.1 P/E Ratios
Canadian Pacific Norfolk Southern

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6.2 EV/EBITDA Ratios
Canadian Pacific
Norfolk Southern
6.3 Free Cash Flows
Norfolk Southern

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Using the free cash flows method, we
calculated six different versions of Norfolk
Southern’s estimated stock price (shown in
the table above on the right side). We calculated share prices using all three of the
predicted growth rates that we found earlier, and also calculated the price using the
two different WACCS (the WACC from CAPM and the WACC from DGM). Earlier, we
decided to grow Norfolk Southern’s pro-formas at the Industry growth rate of 2.9%,
so we selected the FCF stock price that corresponded to this rate, and used the
WACC from CAPM, which seemed to be a more accurate cost of capital. The other
share prices were then disregarded, and using this method, the company would be
valued at just under $45 billion.
Canadian Pacific
The same methodology was used to find the
share price for Canadian Pacific, except we
used the previously selected Time Trend
growth rate or 6.76% for the company, since
it is believed that their growth will be higher
than the industry overall, but certainly not as high as the calculated sustainable
growth rate. This methodology values the firm at just over $30 billion.
6.4 Summary of Valuation Methods

39. 39
(Today’s stock price: $135.49) (-7.27%)
(Today’s stock price: $85.19) (-10.01%)
To estimate what we feel is the most accurate valuation of both company’s stock
price, we generated a weighted average, using all three of the methods we
calculated, as well as incorporation of the Morningstar Analyst’s fair value estimate
of the stock price. For both companies, we weighted the Morningstar Analyst’s
estimate at only 10%. While we believe it is a fair and trustworthy estimation, it is
likely an average of all of the different methods, so we do not want to unfairly
account for one or the other as double in weight if it has already been accounted
for.

40. 40
Next, we weighted the P/E ratio and EV/EBITDA ratio prices as the strongest
weights, as the prices that were found fairly represented the value of the stock.
With Canadian Pacific, we believed that the stock price valuation from the FCF
method was too high, likely driven by a potentially underestimated operating cash
flow - due to an undervalued amount of asset depreciation. Because the amount of
depreciation may have been slightly inaccurate (too small), this could have caused
operating cash flows to appear smaller, and made the overall free cash flows also
appear to be lower, thus affecting the stock price calculation. Because of the
possibility, we weighted the FCF value as less important than P/E and EV/EBITDA so
that it would not skew the average.
Similarly, with Norfolk Southern, the FCF is not as heavily weighted because a
negative change in net working capital was found, which may have altered the
overall cash flows (overvalued), and subsequently led to a misrepresentation in the
stock price. Using the uniquely weighted average method, Canadian Pacific would
be valued at $22,245,954,684 and Norfolk Southern at $27,717,030,870.
Merger Recommendation & Pro Formas
7.1 Overview
CP believes that merging the two companies will enhance competition, ease freight
congestion in the Chicago area, improve service, support the growing economy by
creating a transnational railway system, and generate significant shareholder value
for both companies. However, on April 11, 2016 Canadian Pacific terminated its
third effort to merge with Norfolk Southern because NS was not on board with the
terms CP suggested. Under the proposal, CP CEO, Hunter Harrison, will cut all ties
with CP and become the CEO of NS, all while the merger is being reviewed by the
Service Transportation Board. Harrison wants to increase operating efficiency
(similar to how he turned CP around in 2011), in order to create the largest, most
productive Class 1 railroad company.
NS is also concerned about antitrust issues if they move forward with the merger.
US politicians, other railroad companies, and shippers are all very concerned about

41. 41
the potential merger because they believe it will have a negative impact on
competition. Additionally, the Service Transportation Board is solely responsible for
mergers and acquisitions in the railroad industry. They will not approve any merger
applications involving Class 1 railroads (which includes both CP and NS), unless the
transaction is shown to be in the public interest. Therefore, CP must be able to
prove without a doubt that the merger of these two companies will serve the public
and not decrease competition.
Exhibit 31. Map of Rail
Lines currently owned by
CP & NS.
Source: CPConsolidation.com
7.2 Options Moving Forward
CP and NS have four options they should consider moving forward. These options
include:
1. CP & NS can try to come to an agreement and apply to merge
2. CP or NS can try to merge with another major railroad company
3. CP & NS can acquire smaller, regional companies independently
4. CP & NS can do nothing for the time being and use extra cash to increase
dividends or buy-back stock
Based off of the Pro Forma statements (Exhibit X) created for the merger between
CP and NS, we think that CP should choose option 1 and continue to pursue
merging with NS. The benefits of merging for CP include: creating the first

42. 42
transcontinental railway system owned by one entity, including full access from the
Canadian West Coast to the US Gulf and Atlantic Coast, and their superior financial
position relative to the rest of the industry makes merging with NS an affordable
deal. The benefits for merging for NS include: eliminating $650 million in annual
expenses, enhancing shareholder value, and the opportunity to reduce their
operating ratio. In addition the synergies created by the merger, and the value
saved, are described in Exhibit X.
Exhibit 32. The Synergies and Value Created from CP & NS Merging.
Source: CPConsolidation.com

43. 43
Exhibit 33. Combined Pro Forma Balance Sheet, CP & NS

44. 44
Exhibit 34. Combined Pro Forma Income Statement, CP & NS.
Looking at the combined pro forma statements, it is easy to see that merging will
likely benefit both companies in the long run. We believe that, because the two
companies are in a mature industry and they have consistent, reliable clients, the
growth rate in the first year after merging (whether that is later in 2016, or a few
years down the road) will be about 2.5%. This is less than the projected industry
average of 2.9% because it will take time for the companies to combine their
strengths and weakness. The following year we think the companies will be able to
grow at the industry growth rate, and in years 3-5 we think the synergies and
increased operating efficiencies will allow the firms to grow at increasing rates each
year. However, we do not anticipate that the company would grow faster than
6.76%, the growth rate CP is predicted to grow at in the next few years.
If the firms were to indeed follow through with the merger, they would see
significant improvements in operating ratio, a major measure of profitability in the
railroad industry, since such a large percentage of their revenues are used to
maintain operations. Norfolk Southern really could use this reduction in OR,
especially since many competitors are pushing 60% and NS is currently sitting at

45. 45
71% as of the first quarter of 2016. Overall, Canadian Pacific would gain synergies
from the combining of railway networks, shareholder value would increase, and
Norfolk Southern would be able to receive some turnaround expertise from
Canadian Pacific, especially with the influence of their CEO, Hunter Harrison, who is
respected for his leadership in other recent turnaround projects.
In conclusion, we think that CP should continue to push NS to an agreement. By
becoming the first transcontinental railroad in North America, CP will have an
advantage as the economy grows, and imports and exports increase. CP must show
NS how beneficial their operations system could be for NS’s current financial
situation in order to get them on board. Additionally, CP must convince the Service
Transportation Board that the merger is in the best interest of the public and that it
will not decrease competition within the industry. In order to execute this plan well,
CP should consider revising their offer to NS only after taking care of the antitrust
issues. This means it may take CP a few years to perfect their offer to NS and
convince them that merging is what is best for both companies.

46. 46
Works Cited
Association of American Railroads. North American Freight Rail Industry. Transportation
Research Board. Washington, D.C. March 2014.
<http://onlinepubs.trb.org/onlinepubs/railtransreg/Gray031414.pdf>.
Association of American Railroads. State of the Industry 2016 Report 1 Safety and Innovation.
<https://www.aar.org/report/Documents/AAR%20State%20of%20the%20Industry%202016
%20Full%20Report.pdf>.
Association of American Railroads. Total Annual Spending, 2013 Data.
<https://www.aar.org/Fact%20Sheets/Safety/2013-AAR_spending-graphic-fact-sheet.pdf>.
Knoema.com. Crude Oil Price Forecast: Long Term 2016 to 2025.
<https://knoema.com/yxptpab/crude-oil-price-forecast-long-term-2016-to-2025-data-and-
charts>.
Matusitz, Jonathan. The impact of the railroad on American society: a communication
perspective of technology. Pasos Online. Vol. 7. Pgs: 451-461. 2009.
<http://www.pasosonline.org/Publicados/7309special/PS0309_9.pdf>.
Norfolk Southern. <http://www.nscorp.com/content/nscorp/en/investor-relations/stock-
information.html>.
Pages, E., Lombardozzi, B., Woolsey, L. The Emerging U.S. Rail Industry:Opportunities to
support American manufacturing and spur regional development. National Institute of
Standards and Technology. <http://www.nist.gov/mep/upload/Rail-Report.pdf>.
Quandl. “Coal Prices and Charts” <https://www.quandl.com/collections/markets/coal>.

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Rivera, Edward. IBISWorld Industry Report 48211: Rail Transportation in the US. IBISWorld.
March 2016. Web.
U.S. Department of Transportation Federal Railroad Administration.
<http://www.fra.dot.gov/Page/P0001>.
Yahoo! Finance. <http://finance.yahoo.com/q?s=CP>.