met-ed statement no. 8 before the pennsylvania public ... · appendix a –resume of pauline m....
TRANSCRIPT
Met-Ed Statement No. 8
BEFORE THEPENNSYLVANIA PUBLIC UTILITY COMMISSION
METROPOLITAN EDISON COMPANYDOCKET NO. R-2016-2537349
Direct Testimony of
Pauline M. Ahern, CRRA
List of Topics Addressed
Fair Rate of Return
-i-
TABLE OF CONTENTS
Page
I. INTRODUCTION AND PURPOSE .............................................................................. 1
II. CAPITAL MARKET CONDITIONS............................................................................ 7
III. GENERAL PRINCIPLES AND INVESTMENT RISK ............................................ 14
IV. COMMON EQUITY COST RATE FINDINGS FOR THE ELECTRIC PROXY GROUP...................................................................................... 25
A. DCF Model ......................................................................................................... 27
B. RPM .................................................................................................................... 35
C. CAPM.................................................................................................................. 45
V. COMMON EQUITY COST RATE FINDINGS FOR THENON-PRICE REGULATED PROXY GROUP........................................................ 51
VI. ADJUSTMENTS............................................................................................................ 55
A. Flotation Cost Adjustment ................................................................................ 55
B. Adjustments For Company-Specific Risk Factors.......................................... 58
VII. CONCLUSION OF COMMON EQUITY COST RATE .......................................... 61
Appendix A – Resume of Pauline M. Ahern, CRRA
DIRECT TESTIMONY1OF2
PAULINE M. AHERN, CRRA3
I. INTRODUCTION AND PURPOSE4
Q. Please state your name, occupation and business address.5
A. My name is Pauline M. Ahern. I am a Partner with Sussex Economic Advisors, LLC. 6
My business address is 1900 West Park Road, Suite 250, Westborough, MA 01581. My 7
mailing address is 3000 Atrium Way, Suite 241, Mount Laurel, NJ 08054.8
Q. Please summarize your professional experience and educational background.9
A. I have offered expert testimony on behalf of investor-owned utilities before thirty state 10
regulatory commissions in the United States as well as one provincial regulatory 11
commission in Canada on rate of return issues, including but not limited to common 12
equity cost rate, fair rate of return, capital structure, relative investment risk and credit 13
quality. I am a graduate of Clark University where I was awarded a Bachelor of Arts 14
degree with honors in Economics. I was also awarded a Master of Business 15
Administration with high honors and a concentration in finance by Rutgers University. 16
On behalf of the American Gas Association (“AGA”), I calculate the AGA Gas Index, 17
which serves as the benchmark against which the performance of the American Gas 18
Index Fund (“AGIF”) is measured monthly. The AGA Gas Index and AGIF are a market 19
capitalization weighted index and mutual fund, respectively, comprised of the common 20
stocks of the publicly traded corporate members of the AGA. 21
2
In addition, I am a member of the Society of Utility and Regulatory Financial Analysts 1
(“SURFA”) and currently serve on its Board of Directors, having previously served two 2
terms as SURFA’s President from 2006 – 2008 and 2008 – 2010 and as its 3
Secretary/Treasurer from 2004 – 2006. In 1992, I was awarded the professional 4
designation “Certified Rate of Return Analyst” (“CRRA”) by SURFA, which is based 5
upon education, experience and the successful completion of a comprehensive written 6
examination.7
Lastly, I am an associate member of the National Association of Water Companies, 8
serving on its Finance/Accounting/Taxation and Rates and Regulation Committees; a 9
member of the Advisory Council of the Financial Research Institute – University of 10
Missouri – Robert J. Trulaske, Sr. College of Business; a member of the American 11
Finance and Financial Management Associations; and, a member of AGA’s State Affairs 12
Committee.13
The details of my educational background, expert witness appearances, presentations I 14
have given and articles I have co-authored are set forth in Appendix A to this testimony.15
Q. On whose behalf are you testifying in this proceeding?16
A. I am testifying on behalf of Metropolitan Edison Company (“Met-Ed” or the 17
“Company”).18
Q. What is the purpose of your direct testimony?19
A. The purpose of my testimony is to support the cost rate which Met-Ed should be afforded 20
the opportunity to earn on the common equity portion of its jurisdictional rate base. 21
3
Q. Are you sponsoring an exhibit in this proceeding?1
A. Yes. It has been marked for identification as Met-Ed Exhibit PMA-1 and consists of 2
Schedules 1 through 10.3
Q. Please describe Metropolitan Edison Company. 4
A. Met-Ed provides electric service to approximately 561,400 customers in central and 5
eastern Pennsylvania. As a wholly-owned subsidiary of FirstEnergy Corp. (“FE” or the 6
“Parent”), the Company’s common stock is not publicly traded. Met-Ed had a summer 7
peak load in 2015 of about 2,791 MW, with about two-thirds of that load attributable to 8
residential and small commercial customers. In addition to owning, operating and 9
maintaining 11,292 circuit miles of distribution lines, Met-Ed currently owns 1,406 miles 10
of transmission lines and related facilities within its service territory, which are under the 11
operational control of the PJM Interconnection, LLC (“PJM”) as the regional 12
transmission organization (“RTO”).13
Q. Have you reviewed financial information for Met-Ed?14
A. Yes. As shown on Schedule 1, during the five-year period ending 2014, the achieved 15
average earnings rate on book common equity for Met-Ed was 4.10%. The five-year 16
ending 2014 average common equity ratio based upon total permanent capital was 17
52.64%, while the five-year average dividend payout ratio was 17.71%.18
4
Total debt as a percent of EBITDA1 for the years 2010-2014 ranged between 3.46 and 1
13.46 times, averaging 5.94 times, while funds from operations as a percent of total debt 2
ranged from a negative 2.70% to a positive 8.87%, averaging 4.58%.3
Q. How did you determine Met-Ed’s cost of common equity?4
A. As a wholly-owned subsidiary of FE, Met-Ed’s common stock is not publicly traded. 5
Hence, a market-based common equity cost rate cannot be determined directly for the 6
Company. Consequently, I have assessed the market-based common equity cost rates of 7
companies of relatively similar, but not necessarily identical, risk, i.e., a proxy group, for 8
insight into a recommended common equity cost rate applicable to Met-Ed (the “Electric 9
Proxy Group”). Using companies of relatively similar risk as proxies is consistent with 10
the principles of fair rate of return established in the Hope2 and Bluefield3 cases, adding 11
reliability to the informed expert judgment necessary to arrive at a recommended 12
common equity cost rate. However, no proxy group is identical in risk to any single 13
entity, such as the Company. Accordingly, an assessment of relative risk between the 14
Company and the Electric Proxy Group must be made to determine whether any 15
adjustments to the Electric Proxy Group’s indicated common equity cost rate are 16
necessary. 17
In determining the Electric Proxy Group’s cost of equity, I applied several well-18
recognized models, i.e., the Discounted Cash Flow Model (“DCF”), the Risk Premium 19
Model (“RPM”) and the Capital Asset Pricing Model (“CAPM”). In addition, I applied 20
1 Earnings Before Interest, Taxes, Depreciation and Amortization.2 Federal Power Commission v. Hope Natural Gas Co., 320 U.S. 591 (1944).3 Bluefield Water Works Improvement Co. v. Public Serv. Comm'n, 262 U.S. 679 (1922).
5
the DCF, RPM and CAPM to the market data of a Non-Price Regulated Proxy Group 1
comparable in total risk to the Electric Proxy Group. 2
As summarized on Schedule 2 and in Table 1 below, I conclude that a common equity 3
cost rate of 10.42%, inclusive of flotation costs, is reasonable and appropriate. Once 4
adjustments are made to the 10.42% cost of common equity to reflect Met-Ed’s greater 5
business risk (0.10%) and greater credit risk (0.40%) relative to the Electric Proxy Group, 6
a risk-adjusted cost of common equity of 10.92% results, which, when rounded to 7
10.90%, is my recommended common equity cost rate applicable to Met-Ed in this 8
proceeding.9
10
6
Table 11
Discounted Cash Flow Model 8.80%42Range: 6.33% - 12.31% (midpoint: 9.32%)3
Risk Premium Model 10.51%4Range: 10.25% - 10.77% (midpoint: 10.51%)5
Capital Asset Pricing Model 9.89%6Range: 8.53% - 10.83% (midpoint: 9.68%)7
Cost of Common Equity Models Applied to8 the Non-Price Regulated Proxy Group 11.13%9
Range: 10.86% - 11.29% (midpoint: 11.07%)1011
Indicated Common Equity Cost Rate12Before Adjustment 10.15%513
14Flotation Costs 0.27%15
16Indicated Common Equity Cost Rate17 for the Electric Proxy Group 10.42%18
before Company Specific Risk19Adjustments20
21Business Risk Adjustment 0.10%22
23Credit Risk Adjustment 0.40%24
25Indicated Common Equity Cost Rate26 After Adjustment 10.92%27
28Recommended Common Equity29 Cost Rate 10.90%30
31
32
4 As discussed later in my testimony, application of the DCF model to current market data understates the
required return on common equity by as much as 360 basis points due to a highly unusual and, in all likelihood, temporary convergence of historically anomalous market conditions. Accordingly, the results of that model should be given only very limited weight in deriving a reasonable return on equity in this proceeding.
5 The average of the mean and median of the results of the DCF, CAPM and RPM methods applied to the market data of the Electric Proxy Group and a Non-Price Regulated Proxy Group, 10.14%, has been rounded to 10.15%. By doing so, I have not only considered the results of each cost of common equity model, but have mitigated the effect of outliers on either the high or the low side.
7
II. CAPITAL MARKET CONDITIONS1
Q. Please describe current capital market conditions.2
A. Because the models used to estimate the cost of common equity are meant to reflect 3
current and expected capital market conditions, it is important to assess the 4
reasonableness of the results of any model in the context of observable market data. To 5
the extent model assumptions or results are incompatible with such data, judgment must 6
be applied in both the application of methods, and in the interpretation of their results.7
Q. Please discuss how the Federal Reserve Bank’s market intervention affects the 8
estimation of the cost of capital.9
A. Much has been reported about the Federal Reserve Bank’s (“Fed”) market intervention 10
since 2007, and the effect of that intervention on interest rates. Aside from that effect, an 11
important consideration is the extent to which those actions have obscured the long-12
standing relationships among financial metrics sometimes used in assessing the cost of 13
common equity. 14
Beginning in 2008, the Fed proceeded on a steady path designed to lower long-term 15
government bond yields. Fed policy actions were intended to put downward pressure on 16
longer-term interest rates by having the Fed take onto its balance sheet some of the 17
duration and prepayment risks that would otherwise have been borne by private investors. 18
Under that policy, “Securities Held Outright” on the Fed’s balance sheet increased from 19
approximately $491 billion at the beginning of October 2008 to approximately $4.25 20
trillion by the end of January 2016. In context, the securities held by the Fed represented 21
approximately 3.31% of GDP at the end of September 2008, and rose to approximately 22
8
23.43% of GDP at the end of January 2016.6 As such, Fed policy actions have been a 1
significant source of liquidity, and have had a substantial effect on capital markets. 2
As a result of the Fed’s accommodative monetary policies, the U.S. stock market has 3
recovered with the S&P 500 rising approximately 185.0% from its low in early March 4
2009. That stock price appreciation occurred despite the market’s recent extreme 5
volatility in response to the turmoil in the global economy, falling oil prices, and the 6
uncertainty and direction of the Fed’s interest rate decisions.7
Q. Is the market expecting increases in interest rates?8
A. Yes. The U.S. thirty-year Treasury bond is currently forecasted to yield an average of 9
3.35%7 over the six quarters ended with the second quarter 2017, 4.5% for 2017-2021 10
and 4.8% for 2022-20268 by Blue Chip Financial Forecasts (“Blue Chip”). In addition, 11
the iShares 20+ Year Treasury Bond ETF (“TLT”) Option Chain, an exchange-traded 12
fund of long-term U.S. Government bonds, provides insight into the market’s 13
expectations of future interest rate trends. Because the price of bonds is inversely related 14
to interest rates, the TLT has increased in value as interest rates have fallen over time (see 15
Chart 1, below).16
6 www.federalreserve.gov / www.bea.gov/national/7 From Blue Chip Financial Forecasts, February 1, 2016. Schedule 5, p. 9..8 From Blue Chip Financial Forecasts, December 1, 2015. Schedule 5, p. 10.
9
Chart 1: TLT Index vs. 30-Year Treasury Yield91
23
The TLT provides a market-based understanding of whether investors expect interest 4
rates will increase or decrease by reviewing the premium they are willing to pay for the 5
option to buy or sell the TLT, at the current market price, in the future. If investors are 6
willing to pay more for the option to sell the TLT in the future (at today’s price) than they 7
are willing to pay for the option to buy the TLT (also at today’s price), that suggests that, 8
on balance, the market perceives a greater prospect of interest rate increases than 9
decreases. Based upon data from NASDAQ, as of January 2016, the option to sell the 10
TLT in January 2018 (the furthest priced option) at the current price is more than twice 11
the value of the option to buy the TLT. Because bond prices fall as interest rates 12
increase, this means that investors perceive a greater likelihood of increases in long-term 13
interest rates than decreases.14
Q. What is the market’s current assessment of expected volatility?15
A. One measure of the expected volatility, or risk, of the U.S. stock market is the Chicago 16
Board Options Exchange (“CBOE”) Volatility Index (“VIX”), which measures market 17
9 Source: Yahoo!Finance
y = -17.021x + 170.21R² = 0.982
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expectations of near-term volatility in the U.S. stock market implied by near and next-1
term options on the VIX index. The VIX, sometimes referred to as the “fear index”, is a 2
highly visible and often-reported barometer of investor risk sentiments. 3
Although the VIX is not presented as a percentage, it should be understood as such. 4
Thus, if the VIX stood at 17.00, it would be interpreted as an expected standard deviation 5
in annual returns on the market index of 17.00% over the coming thirty trading days. As 6
Chart 2 reflects, since its inception in 1990, the VIX has averaged approximately 19.83, 7
relatively close to the long-term average annual standard deviation in returns on the S&P 8
500 of 20.55%. 9
Chart 2: VIX Daily Levels and Long-Term Average1010
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12Chart 2 highlights several relevant points. First, the VIX has been at relatively low levels 13
in recent years. However, significant volatility returned to the U.S. stock market 14
10 Source: Bloomberg Financial.
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beginning in the latter portion of 2015. From that broad perspective, equity risk is 1
currently elevated relative to recent historical levels. 2
A further measure of market uncertainty is the volatility of the VIX itself, or the volatility 3
of volatility, as measured by the standard deviation of the VIX. As Chart 3 (below) 4
notes, both moved in a relatively narrow range during 2013, but since then have increased 5
quite noticeably. Such volatility indicates that, although interest rates are still near 6
historical lows in the U.S. market, there remains significant, if not greater, risk to 7
common equity investment in today’s markets, with investors requiring greater returns to 8
bear that risk, consistent with the basic financial principle of risk and return.9
Chart 3: Standard Deviation (100 days) of VIX1110
1112
Just as market intervention by the Fed has reduced interest rates, it has also reduced 13
volatility. For example, each time the Fed began to purchase bonds (as evidenced by the 14
increase in “Securities Held Outright” on its balance sheet), volatility subsequently 15
declined. In fact, in September 2012, when the Fed began to purchase long-term 16
11 Source: Bloomberg Financial.
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securities at a pace of $85 billion per month, volatility (as measured by the VIX) fell, and 1
through October 2014 remained in a relatively narrow range. The reason is quite 2
straight-forward: investors became confident that the Fed would intervene if markets 3
were to become unstable.4
Even with the effect of Fed intervention, periods of increased equity market volatility 5
have been associated with unusually low government bond yields. That relationship 6
makes sense, given that investors increasingly focus on capital preservation during 7
turbulent markets. As Chart 4, below, demonstrates, when volatility peaks (as measured 8
by the VIX), government bond yields fall given that increased demand for safe-haven 9
securities will bid up their price, and down their yield. 10
Chart 4: VIX and U.S. Treasury Yields1211
1213
The important analytical issue is whether we can infer that risk aversion among equity 14
investors is at a historically low level, or lower than it had been in recent years, implying 15
a correspondingly low cost of common equity. Given the negative relationship between 16
12 Source: Bloomberg Financial.
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the expansion of the Fed’s balance sheets and equity market volatility (as measured by 1
the VIX), and in light of the fact that current volatility is considerably greater than prior 2
levels, it is difficult to conclude that fundamental investor risk aversion and investor 3
return requirements are lower than they have been in recent years. In other words, 4
because investors require higher returns for bearing greater risk, given that current market 5
volatility, i.e., risk, is higher than in recent years, investors’ required returns must be 6
higher as well. 7
The low interest rate environment associated with the Fed’s intervention may lead some 8
analysts to conclude that current capital costs, including the cost of common equity, are 9
low and will continue to be so. That conclusion, however, only holds true under the 10
hypothesis of Perfectly Competitive Capital Markets (“PCCM”) and the classical 11
valuation framework which, under normal economic and capital market conditions, 12
underpin the traditional cost of common equity models. PCCM are capital markets in 13
which no single trader, or “market-mover,” would have the power to change the prices of 14
goods or services, including bond and common stock securities. In other words, under 15
the PCCM hypothesis, no single trader would have a significant effect on market prices. 16
Classic valuation theory assumes that investors trade securities rationally with prices 17
reflecting their perceptions of value. Although the Fed has always had the ability to set 18
the benchmark interest rates, is has been maintaining below normal rates to stimulate 19
continued economic and capital market recovery. It therefore is reasonable to conclude 20
that the Fed and other central banks are acting as market-movers, which has a significant 21
effect on the market prices of both bonds and stocks in all markets where a central bank 22
14
is maintaining historically low interest rates. The presence of market-movers such as the 1
Fed in current capital markets runs counter to the PCCM, which is the foundation of 2
traditional cost of common equity models. 3
The engineering of interest rates directly affects the measurement of the cost of common 4
equity. In my opinion, therefore, the results of traditional cost of common equity models 5
should be viewed with even greater scrutiny under current economic and capital market 6
conditions. The current and expected interest rate environment, coupled with the Fed’s 7
engineering of interest rates, suggests that the traditional cost of common equity 8
models’13 tendency to understate the investor required cost of common equity will be 9
exacerbated. Consequently, the results of these models, including those presented in this 10
testimony, are currently and prospectively particularly conservative estimates, i.e., on the 11
low side, of the investor required rate of return on common equity.12
III. GENERAL PRINCIPLES AND INVESTMENT RISK13
Q. What general principles have you considered in arriving at an indicated common 14
equity cost rate of 10.42%, inclusive of flotation costs but exclusive of company-15
specific adjustment for size and credit quality differences, for the Electric Proxy 16
Group?17
A. The cost of common equity is defined as that return which investors require to make an 18
equity investment in a given firm. From the firm’s perspective, that required return, 19
whether it is provided to debt or equity investors, has a cost. Individually, we speak of 20
13 DCF, RPM and CAPM.
15
the “cost of debt” and the “cost of equity”; together, they are referred to as the “cost of 1
capital.”2
The cost of capital (including the costs of both debt and equity) is based upon the 3
economic principle of “opportunity cost,” meaning that investing in any asset/security 4
implies a forgone opportunity to invest in alternative assets/securities. For any 5
investment to make sense to the investor, its expected return must be at least equal to the 6
return expected on alternative investment opportunities of comparable risk. Because 7
investments with like risks should offer similar returns, the opportunity cost of an 8
investment should equal the return available on an investment of comparable risk.9
Although both debt and equity have required costs, they differ in certain fundamental 10
ways. Most noticeably, the cost of debt is contractually defined and can be directly 11
observed in the market as the interest rate or yield on debt securities. The cost of equity, 12
on the other hand, is neither directly observable in the market nor has a contractual 13
obligation. Rather, because common equity investors have a claim on a firm’s cash flows 14
only after debt holders are paid, the uncertainty (or risk) associated with those residual 15
cash flows determines the cost of equity. Because common equity investors bear this 16
“residual risk,” they require higher returns than debt holders. In that basic sense, 17
common equity and debt investors are distinct: they invest in different securities; face 18
different risks; and require different returns.19
The cost of capital, specifically the cost of common equity or the investor required return, 20
is also an economic and financial concept which refers to the ex-ante,14 or the expected 21
14 Before the fact.
16
return on an investment at the market value of the publicly traded common shares of a 1
corporation. According to the basic financial principle of risk and return, the investor 2
required return on investment is a function of the level of investor perceived risk as 3
reflected in the market prices paid. The higher/lower the investor perceived risk, the 4
higher/lower the investor required return. The investor required return is also forward-5
looking, or expectational, as it is the return which the investor expects to receive in the 6
future for investing capital today.7
In unregulated industries, the competition of the marketplace is the principal determinant 8
of the price of products or services. For regulated public utilities, regulation must act as a 9
substitute for marketplace competition. A sufficient level of earnings is required to 10
assure that the utility can: 1) fulfill its obligations to the public while providing safe and 11
reliable service at all times; 2) maintain the integrity of presently invested capital; and 3) 12
attract needed new capital at a reasonable cost in competition with other firms of 13
comparable risk. This is consistent with the previously noted fair rate of return standards 14
established by the U.S. Supreme Court in the Hope and Bluefield cases. 15
In rate base/rate of return regulation, the authorized (allowed) return on common equity is 16
defined as the investor required return. In turn, the investor required return is defined as 17
the return required by the investor on the funds invested in the publicly traded common 18
stocks of companies. As stated previously, the cost of common equity is not directly 19
observable in the capital markets since there is no contractual basis or obligation on the 20
part of a firm to provide a return to its common shareholders, unlike the contractual 21
coupon, or interest, rate on its debt obligations. Therefore, the cost of common equity 22
17
must be estimated from market (economic and financial) data, using financial models1
developed for that purpose, such as the CAPM, DCF and RPM. Consequently, 2
marketplace data must be relied upon in determining a common equity cost rate 3
appropriate for ratemaking purposes. 4
In short, my recommended common equity cost rate is derived from marketplace data of 5
a proxy group of utilities as similar in risk as possible to the Company, based upon 6
selection criteria that will be discussed subsequently. The use of the market data of a 7
proxy group of similar risk companies and the use of multiple cost of common equity 8
cost rate models add reliability to the informed expert judgment used in arriving at a 9
recommended common equity cost rate. 10
Q. Why have you used multiple cost of common equity models to estimate the 11
company’s cost of common equity?12
A. Each of the financial models used to estimate the cost of common equity is subject to 13
certain assumptions, which may be more or less applicable under differing market 14
conditions. The choice of models (including their inputs), the selection of proxy 15
companies, and the interpretation of the models’ results all require the application of 16
reasoned judgment. In the final analysis, the recommended cost of common equity 17
should reflect the return that investors require in light of the subject company’s risks and18
the returns available on comparable investments relative to market conditions at the time 19
the analysis is conducted. 20
Quantitative financial models produce a range of results from which the market, or 21
investor, required return must be estimated. That estimation must be based upon a 22
18
comprehensive review of relevant data and information, including capital market 1
conditions, and does not necessarily lend itself to a strict mathematical estimation. The 2
key consideration in arriving at a recommended common equity cost rate is to ensure that 3
the overall analysis reasonably reflects investors’ expectations in light of capital markets 4
in general, and the investment risk of the subject company (in the context of the proxy 5
companies) in particular.6
Because empirical financial models for determining the cost of common equity are 7
subject to limiting assumptions or other constraints, most finance texts recommend using 8
multiple approaches to estimate the cost of common equity. As a practical matter, no 9
individual model is more reliable than all others under all market conditions. Therefore, 10
it is both prudent and appropriate to use multiple methodologies in order to mitigate the 11
effects of limiting assumptions and inputs associated with any single approach. As such,12
I have considered the results of multiple common equity cost rate models in arriving at 13
my recommended common equity cost rate for the Company.14
That the use of multiple common equity cost rate models adds reliability to the estimation 15
of the investor required return is well supported in the academic literature. 16
Morin states:17
Each methodology requires the exercise of considerable judgment on the 18reasonableness of the assumptions underlying the methodology and on the 19reasonableness of the proxies used to validate a theory. The inability of 20the DCF model to account for changes in relative market valuation, 21discussed below, is a vivid example of the potential shortcomings of the 22DCF model when applied to a given company. Similarly, the inability of 23the CAPM to account for variables that affect security returns other than 24beta tarnishes its use. 25
26
19
No one individual method provides the necessary level of precision for 1determining a fair return, but each method provides useful evidence 2to facilitate the exercise of an informed judgment. Reliance on any 3single method or preset formula is inappropriate when dealing with 4investor expectations because of possible measurement difficulties and 5vagaries in individual companies’ market data. (emphasis added)6
7* * *8
The financial literature supports the use of multiple methods. Professor 9Eugene Brigham, a widely respected scholar and finance academician, 10asserts1(footnote omitted)11
12Three methods typically are used: (1) the Capital Asset 13Pricing Model (CAPM), (2) the discounted cash flow (DCF) 14method, and (3) the bond-yield-plus-risk-premium approach. 15These methods are not mutually exclusive – no method 16dominates the others, and all are subject to error when used 17in practice. Therefore, when faced with the task of 18estimating a company’s cost of equity, we generally use all 19three methods and then choose among them on the basis of 20our confidence in the data used for each in the specific case 21at hand. 22
23Another prominent finance scholar, Professor Stewart Myers, in an early 24pioneering article on regulatory finance, stated(footnote omitted):25
26Use more than one model when you can. Because 27estimating the opportunity cost of capital is difficult, only a 28fool throws away useful information. That means you 29should not use any one model or measure mechanically and 30exclusively. Beta is helpful as one tool in a kit, to be used in 31parallel with DCF models or other techniques for 32interpreting capital market data. (emphasis added)33
34Reliance on multiple tests recognizes that no single methodology produces 35a precise definitive estimate of the cost of equity. As stated in Bonbright, 36Danielsen, and Kamerschen (1988), ‘no single or group test or technique 37is conclusive.’ Only a fool discards relevant evidence. (italics in original)38(emphasis added)39
40* * *41
42While it is certainly appropriate to use the DCF methodology to estimate 43the cost of equity, there is no proof that the DCF produces a more accurate 44estimate of the cost of equity than other methodologies. Sole reliance on 45the DCF model ignores the capital market evidence and financial theory 46
20
formalized in the CAPM and other risk premium methods. The DCF 1model is one of many tools to be employed in conjunction with other 2methods to estimate the cost of equity. It is not a superior methodology 3that supplants other financial theory and market evidence. The broad 4usage of the DCF methodology in regulatory proceedings in contrast to its 5virtual disappearance in academic textbooks does not make it superior to 6other methods. The same is true of the Risk Premium and CAPM 7methodologies. (emphasis added) 158
9Q. Has the Pennsylvania Public Utility Commission (“Commission”) also relied upon 10
multiple models when determining an allowed return on common equity for a utility 11
company?12
A. Yes. In its Opinion and Order entered January 23, 2014, the Commission, too, supported 13
the use of multiple models in establishing an allowed return on equity (“ROE”) when it 14
stated:15
The ALJ concluded that I&E provided the most reasonable resolution of 16this issue. The ALJ stated that the OCA’s proposed rate of return is a bit 17too parsimonious, whereas Columbia’s requested rate of return is 18excessive and based on an overly generous methodology. Accordingly, 19the ALJ adopted I&E’s recommended ROE of 9.15%, which would 20produce an overall rate of return of 7.07% using the 50/50 capital structure 21recommended by I&E. R.D. at 43-46.22
23* * *24
25Upon consideration of the evidence in this proceeding, we will modify the 26ALJ’s recommendation and adopt a rate of return on common equity of 279.75%.28
29* * *30
31In this case, the range of ROE recommendations presented by the Parties 32based on the DCF methodology is 8.25% to 11.35%. Based on our review 33of the testimony, data, and cost models presented, we believe that the 34evidence in this case supports an ROE finding in the reasonable range of 359.25% to 10.25% using the DCF method as the foundation.1636
15 Roger A. Morin, New Regulatory Finance (Public Utility Reports, Inc., 2006) 396-398, 428-431.16 Pennsylvania Public Utility Commission v. Columbia Water Company, Docket No. R-2013-2360798
(Order entered January 23, 2014), pp. 39, 43 (emphasis added).
21
1
Likewise, the following year, in its Opinion and Order entered January 28, 2015, the 2
Commission once again supported the use of multiple models in establishing an allowed 3
ROE when it stated:4
Upon consideration of the evidence in this proceeding, we will modify the 5ALJ’s recommendation and adopt a rate of return on common equity of 610.0%.7
8* * *9
10As discussed, supra, the OCA recommends a return of 9.20% as the 11midpoint of its DCF and CE analyses; I&E recommends a return of 8.89% 12based on its DCF analyses; and the Company proposes a return of 10.3%, 13which utilizes its DCF, RP, and CAPM analyses to which the Company 14adds a size risk adjustment of 75 basis points. Based on our review of the 15testimony, data, and cost models presented, and considering our adoption 16of a 60% / 40% hypothetical capital structure, we believe the range of 17returns provided in evidence supports an ROE finding of 10.0% for our 18ratemaking determinations herein.1719
20
In view of the foregoing, I rely upon the results of three well-tested market models: the 21
DCF, RPM and CAPM in arriving at a common equity cost rate applicable to the 22
Company.23
Q. Please define business risk and explain why it is important to the determination of a 24
fair rate of return.25
A. The investor-required return on common equity reflects investors’ assessment of the total 26
investment risk of the subject firm. Total investment risk often is discussed in the context 27
of business risk and financial risk.28
17 Pennsylvania Public Utility Commission v. Emporium Water Company, Docket No. R-2014-2402324,
(Order entered January 28, 2015), pp. 34-35.
22
Business risk reflects the uncertainty associated with owning a company’s common 1
stock, without consideration of the company’s use of debt and/or preferred financing. 2
One way of understanding the distinction between business and financial risk is to view 3
the former as the uncertainty in the expected earned return on common equity assuming 4
the firm is financed with no debt.5
Examples of the business risk generally faced by utilities include, but are not limited to, 6
the regulatory environment, customer mix and concentration of customers, service 7
territory economic growth, market demand, supply, operations, capital intensity, size, and 8
the degree of operating leverage, all of which have a direct bearing on earnings. 9
Although analysts, including rating agencies, may categorize business risks according to 10
individual categories, as a practical matter they are inter-related and are not wholly 11
distinct from another. Therefore, it is difficult, if not impossible, to specifically and 12
numerically quantify the effect on investors’ required return, i.e., the cost of capital. For 13
the purpose of determining the proper ROE, the relevant issue is where investors see the 14
subject company as falling within a spectrum of risk. To the extent investors view a 15
company as being exposed to additional risk, the required return will increase; the 16
converse also is true. 17
For regulated utilities, business risks are both long and near-term in nature. Whereas 18
near-term business risks are reflected in year-to-year variability in earnings and cash flow 19
brought about by economic or regulatory factors, long-term business risks reflect the 20
prospect of an impaired ability for investors to recover the return on and of their capital. 21
Moreover, unlike unregulated entities, utilities accept the obligation to serve: providing 22
23
safe and reliable service at all times and, as such, generally do not have the option to 1
delay, defer, or reject capital investments. Because those investments are capital-2
intensive, utilities generally do not have the option to avoid raising external funds during 3
periods of capital market distress. 4
Because utilities invest in long-lived, essentially permanent assets, long-term business 5
risks are of considerable concern to equity investors. That is, the risk of not recovering 6
the return on and of their investment extends far into the future. But, the timing and 7
nature of events that may lead to losses also are uncertain and, as a consequence, those 8
risks and their implications for the required ROE tend to be difficult to quantify. That 9
does not mean, however, that the risk is of no consequence to investors. For example, 10
analysts may apply simulation-based methods to assess the potential risk. However, in 11
the final analysis, like the investors that commit their capital, regulatory commissions 12
must review a variety of quantitative and qualitative data and apply their reasoned 13
judgment to determine how long-term risks weigh in their assessment of the market-14
required ROE.15
It is important to also bear in mind the distinction between debt and equity investors 16
when assessing the implications of business risks on the cost of equity. In general, 17
whereas debt holders have a priority claim on earnings and assets, equity holders are the 18
“residual claimants.” Because they bear that residual risk, equity investors require a 19
premium over the return required by debt investors. That is, because returns to equity 20
holders are more risky than returns to bondholders, equity investors must be compensated21
for bearing that additional risk (leading to the equity risk premium). 22
24
Q. Please define financial risk and explain why it is important to the determination of a 1
fair rate of return.2
A. Financial risk is the additional risk that a company may not have sufficient cash flows to 3
meet its financial obligations and is created by the introduction of senior capital, i.e., debt 4
and/or preferred stock, into the capital structure. The higher the proportion of senior 5
capital in the capital structure, the higher the financial risk which must be factored into 6
the common equity cost rate, consistent with the previously mentioned basic financial 7
principle of risk and return, i.e., investors demand a higher common equity return as 8
compensation for bearing higher investment risk.9
Q. Can the investment risk of an enterprise be proxied by bond and credit ratings?10
A. Yes, similar bond/issuer credit (bond/credit) ratings reflect and are representative of 11
similar combined business and financial risks, i.e., total risk faced by bond investors.18 12
Although specific business or financial risks may differ between companies, the same 13
bond/credit rating indicates that the combined risks are similar, albeit not necessarily 14
equal, as the purpose of the bond/credit rating process is to assess overall credit quality or 15
credit risk and not just common equity risk.16
However, it must be kept in mind that a long-term issuer credit or bond issue rating is an 17
opinion regarding the particular company’s overall financial capacity to pay its financial 18
obligations as they come due and payable. The claims of equity holders, on the other 19
hand, are subordinate to the claims of debt holders, and are perpetual in life. As noted 20
18 Risk distinctions within Standard & Poor’s (“S&P”) bond rating categories are recognized by a plus or
minus, i.e., within the A category, an S&P rating can be at A+, A, or A-. Risk distinctions for Moody’s ratings are distinguished by numerical rating gradations, i.e., within the A category, a Moody’s rating can be A1, A2 and A3.
25
above, whereas bondholders can be assured of the probability that a particular company 1
will be able to meet its financial obligations (and thus have higher credit/bond ratings), 2
common equity holders bear the residual risk of insufficient or volatile cash flows in 3
perpetuity. For that fundamental reason, the risks of owning common equity do not 4
directly correspond to the risks of owning bonds. The two have similar considerations, 5
but only to a point.6
IV. COMMON EQUITY COST RATE FINDINGS FOR THE ELECTRIC PROXY 7GROUP8
Q. Please explain how you chose the Electric Proxy Group. 9
A. I chose the Electric Proxy Group by selecting those companies which met the following 10
criteria: 11
1) They are included in the Electric Utility Group19 of Value Line Investment 12
Survey’s Standard Edition; 13
2) They had 70% or greater of their 2014 total operating income derived from, 14
and 70% or greater of their 2014 total assets were devoted to, regulated 15
electric operations; 16
3) They had not publicly announced involvement in any major merger or 17
acquisition activity (i.e., one publicly-traded utility merging with or acquiring 18
another) at the time of the preparation of this testimony; 19
4) They have not cut or omitted their common dividends during the past five 20
years or through the time of the preparation of this testimony; 21
19 Value Line’s Electric Utility Group consists of Electric Utility (East), Electric Utility (Central) and Electric
Utility (West).
26
5) They have Value Line and Bloomberg adjusted betas;1
6) They have positive Value Line five-year dividends per share (“DPS”) growth 2
rate projections; and, 3
7) They have Value Line, Reuters, Zacks or Yahoo! Finance consensus five-year 4
earnings per share (“EPS”) growth rate projections.5
The following eighteen companies met these criteria: 6
ALLETE, Inc. (ALE);7 Alliant Energy Corp. (LNT);8 Ameren Corp. (AEE); 9 American Electric Power Co., Inc. (AEP);10 Consolidated Edison, Inc. (ED);11 Edison International (EIX);12 El Paso Electric Co. (EE);13 Great Plains Energy, Inc. (GXP);14 IDACORP. Inc. (IDA);15 OGE Energy Corp. (OGE);16 Otter Tail Corp. (OTTR);17 PG&E Corp., (PCG);18 Pinnacle West Capital Corp. (PNW):19 PNM Resources, Inc. (PNM);20 Portland General Electric Co. (POR)21 SCANA Corp. (SCG);22 Westar Energy, Inc. (WR); and,23 Xcel Energy Inc. (XEL)24
Q. Have you reviewed financial data for the Electric Proxy Group? 25
A. Yes. Page 1 of Schedule 3 contains comparative capitalization and financial statistics for 26
the Electric Proxy Group for the years 2010 – 2014. 27
As shown on page 1, during the five-year period ending 2014, the achieved earnings rate 28
on book common equity for the group averaged 8.60%. The average common equity 29
ratio based upon permanent capital (excluding short-term debt) was 49.38%, and the 30
27
average dividend payout ratio was 61.09%. Total debt outstanding as a percentage of 1
EBITDA for the years 2010-2014 ranged between 3.56 and 4.05 times, averaging 3.78 2
times, while funds from operations relative to total debt ranged between 22.93% and 3
25.03%, averaging 23.82%.4
Q. Are the cost of common equity models that you use market-based models?5
A. Yes. The DCF model is market-based in that market prices are utilized in developing the 6
dividend yield component of the model. The RPM and CAPM are also market-based in 7
that the bond/issuer ratings and expected bond yields/risk-free rate used in the application 8
of the RPM reflect the market’s assessment of bond/credit risk. In addition, the use of 9
beta coefficients to determine the equity risk premium reflects the market’s assessment of 10
market/systematic risk as beta coefficients are derived from regression analyses of market 11
prices. Moreover, market prices are used in the development of the monthly returns and 12
equity risk premiums used in the Predictive Risk Premium Model (“PRPM”). Selection 13
of the companies in the Non-Price Regulated Proxy Group are market-based in that the 14
selection criteria are based upon statistical regression analyses of market prices. 15
A. DCF Model16
Q. What is the theoretical basis of the DCF model?17
A. The theoretical basis of the DCF model is that the present value of an expected future 18
stream of net cash flows during the investment holding period can be determined by 19
discounting those cash flows at the cost of capital, or the investor’s capitalization rate. 20
DCF theory assumes that an investor buys a stock for an expected total return rate, which 21
is derived from cash flows received in the form of dividends plus appreciation in market 22
28
price (the expected growth rate). Mathematically, the dividend yield on market price plus 1
a growth rate equals the capitalization rate, i.e., the total common equity return rate 2
expected by investors for the proxy group.3
Q. Which version of the DCF model do you use?4
A. I utilize the single-stage constant growth DCF model. The single-stage DCF model is 5
expressed as:6
K = ( D1 / P0 ) + g7
Where: K = Cost of Equity Capital8D1 = Expected Dividend Per Share in one year9P0 = Current Market Price10g = Expected Dividend Per Share Growth11
12
Q. Please describe the dividend yield you used in your application of the DCF model.13
A. The unadjusted dividend yields are based upon a recent (January 29, 2016) dividend 14
divided by the average of closing market prices for the sixty days ending January 29, 15
2016 as shown in Column 1 on page 1 of Schedule 4. 16
Q. Please explain the adjusted dividend yield shown on page 1 of Schedule 4, Column 7.17
A. Because dividends are paid periodically (quarterly), as opposed to continuously (daily), 18
an adjustment must be made to the dividend yield. This is often referred to as the 19
discrete, or the Gordon Periodic, version of the DCF model. DCF theory calls for the use 20
of the full expected growth rate in calculating the dividend yield component of the model. 21
However, since the various companies in the Electric Proxy Group increase their 22
quarterly dividend at various times during the year, a reasonable assumption is to reflect 23
one-half the annual dividend growth rate in the dividend yield component, or D1/2. This 24
29
is a conservative approach, which does not overstate the dividend yield that should be 1
representative of the next twelve-month period. Therefore, the actual average dividend 2
yields in Column 1 on page 1 of Schedule 4 have been adjusted upward to reflect one-3
half the average projected growth rate shown in Column 6.4
Q. Please explain the basis of the growth rates of the Electric Proxy Group that you use 5
in your application of the DCF model. 6
A. Individual investors, with more limited resources than institutional investors, are likely to 7
rely upon widely available financial information services, such as Value Line, Reuters, 8
Zacks and Yahoo! Finance. Investors recognize that such analysts have significant 9
insight into the dynamics of the industries and individual companies they analyze, as well 10
as a company’s ability to effectively manage the effects of changing laws and regulations 11
and ever changing economic and market conditions. 12
Security analysts’ earnings expectations have a significant influence on market prices and 13
are therefore reasonable indicators of investor expectations. As noted by Morin:14
Because of the dominance of institutional investors and their influence on 15individual investors, analysts’ forecasts of long-run growth rates provide a 16sound basis for estimating required returns. Financial analysts exert a 17strong influence on the expectations of many investors who do not possess 18the resources to make their own forecasts, that is, they are a cause of g 19[growth].2020
2122
Over the long run, there can be no growth in DPS without growth in EPS. Thus, the use 23
of expected earnings growth rates in a DCF analysis provides a better matching between 24
investors’ market price appreciation expectations and the growth rate component of the 25
20 Morin, 298-303.
30
DCF. Therefore, I have relied upon security analysts’ five-year forecasts of EPS growth 1
in my application of the DCF model.2
Q. Please summarize your DCF model results.3
A. As shown on page 1 of Schedule 4, the mean result of the single-stage DCF model is 4
8.87%, while the median is 8.72%. I have averaged these two results in arriving at a 5
conclusion of a DCF-indicated common equity cost rate of 8.80% for the Electric Proxy 6
Group. By doing so, I have not only considered the DCF results for each company, but 7
have mitigated the effect of outliers on both the high and the low side. 8
Q. Please comment upon the applicability of the DCF model in establishing a cost of 9
common equity for the company. 10
A. The DCF model has a tendency to misspecify investors' required common equity return 11
rate when the market value of common stock differs significantly from its book value. 12
Mathematically, because the “simplified” DCF model traditionally used in rate regulation 13
assumes a market-to-book ratio of one, it understates or overstates investors' required 14
return rate when market value exceeds or is less than book value, respectively. It does so 15
because, in many instances, market prices reflect investors' assessments of long-range 16
market price growth potential (consistent with the infinite investment horizon implicit in 17
the standard regulatory version of the DCF model) not fully reflected in analysts' shorter 18
range forecasts of future growth in EPS, an accounting proxy. Thus, the market-based 19
DCF model will result in a total annual dollar return on book common equity equal to the 20
total annual dollar return expected by investors only when market and book values are 21
equal, a rare and unlikely situation. For example, in recent years the market values of 22
31
electric utilities’ common stocks have been well in excess of their book values, ranging 1
between 104.38% and 160.88% for the five years ending 2014 (see page 1 of Schedule 2
3). 3
Under DCF theory, the rate of return investors require is related to the market price paid 4
for a security. Thus, market prices form the basis of investment decisions and investors’ 5
expected rates of return. In contrast, a regulated utility is generally limited to earning on 6
a net book value (depreciated original cost) rate base. Although market prices are 7
significantly influenced by analysts’ EPS growth forecasts, market values can diverge 8
from book values for a myriad of macroeconomic reasons including, but not limited to, 9
EPS and DPS expectations, merger or acquisition expectations, interest rates, investor 10
sentiment, unemployment levels, monetary policy, fiscal policy, etc. 11
Traditional rate base/rate of return regulation, where a market-based common equity cost 12
rate is applied to a book value rate base, presumes that market-to-book ratios are at unity 13
or 1.00. However, there is ample empirical evidence over sustained periods which 14
demonstrates that this is an incorrect presumption. Because market-to-book ratios of 15
unity or 1.00 are rarely the case as discussed above, regulatory allowed ROEs, which 16
establish earnings by design, have a limited effect on utilities’ market/book ratios as the 17
market prices of utility common stocks are also influenced by factors beyond the direct 18
influence of the regulatory process.19
32
As noted by Phillips: 1
Many question the assumption that market price should equal book value, 2believing that 'the earnings of utilities should be sufficiently high to achieve 3market-to-book ratios which are consistent with those prevailing for stocks 4of unregulated companies.215
6In addition, Bonbright states: 7
In the first place, commissions cannot forecast, except within wide limits, 8the effect their rate orders will have on the market prices of the stocks of the 9companies they regulate. In the second place, whatever the initial market 10prices may be, they are sure to change not only with the changing prospects 11for earnings, but with the changing outlook of an inherently volatile stock 12market. In short, market prices are beyond the control, though not beyond 13the influence of rate regulation. Moreover, even if a commission did 14possess the power of control, any attempt to exercise it ... would result in 15harmful, uneconomic shifts in public utility rate levels.2216
17Simply put, capital market dynamics are generally independent of the effects of 18
regulatory decisions, but are influenced to a certain extent by regulatory decisions.19
Q. Is it reasonable to expect the market values of utilities’ common stocks to continue 20
to sell well above their book values?21
A. Yes. Market-to-book ratios of regulated utilities vary from year to year, due to such 22
influences as the effects of the “Great Recession,” subsequent economic and capital 23
market recovery and turmoil, global economic and geopolitical conditions, and the like. 24
In my opinion, the common stocks of utilities will continue to sell substantially above 25
their book values, on average, because many investors will likely continue to commit a 26
greater percentage of their available capital to common stocks in view of lower interest 27
rate alternative investment opportunities in today’s markets. The recent past and current 28
21 Phillips, Charles F., The Regulation of Public Utilities – Theory and Practice (Public Utility Reports, Inc.,
1993) 395. 22 James C. Bonbright, Albert L. Danielsen and David R. Kamerschen, Principles of Public Utility Rates
(Public Utilities Reports, Inc., 1988) 334. (italics added).
33
capital market environment is in stark and historical contrast to the late 1970's and early 1
1980's when very high (by historical standards) yields on secured debt instruments in 2
public utilities were available. Despite the fact that the market declined to a low in 3
March 2009 as the “Great Recession” unfolded and the U.S. is now recovering from the 4
“Great Recession,” the majority of utility stocks, on average, have continued to sell at 5
market prices well above their book value. As previously discussed, such sustained high 6
market-to-book ratios have been influenced by factors other than fundamentals such as 7
actual and reported growth in EPS and DPS, and warrant further consideration in setting 8
an authorized ROE. 9
Q. Can the under- or overstatement of the investors’ required rate of return by the 10
DCF model be demonstrated mathematically? 11
A. Yes. Page 2 of Schedule 4 demonstrates how an average market-based DCF cost rate of 12
8.87% based upon the Electric Proxy Group applied to a book value which is below 13
market value will understate the investors’ required return on market value. As shown, 14
there is no realistic opportunity to earn the expected market-based rate of return on book 15
value. In Column A, investors expect an 8.87%23 return on a market price of $49.11,2416
or $4.356. In Column B, when the same return, 8.87%, is applied to a book value of 17
$28.99,25 a return of $2.571 results. Both columns show that the same $1.85626 dividend 18
is indicated, but when the 8.87% is applied to book value, the investor only has the 19
opportunity for $0.715 in market appreciation, or 1.46%. Of course, the converse is also 20
23 Average DCF cost rate from Schedule 3, p. 1.24 Average market price of the Electric Proxy Group derived from Schedule 9, p. 3.25 Average book value of the Electric Proxy Group derived from Schedule 9, p. 3.26 Average adjusted dividend yield for the Electric Proxy Group derived from Schedule 3, p. 1.
34
true. When the market-to-book value is below 1, the DCF cost rate will overstate the 1
investors’ required return on market value. 2
Hence, it is clear that the DCF model misspecifies, that is, it either understates or 3
overstates investors' required cost of common equity capital when market values exceed 4
or are less than their underlying book values. Therefore, as stated above, in order to add 5
reliability to the estimation of the cost of common equity, multiple cost of common 6
equity models should be relied upon, rather than exclusive reliance upon the DCF model, 7
when estimating investors’ expectations.8
In view of the foregoing, at this time the traditional application of the DCF misspecifies 9
investors’ required return. Specifically, it understates investors’ required return because 10
of the confluence of recently rising and volatile market prices, the use of accounting 11
measures as proxies for capital appreciation in the DCF, and the expected continued rise 12
in interest rates and capital costs discussed above. The magnitude of this understatement 13
can be found in the difference between the 5.09% average expected growth in market 14
value, i.e., growth in EPS, shown in Column A on page 2 of Schedule 4, and the growth 15
in market value of 1.46%, shown in Column B, when the 8.87% DCF cost rate is applied 16
to book value, or up to approximately 360 basis points. Coupled with the added 17
reliability and accuracy that the use of multiple cost of common equity models provides 18
in the estimation of the cost of common equity, it is more imperative than ever to not give 19
exclusive or even primary reliance to the DCF analysis at this time. In fact, in my 20
opinion, it would be inappropriate to give any greater weight to the DCF analysis than I 21
already have in deriving my multi-model return on common equity recommendation.22
35
B. RPM1
Q. Please describe the theoretical basis of the RPM. 2
A. The RPM is based upon the basic financial principle of risk and return, namely, that 3
investors require greater returns for bearing greater risk. The RPM recognizes that 4
common equity capital has greater investment risk than debt capital, as common equity 5
shareholders are last in line in any claim on an entity’s assets and earnings as previously 6
discussed. Thus, investors require higher returns from investment in common stocks than 7
from investment in bonds to compensate them for bearing the additional risk. 8
While it is possible to directly observe bond returns and yields, the investor required 9
common equity return cannot be directly determined or observed. According to RPM 10
theory, one can estimate a common equity risk premium over bonds, either historically or 11
prospectively, and then use that premium to derive a cost rate of common equity. 12
According to the RPM, the cost of common equity equals the expected cost rate for long-13
term debt capital plus a risk premium over that cost rate to compensate common 14
shareholders for the added risk of being unsecured and last-in-line for any claim on a 15
corporation's assets and earnings.16
Q. Please explain how you derived your indicated cost of common equity based upon 17
the RPM.18
A. I relied upon the results of the application of two risk premium methods. The first 19
method is PRPM, while the second method is a risk premium model using a total market 20
approach. 21
36
Q. Please explain the PRPM.1
A. The PRPM, published in the Journal of Regulatory Economics (“JRE”)27 and 2
The Electricity Journal (“TEJ”),28 was developed from the work of Robert F. Engle, who 3
shared the Nobel Prize in Economics in 2003 “for methods of analyzing economic time 4
series with time-varying volatility (“ARCH”).”29 Engle found that the volatility in market 5
prices, returns, and equity risk premiums also clusters over time, making them highly 6
useful in predicting future levels of risk and risk premiums. 7
The PRPM estimates the risk/return relationship directly as the predicted equity risk 8
premium is generated by the prediction of volatility, or risk. Thus, the PRPM is not 9
based upon an estimate of investor behavior, but rather upon the evaluation of the actual10
results of that behavior, i.e., the variance of historical equity risk premiums. 11
The inputs to the model are the historical monthly returns on the common shares of each 12
utility in the Electric Proxy Group minus the historical monthly yield on long-term U.S. 13
Treasury securities through January 2016. Using a generalized form of ARCH, known as 14
GARCH,30 each electric utility’s projected equity risk premium was calculated using 15
Eviews© statistical software. When the GARCH model is applied to the historical return 16
27 Autoregressive Conditional Heteroskedasticity. See “A New Approach for Estimating the Equity Risk
Premium for Public Utilities,” Pauline M. Ahern, Frank J. Hanley and Richard A. Michelfelder, Ph.D. The Journal of Regulatory Economics (December 2011), 40:261-278.
28 “Comparative Evaluation of the Predictive Risk Premium ModelTM, the Discounted Cash Flow Model and the Capital Asset Pricing Model”, Pauline M. Ahern, Richard A. Michelfelder, Ph.D., Rutgers University, Dylan W. D’Ascendis, and Frank J. Hanley, The Electricity Journal (May 2013).
29 www.nobelprize.org30 The GARCH model, or Generalized Autoregressive Conditional Heteroskedasticity process, is an
econometric term developed by Dr. Engle in 1982 to describe a method to estimate volatility in financial and capital markets. The general process for a GARCH model involves three steps: 1) estimating a best fitting autoregressive model; 2) computing autocorrelations of the error term; and 3) testing for significance. GARCH models are used by financial professionals in areas including, but not limited to trading, investing, and hedging.
37
data, it produces a predicted GARCH variance series31 and a GARCH coefficient.32 The 1
forecasted thirty-year U.S. Treasury Bond (Note) yield of 3.68% is based upon the 2
consensus forecast for the six quarters ending with the second quarter 2017 derived from 3
the February 1, 2016 Blue Chip averaged with the long-range forecasts for 2017-2021 4
and 2022-2026 from the December 1, 2015 Blue Chip.33 As shown on page 2 of 5
Schedule 5, the mean PRPM indicated common equity cost rate is 10.67% for the Electric 6
Proxy Group, while the median is 10.86%. Consistent with my reliance upon the average 7
of the mean and median DCF results, I use the average of the mean and median PRPM 8
results of 10.77%34 as the indicated PRPM cost rate.9
Q. Please explain the total market approach RPM.10
A. The total market approach RPM adds a prospective public utility bond yield to the 11
average of: 1) an equity risk premium derived from a beta-adjusted total market equity 12
risk premium; 2) an equity risk premium based upon the S&P Utilities Index; and 3) an 13
equity risk premium based upon the authorized returns for electric companies over 14
Moody’s A-rated public utility bonds15
Q. Please explain the basis of the prospective public utility bond yield of 5.51% 16
applicable to the Electric Proxy Group shown on line 5 of page 3 of Schedule 5. 17
A. The first step in the total market approach RPM analysis is to determine the expected 18
bond yield. Because both ratemaking and the cost of capital (including common equity 19
cost rate) are prospective in nature, a prospective yield on similarly-rated long-term debt 20
31 Illustrated in Columns 1 and 2 on page 2 of Schedule 5.32 Illustrated in Column 4 on page 2 of Schedule 5.33 See Schedule 5, pp. 9-10.34 (10.77% = (10.67% + 10.86%) / 2).
38
is essential. Because Blue Chip does not publish consensus forecasts for the Moody’s A-1
rated public utility bond yield, I began with the February 1, 2016 Blue Chip’s consensus 2
forecast of about fifty economists of the expected yield on Aaa-rated corporate bonds for 3
the six calendar quarters ending with the second calendar quarter of 2017 averaged with 4
the long-range forecasts for 2017-2021 and 2022-2026 from the December 1, 2015 Blue 5
Chip.35 As shown on Line 1 of page 3 of Schedule 5, the average expected yield on 6
Moody’s Aaa-rated corporate bonds is 4.78%. Next, in order to derive a prospective 7
Moody’s A2-rated public utility bond yield, an upward adjustment of 0.33%, the average 8
spread between Moody’s Aaa-rated corporation bond yields and Moody’s A-rated public 9
utility bond yields for the three months ending January 201636 must be made to the 10
average Aaa corporate bond yield which results in a bond yield of 5.11% applicable to a 11
Moody’s A2 public utility bond.3712
Likewise, since the Electric Proxy Group’s average Moody’s long-term issuer rating is 13
A3, as shown on page 5 of Schedule 5, a further adjustment of 0.40%,38 or one-third of 14
the average spread of 1.20% between Moody’s A-rated and Baa-rated public utility bonds 15
for the three months ending January 2016, to the prospective Moody’s A2 public utility 16
bond yield of 5.11% is necessary to make the prospective bond yield applicable to the 17
Electric Proxy Group’s average A3 long-term issuer rating.39 Adding the 0.40% to the 18
35 Schedule 5, pp. 9-10.36 Schedule 5, p. 4.37 (5.11% = 4.78% + 0.33%). As shown on Line 3 and explained in Note 2 on page 3 of Schedule 5.38 0.40% = (1/3) * 1.20%. Please see page 4 of Schedule 5 for the derivation of the 1.20%.39 As detailed in Note 3 on page 3 of Schedule 5.
39
5.11% prospective A2 public utility bond yield results in a 5.51% expected bond yield for 1
the Electric Proxy Group as shown on Line 4.40 2
Q. Please explain the basis of the beta derived equity risk premium.3
A. The total beta derived equity risk premium is based upon an average of:4
1) The long-term arithmetic mean historical market equity risk premium;5
2) A predicted equity risk premium based upon the PRPM;6
3) A forecasted market risk premium based upon Value Line’s projected market 7
appreciation and dividend yield; and,8
4) A forecasted equity risk premium based upon the S&P 500 market-value 9
weighted projected market appreciation and dividend yield. 10
Each of these equity risk premiums is described in turn. 11
Q. How did you derive the long-term historical market equity risk premium?12
A. To derive an historical market equity risk premium, I used the most recent Morningstar 13
data on holding period returns for the large company common stocks from the Ibbotson®14
SBBI® 2015 Classic Yearbook – Market Results for Stocks, Bonds, Bill and Inflation 15
1926 – 2014 (“SBBI – 2015”)41 and the average historical yield on Moody’s Aaa and Aa-16
rated corporate bonds for the period 1928-2014. The use of holding period returns over a 17
very long period of time is useful because it is consistent with the long-term investment 18
horizon of investing in a going concern, i.e., a company expected to operate in perpetuity. 19
40 5.51% = 5.11% + 0.40%. As shown on Line 5 and explained in Note 3 on page 3 of Schedule 5.41 Ibbotson® SBBI® 2015 Classic Yearbook – Market Results for Stocks, Bonds, Bills and Inflation 1926 –
2014, Morningstar, Inc., 2015, 153.
40
Morningstar’s long-term arithmetic mean monthly total return rate on large company 1
common stocks is 11.79% and the long-term arithmetic mean monthly yield on Moody’s 2
Aaa and Aa-rated corporate bonds is 6.18%. The resultant long-term historical equity 3
risk premium on the market as a whole is 5.61%.424
I used arithmetic mean monthly total return rates for the large company stocks and yields 5
(income returns) for Moody’s Aaa/Aa corporate bonds because they are appropriate for 6
cost of capital purposes as noted in the SBBI – 2015.43 The use of arithmetic mean return 7
rates and yields are appropriate because ex-post (historical) total returns and equity risk 8
premiums differ in size and direction over time, providing insight into the variance and 9
standard deviation of returns needed by investors in estimating future risk when making a 10
current investment. Absent such valuable insight into the potential variance of returns, 11
investors cannot meaningfully evaluate prospective risk. If investors alternatively relied 12
upon the geometric mean of ex-post equity risk premiums, they would have no insight 13
into the potential variance of future returns because the geometric mean relates the 14
change over many periods of time to a constant rate of change, thereby obviating the 15
period-to-period fluctuations, or variance, critical to risk analysis.16
Q. Please explain the derivation of a PRPM market equity risk premium. 17
A. I used the same PRPM approach described previously to develop a second market equity 18
risk premium estimate. The inputs to the model are the historical monthly returns on 19
large company common stocks from SBBI – 2015 minus the monthly yields on Aaa and 20
Aa corporate bonds during the period from January 1928 through December 2015. Using 21
42 As explained in note 1 on page 8 of Schedule 5.43 SBBI – 2015, 153.
41
the previously discussed generalized form of ARCH, known as GARCH, the market’s 1
projected equity risk premium was determined using Eviews© statistical software. The 2
resulting predicted market equity risk premium based upon the PRPM is 7.38%.443
Q. Please explain the derivation of a projected equity risk premium based upon Value 4
Line data.5
A. As noted previously, because both ratemaking and the cost of capital, including the cost 6
rate of common equity, are prospective, the use of a prospective market equity risk 7
premium is essential. The derivation of the forecasted or prospective market equity risk 8
premium can be found in Note 3 on page 8 of Schedule 5. Consistent with the 9
development of the dividend yield component of my DCF analysis, the third prospective 10
market equity risk premium is derived from an average of the three to five-year estimated 11
median market price appreciation potential by Value Line plus an average of the median 12
estimated dividend yield for the common stocks of the approximately 1,700 firms 13
covered in Value Line’s Standard Edition, both for the thirteen weeks ending February 5, 14
2016. 15
The average median expected price appreciation is 49%, which translates to a 10.48% 16
annual appreciation and, when added to the average (similarly calculated) median 17
dividend yield of 2.35%, equates to a forecasted annual total return rate on the market as 18
44 As shown in Line 2 on page 8 of Schedule 5 and explained in Note 2.
42
a whole of 12.83%. The forecasted Aaa bond yield of 4.78%45 is deducted from the total 1
market return of 12.83%, resulting in an equity risk premium of 8.05%.462
Q. Please explain the derivation of a market equity risk premium based upon the S&P 3
500 composite index companies.4
A. Using data from Bloomberg Financial, a market-value weighted expected total return for 5
the S&P 500 companies can be derived using the expected dividend yields and projected 6
long-term growth in earnings per share as a proxy for capital appreciation. The expected 7
market-value weighted total return for the S&P 500 is 13.46%. Subtracting the 8
prospective yield on Moody’s Aaa-rated corporate bonds of 4.78% results in an 8.68% 9
projected market equity risk premium.4710
Q. What is your conclusion of the market equity risk premium for your total market 11
approach RPM?12
A. It is 7.43% as shown on Line 5 on page 8 of Schedule 5. In arriving at this conclusion, I 13
averaged: 1) the historical market equity risk premium of 5.61%; 2) the PRPM based 14
market equity risk premium of 7.38%; 3) the Value Line-based forecasted market equity 15
risk premium of 8.05%; and, 3) the S&P 500 market-value weighted projected market 16
equity risk premium of 8.68% shown on Line Nos. 1 through 4 on page 8 of Schedule 5.4817
Q. What is your conclusion of a beta derived equity risk premium for use in your total 18
market approach RPM analysis?19
45 See Schedule 5, pp. 9-10.46 As shown on page 8 of Schedule 5 and explained in Note 3.47 As shown on Line 4 on page 8 of Schedule 5 and explained in Note 4.48 (7.43% = (5.61% + 7.38% + 8.05% + 8.68%) / 4).
43
A. The conclusion of the market equity risk premium of 7.43% is then adjusted by the 1
Electric Proxy Group’s beta to account for the market risk of the Electric Proxy Group. 2
Beta is a measure of relative risk to the market as a whole and a logical means by which 3
to allocate an entity’s/proxy group’s share of the total market's equity risk premium 4
relative to corporate bond yields. As shown on page 1 of Schedule 6, the mean and 5
median Value Line and Bloomberg betas for the Electric Proxy Group average 0.69. 6
Multiplying a beta of 0.69 by the market equity risk premium of 7.43%, on Line 4 of 7
page 8 of Schedule 5, results in a beta adjusted equity risk premium of 5.13% for the 8
Electric Proxy Group.49 9
Q. How did you derive the 3.91% equity risk premium based upon the S&P Utility 10
Index and Moody’s A-rated public utility bonds?11
A. I calculated three estimated equity risk premiums based upon the S&P Utility Index. 12
First, I derived the long-term monthly arithmetic mean equity risk premium between the 13
S&P Utility Index total returns of 10.49% and monthly A-rated public utility bond yields 14
of 6.64% from 1928-2015 to arrive at an equity risk premium of 3.85%.50 I then applied 15
the PRPM using historical monthly equity risk premiums from January 1928 through 16
January 2016 to arrive at the PRPM derived equity risk premium of 3.90% for the S&P 17
Utility Index.51 Third, I derived an expected market-value weighted total return on the 18
S&P Utility Index of 9.09% using data from Bloomberg Financial and subtracting the 19
49 As shown on Line 7 on page 8 of Schedule 5.50 As shown on Line 3 on page 11 of Schedule 5.51 As shown on Line 4, on page 11 of Schedule 5.
44
prospective Moody’s A-rated public utility bond yield of 5.11%, resulting in an equity 1
risk premium of 3.98%.522
I rely upon the average of the historical (3.85%), the PRPM (3.90%) and S&P Utility 3
Index (3.98%) derived equity risk premiums, which is 3.91%.534
Q. How did you derive an equity risk premium of 5.19% based on authorized ROEs for 5
electric companies?6
A. The equity risk premium of 5.19% shown on Line 3, page 7 of Schedule 5 is the result of 7
a regression analysis based on regulatory awarded returns on common equity related to 8
the yields on A-rated public utility bonds. That analysis is summarized on page 12 of 9
Schedule 5, which presents the graphical results of a regression analysis of 1,098 rate 10
cases for electric utility companies which were fully litigated during the period from 11
January 1, 1980 through December 31, 2015. The data used were the implicit equity risk 12
premium relative to the yields on A-rated public utility bonds immediately prior to the 13
issuance of each regulatory decision.54 An inverse relationship between the yield on A-14
rated public utility bonds and the equity risk premium is clearly visible in the chart on 15
page 12. In other words, as interest rates decline, the equity risk premium rises and vice 16
versa, a result consistent with regulatory financial literature on the subject.55 Given the 17
expected A-rated utility bond yield of 5.11%, it can be interpolated that the indicated 18
52 As shown on Line 5 on page 11 of Schedule 5.53 (3.91% = ((3.85% + 3.90% + 3.98%) / 3).54 The implied equity risk premium is calculated by subtracting the prevailing yield on Moody’s A rated
public utility bonds from the authorized return on common equity for each case.55 Robert S. Harris and Felicia C. Marston, Estimating Shareholder Risk Premia Using Analysts’ Growth
Forecasts, Financial Management, Summer 1992 63-70; Eugene F. Brigham, Dilip K. Shome, and Steve R. Vinson, The Risk Premium Approach to Measuring a Utility’s Cost of Equity, Financial Management, Spring 1985 33-45; and Farris M. Maddox, Donna T. Pippert, and Rodney N. Sullivan, An Empirical Study of Ex Ante Risk Premiums for the Electric Utility Industry, Financial Management, Autumn 1995, 89-95.
45
equity risk premium applicable to that bond yield is 5.19%, which is shown on Line 3, 1
page 5 of Schedule 5.2
Q. What is your conclusion of an equity risk premium for use in your adjusted total 3
market approach RPM analysis?4
A. The equity risk premium applicable to the Electric Proxy Group is 4.74%,56 derived by 5
averaging the beta-derived premium of 5.13%, the equity risk premium of 3.91% based 6
upon the holding period returns of public utilities with Moody’s A-rated bonds and the 7
equity risk premium of 5.19% based upon the regression analysis of electric utility 8
authorized returns on common equity.9
Q. What is the indicated RPM common equity cost rate based upon the adjusted total 10
market approach?11
A. It is 10.25% for the Electric Proxy Group as shown on Line 7 on Schedule 5, page 3.12
Q. What are the results of your application of the PRPM and the total market 13
approach RPM?14
A. As shown on page 1 of Schedule 5, the indicated RPM-derived common equity cost rate 15
is 10.51%,57 derived by averaging the PRPM result of 10.77% with that based upon the 16
adjusted total market approach, 10.25%. 17
C. CAPM18
Q. Please explain the theoretical basis of the CAPM.19
56 (4.74% = (5.13% + 3.91% + 5.19) / 3).57 (10.51% = ((10.77% + 10.25%) / 2).
46
A. CAPM theory defines risk as the covariability of a security's returns with the market's 1
returns as measured by beta coefficient (β). A beta coefficient less than 1.0 indicates 2
lower variability than the market as a whole, while a beta coefficient greater than 1.0 3
indicates greater variability than the market a whole. 4
The CAPM assumes that all other risk, i.e., all non-market or unsystematic risk, can be 5
eliminated through diversification. The risk that cannot be eliminated through 6
diversification is called market, or systematic, risk. In addition, the CAPM presumes that 7
investors require compensation only for systematic risk that is the result of 8
macroeconomic and other events that affect the returns on all assets. The CAPM is 9
applied by adding a risk-free rate of return to a market risk premium, which is adjusted 10
by the beta coefficient. The traditional CAPM model is expressed as:11
Rs = Rf + β (Rm - Rf)1213
Where:Rs = Return rate on the common stock1415
Rf = Risk-free rate of return1617
Rm = Return rate on the market as a whole1819
β = Adjusted beta (volatility of the security20relative to the market as a whole)21
22Numerous tests of the CAPM have measured the extent to which security returns and beta 23
coefficients are related as predicted by the CAPM, confirming its validity. The empirical 24
CAPM (“ECAPM”) reflects the reality that while the results of these tests support the 25
notion that the beta coefficient is related to security returns, the empirical Security 26
47
Market Line (“SML”) described by the CAPM formula is not as steeply sloped as the 1
predicted SML. Morin58 states:2
With few exceptions, the empirical studies agree that … low-beta 3securities earn returns somewhat higher than the CAPM would predict, 4and high-beta securities earn less than predicted.5
6* * *7
8Therefore, the empirical evidence suggests that the expected return on a 9security is related to its risk by the following approximation:10
11K = RF + x β (RM - RF) + (1-x) β(RM - RF)12
13where x is a fraction to be determined empirically. The value of x that 14best explains the observed relationship. Return = 0.0829 + 0.0520 β is 15between 0.25 and 0.30. If x = 0.25, the equation becomes:16
17K = RF + 0.25(RM - RF) + 0.75 β(RM - RF)5918
19
In view of theory and practical research, I have applied both the traditional CAPM and 20
the ECAPM to the Electric Proxy Group and averaged the results.21
Q. Please describe your selection of beta coefficients for your CAPM analyses.22
A. I rely upon an average of the adjusted beta coefficients published by Value Line and by 23
Bloomberg Financial. While both of those services adjust their calculated (or “raw”) beta 24
coefficients to reflect the tendency of the beta coefficient to regress to the market mean of 25
1.00, Value Line calculates its beta coefficient over a five-year period, while 26
Bloomberg’s calculation is based upon two years of data.27
Q. Please describe your selection of a risk-free rate of return for your CAPM analyses.28
58 Morin 175. 59 Morin 190.
48
A. As shown in Column 5, Schedule 6, the risk-free rate adopted for both applications of the 1
CAPM is 3.68%. The risk-free rate of 3.68% is based upon the average of the consensus 2
forecast of 30-year Treasury bond rates for the six quarters ending with the second 3
calendar quarter of 2017 from the February 1, 2016 Blue Chip averaged with the long-4
range forecasts for 2017-2021 and 2022-2026 from the December 1, 2015 Blue Chip,60 as 5
detailed in Note 2.6
Q. Why is the yield on long-term U.S. Treasury Bonds appropriate for use as the risk-7
free rate?8
A. The yield on long-term U.S. Treasury T-Bonds is almost risk-free and its term is 9
consistent with: 1) the long-term cost of capital to public utilities measured by the yields 10
on A-rated public utility bonds; 2) the long-term investment horizon inherent in utilities’ 11
common stock; and 3) the long-term life of the jurisdictional rate base to which the 12
allowed fair rate of return (i.e., cost of capital) will be applied. In contrast, short-term 13
U.S. Treasury yields are more volatile.14
Q. Please explain the estimation of the expected equity risk premium for the market.15
A. The basis of the market equity risk premium is explained in detail in Note 1 of Schedule 16
6. It is derived from an average of: 17
1) The three to five-year median total market price appreciation projections for 18
the thirteen weeks ending February 5, 2016 reported by Value Line; 19
60 See Schedule 5, pp. 9-10.
49
2) The arithmetic mean monthly equity risk premiums of large company 1
common stocks relative to long-term U.S. Treasury bond income yields from 2
SBBI-2015 from 1926 to 2014;3
3) The PRPM predicted market equity risk premium, using monthly equity risk 4
premiums for large company common stocks relative to long-term U.S. 5
Treasury securities from January 1926 through December 2015;6
4) The results of a regression analysis of the monthly equity risk premiums of 7
large company common stocks relative to long-term U.S. Treasury bond 8
income yields from SBBI-2015 from 1926 to 2014; and,9
5) The market-value weighted projected total return on the S&P 500 minus the 10
projected risk-free rate.11
The Value Line-derived forecasted total market equity risk premium is derived by 12
deducting the projected 3.68% risk-free rate, discussed above, from the Value Line13
projected total annual market return of 12.83%, also discussed above, resulting in a 14
forecasted total market equity risk premium of 9.15%.61 15
The long-term income return on U.S. Government Securities of 5.23% was deducted 16
from the SBBI – 201562 monthly historical total market return of 12.07% resulting in an 17
historical market equity risk premium of 6.84%.6318
61 (9.15% = 12.83% - 3.68%).62 SBBI-2015 196-197, 208-209.63 (6.84% = 12.07% - 5.23%).
50
The PRPM market equity risk premium is 8.32%, derived using the PRPM, discussed 1
above, relative to the yields on long-term U.S. Treasury securities from January 1926 2
through December 2015. 3
To derive the regression analysis-derived market equity risk premium of 8.34%, I used 4
monthly annualized historical returns on the S&P 500 relative to historical yields on 5
long-term U.S. Government Securities from SBBI-2015. The relationship between 6
interest rates and the market equity risk premium was modeled using the observed 7
monthly market equity risk premium as the dependent variable, and the monthly yield on 8
long-term U.S. Government Securities as the independent variable. I used a linear 9
Ordinary Least Squares (“OLS”) regression, in which the market equity risk premium is 10
expressed as a function of the U.S. Government Securities yield:11
RP = α+ β (Rf) 1213
The S&P 500 market-value weighted projected market equity risk premium of 9.78% is 14
derived by subtracting the 3.68% projected risk-free rate, discussed above, from the 15
projected total return of 13.46%, also discussed above.6416
These five market equity risk premiums result in an average total market equity risk 17
premium of 8.49%.6518
Q. What are the results of your applications of the traditional and empirical CAPM to 19
the Electric Proxy Group?20
64 (9.78% = 13.46% - 3.68%).65 (8.49% = ((9.15% + 6.84% + 8.32% + 8.34% + 9.78%) / 5).
51
A. As shown on page 1 of Schedule 6, the mean CAPM/ECAPM cost rate is 9.83% while 1
the median CAPM/ECAPM cost rate is 9.94%, averaging 9.89%. Consistent with my 2
reliance upon the average of the mean and median results of the DCF discussed above, 3
the Electric Proxy Group’s indicated common equity cost rate based upon my CAPM 4
analyses is 9.89%. 5
V. COMMON EQUITY COST RATE FINDINGS FOR THE NON-PRICE 6REGULATED PROXY GROUP 7
Q. You have also included an analysis of data for a Non-Price Regulated Proxy Group. 8
Please explain.9
A. Neither the Hope nor Bluefield cases specify that comparable risk companies have to be 10
regulated utilities. Since rate regulation is a substitute for the competition of the 11
marketplace, non-price regulated firms operating in the competitive marketplace are an 12
excellent proxy if a group can be selected to be comparable in total risk to the Electric 13
Proxy Group upon whose market data I rely to estimate the cost of common equity. As 14
explained below, the selection criteria I utilized are theoretically and empirically sound 15
and produced results for a non-regulated proxy group which is comparable in total risk to 16
the Electric Proxy Group. 17
Q. Please explain how you chose the Non-Price Regulated Proxy Group.18
A. The selection criteria that I utilized for the non-price regulated firms were based upon 19
statistics derived from Value Line regression analyses of weekly market prices over the 20
most recent 260 weeks, i.e., five years, from the market prices paid by investors. Value 21
Line unadjusted betas were used as a measure of systematic risk, while the standard 22
errors of the regressions giving rise to those beta coefficients are a measure of 23
52
unsystematic or firm-specific risk reflecting the extent to which events specific to a 1
firm’s operations affect its stock price. In essence, companies with similar betas and 2
standard errors of the regression have similar total investment risk. The criteria used to 3
select the Non-Price Regulated Proxy Group were:4
1) The unadjusted beta coefficients from the Value Line regressions must lie 5
within plus or minus two standard deviations of the average unadjusted beta 6
coefficients of the Electric Proxy Group;7
2) The residual standard errors of the Value Line regressions which gave rise to 8
the unadjusted beta coefficients must lie within plus or minus two standard 9
deviations of the average residual standard error of the Electric Proxy Group;10
3) The non-regulated firms must be covered by Value Line (Standard Edition); 11
and12
4) The firms must be domestic, non-price regulated companies, i.e., non-utilities.13
The basis of selection and the comparison group’s regression statistics are shown in 14
Schedule 7. The following seventeen companies met these criteria:15
A.J. Gallagher Co. (AJG);16 Becton Dickinson (BDX);17 Brown-Forman ‘B’ (BFB);18 Ball Corp. (BLL);19 Costco Wholesale Corp. (COST);20 Amdocs Ltd. (DOX);21 Ecolab Inc. (ECL);22 Erie Indemnity Co. (ERIE);23 Hormel Foods Corp. (HRL);24 Lilly (Eli) and Co. (LLY);25 The Progressive Corp. of OH (PGR);26 Philip Morris Int’l, Inc. (PM);27 Stericycle Inc. (SRCL);28 Sysco Corp. (SYY);29
53
The Travelers Cos., Inc. (TRV);1 Waste Connections, Inc. (WCN); and2 W.R. Berkley (W.R.) Corp. (WRB).3
4Q. Did you calculate common equity cost rates using the DCF, RPM and CAPM for the 5
Non-Price Regulated Proxy Group?6
A. Yes. Because the DCF, RPM and CAPM have been applied in an identical manner as 7
described above relative to the market data of the Electric Proxy Group, I will not repeat 8
the details of the rationale and application of each model shown on page 1 of Schedule 8. 9
I should note, however, that, in the application of the RPM, I did not use public utility-10
specific equity risk premiums nor apply the PRPM to the individual companies.11
Page 2 of Schedule 8 contains the derivation of the DCF cost rates. As shown, the 12
average of the mean and median DCF cost rates for the Non-Price Regulated Proxy 13
Group is 11.16%. 14
Pages 3 through 5 of Schedule 8 contain the data and calculations relating to the 11.29% 15
RPM cost rate for the Non-Price Regulated Proxy Group. As shown on Line 1 of page 3, 16
the consensus prospective yield on Moody’s Baa-rated corporate bonds of 5.83% is based 17
upon the forecasted yields for the six quarters ending with the second quarter of 2017 18
from the February 1, 2016 Blue Chip, averaged with the long-range forecasted yields for 19
2017-2021 and 2022-2026 also from the December 1, 2015 Blue Chip.66 Since the Non-20
Price Regulated Proxy Group members have an average Moody’s long-term issuer rating 21
of A3 as shown on page 4 of Schedule 8, a downward adjustment of 0.71% to the 22
66 See Schedule 5, pp. 9-10.
54
prospective bond yield is necessary to reflect the difference in ratings67 which results in a 1
projected Baa corporate bond yield of 5.12%. When the beta-adjusted risk premium of 2
6.17%68 relative to the Non-Price Regulated Proxy Group is added to the prospective A3-3
rated corporate bond yields of 5.12%, the indicated RPM cost rate is 11.29%. 4
Page 6 of Schedule 8 contains the details of the application of the traditional CAPM and 5
ECAPM to the Non-Price Regulated Proxy Group. As shown, the mean and median 6
traditional CAPM and ECAPM results are 10.89%/10.83% for the Non-Price Regulated 7
Proxy Group which, when averaged, result in an indicated CAPM cost rate of 10.86%.69 8
Q. What is your conclusion of the cost rate of common equity for the Non-Price 9
Regulated Proxy Group? 10
A. It is 11.13%, as shown on page 1 of Schedule 8. The results of the DCF, RPM and CAPM 11
applied to the Non-Price Regulated Proxy Group are 11.16%, 11.29% and 10.86%, 12
respectively. Based upon these results, I will rely upon the average of the mean and 13
median results of the three models, which is 11.13% for the Non-Price Regulated Proxy 14
Group. 15
Q. Please summarize the indicated common equity cost rate based upon your proxy 16
group findings.17
A. As shown on Schedules 4, 5, 6 and 8, indicated cost rates of common equity were derived 18
using the DCF, CAPM and RPM methods applied to the market data of an Electric Proxy 19
Group and a Non-Price Regulated Proxy Group similar in total risk to the Electric Proxy 20
67 As shown on Line 2 and explained in Note 2 on page 4 of Schedule 7.68 Derived on Schedule 7, p. 5.69 (10.86% = (10.89% + 10.83%) / 2).
55
Group. Based upon an average of the mean and median of these results, I conclude that 1
the indicated cost rate of common equity is 10.14%, rounded to 10.15%. In averaging the 2
mean and median, I have not only considered the results of each cost of common equity 3
model, but have mitigated the effect of outliers on either the high or the low side. Note 4
that the indicated common equity cost rate of 10.15% is exclusive of the recognition of 5
flotation costs and necessary company-specific adjustments for relative size and credit 6
risk.7
VI. ADJUSTMENTS8
A. Flotation Cost Adjustment9
Q. What are flotation costs?10
A. Flotation costs are those costs associated with the sale of new issuances of common 11
stock. They include market pressure and the essential costs of issuance (e.g., 12
underwriting fees and out-of-pocket costs for printing, legal, registration, etc.).13
Q. Why is it important to recognize flotation costs in the allowed common equity cost 14
rate?15
A. It is important because there is no other mechanism in the ratemaking paradigm by which 16
such costs can be recovered. Because these costs are real and legitimate, recovery of 17
these costs should be permitted. As noted by Dr. Morin: 18
The costs of issuing these securities are just as real as operating and 19maintenance expenses or costs incurred to build utility plants, and fair 20regulatory treatment must permit recovery of these costs….21
22
56
The simple fact of the matter is that common equity capital is not 1free….[Flotation costs] must be recovered through a rate of return 2adjustment.703
Q. Should flotation costs be recognized only when there is an equity issuance during 4
the test year or shortly after the test year?5
A. No. As noted above, there is no mechanism to recapture such costs in the ratemaking 6
paradigm other than an adjustment to the allowed common equity cost rate. Flotation 7
costs are charged to capital accounts and are not expensed on a utility’s income 8
statement. As such, flotation costs are analogous to capital investments reflected on the 9
balance sheet. Recovery of capital investments relates to the expected useful lives of the 10
investment. Since common equity has a very long and indefinite life (assumed to be 11
infinity in the standard regulatory DCF model), flotation costs should be recovered 12
through an adjustment to the common equity cost rate even when there has not been an 13
issuance during the test year or in the absence of an expected imminent issuance of 14
additional shares of common stock.15
Historical flotation costs are a permanent loss of investment to the utility and should be 16
accounted for. When any company, including a utility, issues common stock, flotation 17
costs are incurred for legal, accounting, printing fees and the like. For each dollar of 18
issuing market price, a small percentage is expensed and is permanently unavailable for 19
investment in utility rate base. Since these expenses are charged to capital accounts and 20
not expensed on the income statement, the only way to restore the full value of that dollar 21
of issuing price with an assumed investor required return of 10% is for the net 22
investment, $0.95, to earn more than 10% to net back to the investor a fair return on that 23
70 Morin 321.
57
dollar. In other words, if a company issues stock at $1.00 with 5% in flotation costs, it 1
will net $0.95 in investment. Assuming the investor in that stock requires a 10% return 2
on his or her invested $1.00 (i.e., a return of $0.10), the company needs to earn 3
approximately 10.5% on its invested $0.95 to receive a $0.10 return.4
Q. Do the common equity cost rate models you use in your analyses already reflect 5
investors’ anticipation of flotation costs?6
A. No. These models assume no transaction costs. The literature is quite clear that these 7
costs are not reflected in market prices paid for common stocks. For example, Brigham 8
and Daves confirm this and provide the methodology utilized to calculate the flotation 9
adjustment.71 In addition, Dr. Morin confirms the need for such an adjustment even 10
when no new equity issuance is imminent.72 Consequently, it is proper to include a 11
flotation cost adjustment when using cost of common equity models to estimate the 12
common equity cost rate.13
Q. How did you calculate the flotation cost allowance?14
A. I modified the DCF calculation to provide a dividend yield that would reimburse 15
investors for issuance costs in accordance with the method cited in literature by Brigham 16
and Daves as well as Morin. The flotation cost adjustment recognizes the costs of issuing 17
equity that were incurred by FirstEnergy Corp. since August 2003. Based upon the 18
issuance costs shown on page 1 of Schedule 9, an adjustment of 0.27% is required to 19
reflect the flotation costs applicable to the Electric Proxy Group as shown on Schedule 2 20
and Table 2 below:21
71 Brigham and Daves 342.72 Morin 327-30.
58
Table 2 1 Electric2
Proxy Group345
Discounted Cash Flow Model 8.80%736Range: 6.33% - 12.31% (midpoint: 9.32%)7
Risk Premium Model 10.51%8Range: 10.25% - 10.77% (midpoint: 10.51%)9
Capital Asset Pricing Model 9.89%10Range: 8.53% - 10.83% (midpoint: 9.68%)11
Cost of Common Equity Models Applied to12the Non-Price Regulated Proxy Group 11.13%13Range: 10.86% - 11.29% (midpoint: 11.07%)14
15Indicated Common Equity Cost Rate16
Before Adjustment 10.15%741718
Flotation Costs 0.27%1920
Indicated Common Equity Cost Rate21 for the Electric Proxy Group22 before Company-Specific Risk Adjustments 10.42%23
2425
B. Adjustments For Company-Specific Risk Factors26
Q. Does Met-Ed face any unique business risk relative to the Electric Proxy Group?27
A. Yes. Met-Ed is smaller than the average company in the Electric Proxy Group based 28
upon estimated market capitalization as shown in Table 3 below:29
73 As discussed earlier in my testimony, the current DCF model understates the required return on common
equity by as much as 360 basis points due to a highly unusual and, in all likelihood temporary, convergence of historically anomalous market conditions. Accordingly, the results of that model should be given only very limited weight in deriving a reasonable ROE in this proceeding.
74 Based upon an average of the mean and median of the results of the DCF, CAPM and RPM methods applied to the market data of the Electric Proxy Group and a Non-Price Regulated Proxy Group, 10.14%, rounded to 10.15%. By doing so, I have not only considered the results of each cost of common equity model, but have mitigated the effect of outliers on either the high or the low side.
59
Table 31 Times2
Market Greater than3Capitalization (1) the Company4($ Millions)5
6 Met-Ed $1,337.3907
8 Electric Proxy Group $9,647.332 7.2X9
10(1) From page 1 of Schedule 10.11
As shown above, Met-Ed’s estimated market capitalization of $1.337 billion is much less 12
than the average market capitalization of the Electric Proxy Group, $9.647 billion, as of 13
January 29, 2016. Consequently Met-Ed has greater relative business risk because, all 14
else being equal, size has a bearing on risk. Since investors demand a higher return in 15
compensation for assuming greater risk, Met-Ed’s greater relative business risk must be 16
reflected in the cost of common equity derived from the market data of the less business 17
risky Electric Proxy Group.18
Q. How does a company’s size have a bearing on business risk?19
A. Generally because smaller companies are less able to cope with significant events that 20
affect sales, revenues and earnings. For example, smaller companies face more risk 21
exposure to business cycles and economic conditions, both nationally and locally. 22
Additionally, the loss of revenues from a few larger customers can have a greater effect 23
on a small company than on a much bigger company with a larger, more diverse, 24
customer base. 25
Further evidence that smaller firms are more risky is the fact that investors demand 26
greater returns to compensate for the lack of marketability and liquidity of the securities 27
60
of smaller firms. The fact that it is the use of funds invested, and not the source of those 1
funds, which gives rise to the risk of any investment is a basic financial principle.75 2
Brigham76 states:3
A number of researchers have observed that portfolios of small-firms have 4earned consistently higher average returns than those of large-firms 5stocks; this is called “small-firm effect.” On the surface, it would seem to 6be advantageous to the small firms to provide average returns in a stock 7market that are higher than those of larger firms. In reality, it is bad news 8for the small firm; what the small-firm effect means is that the capital 9market demands higher returns on stocks of small firms than on otherwise 10similar stocks of the large firms.11
12Consistent with the financial principle of risk and return discussed above, such increased 13
risk due to small size must be taken into account in the allowed rate of return on common 14
equity. Therefore, the Commission should authorize a cost of common equity in this 15
proceeding that appropriately reflects Met-Ed’s relevant risks, including the impact of its 16
small size.17
Q. Is there a way to quantify a business risk adjustment due to Met-Ed’s small size 18
relative to the Electric Proxy Group? 19
A. Yes. An indication of the magnitude of such an adjustment for the greater relative 20
business risk due to smaller relative size is based upon the size premiums for decile 21
portfolios of New York Stock Exchange (NYSE), American Stock Exchange (AMEX) 22
and NASDAQ listed companies for the 1926-2014 period and related data from Duff & 23
Phelps 2015 Valuation Handbook Guide to Cost of Capital – Market Results through 24
75 Brealey, Richard A. and Myers, Stewart C., Principles of Corporate Finance (McGraw-Hill Book
Company, 1996) 204-205, 229.76 Brigham, Eugene F., Fundamentals of Financial Management, Fifth Edition (The Dryden Press, 1989) 623
(italics added).
61
2014 (D&P – 2015). The size premium for the 3rd decile (0.91%) in which the market 1
capitalization of the Electric Proxy Group falls has been compared with the size premium 2
for the 7th decile (1.71%) in which the estimated market capitalization of Met-Ed falls. 3
As shown on page 1 of Schedule 10, the size premium spread between the 3rd and 7th4
deciles is 0.80%. In view of the foregoing, I am recommending a business risk 5
adjustment of 0.10% to reflect Met-Ed’s smaller size relative to the Electric Proxy Group.6
Q. Is there a way to quantify a credit risk adjustment due to Met-Ed’s Moody’s bond 7
rating of Baa1?8
A. Yes. Met-Ed’s Moody’s issuer credit rating is Baa1.77 In contrast, the average Moody’s 9
issuer credit rating for the Electric Utility Group is A3 as shown on page 4 of Schedule 5. 10
Consequently, Met-Ed has greater credit risk than the Electric Proxy Group. An 11
indication of the magnitude of the necessary upward credit risk adjustment to reflect the 12
greater credit risk inherent in a Moody’s Baa1 issuer credit rating relative to an A3 issuer 13
credit rating is one-third of a recent three-month average yield spread between Moody’s 14
A and Baa2-rated public utility bonds of 1.20%78 or 0.40%.7915
VII. CONCLUSION OF COMMON EQUITY COST RATE 16
Q. What is your recommended common equity cost rate? 17
A. In view of the foregoing, I have adjusted the flotation cost adjusted indicated common 18
equity cost rate of 10.42% upward by 0.10% to reflect Met-Ed’s smaller size relative to 19
the Electric Proxy Group and by 0.40% to reflect its greater credit risk relative to the 20
77 Moody’s Investor Services, December 10, 2015.78 Shown Schedule 5, p. 4.79 0.40% = 1.20% * (1/3).
62DB1/ 87374236.3
Electric Proxy Group. These adjustments result in a common equity cost rate applicable 1
to Met-Ed of 10.92%, rounded to 10.90%. Consequently, I recommend that the 2
Commission provide Met-Ed with the opportunity to earn a common equity cost rate of 3
10.90% on its jurisdictional rate base. My recommendation is derived on Schedule 2 and 4
summarized in Table 4 below: 5
Table 46 Electric7
Proxy Group89
Indicated Common Equity Cost Rate10 for the Electric Proxy Group 10.42%11 before Company Specific Risk12 Adjustments*13
14Business Risk Adjustment 0.1015
16Credit Risk Adjustment 0.4017
18Indicated Common Equity Cost Rate19 After Adjustment 10.92%20
21Recommended Common Equity22 Cost Rate 10.90%23
24* Inclusive of flotation costs.25
26
In my opinion, this return is reasonable, if not conservative, given current capital market 27
conditions and, if achieved, would provide Met-Ed with sufficient earnings to attract 28
necessary new capital.29
Q. Does that conclude your direct testimony?30
A. Yes.31
APPENDIX A
APPENDIX ARÉSUMÉ OF PAULINE AHERN
SUSSEX ECONOMIC ADVISORS, LLC PAGE A-1
Pauline M. Ahern, CRRAPartner
Sussex Economic Advisors, LLC
Ms. Ahern has served as a consultant for investor-owned and municipal utilities and authorities for 28 years. As a Certified Rate of Return Analyst (CRRA), she has extensive experience in rate of return analyses, including the development of ratemaking capital structure ratios, senior capital cost rates, and the cost rate of common equity for regulated public utilities. She has testified as an expert witness before 30 regulatory commissions in the U.S. and Canada.
She also maintains the benchmark index against which the American Gas Association’s (AGA) MutualFund performance is measured. Ms. Ahern has also served as President of the Society of Utility Regulatory and Financial Analysts (SURFA) from 2006-2010 and now sits on its Board of Directors. SURFA is a non-profit organization founded to promote the education and understanding of rate of return analysis which represents utility financial analysts in government, the financial community, industry and academia. She also serves on the Finance/Accounting/Taxation Committees of the National Association of Water Companies. Ms. Ahern is also a member of the Advisory Council, Financial Research Institute, University of Missouri - Robert J. Trulaske, Sr. School of Business. She is also a member of Edison Electric Institute’s Cost of Capital Working Group.
PROFESSIONAL HISTORY
Sussex Economic Advisors, LLC (2015 – Present)Partner
AUS Consultants (1988 – 2015)Principal
Offered testimony as an expert witness on the subjects of fair rate of return, cost of capitaland related issues before state public utility commissions.
Provided assistance and support to clients throughout the entire ratemaking litigationprocess; supervision of the financial analyst and administrative staff in the preparation of fairrate of return and cost of capital testimonies and exhibits which are filed along with experttestimony before various state and federal public utility regulatory bodies as well as thepreparation of interrogatory responses, as well as rebuttal exhibits.
Responsible for the production, publishing, and distribution of the AUS Utility Reports (formerlyC. A. Turner Utility Reports), which has provided financial data and related ratios for about 80public utilities (i.e., electric, combination gas and electric, natural gas distribution, natural gastransmission, telephone, and water utilities, on a monthly, quarterly and annual basis) since 1930. Subscribers include utilities, many state regulatory commissions, federal agencies,individuals, brokerage firms, attorneys, as well as public and academic libraries.
Responsible for maintaining and calculating the performance of the AGA Index, a marketcapitalization weighted index of the common stocks of the approximately 70 corporatemembers of the AGA, which serves as the benchmark for the AGA Gas Utility Index Fund.
Assistant Vice President Prepared fair rate of return and cost of capital exhibits which were filed along with expert
testimony before various state and federal public utility regulatory bodies; supportingexhibits include the determination of an appropriate ratemaking capital structure and the development of embedded cost rates of senior capital and also support the determination of arecommended return on common equity through the use of various market models, such as,but not limited to, Discounted Cash Flow analysis, Capital Asset Pricing Model and Risk
APPENDIX ARÉSUMÉ OF PAULINE AHERN
SUSSEX ECONOMIC ADVISORS, LLC PAGE A-2
Premium Methodology, as well as an assessment of the risk characteristics of the clientutility.
Assisted in the preparation of responses to any interrogatories received regarding suchtestimonies filed on behalf of client utilities. Following the filing of fair rate of return testimonies,assisted in the evaluation of opposition testimony in order to prepare interrogatory questions,areas of cross-examination, and rebuttal testimony and evaluated and assisted in thepreparation of briefs and exceptions following the hearing process.
Submitted testimony before state public utility commissions regarding appropriate capitalstructure ratios and fixed capital cost rates.
Senior Financial Analyst Supervised two analysts and assisted in the preparation of fair rate of return and cost of
capital exhibits which are filed along with expert testimony before various state and federalpublic utility regulatory bodies; the team also assisted in the preparation of interrogatoryresponses.
Evaluated the final orders and decisions of various commissions to determine whether furtheractions were warranted and to gain insight which assisted in the preparation of future rateof return studies.
Assisted in the preparation of an article authored by Frank J. Hanley and A. Gerald Harrisentitled "Does Diversification Increase the Cost of Equity Capital?" published in the July 15, 1991issue of Public Utilities Fortnightly.
Administrator of Financial Analysis for AUS Utility Reports Oversaw the preparation of this monthly publication, as well as the accompanying annual
publication, Financial Statistics - Public Utilities.
Financial Analyst Assisted in the preparation of fair rate of return studies including capital structure
determination, development of senior capital cost rates, determination of an appropriaterate of return on equity, preparation of interrogatory responses, interrogatory questions ofthe opposition, areas of cross-examination and rebuttal testimony, as well as preparation ofthe annual publication C. A. Turner Utility Reports - Financial Statistics - Public Utilities.
Research Dept. of the Regional Economics Division of the Federal Reserve Bank of Boston (1973 – 1975)
Research Assistant Involved in the development and maintenance of econometric models to simulate regional
economic conditions in New England in order to study the effects of, among other things, theenergy crisis of the early 1970's and property tax revaluations on the economy of NewEngland. I was also involved in the statistical analysis and preparation of articles for the NewEngland Economic Review. Also, I was Assistant Editor of New England Business Indicators.
Office of the Assistant Secretary for International Affairs, U.S. Treasury Department,Washington, D.C. (1972)
Research Assistant
Developed and maintained econometric models which simulated the economy of the UnitedStates in order to study the results of various alternate foreign trade policies so that nationaltrade policy could be formulated and recommended.
EDUCATION
APPENDIX ARÉSUMÉ OF PAULINE AHERN
SUSSEX ECONOMIC ADVISORS, LLC PAGE A-3
M.B.A., Rutgers University, High Honors, 1991B.A., Clark University, Honors, 1973
DESIGNATIONS AND PROFESSIONAL AFFILIATIONS
Advisory CouncilFinancial Research InstituteUniversity of Missouri’s Trulaske School of Business
Edison Electric InstituteCost of Capital Working Group
National Association of Water CompaniesMember of the Finance/Accounting/Taxation and Rates and Regulation Committees
Society of Utility and Regulatory Financial AnalystsMember, Board of Directors – 2010-2014 President – 2006-2008 and 2008-2010Secretary/Treasurer – 2004-2006
American Finance AssociationFinancial Management Association
SPEAKING ENGAGEMENTS
“Leadership in the Financial Services Sector”, Guest Professor – Cost of Capital, Business Leader Development Program, Rutgers University School of Business, February 20, 2015, Camden, NJ.
“ROE: Trends & Analysis”, American Gas Association, AGA Mini-Forum for the Financial Analysts Community & Finance Committee Meeting, September 11, 2014, The Princeton Club, New York, NY.
Guest Professor, “Measuring Risk”, Asset Supervision and Administration Commission of the State Council of the Peoples’ Republic of China, Rutgers School of Business, July 21, 2014, New Brunswick, NJ.
Instructor, “Cost of Capital 101”, EPCOR Water America, Inc., Regulatory Management Team, June 9, 2014, Phoenix, AZ.
Moderator: Society of Utility Financial Analysts: 46th Financial Forum – “The Rating Agencies’ Perspectives: Regulatory Mechanisms and the Regulatory Compact”, April 22-25, 2014, Indianapolis, IN.
“The Return on Equity Debate: Its Impact on Budgeting and Investment and Wall Street’s View of Risk”, National Association of Water Companies – 2014 Indiana Chapter Water Summit, March 13, 2014, Indianapolis, IN.
“Regulatory Training in Financing, Planning, Strategies and Accounting Issues for Publicly- and Privately-Owned Water and Wastewater Utilities”, New Mexico State University Center for Public Utilities, October 13-18, 2013, Instructor (Cost of Capital).
“Regulated Utilities – Access to Capital”, (panelist) - Innovation: Changing the Future of Energy, 2013 Deloitte Energy Conference, Deloitte Center for Energy Solutions, May 22, 2013, Washington, DC.
“Comparative Evaluation of the Predictive Risk Premium Model, the Discounted Cash Flow Model and the Capital Asset Pricing Model for Estimating the Cost of Common Equity”, (co-presenter with Richard A. Michelfelder, Ph.D., Rutgers University) – Advanced Workshop in Regulation and Competition, 32
nd
Annual Eastern Conference of the Center for Research in Regulated Industries (CRRI), May 17, 2013, Rutgers University, Shawnee on the Delaware, PA.
APPENDIX ARÉSUMÉ OF PAULINE AHERN
SUSSEX ECONOMIC ADVISORS, LLC PAGE A-4
“Decoupling: Impact on the Risk and Cost of Common Equity of Public Utility Stocks”, before the Society of Utility and Regulatory Financial Analysts: 45th Financial Forum, April 17-18, 2013, Indianapolis, IN.
“Issues Surrounding the Determination of the Allowed Rate of Return”, before the Staff Subcommittee on Electricity of the National Association of Regulatory Utility Commissioners, Winter 2013 Committee Meetings, February 3, 2013, Washington, DC.
“Leadership in the Financial Services Sector”, Guest Professor – Cost of Capital, Business Leader Development Program, Rutgers University School of Business, February 1, 2013, Camden, NJ.
“Analyst Training in the Power and Gas Sectors”, SNL Center for Financial Education, Downtown Conference Center at Pace University, New York City, December 12, 2012, Instructor (Financial Statement Analysis).
“Regulatory Training in Financing Planning, Strategies and Accounting Issues for Publicly and Privately Owned Water and Wastewater Utilities”, New Mexico State University Center for Public Utilities, October 14-19, 2012, Instructor (Cost of Financial Capital).
“Application of a New Risk Premium Model for Estimating the Cost of Common Equity”, Co-Presenter with Dylan W. D’Ascendis, CRRA, AUS Consultants, Edison Electric Institute Cost of Capital Working Group, October 3, 2012, Webinar.
“Application of a New Risk Premium Model for Estimating the Cost of Common Equity”, Co-Presenter with Dylan W. D’Ascendis, CRRA, AUS Consultants, Staff Subcommittee on Accounting and Finance of the National Association of Regulatory Commissioners, September 10, 2012, St. Paul, MN.
“Analyst Training in the Power and Gas Sectors”, SNL Center for Financial Education, Downtown Conference Center at Pace University, New York City, August 7, 2012, Instructor (Financial Statement Analysis).
“Advanced Regulatory Training in Financing Planning, Strategies and Accounting Issues for Publicly and Privately Owned Water and Wastewater Utilities”, New Mexico State University Center for Public Utilities, May 13-17, 2012, Instructor (Cost of Financial Capital).
“A New Approach for Estimating the Equity Risk Premium Applied to Public Utilities”, before the Finance and Regulatory Committees of the National Association of Water Companies, March 29, 2012, Telephonic Conference.
“A New Approach for Estimating the Equity Risk Premium Applied to Public Utilities”, (co-presenter with Frank J. Hanley, Principal and Director, AUS Consultants) before the Water Committee of the National Association of Regulatory Utility Commissioners’ Winter Committee Meetings, February 7, 2012, Washington, DC.
“A New Approach for Estimating the Equity Risk Premium Applied to Public Utilities”, (co-presenter with Richard A. Michelfelder, Ph.D., Rutgers University and Frank J. Hanley, Principal and Director, AUS Consultants) before the Wall Street Utility Group, December 19, 2011, New York City, NY.
“Advanced Cost and Finance Issues for Water”, (co-presenter with Gary D. Shambaugh, Principal & Director, AUS Consultants), 2011 Advanced Regulatory Studies Program – Ratemaking, Accounting and Economics, September 29, 2011, Kellogg Center at Michigan State University – Institute for Public Utilities, East Lansing, MI.
“Public Utility Betas and the Cost of Capital”, (co-presenter with Richard A. Michelfelder, Ph.D., Rutgers University) – Advanced Workshop in Regulation and Competition, 30th Annual Eastern Conference of the Center for Research in Regulated Industries (CRRI), May 20, 2011, Rutgers University, Skytop, PA.
APPENDIX ARÉSUMÉ OF PAULINE AHERN
SUSSEX ECONOMIC ADVISORS, LLC PAGE A-5
Moderator: Society of Utility and Regulatory Financial Analysts: 43rd Financial Forum – “Impact of Cost Recovery Mechanisms on the Perception of Public Utility Risk”, April 14-15, 2011, Washington, DC.
“A New Approach for Estimating the Equity Risk Premium for Public Utilities”, (co-presenter with RichardA. Michelfelder, Ph.D., Rutgers University) – Hot Topic Hotline Webinar, December 3, 2010, Financial Research Institute of the University of Missouri.
“A New Approach for Estimating the Equity Risk Premium for Public Utilities”, (co-presenter with RichardA. Michelfelder, Ph.D., Rutgers University) before the Indiana Utility Regulatory Commission Cost of Capital Task Force, September 28, 2010, Indianapolis, IN.
Tomorrow’s Cost of Capital: Cost of Capital Issues 2010, Deloitte Center for Energy Solutions, 2010 Deloitte Energy Conference, “Changing the Great Game: Climate, Customers and Capital”, June 7-8, 2010, Washington, DC.
“A New Approach for Estimating the Equity Risk Premium for Public Utilities”, (co-presenter with RichardA. Michelfelder, Ph.D., Rutgers University) – Advanced Workshop in Regulation and Competition, 29thAnnual Eastern Conference of the Center for Research in Regulated Industries (CRRI), May 20, 2010, Rutgers University, Skytop, PA.
Moderator: Society of Utility and Regulatory Financial Analysts: 42nd Financial Forum – “The Changing Economic and Capital Market Environment and the Utility Industry”, April 29-30, 2010, Washington, DC.
“A New Model for Estimating the Equity Risk Premium for Public Utilities” (co-presenter with Richard A. Michelfelder, Ph.D., Rutgers University) – Spring 2010 Meeting of the Staff Subcommittee on Accounting and Finance of the National Association of Regulatory Utility Commissioners, March 17, 2010,Charleston, SC.
“New Approach to Estimating the Cost of Common Equity Capital for Public Utilities” (co-presenter with Richard A. Michelfelder, Ph.D., Rutgers University) - Advanced Workshop in Regulation and Competition, 28th Annual Eastern Conference of the Center for Research in Regulated Industries (CRRI), May 14, 2009, Rutgers University, Skytop, PA.
Moderator: Society of Utility and Regulatory Financial Analysts: 41st Financial Forum – “Estimating the Cost of Capital in Today’s Economic and Capital Market Environment”, April 16-17, 2009, Washington, DC.
“Water Utility Financing: Where Does All That Cash Come From?”, AWWA Pre-Conference Workshop: Water Utility Ratemaking, March 25, 2008, Atlantic City, NJ.
PAPERS
“Comparative Evaluation of the Predictive Risk Premium ModelTM
, the Discounted Cash Flow Model and the Capital Asset Pricing Model”, co-authored with Richard A. Michelfelder, Ph.D., Rutgers University, Dylan W. D’Ascendis, and Frank J. Hanley, The Electricity Journal, May, 2013.
“A New Approach for Estimating the Equity Risk Premium for Public Utilities”, co-authored with Frank J. Hanley and Richard A. Michelfelder, Ph.D., Rutgers University, The Journal of Regulatory Economics (December 2011), 40:261-278.
“Comparable Earnings: New Life for Old Precept” co-authored with Frank J. Hanley, Financial Quarterly Review, (American Gas Association), Summer 1994.
ATTACHMENT ATESTIMONY LISTING OF PAULINE AHERN
SUSSEX ECONOMIC ADVISORS, LLC PAGE A-6
SPONSOR DATE CASE/APPLICANT DOCKET NO. SUBJECT
Arizona Corporation Commission
Arizona Water Company 08/15 Arizona Water Company W-01445A-15-0277 Return on Equity
EPCOR Water Arizona, Inc. 03/14 EPCOR Water Arizona, Inc. WS-01303A-14-0010 Return on Equity
Arizona Water Company 04/12Arizona Water Company - Eastern Group W-01445A-11-0310
DSIC Mechanism - Credit Quality; Return on Equity
Chaparral City Water Company 04/13 Chaparral City Water Company W-02113A-13-118 Return on Equity
Arizona Water Company 08/12Arizona Water Company - Northern Group W-01445A-12-0348 Return on Equity
Bermuda Water Co. 09/11 Bermuda Water Co. W-01812A-10-0521 Return on EquityArkansas Public Service Commission
United Water Arkansas, Inc. 03/10 United Water Arkansas, Inc. 09-130-U Fair Rate of Return
United Water Arkansas, Inc. 12/06 United Water Arkansas, Inc. 06-160-U Fair Rate of Return
United Water Arkansas, Inc. 09/03 United Water Arkansas, Inc. 03-161-U Return on EquityArkansas Western Gas Company d/b/a Associated Natural Gas Company 02/97 Associated Natural Gas Company 97-019-U Capital Structure
Arkansas Western Gas Company 02/97 ANG Division – Arkansas 97-019-I Capital Structure
Arkansas Western Gas Company 02/96 ANG Division – Arkansas GR-97-272 Return on Equity
Arkansas Eastern Gas Company 02/96 Arkansas Western Gas Company 96-030-U Capital Structure
British Columbia Utilities Commission
Corix Utilities, Inc. 07/13 Corix Utilities, Inc.Generic Cost of Capital Proceeding- Phase II
Return on Equity
Corix Utilities, Inc. 08/12 Corix Utilities, Inc.Generic Cost of Capital Proceeding – Phase I
Return on Equity
California Public Utilities Commission
San Gabriel Valley Water Company 05/12 San Gabriel Valley Water Company 12-05-002 Return on Equity
San Jose Water Company 05/09 San Jose Water Company U-168-W Return on Equity
San Jose Water Company 05/11 San Jose Water Company U-168-W Return on Equity
Thames RWE re: California-American Water Co. 05/02
Thames RWE re: California-American Water Co. 02-01-036
Return on Equity
Connecticut Department of Public Utility Control
Aquarion Water Co. of Connecticut 03/13 Aquarion Water Co. of Connecticut 13-02-30 Return on Equity
Connecticut Water Company 01/10 Connecticut Water Company 09-12-11 Return on Equity
Aquarion Water Company 03/10 Aquarion Water Company 10-02-13 Return on Equity
ATTACHMENT ATESTIMONY LISTING OF PAULINE AHERN
SUSSEX ECONOMIC ADVISORS, LLC PAGE A-7
United Water Connecticut 09/10 United Water Connecticut 10-09-08 Fair Rate of Return
United Water Connecticut 05/07 United Water Connecticut 07-05-44 Fair Rate of Return
Delaware Public Service Commission
SUEZ Water Delaware Inc. 02/16 SUEZ Water Delaware Inc. Fair Rate of Return
Artesian Water Company 04/14 Artesian Water Company 14-132 Fair Rate of Return
Tidewater Utilities, Inc. 11/13 Tidewater Utilities, Inc. 13-466 Return on Equity
Tidewater Utilities, Inc. 09/11 Tidewater Utilities, Inc. 11-397 Fair Rate of Return
Artesian Water Company 04/11 Artesian Water Company 11-207 Fair Rate of Return
United Water Delaware, Inc. 12/10 United Water Delaware, Inc. 10-421 Fair Rate of Return
United Water Delaware, Inc. 02/09 United Water Delaware, Inc. 09-60 Fair Rate of Return
Tidewater Utilities, Inc. 01/09 Tidewater Utilities, Inc. 09-29 Fair Rate of Return
Artesian Water Company 04/08 Artesian Water Company 14-132 Fair Rate of Return
Sussex Shores Water Company 10/07 Sussex Shores Water Company 07-278 Fair Rate of Return
United Water Delaware, Inc. 05/06 United Water Delaware, Inc. 06-174 Fair Rate of Return
Tidewater Utilities, Inc. 04/06 Tidewater Utilities, Inc. 06-145 Fair Rate of Return
Tidewater Utilities, Inc. 04/04 Tidewater Utilities, Inc. 04-152 Fair Rate of Return
Tidewater Utilities, Inc. 01/02 Tidewater Utilities, Inc. 02-28 Fair Rate of Return
Sussex Shores Water Company 11/99 Sussex Shores Water Company 99-576 Fair Rate of Return
Tidewater Utilities, Inc. 9/99 Tidewater Utilities, Inc. 99-446 Fair Rate of Return
Long Neck Water Company 01/99 Long Neck Water Company 99-31 Overall Rate of Return
United Water Delaware, Inc. 03/98 United Water Delaware 98-98 Return on Equity
United Water Delaware, Inc. 08/96 United Water Delaware, Inc. 96-164Capital Structure and Fixed Capital Cost Rates
Florida Public Service Commission
Utilities Inc. 08/08 Utilities Inc. 080006-WS Fair Rate of Return
Utilities, Inc. of Florida 06/03 Utilities, Inc. of Florida 020071-WS Fair Rate of Return
Hawaiian Public Utilities Commission
GTE Hawaiian Telephone 10/96 GTE Hawaiian Telephone 95-0054
Common Equity Cost, Capital Structure and Storm Damage Cost Recovery
GTE Hawaiian Telephone 06/96 GTE Hawaiian Telephone 95-0051/94-0298
Self-Insurance Property Damage Reserve-Ratepayer Responsibility
Idaho Public Utility Commission
United Water Idaho, Inc. 05/15 United Water Idaho, Inc. UWI-W-15-01 State Property Tax Study
ATTACHMENT ATESTIMONY LISTING OF PAULINE AHERN
SUSSEX ECONOMIC ADVISORS, LLC PAGE A-8
United Water Idaho, Inc. 08/11 United Water Idaho, Inc. UWI-W-11-02 Fair Rate of Return
United Water Idaho, Inc. 11/04 United Water Idaho, Inc. UWI-W-04-04 Fair Rate of Return
Illinois Commerce Commission
Illinois-American Water Company 10/11 Illinois-American Water Company 11-0767 Return on EquityApple Canyon Utility Co. / Lake Wildwood Utilities Corp. 04/10
Apple Canyon Utility Co. / Lake Wildwood Utilities Corp. 09-0548/0549 Fair Rate of Return
Illinois American Water Company 05/09 Illinois American Water Company 09-0319 Return on Equity
Illinois-American Water Company 08/07 Illinois-American Water Company 07-0507 Return on Equity
Aqua Illinois, Inc. 02/06Aqua Illinois, Inc. - Kankakee Water Division 06-0285 Return on Equity
Aqua Illinois 12/04Aqua Illinois - Woodhaven Water & Sewer Divisions 05-0071 Return on Equity
Aqua Illinois 12/04Aqua Illinois - Oak Run Water & Sewer Divisions 05-0072 Return on Equity
United Water Idaho, Inc. 11/04 United Water Idaho, Inc. UWI-W-04-04 Fair Rate of Return
Aqua Illinois 05/04Aqua Illinois - Vermillion Water Division 04-0442 Return on Equity
Aqua Illinois (formerly Consumers Ill. Water Co.) 05/03
Aqua Illinois (formerly Consumers Ill. Water Co.) 03-0403 Fair Rate of Return
Aqua Illinois (formerly Consumers Ill. Water Co.) 04/00
Aqua Illinois (formerly Consumers Ill. Water Co.)
00-0337, 00-0338, 00-0339 Return on Equity
Indiana Utility Regulatory Commission
Indiana-American Water Company 01/14 Indiana-American Water Company 44450 Return on Equity
Pioneer Water LLC 10/13 Pioneer Water LLC 4434 Return on Equity
Utility Center, Inc. 03/10 Utility Center, Inc. 43874 Fair Rate of Return
Twin Lakes Utilities, Inc. 11/06 Twin Lakes Utilities, Inc. 43128 Fair Rate of Return
Utility Center, Inc. 08/07 Utility Center, Inc. 43331 Fair Rate of Return
Twin Lakes Utilities, Inc. 09/03 Twin Lakes Utilities, Inc. 42488 Fair Rate of Return
United Water West Lafayette, Inc. 01/97 United Water West Lafayette, Inc. 41046 Return on Equity
United Water Indiana, Inc. 01/97 United Water Indiana, Inc. 41047 Return on Equity
Iowa Utilities Board
Iowa-American Water Company 04/11 Iowa-American Water Company RPU-2011-0001 Return on Equity
Iowa-American Water Company 04/09 Iowa-American Water Company RPU-2009-0004 Return on Equity
Iowa-American Water Company 08/07 Iowa-American Water Company RPU-2007-0003 Return on Equity
Kentucky Public Service Commission
Water Service Corp. of Kentucky 01/09 Water Service Corp. of Kentucky 2008-00563 Fair Rate of Return
ATTACHMENT ATESTIMONY LISTING OF PAULINE AHERN
SUSSEX ECONOMIC ADVISORS, LLC PAGE A-9
Water Service Corp. of Kentucky 08/05 Water Service Corp. of Kentucky 2005-00325 Fair Rate of Return
Louisiana Public Service Commission
Louisiana Water Service, Inc. 03/08 Louisiana Water Service, Inc. U-30553 Fair Rate of Return
Maine Public Service Commission
Maine Water Company 12/13Maine Water Company – Camden & Rockland Division 2013-00362
Return on Equity
Consumers Maine Water Company 05/00 Consumers Maine Water Company 2000-96 & 2000-175 Return on Equity
Maryland Public Service Commission
Greenridge Utilities, Inc. 05/03 Greenridge Utilities, Inc. 8962 Fair Rate of Return
Michigan Public Service Commission
Alpena Power Company 05/09 Alpena Power Company U-15935 Fair Rate of Return
Alpena Power Company 04/07 Alpena Power Company U-15250 Fair Rate of Return
Alpena Power Company 07/99 Alpena Power Company U-12000 Return on Equity
Missouri Public Service Commission
Missouri Gas Energy 09/13 Missouri Gas Energy GR-2014-0007 Return on Equity
Missouri-American Water Company 06/11 Missouri-American Water CompanyWR-2011-0337 / SR-2011-0338 Fair Rate of Return
Missouri-American Water Company 10/09 Missouri-American Water Company WR-2010-0131 Return on Equity
Missouri American Water Company 03/08 Missouri American Water CompanyWR-2008-0311 / SR-2008-0312 Return on Equity
Missouri American Water Company 12/06 Missouri American Water CompanyWR-2007-0216 / WR-2007-0217 Return on Equity
Missouri-American Water Company 05/03 Missouri-American Water CompanyWR-2003-0500 & WC-2004-0168 Fair Rate of Return
Arkansas Western Gas Company 02/97 ANG Division – Missouri GR-97-272 Capital Structure
New Hampshire Public Utilities CommissionAquarion Water Co. of New Hampshire, Inc. 03/13
Aquarion Water Co. of New Hampshire, Inc. DW 12-085
Return on Equity
New Jersey Board of Public Utilities
Aqua New Jersey, Inc. 1/16 Aqua New Jersey, Inc. Return on Equity
United Water New Jersey, Inc. 10/15 United Water New Jersey, Inc. WR-15101177 Return on Equity
United Water Toms River, Inc. 02/15 United Water Toms River, Inc. W-01303A-14-0010 Return on Equity
Atlantic City Sewerage Company 10/14 Atlantic City Sewerage Company WR-14101263 Return on Equity
Aqua New Jersey, Inc. 01/14 Aqua New Jersey, Inc. WR-14010019 Fair Rate of Return
Middlesex Water Company 11/13 Middlesex Water Company WR-13111059 Return on Equity
United Water New Jersey, Inc. 03/13 United Water New Jersey, Inc. WR-13030210 Fair Rate of Return
ATTACHMENT ATESTIMONY LISTING OF PAULINE AHERN
SUSSEX ECONOMIC ADVISORS, LLC PAGE A-10
Jersey Central Power & Light Company 11/12
Jersey Central Power & Light Company ER-12111052 Return on Equity
United Water Toms River, Inc. 09/12 United Water Toms River, Inc. WR-12090830 Fair Rate of Return
Pinelands Water Company 08/12 Pinelands Water Company WR-12080735 Return on Equity
Pinelands Wastewater Company 08/12 Pinelands Wastewater Company WR-12080734 Return on Equity
Middlesex Water Company 01/12 Middlesex Water CompanyWR-12010027 / PUC 1653-2012 Fair Rate of Return
Aqua New Jersey, Inc. 12/11 Aqua New Jersey, Inc. WR 11120859 Fair Rate of ReturnThe New Jersey Utilities Association 10/11 The New Jersey Utilities Association
PUC 07146-09 (OAL) / WO-090148 (BPU) Return on Equity
United Water New Jersey, Inc. 07/11 United Water New Jersey, Inc. WR-11070428 Fair Rate of ReturnThe Atlantic City Sewerage Company 04/11
The Atlantic City Sewerage Company WR-11040247 Fair Rate of Return
United Water Great Gorge, Inc./United Water Vernon Sewerage, Inc. 10/10
United Water Great Gorge, Inc./United Water Vernon Sewerage, Inc. WR-10100785 Fair Rate of Return
United Water New Jersey, Inc. 12/09 United Water New Jersey, Inc. WR-09120987 Fair Rate of Return
Aqua New Jersey, Inc. 12/09 Aqua New Jersey, Inc. WR-09121005 Fair Rate of ReturnThe Atlantic City Sewerage Company 11/09
The Atlantic City Sewerage Company WR-09110940 Fair Rate of Return
United Water Toms River, Inc. 11/09 United Water Toms River, Inc. WR-09110934 Fair Rate of Return
Middlesex Water Company 08/09 Middlesex Water Company WR-0908066 Fair Rate of Return
United Water New Jersey, Inc. 09/08 United Water New Jersey, Inc. WR-08090710 Fair Rate of Return
United Water West Milford, Inc. 09/08 United Water West Milford, Inc. WR-08100928 Fair Rate of Return
United Water Arlington Hills, Inc. 09/08 United Water Arlington Hills, Inc. WR-08100929 Fair Rate of Return
Applied Wastewater Management 08/08 Applied Wastewater Management WR-08080550 Fair Rate of Return
Middlesex Water Company 04/08 Pinelands Water Company WR-08040282 Return on Equity
United Water Toms River, Inc. 03/08 United Water Toms River, Inc. R-WR-08030139 Fair Rate of Return
Aqua New Jersey, Inc. 12/07 Aqua New Jersey, Inc. WR-07120955 Fair Rate of ReturnThe Atlantic City Sewerage Company 11/07
The Atlantic City Sewerage Company WR-0007110866 Fair Rate of Return
Middlesex Water Company 04/07 Middlesex Water Company PUCRL 05663-2007N Fair Rate of Return
United Water New Jersey, Inc. 02/07 United Water New Jersey, Inc. WR-07020135 Fair Rate of Return
Aqua New Jersey, Inc. 12/05 Aqua New Jersey, Inc. WR-05121022 Fair Rate of Return
Pinelands Water Company 08/05 Pinelands Water Company WR-05080681 Return on Equity
Pinelands Wastewater Company 08/05 Pinelands Wastewater Company WR-05080680 Return on Equity
Middlesex Water Company 05/05 Middlesex Water Company WR-05050451 Fair Rate of Return
ATTACHMENT ATESTIMONY LISTING OF PAULINE AHERN
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Pinelands Wastewater Company 12/03 Pinelands Wastewater Company WR-031201017 Return on Equity
Pinelands Water Company 12/03 Pinelands Water Company WR-031201016 Return on EquityAqua New Jersey, Inc. (formerly Consumers New Jersey Water Co.) 12/03
Aqua New Jersey, Inc. (formerly Consumers New Jersey Water Co.) WR-03120974 Return on Equity
Middlesex Water Company 11/03 Middlesex Water Company WR-03110900 Fair Rate of Return
Mount Holly Water Company 07/03 Mount Holly Water CompanyWR-03070509 & OAL PUCRL 07280-2003N Fair Rate of Return
Elizabethtown Water Company 07/03 Elizabethtown Water CompanyWR-03070510 & OAL PUCRL 07281-2003N Return on Equity
New Jersey-American Water Company 04/03
New Jersey-American Water Company
WR-03070511 & OAL PUCRL 07279-2003N Fair Rate of Return
Thames RWE re: New Jersey-American Water Co. 08/02
Thames RWE re: New Jersey-American Water Co. WM-01120833 Return on Equity
Aqua New Jersey, Inc. (formerly Consumers New Jersey Water Co.) 03/02
Aqua New Jersey, Inc. (formerly Consumers New Jersey Water Co.) WR-02030133 Return on Equity
Elizabethtown Water Company 04/01 Elizabethtown Water Company WR-01040205 Overall Fair Rate of Return
Middlesex Water Company 06/00 Middlesex Water Company WR-00060362 Fair Rate of ReturnAqua New Jersey, Inc. (formerlyConsumers New Jersey Water Co.) 03/00
Aqua New Jersey, Inc. (formerly Consumers New Jersey Water Co.)
WR-00030174 & OAL PUCRS04524-00S Return on Equity
Middlesex Water Company 09/98 Middlesex Water Company 98-090795 Fair Rate of Return
Middlesex Water Company 11/96 Middlesex Water Company 96-110818 Return on Equity
New York State Public Service Commission
SUEZ New York Inc. 2/16 SUEZ New York Inc. 16-W-0130 Fair Rate of ReturnUnited Water New Rochelle, Inc. / United Water West Chester, Inc. 11/13
United Water New Rochelle, Inc. / United Water West Chester, Inc. 13-W-0539/13-W-564 Return on Equity
United Water New York, Inc. 07/13 United Water New York, Inc. 13-W-0295 Fair Rate of ReturnLong Island American Water Company d/b/a Long IslandAmerican Water for Water Service 05/11
Long Island American Water Company 11-W-0200 Return on Equity
United Water Owego-Nichols, Inc. 02/11 United Water Owego-Nichols, Inc. 11-W-0082 Fair Rate of Return
United Water Westchester, Inc. 11/09 United Water Westchester, Inc. 09-W-0828 Fair Rate of Return
United Water New Rochelle Inc. 11/09 United Water New Rochelle Inc. 09-W-0824 Fair Rate of Return
United Water New York, Inc. 09/09 United Water New York, Inc. 09-W-0731 Fair Rate of Return
United Water Owego/Nichols, Inc. 05/07 United Water Owego/Nichols, Inc. 07-W-0639 / 07-W0872 Fair Rate of ReturnUnited Water New York, Inc. / South County 01/06 United Water New York, Inc.
Cases 06-W-0131 and 06-W-0244 Fair Rate of Return
United Water New Rochelle, Inc. 09/04 United Water New Rochelle, Inc. 04-W-1221 Fair Rate of Return
ATTACHMENT ATESTIMONY LISTING OF PAULINE AHERN
SUSSEX ECONOMIC ADVISORS, LLC PAGE A-12
North Carolina Utility CommissionCarolina Water Service of North Carolina 08/15
Carolina Water Company of North Carolina W-354, Sub 344 Return on Equity
Aqua North Carolina, Inc. 12/13 Aqua North Carolina, Inc. W-218, Sub 363 Fair Rate of Return
Carolina Water Service, Inc. of NC. 10/13 Carolina Water Service, Inc. of NC. W-354 Sub 336 Fair Rate of Return
Pluris, LLC 08/12 Pluris, LLC W-1282, Sub 8 Return on Equity
Aqua North Carolina, Inc. 05/11 Aqua North Carolina, Inc. W-218, Sub 319 Fair Rate of Return
Carolina Water Service, Inc. of NC 10/10 Carolina Water Service, Inc. of NC W-354. Sub 324 Fair Rate of Return
Carolina Water Service, Inc. of NC 10/10Carolina Water Service, Inc. of NC -Ops. in Currituck Co. W-354. Sub 327 Fair Rate of Return
Transylvania Utilities, Inc. 05/06 Transylvania Utilities, Inc. W-1012, Sub 7 Fair Rate of Return
Carolina Pines Utilities, Inc. 04/04 Carolina Pines Utilities, Inc. W-1151 Return on Equity
Transylvania Utilities, Inc. 04/04 Transylvania Utilities, Inc. W-1012, Sub 5 Return on Equity
Nero Utilities, Inc. 04/04 Nero Utilities, Inc. W-1152 Return on Equity
Pennsylvania Public Utility Commission
United Water Pennsylvania Inc. 01/15 United Water Pennsylvania Inc. R-2015-2462523 Return on Equity
Penn Estates Utilities, Inc. 12/11 Penn Estates Utilities, Inc. R-2011-2255159 Return on Equity
United Water Pennsylvania, Inc. 05/11 United Water Pennsylvania, Inc. R-2011-2232985 Fair Rate of Return
United Water Pennsylvania, Inc. 09/09 United Water Pennsylvania, Inc. R-2009-2122887 Fair Rate of ReturnPenn Estates Utilities, Inc. (Water) / (Sewer) 09/09
Penn Estates Utilities, Inc. (Water) / (Sewer)
R-2009-2117532 / R-2009-2117400 Fair Rate of Return
Utilities, Inc. - Westgate 09/09 Utilities, Inc. - Westgate R-2009-2117389 Fair Rate of Return
Utilities, Inc. of Pennsylvania 09/09 Utilities, Inc. of Pennsylvania R-2009-2117402 Fair Rate of Return
Trigen-Philadelphia Energy Corp. 06/09 Trigen-Philadelphia Energy Corp. R-2009-2111011 Fair Rate of Return
The Columbia Water Company 12/08 The Columbia Water Company R-2008-2045157 Return on EquityThe Newtown Artesian Water Company 11/08
The Newtown Artesian Water Company R-2008-2042293 Fair Rate of Return
NRG Energy Center Harrisburg 03/08 NRG Energy Center Harrisburg R-2008-2028395 Fair Rate of ReturnTotal Environmental Solutions, Inc. - Treasure Lake Water Division 02/08
Total Environmental Solutions, Inc. -Treasure Lake Water Division R-00072493 Fair Rate of Return
Total Environmental Solutions, Inc. - Treasure Lake Sewer Division 02/08
Total Environmental Solutions, Inc. -Treasure Lake Sewer Division R-00072495 Fair Rate of Return
Emporium Water Company 06/06 Emporium Water Company R-00061297 Fair Rate of Return
NRG Energy Center Pittsburgh 06/06 NRG Energy Center Pittsburgh R-00061435 Fair Rate of Return
City of DuBois, PA 04/06 City of DuBois, PA R-00050671 Fair Rate of Return
United Water Pennsylvania, Inc. 01/06 United Water Pennsylvania, Inc. R-00051186 Fair Rate of Return
ATTACHMENT ATESTIMONY LISTING OF PAULINE AHERN
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Valley Energy, Inc. 10/04 Valley Energy, Inc. R-00049345 Fair Rate of Return
Borough of Hanover 08/02 Borough of Hanover R-00027522 Fair Rate of Return
Audubon Water Company 04/02 Audubon Water Company R-00027104 Fair Rate of Return
Wellsboro Electric Company 10/01 Wellsboro Electric Company R-00016356 Fair Rate of Return
Emporium Water Company 09/00 Emporium Water Company R-00005050 Fair Rate of Return
Penn Estates Utilities, Inc. 01/00 Penn Estates Utilities, Inc.R-00005031 & R-00005032 Fair Rate of Return
Pittsburgh Thermal, L.P. 11/99 Pittsburgh Thermal, L.P. R-00994641 Fair Rate of Return
PG Energy 03/98 PG Energy R-009880
Capital Structure and Embedded Fixed Capital Cost Rates
Western Utilities, Inc. 08/97 Western Utilities, Inc. R-00963856 Fair Rate of Return
PG Energy 05/96 PG Energy R-0096312
Capital Structure and Embedded Fixed Capital Cost Rates
Public Service Commission of Nevada
Utilities Inc. of Central Nevada 06/15 Utilities Inc. of Central Nevada 15-06063 Fair Rate of Return
Utilities Inc. of Central Nevada 12/09 Utilities Inc. of Central Nevada 09-12017 Fair Rate of Return
Utilities Inc., of Nevada 06/09 Utilities Inc., of Nevada 09-06037 Fair Rate of Return
Spring Creek Utilities, Inc. 06/08 Spring Creek Utilities, Inc. 08-06036 Fair Rate of Return
Utilities, Inc. of Central Nevada 12/06 Utilities, Inc. of Central Nevada 06-12023 Fair Rate of Return
Spring Creek Utilities, Inc. 04/06 Spring Creek Utilities, Inc. 06-01002 Fair Rate of Return
Public Service Commission of South Carolina
United Utility Companies, Inc. 09/13 United Utility Companies, Inc. 2013-199-WS Capital Structure
Utilities Services of South Carolina 09/13 Utilities Services of South Carolina 2013-201-WS Capital Structure
Tega Cay Water Services Inc. 12/12 Tega Cay Water Services Inc. 2012-177-WS Fair Rate of Return
Carolina Water Service, Inc. 08/11 Carolina Water Service, Inc. 2011-47-WS Fair Rate of Return
Tega Cay Water Service, Inc. 04/10 Tega Cay Water Service, Inc. 2009-473-WS Fair Rate of Return
United Utility Companies, Inc. 02/10 United Utility Companies, Inc. 2009-479-W/S Fair Rate of Return
Utilities Services of South Carolina 11/07 Utilities Services of South Carolina 2007-286-WS Fair Rate of Return
Southland Utilities, Inc. 09/07 Southland Utilities, Inc. 2007-244-W Fair Rate of Return
Tega Cay Water Service, Inc. 07/06 Tega Cay Water Service, Inc. 2006-97-WS Return on Equity
United Utility Companies, Inc. 07/06 United Utility Companies, Inc. 2006-107-W/S Fair Rate of Return
Carolina Water Service, Inc. 06/06 Carolina Water Service, Inc. 2006-92-W/S Fair Rate of Return
Utilities Services of South Carolina 11/05 Utilities Services of South Carolina 2005-217-WS Fair Rate of Return
Carolina Water Service of South 04/05 Carolina Water Service of South 2004-357-W/S Fair Rate of Return
ATTACHMENT ATESTIMONY LISTING OF PAULINE AHERN
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Carolina Carolina
United Utility Companies 01/02 United Utility Companies 2000-0210-W/S Fair Rate of Return
Carolina Water Service of South Carolina 06/01
Carolina Water Service of South Carolina 2000-0207-W/S
Fair Rate of Return
Public Utility Commission of Ohio
Aqua Ohio, Inc. 12/13 Aqua Ohio, Inc. 13-2124-WW-AIR Return on Equity
Ohio American Water Company 8/12 Ohio American Water Company 11-4161-WS-AIR Fair Rate of Return
Ohio American Water Company 6/09 Ohio American Water Company 09-391-WS-AIR Fair Rate of Return
Ohio American Water Company 10/06 Ohio American Water Company 06-433-WS-AIR Fair Rate of Return
Ohio-American Water Company 11/04 Ohio-American Water Company 03-2390-WS-AIR Return on Equity
Regulatory Commission of Alaska
Fairbanks Natural Gas, LLC 6/14 Fairbanks Natural Gas, LLC U-14-102 Fair Rate of Return
Rhode Island Public Utilities Commission
United Water Rhode Island, Inc. 8/13 United Water Rhode Island, Inc. 4434 Fair Rate of Return
United Water Rhode Island, Inc. 6/11 United Water Rhode Island, Inc. 4255 Fair Rate of Return
Virginia State Corporation Commission
Aqua Virginia, Inc. 8/14 Aqua Virginia, Inc. PUE-2014-00045 Return on Equity
Massanutten Public Service Corporation
9/09 Massanutten Public Service Corporation PUE-2009-00041
Return on Equity
Land'Or Utility Company 12/06 Land'Or Utility Company PUE-2006-00128 Return on Equity
Massanutten Public Service Corporation
12/06 Massanutten Public Service Corporation PUE-2006-00126
Return on Equity
Reston Lake Anne Air Conditioning Corp.
5/12 Reston Lake Anne Air Conditioning Corp. PUE-2011-00130
Return on Equity
Aqua Virginia, Inc. 10/11 Aqua Virginia, Inc. (Monticello) PUE-2005-00080 Return on Equity
Aqua Virginia, Inc.10/11 Aqua Virginia, Inc. - Sydnor
Hydrodynamics, Inc. PUE-2011-00099Return on Equity
United Water Virginia, Inc. 10/97 United Water Virginia, Inc. PUE-2097-0544 Fair Rate of Return
Washington Utilities & Transportation Commission
Washington Natural Gas Company 03/95 Washington Natural Gas Company UG-950278Capital Structure Ratios -Fixed Capital Cost Rates