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NEW TWISTS ON NEW TWISTS ON THE DCF THE DCF or THE “C” IN DCF or THE “C” IN DCF Society of Utility and Regulatory Financial Analysts Georgetown University P. Moul & Associates Conference Center 856-428-7515 April 28, 2006 [email protected]

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Page 1: NEW TWISTS ON THE DCF or THE C IN DCF Society of Utility and Regulatory Financial Analysts Georgetown University P. Moul & Associates Conference Center

NEW TWISTS ONNEW TWISTS ONTHE DCF THE DCF

or THE “C” IN DCFor THE “C” IN DCF

Society of Utility and Regulatory Financial Analysts

Georgetown University P. Moul & AssociatesConference Center 856-428-7515April 28, 2006 [email protected]

Page 2: NEW TWISTS ON THE DCF or THE C IN DCF Society of Utility and Regulatory Financial Analysts Georgetown University P. Moul & Associates Conference Center

Discounted Cash FlowDiscounted Cash Flow• AttributesAttributes• DeficienciesDeficiencies

NEW TWISTS ON THE DCF or THE “C” NEW TWISTS ON THE DCF or THE “C” IN DCFIN DCF

Page 3: NEW TWISTS ON THE DCF or THE C IN DCF Society of Utility and Regulatory Financial Analysts Georgetown University P. Moul & Associates Conference Center

NEW TWISTS ON THE DCF or THE “C” NEW TWISTS ON THE DCF or THE “C” IN DCFIN DCF

Role in Public Utility Role in Public Utility RatesettingRatesetting• ““Must have” evidenceMust have” evidence• Dominates rate of return Dominates rate of return evidenceevidence

• Susceptible to manipulationSusceptible to manipulation

Page 4: NEW TWISTS ON THE DCF or THE C IN DCF Society of Utility and Regulatory Financial Analysts Georgetown University P. Moul & Associates Conference Center

NEW TWISTS ON THE DCF or THE “C” NEW TWISTS ON THE DCF or THE “C” IN DCFIN DCF

““C” is for CASHC” is for CASH• It is what utilities require to It is what utilities require to sustain the business and sustain the business and provide investorsprovide investors

Page 5: NEW TWISTS ON THE DCF or THE C IN DCF Society of Utility and Regulatory Financial Analysts Georgetown University P. Moul & Associates Conference Center

59%

8%5%

17%

5%

6%

Reinvestment inBusiness

Payments to Owners

Labor & Materials

Tax Payments

Payments to Lenders

Cost of Fuel and EnergyPurchases

NEW TWISTS ON THE DCF or THE “C” NEW TWISTS ON THE DCF or THE “C” IN DCFIN DCF

Distribution of Cash ReceiptsDistribution of Cash Receipts

Page 6: NEW TWISTS ON THE DCF or THE C IN DCF Society of Utility and Regulatory Financial Analysts Georgetown University P. Moul & Associates Conference Center

NEW TWISTS ON THE DCF or THE “C” NEW TWISTS ON THE DCF or THE “C” IN DCFIN DCF

Why does ROR and specifically Why does ROR and specifically DCF get so much attention?DCF get so much attention?• Largest “swing” item in rate Largest “swing” item in rate

case COScase COS• Results must conform with Results must conform with “common sense” outcome“common sense” outcome

Page 7: NEW TWISTS ON THE DCF or THE C IN DCF Society of Utility and Regulatory Financial Analysts Georgetown University P. Moul & Associates Conference Center

NEW TWISTS ON THE DCF or THE “C” NEW TWISTS ON THE DCF or THE “C” IN DCFIN DCF

““C” is also for Common C” is also for Common SenseSense• What other methods sayWhat other methods say• Reaction of investment Reaction of investment communitycommunity

Page 8: NEW TWISTS ON THE DCF or THE C IN DCF Society of Utility and Regulatory Financial Analysts Georgetown University P. Moul & Associates Conference Center

NEW TWISTS ON THE DCF or THE “C” NEW TWISTS ON THE DCF or THE “C” IN DCFIN DCF

SoCal EdisonSoCal Edison (2000)(2000)

• Company Proposed 11.6%Company Proposed 11.6%• Staff 8.71%Staff 8.71%• ALJ 9.68%ALJ 9.68%• Further Proceedings Further Proceedings

9.47%9.47%• Commission determined Commission determined

11.73%11.73%• Commission Granted Commission Granted

11.6%11.6%

Kern RiverKern River (2006)(2006)

• Company Proposed Company Proposed 15.1%15.1%

• Staff & IntervenorsStaff & Intervenors

9.0% to 9.4%9.0% to 9.4%• ALJ 9.34%ALJ 9.34%• Commission Commission (?)(?)• HIOSHIOS (2005) 11.22% (2005) 11.22%

Page 9: NEW TWISTS ON THE DCF or THE C IN DCF Society of Utility and Regulatory Financial Analysts Georgetown University P. Moul & Associates Conference Center

Histogram of Market-to-Book Ratiosfor Electric Utilities

14

25

15

5

0

5

10

15

20

25

Market to Book Ratio

Years

NEW TWISTS ON THE DCF or THE “C” NEW TWISTS ON THE DCF or THE “C” IN DCFIN DCF

Page 10: NEW TWISTS ON THE DCF or THE C IN DCF Society of Utility and Regulatory Financial Analysts Georgetown University P. Moul & Associates Conference Center

NEW TWISTS ON THE DCF or THE “C” IN NEW TWISTS ON THE DCF or THE “C” IN DCFDCF

ku = ke - (((ku - i ) 1-t) D / E ) - (ku - d ) P/E

where: ku= cost of equity for an all-equity firm ke = market determined cost equity i = cost of debt d = dividend rate on preferred stock D = debt ratio P = preferred stock ratio E = common equity ratio

Modigliani and Miller

Page 11: NEW TWISTS ON THE DCF or THE C IN DCF Society of Utility and Regulatory Financial Analysts Georgetown University P. Moul & Associates Conference Center

NEW TWISTS ON THE DCF or THE “C” NEW TWISTS ON THE DCF or THE “C” IN DCFIN DCF

So could we have rate cases So could we have rate cases without DCF?without DCF?• Sure, no DCF inSure, no DCF in BluefieldBluefield or or

HopeHope• Customers are probably unaware Customers are probably unaware

of the arcane processes of utility of the arcane processes of utility ratesettingratesetting

• Investors are aware, and do actInvestors are aware, and do act• The “C” word is cash, and also The “C” word is cash, and also

Common SenseCommon Sense