new twists on the dcf or the c in dcf society of utility and regulatory financial analysts...
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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]
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
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
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
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
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
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
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%
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
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
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