20081024Kahal Direct.pdf

Department of Energy
Washington, DC 20585 RECE\\fE,
laDS eei 24 AM '0: 03
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UTlUT\ES CO
October 23,2008
VIA OVERNIGHT SERVICE
Ms. Jean Jewell
Commission Secretary
Idaho Public Utilities Commission
P.O. Box 83720
Boise, il 83720-0074
RE: Case No. IPC-E-08-10
Dear Ms. Jewell:
Enclosed please find:
(1) an original and 10 copies of the Direct Testimony and Exhibits of Mattew i. Kahal
on behalf of the United States Departent of Energy in the above-captioned proceeding;
(2) an additional copy of each of these items, that I request be date-stamped and retued
in the enclosed postage paid envelope;
(3) a disk upon which each of these items is set out in computer searchable form.
If you have any questions concerning this fiing, please contact me at [phone].
Arhur Perr B er
Attorney for the United States
Departent of Energy
Offce of the General Counsel
United States Deparent of Energy
1000 Independence Avenue SW
Washington, D.C. 20585
Arhur.Bruder~hq.doe.gov
[phone]
* Printed wrth soy ink on recycled paper
CERTIFICATE OF SERVICE - IDAHO PUC CASE NO. IPC-E-08-10
I hereby certify that I have, this 23 th day of October, 2008, served or caused to be served
a tre and correct copy of the attached Testimony and Exhibits of Matthew I Kahal on
Behalf of the United States Departent of Energy upon each of the parties listed below,
by: (1) placing the same in the United States Mail, addressed to the street address set out
below, and (2) transmitting the same electronically to the email address set out below.
Barton L. Kline
Lisa D. Nordstrom
Idaho Power Company
1221 W. Idaho St. (83702)
P.O. Box 70
Boise, ID 83707-0070
bkline~idahopower.com
Inordstrom~idahopower.com
John R. Gale
Vice President, Regulatory Affairs
Idaho Power Company
1221 W. Idaho St. (83702)
P.O. Box 70
Boise, ID 83707-0070
rgale~idahopower.com;
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Weldon Stutzman
Neil Price
Deputy Attorneys General
Idaho Public Service Commission
472 W. Washington (83702)
PO Box 83720
Boise, ID 83720-0074
weldon.Stutzman~puc.idaho.gov
neiL. price~puc.idaho.gov
Peter J. Richardson
Richardson & O'Leary
515 N. 27th St.
P.O. Box 7218
Boise, ID 83702
peter~richardsonandoleary
Dr. Don Reading
Ben Johnson Associates
6070 Hil Road
Boise, ID 83703
dreading~mindspring.com
Randall C. Budge
Eric L. Olsen
Racine, Olson, Nye, Budge &
Bailey, Chartered
P.O. Box 1390;
201 E. Center
Pocatello, il 83204-1391
rcb~racine1aw .net
elo~racinelaw .net
Anthony Yanel
29814 Lake Road
Bay Vilage, OH 44140
yankel~attbi.com
Michael Kurz, Esq.
Kur J. Boehm, Esq.
Boehm, Kurz & Lowry
36 E. Seventh Street, Suite 1510
Cincinnati, OH 45202
mkz~BKLlawfirm.com
kboehm~ BKLlawfirm.com
Conley E. Ward
Michael Creamer
Givens Pursley LLP
601 W. Banock Street
PO Box 2720
Boise, ID 83701-2720
cew~givenspursley.co
Dennis E. Peseau, Ph.D.
Utility Resources, Inc.
1500 Libert Street, Suite 250
Salem, OR 97302
dpcseau~cxcitc.com
Brad M. Purdy
Attorney at Law
2019 N.17thSt.
Boise, Idaho 83702
bmpurdy~hotmail.com
-2-
Ken Miler
Snake River Alliance
Box 1731
Boise, ID 83701
kmiler~snakeriverallance.org
Kevin Higgins
Energy Strategies LLC
Parkside Towers
215 South State Street
Suite 200
Salt Lake City, UT 84111
khiggins~energystrat.com
~ll1~_
Arhur Perr BruJer, Esq.
Offce of the General Counsel
United States Departent of Energy
Washington, DC 20585
[phone]
-3-
BEFORE THE
RECEIVED
,BOO OCT 24 A"ID: 03
IDAHO PUBLIC
UTILITIES COMMISSION
STATE OF IDAHO
PUBLIC UTILITIES COMMISSION
IN THE MATTER OF THE APPLICATION
OF IDAHO POWER COMPANY FOR
AUTHORITY TO INCREASE ITS RATES'
AN CHAGES FOR ELECTRIC
SERVICE
. )
)
) ,CASE NO.IPC-E-08-10
)
)
DIRCT TESTIMONY OF
MATTHEW i. KA
ON BEHALF OF THE
U.S. DEPARTMENT OF ENERGY
OCTOBER 24, 2008
EXETER
ASSOCIATES, INC.
5565 Sterrett Place
Suite 310
Columbia, Maryland 20904
TABLE OF CONTENTS
PAGE
i. QUALIFICATIONS .............................................................................................................. 1
II. OVERVIEW ......................................................................................................................,...3
A. Summar of Recommendations ...................................... ........ ...................................... 3
B. Capital Cost Trends.......................................................................................................8
C. Cost of Equity Summary ............................................................................................. 11
D. Testimony Organzation.............................................................................................. 13
III. COST OF COMMON EQUITY .......................................................................................... 14
A. Using the DCF Model........ .............................................................................. ........... 14
B. DCF Study Using the West Region Group of Electrc Utility Companies................. 18
C. DCF Study Using the Restrcted Proxy Group ........................................................... 24
D. Dr. Avera's DCF Estimates ........................................................................................ 26
IV. REVIEW OF DR. AVERA'S DCF, CAPM AND COMPARLE EARNINGS............. 30
A. DCF Analysis..............................................................................................................30
B. CAPM Results .................................. ......................... ................................ ................. 31
C. Comparable Earings..................................................................................................37
V. CONCLUSIONS ON FAIR RATE OF RETURN ........................................................,..... 40
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I. QUALIFICATIONS
PLEASE STATE YOUR NAME AND BUSINESS ADDRESS.
My name is Mattew i. Kahal. I am employed as an independent consultant
retained in this matter by the firm of Exeter Associates, Inc. My business address
is 5565 Sterrett Place, Suite 310, Columbia, Marland 21044.
PLEASE STATE YOUR EDUCATIONAL BACKGROUND.
I hold B.A. and M.A. degrees in economics from the University of Maryland and
have completed all course work and qualifying examination requirements for the
Ph.D. degree in economics. My areas of academic concentration included
industrial organzation, economic development and econometrcs.
WHT IS YOUR PROFESSIONAL BACKGROUND?
I have been employed in the area of energy, utilty and telecommunications
consulting for the past 30 years workig on a wide range of topics. Most of my
work has focused on electric utility integrated planing, plant licensing,
envionmental issues, mergers and financial issues. I was a co-founder of Exeter
Associates, and from 1981 to 2001 I was employed at Exeter Associates as a
Senior Economist and Principal. Durng that time, I took the lead role at Exeter in
performng cost of capital and financial studies. In recent years, the focus of much
of my professional work has shifted to electric utility restrcturng and
competition.
Prior to entering consulting, I served on the Economics Deparent
faculties at the University of Maryland (College Park) and Montgomery College
teaching courses on economic principles, development economics and business.
HA VE YOU PREVIOUSL Y TESTIFIED AS AN EXPERT WITNESS
BEFORE UTILITY REGULATORY COMMISSIONS?
Matthew i. Kahal, Di 1
Deparent of Energy
1 A.Yes. I have testified before approximately two-dozen state and federal utility
2 commissions in more than 300 separate reguatory cases. My testimony has
3 addressed a variety of subjects including fair rate of retur, resource planing,
4 financial assessments, load forecasting, competitive restructung, rate design,
5 purchase power contracts, merger economics and other reguatory policy issues.
6 These cases have involved electrc, gas, water and telephone utilities. In 1989,
7 I testified before the U.S. House of Representatives, Committee on Ways and
8 Means, on proposed federal tax legislation affecting utilities.
9 Q.
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WHT PROFESSIONAL ACTIVITIES HAVE YOU ENGAGED IN
SINCE LEAVING EXETER AS A PRICIPAL IN 2001?
11 A.Since 2001, I have worked on a varety of consulting assignents pertaining to
12 electric restrctuing, purchase power contracts, environmenta controls, cost of
13 capital and other reguatory issues. Curent and recent clients include the U. S.
14 Deparent of Justice, U. S. Air Force, U. S. Deparent of Energy, the Federal
15 Energy Regulatory Commission, Connecticut Attorney General, Pennsylvana
16 Offce of Consumer Advocate, New Jersey Division of Counsel, Rhode Island
17 Division of Public Utilties, Louisiana Public Service Commission, Arkansas
18 Public Service Coinission, Marland Deparment of Natual Resources and
19 Energy Administration, and Maine Office of the Public Advocate.
20 Q.
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22 A.
HAVE YOU PREVIOUSLY TESTIFIED IN MATTERS BEFORE THIS
COMMISSION?
Yes. I have testified on cost of capital before the Idaho Public Utilties
23 Commssion on previous occasions, including Idaho Power Company's ("IPC"
24 or "the Company") base rate case in 1994 (IPC-E-94-5) and in last year's case
25 (IPC-E-07-8).
Mattew i. Kahal, Di 2
Deparment of Energy
II. OVERVIEW
1 A.Summary of Recommendations
2 Q.
3
WHAT IS THE PURPOSE OF YOUR TESTIMONY IN THIS
PROCEEDING?
4 A.J have been asked by the U.S. Deparment of Energy ("DOE") to develop a
5 recommendation concerning the fair rate of retu on the jurisdictional electric
6 utility rate base of Idaho Power Company ("IPC" or "the Company"). IPC is the
7 electric utility subsidiary ofIdaCorp, Inc., and it accounts for the vast majority of
8 IdaCorp's invested capital and operations. My work in this case includes both a
9 review of the Company's proposal concerning rate of retu and the preparation
10 of an independent study of the cost of common equity.
11 Q.
12
13 A.
WHT IS THE COMPANY'S RATE OF RETURN PROPOSAL IN
THIS CASE?
As presented on Exhibit 27 sponsored by Mr. Steven Keen, the Company
14 proposes an overall rate of retur of8.55 percent, based on the projected
15 capitalization and debt costs at December 31, 2008. The capital structue
16 proposed in this case includes 50.7 percent common equity and 49.3 percent long-
17 term debt, with no preferred stock or short-term debt included in the capital
18 strctue. In developing the requested overall rate of retur Mr. Keen selects a
19 retu on common equity of 11.25 percent. IPC' s outside cost of capital witness,
20 Dr. Wiliam Avera, recommends a retur on common equity range of 10.8 to
21 11.8 percent.
22 .Q.
23 A.
WHT IS MR. KEEN'S APPROACH TO CAPITAL STRUCTURE?
IPC is a wholly-owned subsidiar of IdaCorp, Inc., a utility holding company, and
24 is pricipally engaged in electrc utilty retail . operations in Idaho, with a small
Mattew I. Kahal, Di 3
Deparent of Energy
1 amount of retail utility operations in Oregon. Mr. Keen bases the ratemakng
2 capital strctue on the projected Idaho Power Company capital strcture at
3 December 31, 2008. As of this date, IPC expects to have no preferred stock
4 outstanding, and Mr. Keen includes the effects of expected long-term debt
5 issuances.
6 Mr. Keen also provides an estimate of the actual embedded cost of debt,
7 inclusive of the prospective cost rates for the Company's variable rate debt and its
8 projected new debt issuances. This produces an embedded cost of debt of
9 5.927 percent.
10 Q.
11
12
HOW DOES MR. KEEN'S RATE OF RETURN REQUEST COMPARE
WITH THE REQUEST IN LAST YEAR'S RATE CASE (CASE NO.
IPC-E-07-08)?
13 A.In last year's case, Mr. Keen also proposed a projected "50/50" capital structure
14 and a projected year-end cost of debt~ However, in this case he has lowered the
15 requested retu on common equity from 11.5 percent to 11.25 percent. In
16 addition, the cost of debt in this case has risen from 5.59 percent to 5.93 perc.ent.
17 The lower retu on equity request follows the reduction in the range
18 recommended by Dr. Avera, as compared to his testimony last year.
19 Q.
20
WHT IS YOUR RECOMMENDATION AT THIS TIME ON RATE OF
RETURN?
21 A.As presented on my Exhbit No. 601, at this time I am recommending a retur on
22 the IPC jursdictional rate base of 8.18 percent, which includes a 10.5 percent
23 retu on common equity. The 10.5 percent figure is at the high end of my range
24 of evidence. Depending on the Commission's treatment of certain ratemaking
Mattew i. Kahal, Di 4
Deparent of Energy
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policy issues (such as the Power Clause Adjustment) raised by the Company as
major risk factors, the Commssion should consider a range of 10.25 to 10.5.
The 10.5 percent upper end figue is based primarly upon discounted cash
flow (DCF) evidence using a proxy group of electric utility companes operating
in the West Region of the U.S. I also present DCF evidence using a subset of Dr.
Avera's proxy companes, i.e., those non-West Region companes in his group
that operate as integrated, fully-regulated utilities. In addition, I have reviewed
and considered Dr. Avera's evidence using the Capital Asset Pricing Model
(CAPM), although I find the CAPM to be much less usefu than the DCF studies.
Finally, I compare my DCF results to "comparable earngs" evidence, although
ths is not a market cost of equity estimation method. The results of a comparable
earings analysis, while not the basis of my position in this case, do not support a
result exceeding 10.5 percent. The 10.5 percent is somewhat higher than my DCF
midpoint results, providing IPC with a premium over the "baseline" proxy group
cost of equity estimate. As mentioned above and discussed in Section V of my
testimony, the 10.5 percent is an upper end recommendation before consideration
of certain proposed regulatory policy changes.
In formulating my overall rate of retu recommendation, I have accepted
the Company's proposed December 31, 2008 capital structue and embedded cost
of debt, subject to possible updating. This capital strctue is nearly identical to
that used in last year's case and provides IPC with a slightly thicker equity ratio
than approved by the Commssion in the 2004 rate case. These percentages
appear to be consistent with IPC's financial objectives.
WHT RATE OF RETURN DID THE COMMISSION APPROVE IN
THE LAST FULLY-LITIGATED RATE CASE?
Mattew i. Kahal, Di 5
Deparent of Energy
1 A.In lPC's last fully-litigated case, decided in 2004 (Case No. IPC-E-03-13, May
2 25,2004), the Commission set the Company's rate of retur on equity (ROE) at
3 10.25 percent, in conjunction with a common equity ratio of 46 percent. In that
4 rate order, the Commission concluded that the authorized 10.25 percent retur on
5 equity appropriately reflected the Company's business risks. The Commìssion's
6 retur on equity quantification in that Order relied priarily on DCF and
7 comparable earnings evidence. (Order, page 38) Since that case, the Company's
8 rate case filings have been resolved by settlement agreement without an explicit
9 cost of equity ruling,
10 Q.
11
WHAT RETURN ON EQUITY DID YOU RECOMMEND IN THE
YEAR' S RATE CASE FOR IPC?
12 A.In last year's case, I recommended 10.25 percent, consistent with the
13 Commission's ruling in the 2004 rate case. Ths recommendation was fully
14 supported by the cost of capital evidence at that time. Although the cost of capital
15 data in this case have not changed substantially, I believe that the diffculties in
16 financial markets (along with IPC's fiancial position) may warant a moderately
17 higher retu than I recommend in last year's case. At the same time, the
18 Commission should consider possible regulatory changes that mitigate the
19 Company's risk.
20 Q.
21 A.
WHAT is THE ASSESSMENT OF IPC BY THE RATING AGENCIES?
As sumarized in Mr. Keen's testimony, all thee major credit rating agencies
22 rate IPC medium to high trple B, low single A, with the low single A applicable
23 only to the Company's secured debt. The recent reports from the thee major
24 credit rating agencies (Standard & Poors, Moody's and FitchRatings) were
25 provided as par of Mr. Keen's and Dr. Avera's workpapers, and all thee
Mattew i. Kahal, Di 6
Deparent of Energy
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organzations provide generally similar business risk assessments. For example,
FitchRatings notes as "Key Credit Strengts" the PCA recovery mechanism,
IPC's favorable rates and strong growt prospects. (July 9,2007) Standard &
Poors identifies the Company's strengts as being "a strong power cost
adjustment (PCA) mechansm," supportive regulation, low-cost generation and
the absence of unegulated business. (February 1,2008) Moody's refers to IPC's
"generally low business risk profie", reasonably supportive regulatory treatment
and the Company's low costs of supply as positive for ratings. (June 4, 2008)
Simlarly, each of the three credit rating agencies mentions the same
negative factors. The principal rating concerns include IPC's large construction
program (including the risks of rate disallowances), the risk of adverse hydrologic
conditions and weak near-term financial metrcs. S&P lowered its IdaCorp and
IPC credit ratings by one notch in Januar 2008 (though it changed its outlook
from "negative" to "stable") due primarly to the perceived weakening credit of
metrics.
WHT DO YOU CONCLUDE?
Based on my review of the information submitted in this case, including the
recent credit rating reports, I conclude that IPC is an approximately average risk
electric utility. Thus, the West Region group of vertically-integrated electric
companes provide a generally reasonable risk proxy for IPC.
Mattew i. Kahal, Di 7
Deparent of Energy
1 B.Capital Cost Trends
2 Q.
3
HAVE YOU REVIEWED THE TRENDS IN MAT CAPITAL
COSTS OVER THE PAST DECADE?
4 A.Yes. My Exhibit No. 602 shows capital cost indicators on an anual basis since
5 1992 and on a monthy basis durg Janua 2002 to September 2008. The
6 indicators include infation (as measurd by the anual change in the Consumer
7 Price Index), short-term Treasury yields, ten-year Treasury yields and single A-
8 rated long-term utility bond yields (per Moody's).
9 This schedule shows that despite year-to-year fluctuations there has been a
10 downward trend in capital costs over this time period, at least for long-term
11 securities. Short-term interest rates tend to be governed by Federal Reserve
12 Board (Fed)policy, and up until about a year ago the Fed had been "tightening"
13 (i.e., raising short-term rates) in response to a strengthening U.S. economy. In
14 response to a slowing U.S. economy and distress in the housing market the Fed
15 has reversed this trend and has reduced short-term interestrates. As measured by
16 utility bond yields, it appears that capital costs "bottomed out" in mid-2005, with
17 single A utility bond yields reaching a low point in the mid 5- percent range.
18 Long-term interest rates remained relatively low though most of 2006 (i.e., long-
19 term utilty bond yields at approximately 6 percent), and this has continued since
20 then. Long-term rates can move from month-to-month but the underlying trend
21 has been relatively stable. Single A utilty bond yields generally have remained in
22 the 6.0 to 6.5 percent range, with Ten-Year Treasur yields moving downward in
23 2008 to the 3.7 to 4.0 percent range. The precipitous decline this year in Treasury
24 securty yields reflects weakess in the U.S. economy and the "flght to quaity"
25 effect which takes hold durng periods of economic distress.
Mattew I. Kahal, Di 8
Deparent of Energy
1 In recent months, financial markets distress and equity market volatility
2 has increased drastically, with credit markets beginnng in late September
3 freezing up. This is a serious economic crisis that has required historical remedial
4 action by U.S. and foreign governents. As of this wrting, it is difficult to
5 predict when normal conditions, reflecting underlying business fudamentals, will
6 retu to financial markets.
7 Q.
8
ACCORDING TO EXHIBIT NO. 602, THERE WAS AN UPWARD
MOVEMENT IN INFLATION.IN THE PAST YEAR. WHAT
9 ACCOUNTS FOR THIS CHAGE?
10 A.The upward movement in inflation has been in response to price spikes for energy
11 and, to some degree, increased food prices. However, the underlying "core"
12 inflation (excluding the volatile fuel and food sectors) remains relatively stable.
13 For example, the long-term "consensus" forecast of the GDP Deflator (Blue Chip
14 Economic Indicators, October 10,2008) is 2.1 to 2.2 percent annually. The
15 favorable "core" inflation outlook is based on strong productivity growt in the
16 U.S. economy, the expansion of global competition which tends to hold down
17 increases in U.S. product prices and Fed monetary policy that over time
18 emphasizes infation control.
19 Q.
20
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22 A.
YOUR EXHIBIT NO. 602 PROVIDES DATA ON LONG-TERM
INTEREST RATES. IS THIS INDICATIVE OF COMMON EQUITY
COST RATES?
At least in a general sense, I believe it is. The forces over time that lead to lower
23 yields on long-term debt also favorably afect the cost of equity, although I would
24 acknowledge that equity and debt cost rates do not necessarly move together in
Mattew i. Kahal, Di 9
Deparent of Energy
1 lock step. The favorable trends over time in long-term debt cost rates are also
2 likely to affect IPC's equitr cost rate for providing electrc service.
3 There is another force at work that fuer contributes to a reduced cost
4 rate for equity -- federal tax policy. In mid-2003, Congress enacted legislation
5 granting favorable income tax treatment for dividend payments and capital gains.
6 (Legislation extending this favorable tax treatment was enacted by Congress last
7 year.) Lower taxes on returns to equity investments mean that investors are
8 willing (or should be wiling) to accept lower returns for holding common stocks
9 (such as those of electric and other utilties), paricularly as compared with bonds,
10 which do not enjoy this benefit. The DCF method, "Yhich uses relatively curent
11 market data, can fully capture this effect. Other methods, such as historical risk
12 premium method (as used by Dr. Avera), may not be able to do so.
13 Q.
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AT THIS TIME, THE U. S. AND GLOBAL FINANCIAL MATS
HAVE BEEN SEVEREL Y DISTRSSED, DESCRIBED BY MANY
OBSERVERS AS A "CRISIS." HAVE YOU DIRECTLY
INCORPORATED THIS CRISIS INTO YOUR RECOMMENDAITON?
17 A.No, I have not. My cost of equity evidence is based on market data from the six
18 months ending September 2008, largely a period of financial weakess and stress
19 but not financial crisis. The purose of this proceeding is to set permanent rates
20 for IPC, and it would not be proper to set fair rate of retur based on financial
21 crisis conditions, which likely will be temporary. Moreover, the standard models
22 (such as DCF and CAPM) normally employed for estimating the utilty cost of
23 capital canot meaningfully be applied to crisis conditions.
Mattew i. Kahal, Di 10
Deparent of Energy
1 C.Cost of Equity Summary
2 Q.
3
HOW DID DR. AVERA OBTAIN HIS RECOMMENDED COST OF
EQUITY RANGE?
4 A.Dr. Avera emphasized two cost of capita methodologies, the DCF and the
5 CAPM, and he also employed comparable earngs evidence, a method which
6 does not directly measure the cost of equity. He reports the following results:
7
Dr. Avera's ROE Summary
1. DCF
2. CAPM
3. Comparable Earings
4. Flotation Cost Adder
11.0 - 12.6%
10.2 - 11.9%
11.1%
0.0%
Source: Avera, page 73
8
9 Dr. A vera concludes that ths evidence supports a "bare bones" cost of
10 equity range of 10.8 to 11.8 percent based on these methods. While he does not
11 propose a specific allowance for flotation expense, he suggests this potential cost
12 should be considered in selecting an allowed retun on equity within ths range.
13 Q.WHAT ARE YOUR COST OF EQUITY RESULTS?
14 As mentioned earlier, my recommendation (before considering the need
15 for an IPC risk premium) is based priarly on the DCF evidence. I have applied
16 the DCF model to a broad proxy group of West Region electric utilty companies.
17 This group is very similar to the proxy group used by Dr. Avera in the 2004 rate
18 case and in a 2006 IPC rate case before the Federal Energy Regulatory
19 Commission ("FERC"), as indicated in response to DOE 1-19. My full group
20 DCF analysis produces a range of9.9 to 10.4 percent with a midpoint of 10.2
Mattew i. Kahal, Di 11
Deparent of Energy
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percent. Using a subset of that group (i.e., excluding California electrics and two
other companes), the range becomes 9.6 to 10.6 percent, with a midpoint of about
10.1 percent. Dr. Avera's own DCF evidence, based on a subset of his industry
group, i.e., just those integrated electrc utilties operating in "non-restructued"
states, supports a DCF estimate in the range of about 9 to 11 percent, with a 10.5
percent midpoint. These three DCF studies are summarzed on my Exhibit No.
604, pages 1 and 2, and on Exhibit No. 605.
I also present evidence on comparable earnings as additional background
information for the Commission. The recent historical and projected eared
retus for the proxy electric companes are generally in the 9 to 10 percent range,
on average, or somewhat higher.
Considering this cost of capital evidence, I believe a reasonable range for
the "baseline" cost of equity would be about 10.0 to 10.5 percent, with tlie best
evidence supporting retus toward the midpoint or lower end of this range.
Hence, my recommendation of 10.5 percent (before consideration of possible
risk-mitigating regulatory changes) is consistent with this baseline evidence plus a
small retur premium to recognze the stressed financial environment and
concerns of credit rating agencies.
HAVE YOU INCLUDED AN ADJUSTMENT FOR COMMON STOCK
ISSUANCE COSTS?
No, I have not done so since there is no indication in discovery responses of any
curent or near-term plans by IdaCorp to conduct a public issuance of common
stock. The last such public issuance occured in 2004. Notably, Dr. Avera also
presents no evidence for a flotation adjustment adder, nor does he calculate such
Mattew i. Kahal, Di 12
Deparent of Energy
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an adder. Consequently, there is no basis for suggesting such costs somehow are
being "left out" of the cost of capital determination.
Testimony Organization
HOW is TH REMAINDER OF YOUR TESTIMONY ORGANIZED?
Section III presents my DCF evidence based on the application of that model to
the West Region electrc utilities. Section IV is my reply to Dr. Avera's cost of
equity evidence. In presenting that reply I discuss his DCF evidence, Capital
Asset Pricing Model (CAPM) studies and his comparable earings data. In
Section IV, I present alternative comparable earings information. Finally,
Section V presents a summar of my conclusions and recommendations.
Mattew I. Kahal, Di 13
Deparent of Energy
III. COST OF COMMON EQUITY
1 A.Using the DCF Model
2 Q.
3
WHT STANDARD ARE YOU USING TO DEVELOP YOUR
RETURN ON EQUITY RECOMMENDATION?
4 A.As a general matter, the ratemakng process is designed to provide the utilty an
5 opportunity to recover its prudently-incured costs of providing utilty service to
6 its customers, including the reasonable costs of financing its used and useful
7 investment. Consistent with this "cost-based" approach, the fair and appropriate
8 retu on equity award for a utility is its cost of equity. The utility's cost of equity
9 is the retu required by investors (i.e., the "market retu") to acquire or hold that
10 Company's common stock. A retu award greater than the market retur would
11 be excessive and would overcharge customers for utilty service. Similarly, an
12 insufficient retur could unduly weaken the utility and impair incentives to invest.
13 Although the concept of the cost of equity may be precisely statea, its
14 quantification poses challenges to regulators. The market cost of equity, unlike
15 certain other utility costs, canot be directly observed (i.e., investors do not
16 directly, unambiguously state their retu requirements), and it therefore must be
17 estimated using analytic technques. The DCF model is one such technique
18 familiar to analysts and ths Commission and was relied upon in IPC's last fuly-
19 litigated rate case, in 2004.
20 Q.
21
22 A.
IS THE COST OF EQUITY A FAIR RETURN A WAR FOR THE
UTILITY AND CUSTOMERS?
Generally speakng, I believe it is. A retu award commensurate with the cost of
23 equity generally provides fair and reasonable compensation to utilty investors
24 and normally should allow effcient utility management to successfuly finance its
Mattew i. Kahal, Di 14
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operations on reasonable terms. Certainly, ths has been the case for IPC based on
the 10.25 percent equity retur granted by the Commission in its rate case in
2004. Setting the retur on equity equal to a reasonable estimate of the cost of
equity also is fair to ratepayers.
I recognize that there can be exceptions to this general rule. For example,
in some instances, utilities have sought rate of retu adders as a reward for
asserted good management performance. In this case, the Company is seeking a
return on equity that approximates the midpoint of Dr. Avera's 10.8 to 11.8
percent cost of equity range. Mr. Keen further justifies the 11.25 percent request
(an increase of 100 basis points compared to the 10.25 percent previously
awarded) on a range of business risks that IPC curently faces.
WHT DETERMINES A COMPANY'S COST OF EQUITY?
It should be understood that the cost of equity is essentially a market price, and as
such, it is ultimately determined by the forces of supply and demand operating in
financial markets. In that regard, there are two key factors that determine this
price. First, a company's cost of equity is determined by the fudamental
conditions in capital markets (e.g., outlook for infation, monetar policy, changes
in investor behavior, investor asset preferences, etc.). The second factor (or set of
factors) is the business and financial risks encountered by the utilty in question.
For example, the fact that a utilty company effectively operates as a regulated
monopoly, dedicated to providing an essential service (in this case electric utilty
service), typically would imply low business risk and therefore a relatively low
cost of equity, as compared to most unegulated companies operating in
competitive markets.
Matthew i. Kahal, Di 15
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DOES DR. AVERA INCORPORATE THESE PRICIPLES?
In general, he attempts to incorporate these priciples in conducting his DCF and
CAPM analyses. However, I disagree with his recommendation of a retur on
equity range substatially higher than that granted by the Commission in 2004.
Moreover, I question whether his "risk premium" analyses (i.e., his CAPM
studies) reliably measure the cost of equity, and I also question his use of
unregulated companies as being appropriate "risk proxies" for the fully-regulated
LPC. The use of unregulated companies as a proxy group for a utility is a non-
standard approach.
WHAT METHODS AR YOU USING IN THIS CASE?
I employ the DCF method applied to proxy groups of electric utility companies to
obtain a "baseline" cost of equity, and I also ~onsider comparable earings
evidence. However, for reasons discussed in my testimony, I emphasize the DCF
model results in formulating my recommendation. It has been my experience that
most utility reguatory commissions (federal and state) heavily emphasize the use
of the DCF model to determine the cost of equity when setting the fair retur.
While I do not rely on the CAPM to develop my recommendation, the next
section of my testiony provides a discussion of this method and Dr. Avera's
application of it. The comparable earings method can provide perspective, but it
is not a cost of equity method.
PLEASE DESCRIBE THE DCF MODEL.
As mentioned, ths model has been widely used in the regulatory community,
including by this Commission. Its widespread acceptace is due to the fact that
the model is market-based and is derived from standard and accepted
economic/financial theory. The model is transparent and readily understandable.
Mattew i. Kahal, Di 16
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24 A.
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The DCF theory begins by recognizing that any publicly-traded common
stock (utility or otherwse) will sell at a price reflecting the discounted stream of
cash flows expected by investors. The objective is to estimate that discount rate.
Using certain simplifying assumptions (that I believe are generally
reasonable for utilities), the DCF model for dividend paying stocks can be
distiled down as follows:
Ke = (DolPo) (1 + 0.5g) + g, where
Ke = cost of equity;
Do = the current anualized dividend;
Po = stock price at the current time; and
g = the long-term anualized dividend growt rate.
As an example, assume a utility company has a curent share price of
$20.00, pays a curent anualized dividend per share of$1.00, and its dividend is
expected to grow over time by 5 percent per year. The DCF formcla would
calculate the investor market rate of retu to be:
($1.00/ $20.00) (1.025) + 5.0% = 10.13%
Ths is referred to as the constant growt DCF model, because for
,mathematical simplicity, it is assumed that the growt rate is constant for an
indefinitely long time period. While this constancy assumption may seem
restrctive in many cases, for traditional utilities (which tend to be more stable
than most unegulated companies) the assumption generally is reasonable,
paricularly when applied to a group of companies.
HOW HAVE YOU APPLIED THIS MODEL?
Strctly speakng, the model can be applied only to publicly-traded companes,
i.e., companes whose market prices (and therefore market valuations) are
Mattew i. Kahal, Di 17
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transparently revealed. Consequently, the model canot be applied to IPC, which
is a wholly-owned subsidiary of IdaCorp, and therefore, a market proxy is needed.
In theory, IdaCorp could serve as that market proxy, and I include IdaCorp as one
of my 13 West Region proxy companies.
In any case, I believe that an appropriately selected proxy group
(preferably one reasonable in size) is likely to be more reliable than a single
company study. This is because there is "noise" or fluctuations in stock price (or
other) data that cannot always be readily accounted for in a simple DCF study.
The use of an appropriate proxy group helps to allow such "data anomalies" to
cancel out in the averaging process.
For the same reason, I prefer to use market data that are relatively curent
but averaged over a period of several months (i.e., six m0!1ths rather than purely
relying upon "spot" market data). It is important to recall that this is not an
academic exercise but involves the setting of "permanent" utility rates that are
likely to be in effect for several years. The practice of averaging market data over
a period of several month can add stability to the results. Dr. A vera, by
comparson, appears to favor "spot" market data (i.e., as of May 2008) and has
not indicated any plans to provide an update.
DCF Study Using the West Region Group of Electric Utilty Companies
HOW DID YOU SELECT YOUR PROXY GROUP IN THIS CASE?
I have applied the DCF model to a group of 13 companies listed in the Value Line
Investment Survey as being West Region Electrc Utilities. This is the same
general approach as taen by Dr. Avera in the 2004 rate case and more recently
for IPC in a FERC case in 2006. He employed in the 2006 FERC case 11 West
Matthew i. Kahal, Di 18
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Region companies, and 10 of his 11 proxy companies are par of my proxy group.
I initially include all of the West Region electrics that are listed in Value Line
except for three companies that have dividend anomalies that make application of
the DCF problematic. Sierra Pacific Resources only recently began paying a
dividend, and it is curently at a very minimal leveL. EI Paso Electric does not pay
a dividend, and PNM Resources cut its dividend within the last three months. As
a second proxy group, I have eliminated five West Region electrics from my list
of 13 companies. Specifically, I eliminate all three California utilities, since
California is a restructured state; MDU Resources, since it is rated "1" for Safety
by Value Line and has unusual growt characteristics; and UniSource since its
DCF characteristics are unusually low. Ths second or "restricted group" includes
eight West Region electric companes.
I provide a listing of these 13 companes on Exhbit No. 603, along with
certain risk indicators (i.e., Value Line Safety Rating, common equity ratio, beta
and financial strengt rating). The "beta" measure is explained fuher later in
Section IV of my testimony. My exhibit shows the average values for these risk
indicators using both the full 13-company group and the restrcted 8-company
group. The averages for the two proxy groups appear to be very similar, with the
13-company group having a slightly stronger Safety Rating. In general, IdaCorp
appears to have risk attributes generally similar to the averages of both groups,
with perhaps slightly greater risk. Unfortately, these risk indicators are not
published by Value Line for IPC since it is not a publicly-traded company.
HAVE EITHER YOU OR DR. AVERA PROPOSED AN
ADJUSTMENT TO THE COST OF EQUITY FOR ANY RISK
DIFFERENCE BETWEEN THE PROXY COMPANIES AND IPC?
Mattew i. Kahal, Di 19
Deparent of Energy
1 A.No. Dr. Avera adopts a cost of equity range of 10.8 to 11.8 percent, and
2 Mr. Keen selects 11.25 percent which is close to the midpoint of that range.
3 Whle Mr. Keen discusses risk issues, he does not quatify or propose a specific
4 cost of equity adjustment. I also do not propose a discrete risk adjustment relative
5 to my proxy group DCF results, although my 10.5 percent recommendation is
6 toward the upper end of my DCF range.
7 Q.HOW HAVE YOU APPLIED THE DCF MODEL TO THIS GROUP?
8 i\.I have elected to use a six-month time period to measure the dividend yield
9 component (Do/Po) of the DCF formula. Using the Standard & Poor's Stock
10 Guide, I compiled the month-ending dividend yields for the six months ending
11 September 2008, the most recent data available to me as of this time. The
12 dividend yields are month-ending, and since the October 2008 edition of the Stock
13 Guide is not yet available, I have used Yahoo Finance as the data source for my
14 September 2008 yields (i.e., as of September 30, 2008).
15 I show these dividend yield data on page 3 of Exhbit No. 604 for each
16 proxy company, April though September 2008. Over this six-month period,
17 the 13-company group average dividend yields were relatively stable ranging
18 from a high of3.88 percent in June to a low of3.62 percent in April 2008,
19 averaging 3.73 percent for the full six months. Ths indicates a slight upward
20 trend over ths recent six-month period.
21 For DCF puroses and at this time, I am using a proxy group six-month
22 average dividend yield of 3.73 percent.
23 Q.
24 A.
is 3.73 PERCENT YOUR FINAL DIVIDEND YIELD?
Not quite. Strictly speaking, the dividend yield used in the model should be the
25 . value the investor expects over the next 12 months. Using the standard "half
Matthew i. Kahal, Di 20
Deparent of Energy
1 year" growt rate adjustment technque, the DCF adjusted yield becomes 3.9
2 percent. This is based on assuming that half of a year of growth is 3.0 percent
3 (i.e., a full year growt is about 6.0 percent).
4 Q.
5
DOES DR. AVERA EMPLOY THE SAME GROWTH RATE
ADmSTMENT?
6 A.It appears that he indirectly uses a similar approach that would produce about the
7 same end result as my dividend adjustment. As best I can determine, he employs
8 Value Line's estimate of the per share dividend over the next 12 months. For a
9
10
group of companies, this would be roughly analogous to using the "O.5g"
adjustment factor.
11 Q.
12
HOW HAVE YOU DEVELOPED YOUR GROWTH RATE
COMPONENT?
13 A.Unlike the dividend yield, the investor growth rate canot be directly observed
14 but instead must be inferred though a review of available evidence. The growt
15 rate in question is the long-ru dividend per share growth rate, but analysts
16 frequently use projected eargs growt as a proxy for (long-term) dividend
17 growth. This is because in the long-ru earings are the ultimate source of
18 dividend payments to shareholders, and this is likely to be paricularly true for a
19 large group of companes.
20 One possible approach is to examine historical growt as a guide to
21 investor expected futue growth, for example the recent five-year or ten-year
22 growt in earings, dividends and book value per share. However, my experience
23 in recent years with utilities has been that these historic measures have been very
24 volatile and are not reliable as long-ru prospective measures. This may be due in
25 par to extensive corporate restrctung in the energy industr. I note that
Matthew i. Kaal, Di 21
Deparent of Energy
1 Dr. Avera also chooses to rely primarily on prospective rather than historical
2 growt measures. The DCF growt rate should be prospective, and one usefu
3 source of information on prospective growt is the published projections of
4 earngs per share (typically five years) prepared by securties analysts.
5 Dr. Avera places primar weight on ths information (along with his calculations
6 of earngs retention growt), using earings growth rates published by Value
7 Line, TBES and Zacks, and I agree that this type of evidence warrants substantial
8 emphasis.
9 Q,
10 A.
PLEASE DESCRIBE YOUR EVIDENCE.
Exhibit No. 604, page 4 of 5, presents four well-known sources of projected
11 earngs growt rates. Tli.."ee of these four sources -- First Call, Zacks and
12 CNNoney.com -- provide averages from securities analyst sureys conducted
13 by or for these organizations (tyically reporting the median value). The fourh,
14 Value Line, is that organzation's own estimates. Value Line publishes its own
15 projections using anual average earings per share for a thee-year historic base
16 period of 2005-2007 to a forecast period of2011-2013.
17 As this exhibit shows, the growth rates var somewhat among the four
18 sources, both for individua companes and for the group averages. These group
19 averages are 6.33 percent for CNN, 7.83 percent for First Call, 6.89 percent for
20 Zacks and 4.85 percent for Value Line. In this case, I have calculated the average
21 of these four sources, or about 6.2 percent, as a reasonable measuie of expected
22 growt, and a range of 6.0 to 6.5 percent.
23 Q.
24
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IS THERE ANY OTHER EVIDENCE THAT SHOULD BE
CONSIDERED?
Matthew I. Kahal, Di 22
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Yes. There are a number of reasons why investor expectations of long-ru
dividend growth could differ from the limited, five-year earngs projections from
securties analysts. Consequently, while securities analyst estimates should be
considered and given substantial weight, these growth rates should be subject to a
reasonableness test and corroboration, to the extent feasible.
On Exhibit No. 604, page 5 of 5, I hav'e compiled three other measures of
grmvth published by Valüe Line, i.e., growth rates of dividends and book vahie
per share and long-nm retained earnings grovvth. (Retained earnings growth
reflects the growth over time one would expect from the reinvestment of retained
eargs, i.e., earings not paid out as dividends. It is one of the growt sources
consideæd by Dr. Avera.) As shown on this Exhibit, these growth measures tend
to be similar to or less than analyst growt projections shown on page 4 of the
Exhibit. Dividend growth averages 5.33 percent, book value growt averages
5.00 percent, and earngs retention growth averages 4.54 percent. Notably, each
of these alternative measures of growth falls below the 6.0 to 6.5 percent range
cited above. Ths suggests that the growth rate range based on earngs
projections sureys I have calculated for DCF puroses may be conservatively
high.
WHAT IS YOURDCF CONCLUSION?
I sumarze my DCF analysis on page 1 of Exhbit No. 604. The adjusted
dividend yield for the six months ending September 2008 is 3.9 percent for this
group. Published earngs growth rate projections would support a long-ru
growt rate in the range of about 6.0 to 6.5 percent, as explained above.
Suming the adjusted yield and growth rate range produces a total retu of9.9
percent to 10.4 percent, and a midpoint result of 10.15 percent.
Mattew I. Kahal, Di 23
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WHY DO YOU NOT INCLUDE AN ADJUSTMENT FOR FLOTATION
COSTS?
If a utility issues new common stock through public offering, it will likely incur
flotation expenses, principally underwting fees. This is potentially a recoverable
expense, and one way of providing recovery is though a rate of retur adder.
Dr. Avera proposed an adder of 0.2 percent in last year's case, but does not
include any adjustment in this current case. Instead, he suggests that this should
be a consideration in selecting a final authorized return. However, he presents no
data showing that these costs actually have been incurred.
Given this lack of evidence and company data responses indicating that
there are no material flotation costs, this should not be a factor in setting the
authorized retur.
DOES YOUR DCF STUDY TAK INTO ACCOUNT THE CURNT
FINANCIAL CRISiS?
No, not directly. It is based on market conditions durng the second and third
calendar quarers of 2008, which I believe is appropriate for rate setting in ths
case. Ths was a period of elevated stress and volatility but was largely prior to
the severe financial crisis that emerged in recent weeks. I discuss this issue later
in the "Conclusions" section of my testimony.
DCF Study Using the Restricted Proxy Group
WHT IS THE PURPOSE OF YOUR RESTRICTED PROXY GROUP
STUDY?
I have eliminated five proxy companes in order to obtain a proxy group that is
25 more representative of IPC than the 13-company proxy group. I have done so by
26 eliminating the thee California companies (pG&E, Edison International and
Mattew i. Kaal, Di 24
Deparent of Energy
1 Sempra) since they operate in a very different regulatory environment than the
2 rest of the West Region. I also eliminated two companies (MDU and UniSource)
3 that appear to be "outlers" in terms of the DCF growth rate results, with MDU
4 being unusually high and UniSource being unusually low. Moreover, MDU
5 differs from other West Region companies begin rated "1" for Safety by Value
6 Line. Ths leaves a restricted West Region electrc proxy group of eight
7 companies.
8 Q.
9
HO'V HAVE YOU CONDUCTED YOUR DCF STUDY FOR THIS
GROUP?
10 A.I have conducted my DCF analysis for the restricted group in the same maner as
11 my DCF analysis for t.lie full, 13-company group. I present the data used in
12 restricted group analysis on DOE Exhibit No. 604. On pages 3, 4 and 5 of that
13 exhibit, the restrcted proxy group averages are shown in the row below the full
14 group averages. Page 2 of that Exhbit presents the DCF summary.
15 For the six months ending September 2008, the group dividend yield
16 averages 4.33 percent, which translates into an adjusted yield of 4.6 percent.
17 Based on the evidence on pages 4 and 5 of that Exhibit, a reasonable growt range
18 would be 5.0 to 6.0 percent, somewhat less than the growt rate range for the ful
19 group. Combining the adjusted yield plus the range of growth produces a total
20 retur range of9.6 to 10.6 percent, and a midpoint of 10.1 percent. Again, no
21 adjustment is needed for flotation expense.
22 Q.
23
HOW DID YOU DEVELOP THE 5.0 TO 6.0 PERCENT GROWTH
RATE RANGE?
24 A.Page 4 of Exhibit No. 604 shows the published earings growt rates from my
25 four sources - Value Line, CNN, Zacks and First Call. The four sources average
Mattew i. Kahal, Di 25
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1 to 5.78 percent for the restrcted proxy group, with First Call being an "outlier" of
2 7.19 percent. Ths appears to be due primarly to one anomalous data point-
3 a 14.8 percent growth rate for Hawaiian Electrc. (Similarly, Value Line has an
4 anomalously low growt rate for one company, Pinnacle West.)
5 Page 5 of ths Exhibit provides Value Line growt measures other than
6 earings for the restricted proxy growth - dividends, book value and earings
7 retention. Each of these growth measures for the group is in the 3 to 4 percent per
8 year range.
9 Consideration of all of this information, but emphasizing published
10 earings gro\vth projections, supports a DCF growth rate ra.rige of 5.0 to
11 6.0 percent at this time.
12
13 D.Dr. Avera's nCF Estimates
14 Q.
15
16 A.
HOW DID DR. AVERA ESTIMATE THE COST OF EQUITY USING
THE DCF MODEL?
Dr. Avera employed an application of the standard DCF model to two proxy
17 groups of companes. The first analysis group uses a proxy group of 27 electric
18 utility companies in conjunction with four DCF growth measures. Three of the
19 growth measures are analyst projections of the growt in earngs per share
20 (published by IBES, Zacks and Value Line), and the four is Dr. Avera's own
21 calculations of growt from retaned earings (derived using Value Line data).
22 The DCF calculations employ market data as of May 2008, and four sources of
23 growt produce DCF estimates for the 27-company group of 11.7 percent,
24 11.6 percent, 11.1 percent and 9.5 percent. The average of the four measures
Mattew i. Kahal, Di 26
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produces an estimated investor retu of about 11.0 percent, which is somewhat
above the upper end of my own DCF range.
Dr. Avera's second DCF study does not employ utility companes at all,
but instead uses a group of uneguated companes. Not surrisingly, the non..
utility study produces dratically higher DCF results -- 12.3 percent,
12.8 percent, 12.5 percent and 12.7 percent using the four growth rate measures,
averaging 12.6 percent. This is roughly a 15 percent cost of equity increase over
his utility study DCF results.
ARE DR. AVERA'S DCF RESULTS REASONABLE?
His electric utility study is only moderately above the upper end of my DCF
results and in that sense might seem to be a plausible estimate at least for this
proxy group. However, his study of non-utility companies produces a completely
unealistic estimate ofIPC's cost of equity, and Dr. Avera has no convincing
explanation for the enormous difference in the results of his two studies. Since he
ultimately recommends a range of 10.8 to 11.8 percent, it appears that he is
putting no weight on his non-utilty DCF study in formulating his
recommendation. I believe that his non-utility study has little to do with IPC's
actual cost of equity and is not reasonable for use in this case.
I have concerns regarding the comparability of the 27 companes in his
electric company proxy group as well. This is because a number of his proxy
group electrc companes operate in competitively restrctured states, and some of
the companies have substantial non-utility operations. The most appropriate risk
proxies for IPC would be electrc utility companies that are fully or predominantly
regulated utility and vertically-integrated, such as the 13 companies in my West
Region proxy group.
Mattew i. Kahal, Di 27
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1 Q.WHICH UTILITY COMPANIES SHOULD BE ELIMINATED FROM
HIS PROXY GROUP?2
3 A.Companes in Dr. Avera's group operating mostly in restructured states and/or
4 with substatial unegulated operations would include:
S . Allegheny Energy (Pennsylvania, Maryland)
6 . CenterPoint Energy (Texas)
7 . CMS Energy (Michigan)
8 · DPL, Inc. (Ohio)
9 . DTE Energy Co. (Michigan)
10 . Northeast Utilities (New England)
11 . PEPCO Holdings (Maryland, D.C., Delaware)
12 . PPL Corp. (Pennsylvania)
13 . Public Service Enterprise Group (New Jersey)
14 . PG&E Corp. (California)
15 . UIL Holdings (Connecticut)
16 I believe these companes are less useful and appropriate as proxies for
17 IPC than his other electrc utility companies.
18 Q.
19
HOW WOULD THE REMOVAL OF THE COMPANIES IN
RESTRUCTURD STATES AFFECT HIS DCF RESULTS?
20 A.On my Exhbit No. 60S, I reproduce Dr. Avera's electric utility DCF calculations
21 using his four growth rate measures but removing the companes from the
22 restctued states and their non-utilty operations. I have also excluded the West
23 Region companes in his group since those companies are already included in my
24 DCF stdy. As Exhbit No. 605 shows, a DCF study of the fully reguated and
25 vertcally-integrated utility subset, provides a retu range (using his four growt
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1 measures) of about 9.0 to 11.2 percent, averaging 10.5 percent. This corresponds
2 to the upper end of my own DCF study results and is well below his full 27-
3 company average of 11.0 percent. Please note that these are Dr. Avera's own
4 DCF calculations but utilzing a more appropriate subset of his electrc company
5 proxy group, rather than the full 27-company group.
'6 Q.
.7
8 A.
IS IT REASONABLE TO REMOVE THE COMPANIES FROM
RESTRUCTURED STATES?
Yes. I believe the integrated, fully-regulated companies are a more appropriate
9 risk proxy for IPC. In the 2004 case, the Commission recognized this distinction
10 noting that, "Idaho is not likely to have deregulation risks like those experienced
11 in other states". (Order, page 43, Case No. IPC-E-03-13) Clearly, those "other
12 states" would include California, the Norteast and Mid-Atlantic states, as
13 indicated above.
Mattew i. Kahal, Di 29
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1 iv. REVIEW OF DR. AVERA'S DCF, CAPM AN COMPARBLE EARNNGS
2 A.DCF Analysis
3 Q.WHT AR YOUR OBJECTIONS TO DR. AVERA'S DCF
4 ANALYSIS?
5 A.Dr. Avera performs two DCF studies, one using a 27-company proxy group of
6 electric companies and a second that uses a large group of unregulated companies
7 operating in compctitive markets. As prcviously discussed, he obtains vastly
8 different results for the two proxy groups - 11.0 percent for his electric company
9 group and 12.6 percent for the unegulated companes. In my opinion, the DCF
10 study for the unregulated companies has no value at all in determining the
11 regulated fair return in this case for IPC and therefore should be disregarded.
12 The DCF study for the electric group is more reasonable and closer to my
13 upper end results in ths case. However, as noted earlier, even ths analysis is
14 improperly burdened by the inclusion of electric companies operating in
15 restrctured states, with some of these companes having substantial non-
16 reguated operations (e.g., Allegheny Energy, PPL Corporation, etc.), which adds
17 substantial risk. Removing the "restrctured" companes would reduce the group
18 cost of equity to about 10.5 percent as I have shown on my Exhibit 605.
19 Q.
20 A.
DOES THE COMMISSION REL Y ON DCF EVIDENCE?
Yes, in conjunction with the comparables earng method. In paricular, the
21 Commission's Order in Case No. IPC-E-03-13 (page 38) states:
22
23 The Commission has relied primarily on the discounted cash flow
24 method (DCF) and the comparable earings method in previous
25 cases, and we do so again in this case.
Mattew i. Kahal, Di 30
Deparent of Energy
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5 Q.
6 A.
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20 Q.
21 A.
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That Order fuer observes that IPC is not burdened by "deregulation nsks" such
as those experienced in other states. (Id., page 43)
CAPM Results
WHT RESULTS DOES DR. AVERA OBTAIN USING THE CAPM?
Dr. Avera uses two approaches to applying the CAPM and two proxy groups~
i.e., his electric company and unregulated utility company groups. The two
approaches involve estimating the market risk premium using (a) long-run
historical market returs on stocks versus bonds; and (b) a "prospective" estimate
of the return on a subset of the overall stock market (specifically, the expected
retur on the dividend-paying stocks in the S&P 500). The two groups and
. methods produce the following CAPM cost of equity estimates:
1. Utility/hstorical method - 10.8%
2. Non-utilty/hstorical method - 10.2%
3. Utilty/prospective method - 11.9%
4. Non-utilty/prospective method - 11.2%
The four CAPM studies average to about 11.0 percent, but the electric company
cost of equity is found to be higher than the unegulated company cost. This is
counterintuitive and exactly the reverse of his DCF results.
PLEASE DESCRIBE THE CAPM APPROACH USED BY DR. AVERA.
The CAPM is a form of the "risk premium" approach and is based on modern
portolio theory. According to ths model, the cost of equity (Ke) is equal to the
yield on a risk-free asset plus an equity risk premium multiplied by a firm:s
"beta" statistic. "Beta" is a firm-specific risk measure which is computed as the
movements in a company's stock price (or market retu) relative to
Mattew i. Kahal, Di 31
Deparent of Energy
1
2
contemporaneous movements in the broadly defined stock market. According to
CAPM theory, this measures the investment risk that canot be reduced or
3 eliminated though asset diversification (i.e., holding a broad portfolio of assets).
4 The overall market, by definition, has a beta of 1.0, and a company with lower
5
6
than average investment risk (e.g., a utility company) normally would have a beta
below 1.0. The "risk premium" is defined as the expected retur on the overall
7 stock market minus the yield or return on a risk-free asset.
8 The CAPM formula is:
9 Ke =Rr + ß (Rm - Rr), where
Ke =the firm's cost of equity;
Rm =the expected return on the overall market;
Rr =the yield on the risk free asset; and
ß =the firm (or group of firms) risk measure.
10
11
12
13
14 Two of the three principal varables in the model are directly observable --
15 the yield on a risk-free asset (e.g., a Treasury securty yield) and the beta. For
16 example, Value Line publishes estimated betas for each of the companes that it
17 covers. The greatest area of controversy, however, is in the measurement of the
18 expected stock market retu (and therefore the equity risk premium), since that
19 varable canot be directly observed.
20 Whle the beta itself also is techncally "observable," different investor
21 service publications or sources provide differing estimates of betas depending on
22 the calculation methods that they use. These beta differences can have large
23 impacts on the CAPM cost of equity results. In this case, Dr. Avera employs
24 Value Line published betas, and I have used Value Line betas as well in past
Matthew i. Kahal, Di 32
Deparent of Energy
1
2
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4 Q.
5 A.
6
7
8
9
10
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13
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15 Q.
16 A.
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18
19
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25
cases. However, I note that other sources have very different utility betas, which
could yield lower (or higher) results. I show an alternate source of betas, which
I compare with the Value Line betas, in ths subsection of my testimony.
HOW HAS DR. AVERA APPLIED THIS MODEL?
Dr. Avera uses a long-term Treasur yield as the risk-free retu (i.e.,
4.6 percent), and the average beta for his electrc proxy group is 0.88 (0.79 for the
non-utility group). His "historic" and "prospective" risk premium values are
7. i percent and 8.3 percent, respectively.
These parameters yield the following CAPM calculations for his two
proxy groups:
Ke = 4.6% + 0.88 (7.1) = 11.2%
Ke = 4.6% + 0.88 (8.3) = 11.9%
Ke = 4.6% + 0.79 (7.1) = 10.2%
Ke = 4.6% + 0.79 (8.3) = 11.2%
(utilty/historical)
(utilty/prospective)
(non- utility/historical)
(non-utility/prospective)
WHY DO YOU QUESTION THE VALUE LINE BETA ESTIMATES?
Dr. Avera considered only one source for the beta statistics, a critical parameter
for an application of the CAPM. This differs from his DCF study where he used
thee public sources for the. published earngs growt rates.
I have assembled growt rates from another source (YahooFinance.com),
and I compare them to the Value Line figures for my proxy group, as shown
below. For the full 13-company group, the betas (on average) are similar-
0.85 for Value Line versus 0.88 for Yahoo Finance. For the restrcted proxy
group, the Yahoo Finance figures are slightly lower, 0.78 versus the Value Line
0.83. Based on curent evidence, the differences in the published beta sources for
the two proxy groups do not seem large.
Mattew i. Kahal, Di 33
Deparent of Energy
1
2
3
4 Q.
5
6 A.
7
8
Based on ths information, a reasonable range would be 0.78 to 0.88 for
beta. This taes into account both sources of beta and both the full and restrcted
proxy groups.
Alternative Beta Estimates for the
West Region Electrics
Value Line Yahoo Finance
Avista 0.90 0.70
Black Hills 0.90 1.20
Edison Int.0.90 0.95 .
Hawaiian 0.75 0.41
IdaCorp 0.90 0.68
MDU Resources 1.00 0.86
Pinnacle West 0.80 0.75
PG&E 0.85 0.93
Portland General 0.80 0.85
Puget Energy 0.80 0.85
Sempra 0.95 0.90
UniSource 0.75 1.64
Xcel 0.80 0.76
Full Group Average 0.85 0.88
Restricted Group Average 0.83 0.78
Source: Value Line Investment Survey, August 8, 2008, YahooFinance.com,September
2008.
DO YOU FIND THE 7.1 TO 8.3 PERCENT RISK PREMIUM TO BE
REASONABLE?
No, I believe these risk premium values are too high. The "historical" 7.1 percent
is a 1926-2007 stock market arithetic average risk premium, based on afer-the-
fact market retus, compiled by Ibbotson Associates. However, Dr. Avera
Matthew I. Kahal, Di 34
Deparent of Energy
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24 Q.
25
overlooks a key limitation in that estimate (as a measure of to day's risk premium)
that Dr. Ibbotson himself ha emphasized. His recent research has concluded that
the 7.1 percent average historic value is biased upward by a rising price/earings
ratio over the historic period, and the continuation of that trend would be
inconsistent with standard financial theory. He has corrected the historic data
removing this upward bias, obtaining a corrected historic (arithmetic average) risk
premium of5.9 percent. (Roger G. Ibbotson and Peng Chen, "Stock Market
Returns in the Long Run: Participating in the Real Economy", Financial Analyst
Journal, 2003.)
Dr. Avera's "prospective" 8.3 percent risk premìum itself is based on his
very questionable assumption Lliat earings on unegulated companies (i.e., the
dividend paying stocks in the S&P 500) will increase by 10.4 percent per year for
the long ru. I believe that ths is excessively optimistic as an overall average
expectation for the long-term rate of growth in corporate earings. For example,
the Value Line Selection and Opinion, page 3975 (August 22,2008), projects the
year-to-year growt rate in After-Tax Profits for 2009 to 2012 to range from
4.2 to 8.0 percent per year. Blue Chip Economic Indicators (October 10, 2008),
a surey of major forecasting organzations, publishes a "consensus" forecast that
U. S. pre-tax corporate profits (curent $) will grow by 5.5 percent anually for
2010-2014 and 5.0 percent anually for 2015-2019. In light of these prominent
economic forecasts, Dr. Avera's corporate earings forecast growth rate of
10.4 percent (and resulting 8.3 percent risk premium) is implausibly high, as a
measure of a long-ru growt rate.
ARE YOU A WARE OF ANY OTHER EVIDENCE THAT WOULD
CHALLENGE THE 7.1 TO 85 PERCENT RISK PREMIUM RAGE?
Matthew i. Kahal, Di 35
Deparent of Energy
1 A.
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9 Q.
10 A.
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Yes. The prominent textbook by Brealy, Myers and Allen (Principles of
Corporate Finance, 8th Edition, page 152) cites to surey data estimates of the
equity risk premiums. A 2001 Yale University surey study of financial
economists finds a 5.5 percent risk premium, and a 2003 Duke University study
of corporate Chief Financial Offcers ("CFOs") obtains a 3.8 percent risk
premium. Whle surey estimates are not necessarly precise measures, this is.
"real world" information that challenges the reasonableness of Dr. Avera's clearly
overstated equity risk premium range of 7.1 to 8.3 percent.
ARE YOU SPONSORIG A CAPM STUDY?
No, I am not sponsoring such a study as a basis for establishing IPC's cost of
equity in this case for the reasons discussed above. It is also apparent that the
Commission has concerns about this method's usefulness and in paricular "the
measurement and proper use of Beta". (Order No. 29505, page 38, May 25,
2004) However, as a comparson and check on Dr. Avera's CAPM, I present a
CAPM calculation using: a risk-free rate of 4.5 percent (slightly lower than the
figure used by Dr. Avera, based on the most recent six months of yields for
20-year Treasury bonds), a beta of 0.83 (the midpoint of the Value Line and the
Yahoo Finance range of betas) and a 6.0 percent risk premium.
Ke = 4.5% + 0.83 (6.0) = 9.5 percent
Whle I do not advocate the use in this case of the CAPM method,
I believe the 9.5 percent result shown above for IPC should be compared with
Dr. Avera's range of 10.2 to 11.9 percent. The 10.2 percent is withn the rangè of
reasonableness but the 11.9 percent clearly is excessive.
Matthew i. Kahal, Di 36
Deparent of Energy
1 Q.WHAT CAPM ESTIMATE WOULD YOU OBTAIN USING DR.
AVERA'S HISTORICAL MART RISK PREMIUM OF
7.1 PERCENT?
2
3
4 A.That risk premium value produces the following cost of equity estimate using the
5
6
CAPM:
Ke = 4.5% + 0.83 (7.1) = 10.4 percent
7 Again, while I do not recommend this analysis, ths estimate is consistent with the
8 range of my DCF studies.
9
10 C.Comparable Earnings
11 Q.
12
13 A.
WHT RESULTS DID DR. AVERA OBTAIN FROM HIS
COMPARABLE EARNINGS STUDY?
Dr. Avera focused on the Value Line projections of the eared return on equity
14 for his electric utilty proxy group (11.1 percent). He also cites to the Value Line
15 estimated retu on equity of 11.5 percent for 2008 and 13.5 percent for the
16 electric industry as a whole for the thee to five-year forecast horizon. Based on
17 this information, he finds a comparable earings estimate of 11.1 percent. (Avera,
18 page 73 and his Exhibit 25)
19 Q.
20
21 A.
DOES HIS COMPARBLE EARINGS ANALYSIS PROVIDE A
MARKT COST OF EQUITY ESTIMATE?
No, and he does not appear to claim that it does. Rather, these are one
22 publication's (i.e., Value Line's) estimates of the accountingretums on book
23 equity that electric companies might ear in the future. It does not measure either
24 the retu requirements or expectations for financial markets. One key reason
Mattew i. Kahal, Di 37
Deparent of Energy
1 why that is so is because the electric utility companies have stock prices that
2 typically are at a premium to book value, a fact that Dr. Avera does not mention.
3 Q.WHY DOES THE MAT-TO-BOOK RATIO MATTER?
4 A.Consider an electrc utilty with earngs per share of $2.20 and a book value of
5 $20. This would equa Dr. Avera's 11.0 percent accounting retu on equity.
6 However, if the stock price is $30, then the investor is really earing $2.2/ $30 =
7 7.3 percent on the market value of his investment. Put another way, the investor
8 is willing to pay $30 per share for the stock and receive $2.20 in current earnings.
9 The fact that the market value of the stock signficantly exceeds book value
10 renders the usefulness of Dr. Avera's comparable earnings study highly
11 questionable.
12 Q.DO YOU HAVE ANY ALTERNATIVE CALCULATIONS OF
13 COMPARLE EARNINGS?
14 A.Yes. As a comparison, I have compiled the historical (i.e., 2006 - 2008) and
15 projected (2011 - 2013) eared returns on equity, as published by Value Line, on
16 Exhibit No. 606 for my West Region electrc group and for Dr. Avera's electrc
17 group, i.e., the vertically-integrated (non-West Region) subset of that group.
18 (please note that 2008 results are parly actual and partly projected.)
19 As shown on page 1, the West Region 13-company proxy group eared
20 retur on equity ranges from about 9.2 percent to 10.4 percent, on average, for
21 both the historic and projected period. The eared retus for the 8-company
22 restrcted proxy group are even lower, averaging about 8.5 percent. For
23 Dr. Avera's vertically-integrated companies, the results are similar. (Page 2 of
24 Exhibit No. 606) Durg the historical period, the group average retu on equity
Mattew i. Kaal, Di 38
Deparent of Energy
1
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5
6 Q.
7 A.
8
9
is about 9.6 percent but increases to 10.6 percent for the projected 2011 - 2013
time period.
If the two proxy groups on pages 1 and 2 of Exhibit No. 606 are
combined, the average eared retus on equity would generally fall in the 9 to
10 percent range.
WHT DO YOU CONCLUDE?
While not a market cost of equity method, the comparable earnings analysis
results are roughly consistent with or below my DCF evidence and help to support
a retu on equity award in ths case not to exceed 10.5 percent.
Mattew I. Kaal, Di 39
Deparent of Energy
1 V. CONCLUSIONS ON FAIR RATE OF RETURN
2 Q.
3
4
PLEASE SUME THE CONCLUSIONS THAT YOU HAVE
REACHED CONCERNING THE COMPANY'S RATE OF RETURN
REQUEST.
5 A.IPC in this case is seeking an overall rate of retu of 8.55 percent, based on a
6 projected year-end 2008 capital strctue and embedded cost of debt and inclusive
7 of a retum on common equity of 11.25 percent. The requested retum on equity is
8 the approximate midpoint of Dr. Avera's study range of 10.8 to 11.8 percent.
9 IPC's 11.25 percent retu on equity request is a reduction from last year's
10 request but is a very Ìarge increase over the 10.25 percent retu on equity
11 awarded by the Commission in the 2004 rate case, an award accompaned by a
12 46 percent common equity ratio.
13 I find acceptable the Company's proposed capital strcture and embedded
14 cost of debt. However, I do not agree with IPC' s request and supporting evidence
15 to increase the retu on common equity from 10.25 percent awarded in 2004 to
16 11.25 percent. IPC remains a financially sound, credit worty utility with
17 recognized favorable business risk attbutes. Most of the evidence presented by
18 Dr. Avera signficantly overstates the IPC cost of equity and fair return.
19 Q.
20
21 A.
PLEASE SUMMAZE YOUR SPECIFIC DISAGREEMENTS WITH
DR. AVERA.
Dr. Avera presents thee types of studies: DCF, CAPM and comparable earngs.
22 My only significant disagreement with his DCF evidence is with his proxy
23 company selection. His non-utilty DCF study obtaned 12.6 percent, but
24 unegulated companes from other industres are not proper risk or business
25 proxies for IPC's Idaho monopoly utilty operations. These ungulated
Mattew i. Kahal, Di 40
Deparent of Energy
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19 Q.
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21 A.
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companes from other industres are fundamentally different from IPC. His
electrc company DCF study is an improvement, but even that study is impaied
by its inclusion of several "restrctued" companes. Some of those companies
have risk profies and operating environments much different than IPC. His
subset of vertically-integrated (non-West Region) companies yields DCF results
averaging about 10.5 percent.
The CAPM significantly overstates the cost of equity by assuming a stock
market risk premium in approximately the 7 to 8 percent range, \vhen a more
realistic estimate is 6 percent or less, and he selects a utility "beta" value of 0.88
based on a single source. In addition to these shortcomings, the Comniission has
expressed concerns over the reliability and applicability to IPC of the CAPM as a
basis for determining the cost of capitaL.
Finally, Dr. Avera obtains an 11.0 percent result based on Value Line
projections of accounting retus on common equity for his utility proxy group
(and the industry as a whole). Ths evidence is problematic and overstated for the
reason stated previously -- the utilty group includes many companies that operate
in an unegulated environment in restructured states. Moreover, his calculations
ignore the fact that these companies sell at a large premium to book value.
PLEASE SUMMARIZE YOUR OWN EVIDENCE ON COST OF
CAPITAL FOR IPC.
I recommend an overall retu of8.l8 percent, which includes a 10.5 percent cost
of capitaL. I rely primarly on a DCF study of two groups of West Region electrc
utilities, obtaing a range of 9.4 to 10.4 percent (9.9 to 10.4 percent and 9.6 to
10.6 percent for the two groups). Consistent with Dr. Avera, I have used the
standard, constant growt DCF model, recent stock market data and securties
Mattew i. Kahal, Di 41
Deparent of Energy
1 analyst projections of earings growt. My two West Region proxy groups are
2 reasonably comparable to IPC since all of these companes are vertically-
3
4
5
6
integrated electrcs primarly operating under standard regulation. This is similar
to the proxy group previously used by Dr. Avera in the 2004IPC rate case as well
as in a recent FERC IPC rate proceeding.
As a check and to respond to Dr. Avera, I have employed the comparable
7 earnings method, using my proxy group and the vertically-integrated portion of
8 Dr. Avew's proxy group. For these companies, the historical and projected
9 eared retus on equity display averages in the range of about 9.0 to
10.0 percent, or at most about 10.6 percent. The comparable earnings evidence10
11
12
helps to support the reasonableness of my 10.5 percent recommendation in this
case.
13 Q.
14
DOES YOURRECOMMENDATIN REFLECT THE EFFECTS ON THE
COST OF CAPITAL OF THE CURRNT FINANCIAL CRISiS?
15 A.No, it does not. As of this writing, the dimensions of this crisis are not fully
16 understood and canot be captured by standard, equilibrium models such as the
17 DCF or CAPM. These conditions canot form the basis for setting IPC's fair rate
18 of retu and permanent retail rates. My analysis employs market data from the
19 most recent six months ending September 2008, a period of stress and enhanced
20 volatility but not severe financial disruption and crisis. Nonetheless, I believe it
21 appropriate to award IPC an equity retur no higher than 10.5 percent, a figure
22 toward the upper end of my DCF range.
23 While my recommendation at ths time is 10.5 percent, this is before
24 consideration of potential regulatory changes (discussed at lengt by Company
25 witnesses) that may have the effect of mitigating IPC's investment risk. Credit
Mattew I. Kahal, Di 42
Deparent of Energy
1
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8
9
10 Q.
11 A.
rating agency reports also have discussed these regulatory issues. Such changes
could include allowig the use of a forecasted test year; changing (i.e., increasing)
the cost reconciliation percent (curently 90 percent) under the Power Cost
Adjustment (PCA) clause; and potential modifications to the Load Growth
Adjustment Rate (LGAR). It is my understanding that the Company, Staff and
certain paries are in the process of addressing the PCA and LGAR issues.
Depending on how these regulatory policy issues ultimately are resolved, the
Commission should consider a return on equity i.\varcl in this CZLie of 10.25 to 10.5
percent, with the 10.5 percent being an upper bound figure in this case.
DOES THIS CONCLUDE YOUR DIRECT TESTIMONY
Yes, it does.
W:\6112\mik\dirtest\direct.doc
Mattew i. Kahal, Di 43
Deparent of Energy
STATE OF IDAHO
BEFORE THE
PUBLIC UTILITIES COMMISSION
IN THE MATTER OF THE APPLICATION
OF IDAHO PO\VER COMPANY FOR
AUTHORITY TO INCREASE ITS RATES
AND CHARGES FOR ELECTRIC
SERVICE
)
)
)
)
)
RECEIVE
zon OCT 24 AM 10: 03
IDAHO PUBLlC
UTILITIES COMMISSION
CASE NO. IPC-E-08-10
EXHIBITS ACCOMPANYING THE
DIRECT TESTIMONY OF
MATTHEW i. KARA
ON BEHALF OF THE
U.S. DEPARTMENT OF ENERGY
OCTOBER 24, 2008
EXETER
ASSOCIATES, INC.
5565 Sterrett Place
Suite 310
Columbia, Maryland 20904
IDAHO POWER COMPANY
Rate of Retu Sumar
(F orcasted Estimate for the Period Ending December 31, 2008)
Percent of
Capital Tvpe Total!Cost Rate!
Long-Term Debt 50.73'/0 5.92'%
Preferred Stock 0.00 0.00
Common Equity 49.27 10.502
Total 100.00%
Weighted Cost
3.01'/0
0.00
5.17
8.18%
i IPC Exhibit 27 of witness S. Keen.2 Schedule MIK-4, page i of 4.
Exhibit No. 601
Case No. IPC-E-08-1O
M. Kahal, DOE
Page 1 of 1
IDAHO POWER COMPANY
Trends in Capital Costs
Anualized 10-Year 3-Month Single A
Inflation (Cpn Treasury Yield Treasury Yield Utility Yield
1992 3.0%7.0%3.5%1:.7%
1993 3.0 5.9 3.0 7.6
1994 2.6 7.1 4.3 8.3
1995 2.8 6.6 5.5 7.9
1996 3.0 6.4 5.0 7.8
1997 2.3 6.4 5.1 7.6
1998 1.6 5.3 4.8 7.0
1999 2.2 5.7 4.7 7.6
2000 3.4 6.0 5.9 8.2
2001 2.9 5.0 3.5 7.8
2002 1.6 4.6 1.6 7.4
2003 1.9 4.1 1.0 6.6
2004 2.7 4.3 1.4 6.2
2005 3.4 4.3 3.0 5.6
2006 2.5 4.8 4.8 6.1
2007 2.8 4.6 4.5 6.3
Exhbit No. 602
Case No. IPC-E-08-10
M. Kahal, DOE
Page 1 of4
Exhibit No. 602
Case No. IPC-E-08-10
M. Kahal, DOE
Page 2 of4
Exhbit No. 602
Case No. IPC-E-08-1O
M. Kahal, DOE
Page 3 of4
IDAHO POWER COMPANY
Trends in Capital Costs (Continued)
Annualized lO-Year 3-Month Single A
Inflation (CPU Treasury Treasury Utilty Yield
2007
Januar 2.1%4.8%5.1%6.0%
Februar 2.4 4.7 5.2 5.9
March 2.8 4.6 5.1 5.9
April 2.6 4.7 5.0 6.0
f\1ay 2.7 4.8 5.0 6.0
June 2.7 5.1 5.0 6.3
July 2.4 5.0 5.0 6.3
August 2.0 4.7 4.3 6.2
September 2.8 4.5 4.0 6.1
October 3.5 4.5 4.0 6.0
November 4.3 4.2 -3.4 6.0
2008
Januar 4.3%3.7%2.8%6.0%
February 4.0 3.7 2.2 6.2
March 4.0 3.5 1.3 6.2
April 3.9 3.7 1.3 6.3
May 4.2 3.9 1.8 6.3
June 5.0 4.1 1.9 6.4
July 5.6 4.0 1.7 6.4
August 5.4 3.9 1.8 6.4
September 4.9 3.7 1.2
Source: Economic Report of the President, Mergents Bond Record,
Federal Reserve Statistical Release, Consumer Price Index Summary.
Exhibit No. 602
Case No. IPC-E-08-10
M. Kahal, DOE
Page40f4
IDAHO POWER COMPANY
Value Line Risk Indicators for the Western Proxy Companes
Safety 2007 Common Financial
Company Rating Beta Equity Ratio.Strength
(1)Avista Corp.3 0.90 59.0%B+
(2)Black Hils Corp 3 0.90 63.2 B+
(3)Edison Tiiternatiomil ,0.90 4ó.0 B++j
(4)Hawaii Electric Ind.2 0.75 51.0 B++
(5)IDACORP 3 0.90 51.1 B+
(6)MDU Resources Group 1 1.00 68.4 A+
(7)PG&ECorp.2 0.85 50.4 B++
(8)Pinnacle West 2 0.80 53.0 A
(9)Portland General 2 0.80 50.1 B++
(10)Puget Energy 3 0.80 48.5 B+
(11)Sempra 2 0.95 63.7 A
(12)UniSource 3 0.75 31.2 C++
(13)Xcel Energy ~0.80 49.4 B++
Average 2.4 0.85 52.7%
Average 2.5 0.83 53.2%
(w/o MDU, Unisource, and the three California utilties.)
Source:Value Line Investment Survey, August 8, 2008.
* Please note that the common equity ratios published by Value Line exclude short-term debt and the
curent portion of long-term debt.
Exhbit No. 603
Case No. IPC-E-08-10
M. Kahal, DOE
Page 1 ofl
IDAHO POWER COMPAN
DCF Sumar for Full 13- Company West Region Proxy Group
(1)Dividend Yield (April-September 2008)3.73%
(2)Adjusted Yield (3.73 x 1.03)3.9
(3)DCF Growth Rate 6.0 - 6.5
(4 )Flotation /\djustllcnt 0.00
(5)Total Return 9.9 - 10.4
(6)Midpoint 10.15
Recommendation 10.50%
(1)DCF Model: Ke = (DJPo) (1 + O.5g) + g, where
Ke = cost of equity
Do = current anualized dividend
Po = current share price
g = long-term dividend growt rate
Exhbit No. 604
Case No. IPC-E-08-10
M. Kahal, DOE
Page 1 of5
IDAHO POWER COMPANY
DCF Sumar for the Restrcted West Region Proxy Group(l)(2)
(1)Dividend Yield (April-September 2008)4.33%
(2)Adjusted Yield (4.33 x 1.03)4.6
(3)DCF Growt Rate 5.0 - 6.0
(4)Flotation Adjustment 0.00
(5)Total Return 9.6 - 10.6
(6)Midpoint 10.1
Recommendation 10.5%
(1)DCF Model: Ke = (Do/Po) (1 + O.5g) + g, where
Ke = cost of equity
Do = current annualized dividend
Po = curent share price
g = long-term dividend growt rate
(2)Excludes MDU, Unisource and the three California utilties
(Edison International, PG&E and Sempra)
Exhibit No. 604
Case No. IPC-E-08-10
M. Kahal, DOE
Page 2 of5
ID
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5
IDAHO POWER COMPANY
Analyst Projected Growt Rates
Five-Year Earings Per Share
Value
Company CNN Zacks First Call Line Average
(1)Avista 5%5.0%4.5%9.0%5.88%
(2)Black Hils 7 6.5 7.0 1.0 5.38
(3)Edisonlnt.8 8.8 7.6 5.0 7.35
(4)Hawaiian 3 '- /14.ö /.5 i ..J6
(5)IdaCorp 6 6.0 6.0 2.0 5.00
(6)MDU 10 12.7 13.67 7.0 10.84
(7)PG&ECorp.8 7.7 7.4 5.0 7.03
(8)Pinnacle West 4 6.7 4.5 (1)3.55
(9)Portland 7 6.5 8.0 7.0 7.13
(10)Puget Energy 4 6.0 6.0 5.0 5.25
(11)Sempra 7 7.0 7.8 6.0 6.95
(12)UniSource NA NA NA 2.0 2.00
(13)Xcel --iL J:7.5 6.70
Average 6.33%6.89%7.83%4.85%6.19%
Average 5.38%5.81%7.19%4.75%5.78%
(w/o MDU, Unisource and the California utilities)
Sources:.CNN Money.com, MSN Money.com (Zacks), Yahoo Finance.com
(First Call), Value Line IfTestment Survey, September 2008.
Exhibit No. 604
Case No. IPC-E-08-10
M. Ka, DOE
Page 4 of5
IDAHO POWER COMPANY
Value Line Growt Rate Indicators
Five-Year Projections
20110-2013
Dividends Book Value Retained to
Company Per Share Per Share Common Equity
(1)Avista 12.5%3.5%3.0%
(2)Black Hils 3.0 7.0 2.5
(3)Edison Int.7.0 9.0 7.0
(4)Hawaiian 1.0 2.5 4.0
(5)Idaho 0.0 2.0 3.5
(6)PG&ECorp.9.0 5.5 5.0
(7)MDU 6.5 9.5 8.5
(8)Pincle West 2.0 2.0 2.0
(9)Portland 4.5 4.0
(10)Puget Energy 4.5 3.5 3.0
(11)Sempra 9.0 8.0 9.0
(12)UniSource 6.5 3.5 2.5
(13)Xcel 3.0 4.5 5.0
Average 5.33%5.00%4.54%
Average 3.71%3.690/0 3.38%
(w/o MDU, Unisource and the California utilities)
Sources:Value Line Investment Survey, August 18,2008.
Exhibit No. 604
Case No. IPC-E-08-1O
M. Kah, DOE
Page 5 of5
IDAHO POWER COMPANY
Dr. Avera's DCF Estimates Based on Alternative Growth Rate Sources
(Integrated Utility Subsample)
Company mES V.L.Zacks brxsv Average
(1)American Elec. Power 10.6%9.9%9.3%9.3%9.8%
(2)Cleco Corp.NA 11.1 13.1 8.0 10.7
(3)Empire District 12.1 16.1 NA 10.0 12.7
(4)NiSource NA 10.1 8.1 NA 9.1
(5)Prngress Energv 12.2 10.R 10.5 R.5 i 0.5
(6)TECO Energy 9.7 8.6 13.1 9.4 10.2
(7)Westar 10.4 NA 9.9 8.1 9.5
(8)Wisconsin Energy 12.0 .L .l 9.9 lL
Average 11.2%11.1%10.8%9.0%10.48%
Source:Dr. A vera Exhibit No. 17. Excludes utilties from restrctued states and
Western utilties.
Exhbit No. 605
Case No. IPC-E-08-10
M. Kahal, DOE
Page 1 of1
IDAHO POWER COMPANY
Historical/Projected Eared Retu on Equity
Eastern and Central Integrated Utility Companes
Company 2006 2007 2008 2011-2013
(1)American Electrc 12.0%11.4%12.0%12.0%
(2)Cleco Corp.8.3 7.8 9.5 11.0
(3)ElllIJire i)istrict 8.5 6.2 8.0 10.5
(4)NiSource 6.3 6.1 7.0 8.0
(5)Progress Energy 6.1 8.2 9.0 9.5
(6)TECOEnergy 14.1 13.2 8.5 13.0
(7)Westar 10.7 9.2 9.0 8.5
(8)Wisconsin 10.8 10.9 10.5 12.0
Average 9.6%9.1%9.2%10.6%
Sources:Value Line Investment Survey, August 29 and September 26, 2008.
Exhibit No. 606
Case No. IPC-E-08-10
M. Kahal, DOE
Page 2 of2