20110601Avera Di, Exhibits.pdf

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BEFORE THE IDAHO PUBLIC UTILITIES COMMISSION
IN THE MATTER OF THE APPLICATION
OF IDAHO POWER COMPANY FOR
AUTHORITY TO INCREASE ITS RATES
AND CHARGES FOR ELECTRIC SERVICE
TO ITS CUSTOMERS IN THE STATE OF
IDAHO.
CASE NO. IPC-E-II-08
I DAHO POWER COMPANY
DIRECT TESTIMONY
OF
WILLIAM E. AVERA
DIRECT TESTIMONY OF WILLIAM E. AVERA
TABLE OF CONTENTS
I . INTRODUCTION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. 1
A. Overview. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. 3
B. Surrnary of Conclusions............................ 6
II. FUAMNTAL ANYSES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. 10
A. Idaho Power Company.............................. 10
B. Operating Risks.................................. 12
C. Impact of Capital Market Conditions.............. 22
III. CAITAL MAT ESTIMATES . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. 27
A. Overview. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. 27
B. Comparable Risk Proxy Groups..................... 32
C. Discounted Cash Flow Analyses. . . . . . . . . . . . . . . . . . .. 37D. Capi tal Asset Pricing Model. . . . . . . . . . . . . . . . . . . . .. 55
E. Risk Premium Approach. . . . . . . . . . . . . . . . . . . . . . . . . . .. 62
F. Comparable Earnings Approach..................... 65
G. Flotation Costs.................................. 69
IV. RETUR ON EQUITY FOR IDAHO POWER COMPAN . . . . . . . . . . . . .. 71
A. Implications for Financial Integrity............. 72
B. Capi tal Structure................................ 75C. Return on Equity Recommendation.................. 81
Exhibit No.1:Exhibit No.2:
Exhibi t No.3:Exhibit No.4:Exhibit No.5:
Exhibit No.6:
Exhibi t No.7:Exhibit No.8:Exhibit No.9:
Exhibi t No. 10:
Qualifications of William E. Avera
DCF Model - Utility Proxy Group
Sustainable Growth - Utility Proxy Group
DCF Model - Non-Utility Proxy Group
Sustainable Growth - Non-Utility Proxy
Group
CAPM - Current Bond Yield
CAPM - Proj ected Bond Yield
Electric Utility Risk Premium
Comparable Earnings Approach
Capi tal Structure
1 I . INTRODUCTION
2 Q.Please state your name and business address.
3 A.William E. Avera, 3907 Red River, Austin,
4 Texas.
5 Q.In what capacity are you employed?
6 A.I am the President of FINCAP, Inc., a firm
7 providing financial, economic, and policy consulting
8 services to business and government.
9 Q.Please describe your educational background
10 and professional experience.
11 A.I received a Bachelor of Arts degree with a
12 maj or in economics from Emory Uni versi ty. After serving in
13 the U. S. Navy, I entered the doctoral program in economics
14 at the Uni versi ty of North Carolina at Chapel Hill. Upon
15 receiving my Ph.D., I joined the faculty at the University
16 of North Carolina and taught finance in the Graduate School
17 of Business. I subsequently accepted a position at the
18 University of Texas at Austin where I taught courses in
19 financial management and investment analysis. I then went
20 to work for International Paper Company in New York City as
21 Manager of Financial Education, a position in which I had
22 responsibili ty for all corporate education programs in
23 finance, accounting, and economics.
24 In 1977, I joined the staff of the Public Utility
25 Commission of Texas (~PUCT") as Director of the Economic
2 6 Research Division. During my tenure at the PUCT, I managed
27 a division responsible for financial analysis, cost
AVERA, DI 1
Idaho Power Company
1 allocation and rate design, economic and financial research,
2 and data processing systems, and I testified in cases on a
3 variety of financial and economic issues. Since leaving the
4 PUCT, I have been engaged as a consultant. I have
5 participated in a wide range of assignments involving
6 utility-related matters on behalf of utilities, industrial
7 customers, municipalities, and regulatory commissions. I
8 have previously testified before the Federal Energy
9 Regulatory Commission (~FERC"), as well as the Federal
10 Communications Commission, the Surface Transportation Board
11 (and its predecessor, the Interstate Commerce Commission),
12 the Canadian Radio-Television and Telecommunications
13 Commission, and regulatory agencies, courts, and legislative
14 committees in over 40 states, including the Idaho Public
15 Utilities Commission (~IPUC" or ~the Commission").
16 In 1995, I was appointed by the PUCT to the
17 Synchronous Interconnection Committee to advise the Texas
18 legislature on the costs and benefits of connecting Texas to
19 the national electric transmission grid. In addition, I
20 served as an outside director of Georgia System Operations
21 Corporation, the system operator for electric cooperatives
22 in Georgia.
23 I have served as Lecturer in the Finance Department
24 at the University of Texas at Austin and taught in the
25 evening graduate program at St. Edward's University for
26 twenty years. In addition, I have lectured on economic and
27 regulatory topics in programs sponsored by uni versi ties and
AVERA, DI 2
Idaho Power Company
1 industry groups. I have taught in hundreds of educational
2 programs for financial analysts in programs sponsored by the
3 Association for Investment Management and Research, the
4 Financial Analysts Review, and local financial analysts
5 societies. These programs have been presented in Asia,
6 Europe, and North America, including the Financial Analysts
7 Seminar at Northwestern Uni versi ty. I hold the Chartered
8 Financial Analyst (CFA~) designation and have served as Vice
9 President for Membership of the Financial Management
10 Association. I have also served on the Board of Directors
11 of the North Carolina Society of Financial Analysts. I was
12 elected Vice Chairman of the National Association of
13 Regulatory Commissioners (~NARUC") Subcommittee on Economics
14 and appointed to NARUC's Technical Subcommittee on the
15 National Energy Act. I have also served as an officer of
16 various other professional organizations and societies.
17 Exhibi t No. 1 contains a resume presenting the details of my
18 experience and qualifications.
19 A.Overview.
20 Q.What is the purpose of your testimony in this
21 case?
22 A.The purpose of my testimony is to present to
23 the IPUC my independent evaluation of the fair rate of
24 return on equity (~ROE") for the jurisdictional utility
25 operations of Idaho Power Company (~Idaho Power" or ~the
26 Company"). The overall rate of return applied to Idaho
AVERA, DI 3
Idaho Power Company
1 Power's 2011 test year rate base is developed in the
2 testimony of Mr. Steven R. Keen.
3 Q.Please summarize the information and materials
4 you relied on to support the opinions and conclusions
5 contained in your testimony.
6 A.To prepare my testimony, I used information
7 from a variety of sources that would normally be relied upon
8 by a person in my capacity. I am familiar with the
9 organization, finances, and operations of Idaho Power from
10 my participation in prior proceedings before the IPUC, the
11 Public Utility Commission of Oregon (~OPUC"), and the FERC.
12 In connection with the present filing, I considered and
13 relied upon corporate disclosures and management,
14 discussions, publicly available financial reports and
15 filings, and other published information relating to the
16 Company and its parent, IDACORP, Inc. (~IDACORP"). I also
1 7 reviewed information relating generally to current capital
18 market conditions and specifically to current investor
19 perceptions, requirements, and expectations for Idaho
20 Power's electric utility operations. These sources, coupled
21 with my experience in the fields of finance and utility
22 regulation, have given me a working knowledge of the issues
23 relevant to investors' required rate of return for Idaho
24 Power, and they form the basis of my analyses and
25 conclusions.
26 Q.What is the practical test of the
27 reasonableness of the ROE used in setting a utility's rates?
AVERA, DI 4
Idaho Power Company
1 A.The ROE compensates investors for the use of
2 their capital to finance the plant and equipment necessary
3 to provide utility service. Investors commit capital only
4 if they expect to earn a return on their investment
5 commensurate with returns available from al ternati ve
6 investments with comparable risks. To be consistent with
7 sound regulatory economics and the standards set forth by
8 the Supreme Court in the Bl uefield1 and Hope2 cases, a
9 utili ty' s allowed ROE should be sufficient to:(1) fairly
10 compensate the utility's investors, (2) enable the utility
11 to offer a return adequate to attract new capital on
12 reasonable terms, and (3) maintain the utility's financial
13 integrity.
14 Q.How is your testimony organized?
15 A.I first reviewed the operations and finances
16 of Idaho Power and the general conditions in the utility
17 industry and the capital markets. With this as a
18 background, I described the conceptual principles underlying
19 investors' required rate of return and then conducted
20 various well-accepted quantitative analyses to estimate the
21 current cost of equity, including al ternati ve applications
22 of the discounted cash flow (~DCF"), the Capital Asset
23 Pricing Model (~CAPM"), an equity risk premium approach
i Bluefield Water Works & Improvement Co. v. Pub. Servo Comm'n, 262
u.s. 679 (1923).
2 Fed. Power Comm'n v. Hope Natural Gas Co., 320 u.s. 591 (1944).
AVERA, DI 5
Idaho Power Company
1 based on allowed rates of return, as well as reference to
2 comparable earned rates of return expected for utili ties.
3 Based on the cost of equity estimates indicated by my
4 analyses, the Company's ROE was evaluated taking into
5 account the specific risks and economic requirements for
6 Idaho Power, as well as other factors (e. g., flotation
7 costs) that are properly considered in setting a fair ROE
8 for the Company.
9 B.Sumry of Conciusions.
10 Q.What are your findings regarding the fair rate
11 of return on equity for Idaho Power?
12 A.Based on the results of my analyses and the
13 economic requirements necessary to support continuous access
14 to capital, I recommend that Idaho Power be authorized a
15 fair rate of return on equity in the range of a ~bare bones"
16 low end of 10.40 percent to a high end (including flotation
17 costs) of 11.55 percent.The bases for my conclusion are
18 summarized below:
19 .In order to reflect the risks and
20 prospects associated with Idaho Power's jurisdictional
21 utility operations, my analyses focused on a proxy group of
22 other utilities with comparable investment risks.
23 Consistent with the fact that utilities must compete for
24 capi tal with firms outside their own industry, I also
25 referenced a proxy group of comparable risk companies in the
26 non-utility sector of the economy;
AVERA, DI 6
Idaho Power Company
1 .Because investors' required return on
2 equity is unobservable and no single method should be viewed
3 in isolation, I applied the DCF, CAPM, and risk premium
4 methods, as well as the comparable earnings approach, to
5 estimate a fair ROE for Idaho Power;
6 .Based on the results of these analyses,
7 and giving less weight to extremes at the high and low ends
8 of the range, I concluded that the cost of equity for the
9 proxy groups of utilities and non-utility companies is in
10 the range of 10.4 percent to 11.4 percent, or 10.55 percent
11 to 11.55 percent after incorporating a minimal adj ustment to
12 account for the impact of common equity flotation costs;
13 .Considering the expected upward trend in
14 capital costs and the need to support financial integrity
15 and fund crucial capital investment even under adverse
16 circumstances , it is my opinion that this 10.55 percent to
17 11.55 percent range bounds a reasonable rate of return on
18 common equity for Idaho Power; and
19 .As reflected in the testimony of Mr.
20 Keen, Idaho Power is requesting a fair ROE of 10.5 percent
21 to balance customer impact during these challenging economic
22 times with the Company's need to maintain is financial
23 integrity and access to capital. This 10.5 percent ROE
24 falls at the bottom end of my ~bare bones" cost of equity
25 range and, in my professional opinion, represents a
AVERA, DI 7
Idaho Power Company
1 reasonable, even if conservative, rate of return on common
2 equi ty for Idaho Power.
3 Q.What is your conclusion as to the
4 reasonableness of the Company's capital structure?
5 A.Based on my evaluation, I concluded that a
6 common equity ratio of approximately 51 percent represents a
7 reasonable basis from which to calculate Idaho Power's
8 overall rate of return. This conclusion was based on the
9 following findings:
10 .Idaho Power's proposed common equity ratio
11 is entirely consistent with the range of capitalizations
12 maintained by the firms in the proxy group of electric
13 utilities at year-end 2010 and based on investors'
14 expectations;
15 .My conclusion is reinforced by the
16 investment community's focus on the need for a greater equity
17 cushion to accommodate higher operating risks, including the
18 uncertainties posed by exposure to variable hydro conditions,
19 and the pressures of capital investments. Financial
20 flexibili ty plays a crucial role in ensuring the wherewithal
21 to meet the needs of customers, and Idaho Power' s capital
22 structure reflects the Company's ongoing efforts to support
23 its credit standing and maintain access to capital on
24 reasonable terms.
AVERA, DI 8
Idaho Power Company
1 Q.What other evidence did you consider in
2 evaluating your recommendation in this case?
3 A.My recommendation was reinforced by the
4 following findings:
5 .Sensi ti vi ty to financial market and
6 regulatory uncertainties has increased dramatically and
7 investors recognize that constructive regulation is a key
8 ingredient in supporting utility credit standing and
9 financial integrity;
10 .Because of Idaho Power's reliance on
11 hydroelectric generation, the Company is exposed to
12 relatively greater risks of power cost volatility;
13 .Providing Idaho Power with the opportunity
14 to earn a return that reflects these realities is an
15 essential ingredient to support the Company's financial
16 position, which ultimately benefits customers by ensuring
17 reliable service at lower long-run costs; and
18 .Continued support for Idaho Power's
19 financial integrity, including a reasonable ROE, is
20 imperative to ensure that the Company has the capability to
21 maintain an investment grade rating while confronting
22 potential challenges associated with funding infrastructure
23 development necessary to meet the needs of its customers.
AVERA, DI 9
Idaho Power Company
1 II. FUAMNTAL ANALYSES
2 Q.What is the purpose of this section?
3 A.As a predicate to the quanti tati ve analyses
4 that I address later in this testimony, this section briefly
5 reviews the operations and finances of Idaho Power. In
6 addition, it examines the risks and prospects for the
7 electric utility industry and conditions in the capital
8 markets and the general economy. An understanding of the
9 fundamental factors driving the risks and prospects of
10 electric utili ties is essential in developing an informed
11 opinion of investors' expectations and requirements that are
12 the basis of a fair ROE.
13 A.Idaho Power Company.
14 Q.Briefly describe Idaho Power.
15 A.Idaho Power is a wholly-owned subsidiary of
16 IDACORP and is principally engaged in providing integrated
17 retail electric utility service in a 24,000 square mile area
18 in southern Idaho and eastern Oregon. During 2010, Idaho
19 Power's energy deliveries totaled 15.5 million megawatt-
20 hours (~MWh"). Sales to residential customers comprised 37
21 percent of retail sales, with 28 percent to commercial, 23
22 percent to industrial end-users, and 12 percent attributable
23 to irrigation pumping. Idaho Power also participates in the
24 wholesale power market and supplies firm wholesale power
25 service under sales contracts. At year-end 2010, Idaho
AVERA, DI 10
Idaho Power Company
1 Power had total assets of $4.6 billion, with total revenues
2 amounting to approximately $ 1.0 billion.
3 In addition to its thermal baseload and peaking
4 uni ts located in Wyoming, Nevada, Oregon, and Idaho, Idaho
5 Power's existing generating units include 17 hydroelectric
6 generating plants located in southern Idaho and eastern
7 Oregon. The electrical output of these hydro plants, which
8 has a significant impact on total energy costs, is dependent
9 on streamflows. Although Idaho Power estimates that
10 hydroelectric generation is capable of supplying
11 approximately 55 percent of total system requirements under
12 normal conditions, the Company has experienced prolonged
13 periods of persistent below-normal water conditions in the
14 past.
15 Idaho Power's retail electric operations are subject
16 to the jurisdiction of the IPUC and the OPUC, with the
17 interstate jurisdiction regulated by FERC. Additionally,
18 Idaho Power's hydroelectric facilities are subj ect to
19 licensing under the Federal Power Act, which is administered
20 by FERC, as well as the Oregon Hydroelectric Act.
21 Relicensing is not automatic under federal law, and Idaho
22 Power must demonstrate that it has operated its facilities
23 in the public interest, which includes adequately addressing
24 environmental concerns.
25 Q.How are fluctuations in Idaho Power's
26 operating expenses caused by varying hydro and power market
27 conditions accommodated in its rates?
AVERA, DI 11
Idaho Power Company
1 A.The IPUC has approved a Power Cost Adjustment
2 (~PCA") mechanism for Idaho Power, under which rates are
3 adj usted annually to reflect changes in variable power
4 production and supply costs. When hydroelectric generation
5 is reduced and power supply costs rise above those included
6 in base rates, the PCA allows Idaho Power to increase rates
7 to recover a portion of its additional costs. Conversely,
8 rates are reduced when increased hydroelectric generation
9 leads to lower power supply costs. Although the PCA
10 provides for rates to be adj usted annually, it applies to 95
11 percent of the deviation between actual power supply costs
12 and normalized rates.
13 Q.What credit ratings have been assigned to
14 Idaho Power?
15 A.Idaho Power has been assigned a corporate
16 credit rating of ~BBB" by Standard & Poor's Corporation
17 (~S&P") and an issuer rating of ~Baa1" from Moody's Investor
18 Services, Inc. (~Moody' s") .
19 B.eperatinq Risks.
20 Q.How have investors' risk perceptions for the
21 utility industry evolved?
22 A.Implementation of structural change, along
23 wi th other factors impacting the economy and the industry,
24 has caused investors to rethink their assessment of the
25 relative risks associated with utilities. The past decade
26 witnessed steady erosion in credit quality throughout the
27 utili ty industry, both as a result of revised perceptions of
AVERA, DI 12
Idaho Power Company
1 the risks in the industry and the weakened finances of the
2 utilities themselves.In December 2009, S&P observed with
3 respect to the industry's future that:
4 Looming costs associated wi th5 environmental compliance, slack
6 demand caused by economic weakness,7 the potential for permanent demand8 destruction caused by changes in9 consumer behavior and closing of10 manufacturing facilities, and11 numerous regulatory filings seeking12 recovery of costs are some of the13 significant challenges the industry14 has to deal with.3
15 Similarly, Moody's noted:
16 (AJ sustained period of sluggish17 economic growth, characterized by
18 high unemployment, could stress the19 sector's recovery prospects,20 financial performance, and credit21 ratings. The quali ty of the22 sector's cash flows are already23 showing signs of decline, partly24 because of higher operating costs25 and investments. 4
26 More recently, Moody's concluded, ~we also see the
27 sector's overall business and operating risks increasing.,,5
3 Standard & Poor's Corporation, "U. S. Regulated Electric Utilities
Head into 2010 With Familiar Concerns," RatingsDirect (Dec. 28, 2009).
4 Moody's Investors Service, "U. S. Electric Utilities: Uncertain
Times Ahead; Strengthening Balance Sheets Now Would Protect Credit,"
Special Comment (Oct. 28, 2010).
5 Moody's Investors Service, "Regulation Provides Stability as Risks
Mount," Industry Outlook (Jan. 19, 2011).
AVERA, DI 13
Idaho Power Company
1 Q.How does Idaho Power's generating resource mix
2 affect investors' risk perceptions?
3 A.Because approximately one-half of Idaho
4 Power's total energy requirements are provided by
5 hydroelectric facilities, the Company is exposed to a level
6 of uncertainty not faced by most utilities. While
7 hydropower confers advantages in terms of fuel cost savings
8 and di versi ty, reduced hydroelectric generation due to
9 below-average water conditions forces Idaho Power to rely
10 more heavily on wholesale power markets or more costly
11 thermal generating capacity to meet its resource needs. As
12 S&P has observed:
13 A reduction in hydro generation14 typically increases an electric15 utility's costs by requiring it to16 buy replacement power or run more17 expensi ve generation to serve18 customer loads. Low hydro19 generation can also reduce20 utilities' opportunity to make off-21 system sales. At the same time, low22 hydro years increase regional23 wholesale power prices, creating24 potentially a double impact25 companies have to buy more power26 than under normal conditions, paying27 higher prices. 6
28 Uncertainties over water conditions are a persistent
29 operational risk associated with Idaho Power.Investors
30 recognize that volatile energy markets, unpredictable stream
6 Standard & Poor's Corporation, "Pacific Northwest Hydrology and Its
Impact on Investor-Owned Utilities' Credit Quality," RatingsDirect (Jan.
28, 2008).
AVERA, DI 14
Idaho Power Company
1 flows, and Idaho Power's reliance on wholesale purchases to
2 meet a significant portion of its resource needs can expose
3 the Company to the risk of reduced cash flows and
4 unrecovered power supply costs.S&P noted that Idaho Power,
5 along with Avista Corporation, ~face the most substantial
6 risks despite their PCAs and cost-update mechanisms,,,7 and
7 recently concluded that Idaho Power's generation mix
8 ~exposes the company to substantial replacement power risk
9 in the event of low water flows that lead to reduced
10 generation. ,,8 Similarly, Moody's observed that Idaho Power
11 ~has a high dependency .. on hydro resources making it
12 vulnerable to drought conditions.,,9 In addition to weather-
13 related fluctuations in water flows, Idaho Power is also
14 exposed to uncertainties regarding water rights and the
15 administration of those rights.
16 Q.Is the potential for energy market volatility
17 an ongoing concern for investors?
18 A.Yes.In recent years, utilities and their
19 customers have had to contend with dramatic fluctuations in
20 fuel costs due to ongoing price volatility in the spot
21 markets, and investors recognize the potential for further
22 turmoil in energy markets.In times of extreme volatility,
7 Id.
Standard & Poor's Corporation, "Summary: Idaho Power Co.,"
RatingsDirect (Nov. 24, 2010).
9 Moody's Investors Service, "Credit Opinion: Idaho Power Company,"
Global Credit Research (Mar. 9, 2011).
AVERA, DI 15
Idaho Power Company
1 utilities can quickly find themselves in a significant
2 under-recovery position with respect to power costs, which
3 can severely stress liquidity. The investment community
4 also recognizes that financial performance can be negatively
5 impacted when low wholesale prices impair revenues from
6 surplus energy sales, as has been the case recently in the
7 Pacific Northwest. 10
8 While current expectations for significantly lower
9 wholesale power prices reflect weaker fundamentals affecting
10 current load and fuel prices, investors recognize the
11 potential that such trends could quickly reverse.For
12 example, heightened uncertainties in the Middle East have
13 led to sharp increases in petroleum prices, and the
14 potential ramifications of the Japanese nuclear crisis on
15 the future cost and availability of nuclear generation in
16 the u. s. have not been lost on investors.S&P observed that
1 7 ~short-term price volatility from numerous possibilities
18 . is always possible, ,,11 while Moody's recognized that
19 ~the inherent volatility of commodity costs comprises one of
20 the most significant risk factors to the industry, ,,12 and
21 concluded, ~This view, that commodity prices remain low,
10 See, e. g., Standard & Poor's Corporation, "Summary: Energy
Northwest, Washington Bonneville Power Administration, Oregon; Wholesale
Electric," RatingsDirect (Apr. 27, 2011).
11 Standard & Poor's Corporation, "Top 10 Investor Questions: u. S.
Regulated Electric Utilities," RatingsDirect (Jan. 22, 2010).
12 Moody's Investors Service, "Credit Opinion: Avista Corp.," Global
Research (Mar. 17, 2011).
AVERA, DI 16
Idaho Power Company
1 could easily be proved incorrect, due to the evidence of
2 historical volatility. ,,13
3 Q.Does the PCA completely shield Idaho Power
4 from exposure to fluctuations in power supply costs?
5 A.No. The investment community views the
6 Company's ability to periodically adj ust retail rates to
7 accommodate fluctuations in fuel costs as an important
8 source of support for Idaho Power's financial integrity.
9 Nevertheless, they also recognize that there can still be a
10 lag between the time Idaho Power actually incurs the
11 expendi ture and when it is recovered from ratepayers. This
12 lag can impinge on the utility's financial strength through
13 reduced liquidity and higher borrowings. As a result, the
14 Company is not insulated from the potential need to finance
15 deferred fuel costs. 14 Indeed, despite the significant
16 investment of resources to manage fuel procurement,
17 investors are aware that the best that Idaho Power can do is
18 to recover something less than its actual costs during times
19 of rising fuel costs.In other words, Idaho Power earns no
20 return on deferred fuel costs and is exposed to
21 disallowances for imprudence in its fuel procurement.
22 Similarly, as discussed in the testimony of Mr. Keen, Idaho
13 Moody's Investors Service, "U. S. Electric Utili ties: Uncertain
Times Ahead; Strengthening Balance Sheets Now Would Protect Credit,"
Special Comment (Oct. 28, 2010).
14 S&P has noted that the Company's financial metrics have been
negatively impacted in the past as a result of power cost deferrals.Standard & Poor's Corporation, "Idaho Power Co.," RatingsDirect (Feb. 1,
2008) .
AVERA, DI 17
Idaho Power Company
1 Power devotes considerable resources to the administration
2 of power purchase contracts (~PPAs"), which provide no
3 opportuni ty to earn a return for shareholders.
4 Q. What other financial pressures impact
5 investors' risk assessment of Idaho Power?
6 A. Investors are aware of the financial and
7 regulatory pressures faced by utili ties associated with
8 rising costs and the need to undertake significant capital
9 investments.S&P noted that cost increases and capital
10 proj ects, along with uncertain load growth, were a
11 significant challenge to the utility industry. 15 As Moody's
12 observed:
13 (WJ e also see the sector's overall14 business risk and operating risks15 increasing, owing primarily to16 rising costs associated with17 upgrading and expanding the nation's18 trillion dollar electric19 infrastructure. 16
20 Similarly, S&P noted that cost increases and capital
21 projects, along with uncertain load growth, were a
22 significant challenge to the utility industry. 17 Providing
23 the infrastructure necessary to meet the energy needs of
15 Standard & Poor's Corporation, "Industry Economic and Ratings
Outlook," RatingsDirect (Feb. 2, 2010).
16 Moody's Investors Service, "Regulation Provides Stability as Risks
Mount," Industry Outlook (Jan. 19, 2011).
17 Standard & Poor's Corporation, "Industry Economic and Ratings
Outlook," RatingsDirect (Feb. 2, 2010).
AVERA, DI 18
Idaho Power Company
1 customers imposes additional financial responsibilities on
2 Idaho Power.
3 Q.Does Idaho Power anticipate the need to access
4 the capital markets going forward?
5 A.Most definitely. Idaho Power will require
6 capi tal investment to meet customer growth, provide for
7 necessary maintenance and replacements of its utility
8 infrastructure, as well as fund new investment in electric
9 generation, transmission, and distribution facilities.
10 Idaho Power is in a period of significant infrastructure
11 development and has several major projects in development,
12 including construction of the 300 megawatt (~MW") Langley
13 Gulch power plant, which is expected to achieve commercial
14 operation in the summer of 2012.
15 As Moody's noted, ~IPC' s capital expenditures are
16 expected to range from $775 - $805 million over the next
17 three years. ,,18 Investors are aware of the challenges posed
18 by rising costs and burdensome capital expenditure
19 requirements, especially in light of ongoing capital market
20 and economic uncertainties. Support for Idaho Power's
21 financial integrity and flexibility will be instrumental in
22 attracting the capital necessary to fund these proj ects in
23 an effective manner.
18 Moody's Investors Service, "Credit Opinion: Idaho Power Company,"
Global Credit Research (Mar. 9, 2011).
AVERA, DI 19
Idaho Power Company
1 Q.What other considerations affect investors'
2 evaluation of Idaho Power?
3 A.Utili ties are confronting increased
4 environmental pressures that could impose significant
5 uncertainties and costs. Moody's noted that ~the prospect
6 for new environmental emission legislation - particularly
7 concerning carbon dioxide - represents the biggest emerging
8 issue for electric utilities. ,,19 While the momentum for
9 carbon emissions legislation has slowed, expectations for
10 eventual regulations continue to pose uncertainty.Fitch
11 recently concluded, ~Prospects of costly environmental
12 regulations will create uncertainty for investors in the
13 electrici ty business in 2011. ,,20 Moody's observed that
14 ~increasingly stringent environmental mandates" were a key
15 risk confronting Idaho Power. 21
16 Q.Would investors consider Idaho Power's
1 7 relative size in their assessment of the Company's risks and
18 prospects?
19 A.Yes. A firm' s relative size has important
20 implications for investors in their evaluation of
21 al ternati ve investments, and it is well established that
19 Moody's Investors Service, "U. S.
Utilities," Industry Outlook (Jan. 2009).
Investor-Owned Electric
20 Fitch Ratings Ltd., "2011 Outlook: U.s. Utilities, Power, and
Gas," Global Power North America Special Report (Dec. 20, 2010).
21 Moody's Investors Service, "Credit Opinion: Idaho Power Company,"
Global Credit Research (Mar. 9, 2011).
AVERA, DI 20
Idaho Power Company
1 smaller firms are more risky than larger firms. With a
2 market capitalization of approximately $1.8 billion, Idaho
3 Power is one of the smallest publicly traded electric
4 utilities followed by The Value Line Investment Survey
5 (~Value Line"), which have an average capitalization of
6 approximately $ 7 . 3 billion. 22
7 The magnitude of the size disparity between Idaho
8 Power and other firms in the utility industry has important
9 practical implications with respect to the risks faced by
10 investors.All else being equal, it is well accepted that
11 smaller firms are more risky than their larger counterparts,
12 due in part to their relative lack of diversification and
13 lower financial resiliency. 23 These greater risks imply a
14 higher required rate of return, and there is ample empirical
15 evidence that investors in smaller firms realize higher
16 rates of return than in larger firms. 24 Common sense and
17 accepted financial doctrine hold that investors require
18 higher returns from smaller companies, and unless that
19 compensation is provided in the rate of return allowed for a
22 www.valueline.com (Retrieved Mar. 25, 2011).
23 It is well established in the financial literature that smaller
firms are more risky than larger firms. See, e.g., Eugene F. Fama and
Kenneth R. French, "The Cross-Section of Expected Stock Returns," TheJournal of Finance (June 1992); George E. Pinches, J. Clay Singleton,
and Ali Jahankhani, "Fixed Coverage as a Determinant of Electric Utility
Bond Ratings," Financial Management (Summer 1978).
24 See for example Rolf W. Banz, "The Relationship Between Return and
Market Value of Common Stocks," Journal of Financial Economics
(September 1981) at 16.
AVERA, DI 21
Idaho Power Company
1 utility, the legal tests embodied in the Hope and Bluefield
2 cases cannot be met.
3 C.Impact of Capi tai Market Conditions.
4 Q.What are the implications of recent capital
5 market conditions?
6 A.The deep financial and real estate crisis that
7 the country experienced in late 2008, and continuing into
8 2009, led to unprecedented price fluctuations in the capital
9 markets as investors dramatically revised their risk
10 perceptions and required returns. As a result of investors'
11 trepidation to commit capital, stock prices declined sharply
12 while the yields on corporate bonds experienced a dramatic
13 increase.
14 Wi th respect to utilities specifically, as of March
15 2011, the Dow Jones Utility Average stock index remained
16 approximately 20 percent below the previous high reached in
17 May 2008. This prolonged sell-off in common stocks and
18 sharp fluctuations in utility bond yields reflect the fact
19 that the utility industry is not immune to the impact of
20 financial market turmoil and the ongoing economic downturn.
21 As the Edison Electric Institute noted in a letter to
22 congressional representatives in September 2008 as the
23 financial crisis intensified, capital market uncertainties
24 have serious implications for utilities and their customers:
25 In the wake of the continuing26 upheaval on Wall Street, capital27 markets are all but immobilized, and28 short-term borrowing costs to
AVERA, DI 22
Idaho Power Company
1 utili ties have already increased2 substantially. If the financial3 crisis is not resolved quickly,4 financial pressures on utili ties5 will intensify sharply, resulting in6 higher costs to our customers and,
7 ultimately, could compromise service8 reliabili ty. 25
9 While conditions have improved significantly since
10 the depths of the crisis, investors have nonetheless had to
11 confront ongoing fluctuations in share prices and stress in
12 the credit markets. As the Wall Street Journal noted in
13 February 2010:
14 Stocks pulled out of a 167-point15 hole with a late rally Friday,16 capping a wild week reminiscent of17 the most volatile days of the credit18 crisis.19 * * *
20 It was a return to the unusual21 relationships, or correlations, seen22 at maj or flash points over the past23 two years when investors fled risky24 assets and jumped into safe havens.25 This market behavior, which has26 reasserted itself repeatedly since27 the financial crisis began, suggests28 that investment decisions are still29 being driven more by government30 support and liquidity concerns than31 market fundamentals. 26
32 In response to renewed capital market uncertainties
33 ini tiated by unrest in the Middle East, the natural disaster
25 Letter to House of Representatives, Thomas R. Kuhn, President,
Edison Electric Institute (Sep. 24, 2008).
26 Gongloff, Mark, "Stock Rebound Is a Crisis Flashback - Late Surge
Recalls Market's Volatility at Peak of Credit Difficulties; Unusual
Correlations," Wall Street Journal at B1 (Feb. 6, 2010).
AVERA, DI 23
Idaho Power Company
1 in Japan, ongoing concerns over the European sovereign debt
2 crisis, and questions over the sustainabili ty of economic
3 growth, investors have repeatedly fled to the safety of U. s.
4 Treasury bonds, and stock prices have experienced renewed
5 volatili ty. 27 The dramatic rise in the price of gold and
6 other commodities also attests to investors' heightened
7 concerns over prospective challenges and risks, including
8 the overhanging threat of inflation and renewed economic
9 turmoil. With respect to utili ties , Fitch observed that,
10 ~the outlook for the sector would be adversely affected by
11 significantly higher inflation and interest rates. ,,28
12 Moody's recently concluded:
13 Over the past few months, we have14 been reminded that global financial15 markets, which are still receiving16 extraordinary intervention benefits17 by sovereign governments, are18 exposed to turmoil. Access to the19 capital markets could therefore20 become intermittent, even for safer,21 more defensive sectors like the22 power industry. 29
23 Uncertainties surrounding economic and capital
24 market conditions heighten the risks faced by utilities,
27 The Wall Street Journal recently reported that the Dow Jones
Industrial Average experienced its largest drop since August 2010, which
marked the fourth triple-digit move in less than two weeks. Tom
Lauricella and Jonathan Cheng, "Dow Below 12000 on Mideast Worries -
Troubles in Europe and China Add to Jitters," Wall Street Journal C1
(March. 11, 2011).
28 Fitch Ratings Ltd., "2011 Outlook: u.s. Utilities, Power, and
Gas," Global Power North America Special Report (Dec. 20, 2010).
29 Moody's Investors Service, "Regulation Provides Stability as Risks
Mount," Industry Outlook (Jan. 19, 2011).
AVERA, DI 24
Idaho Power Company
1 which, as described earlier, face a variety of operating and
2 financial challenges.
3 Q.How do interest rates on long-term bonds
4 compare with those proj ected for the next few years?
5 A.Table WEA-1 below compares current interest
6 rates on 30-year Treasury bonds, triple-A rated corporate
7 bonds, and double-A rated utility bonds with near-term
8 projections from Value Line, IHS Global Insight, Blue Chip
9 Financial Forecasts (~Blue Chip"), and the Energy
10 Information Administration (~EIA"), which is a statistical
11 agency of the u.s. Department of Energy:12 TABLE WE-113 INTEREST RATE TRENDS
Current (a)2012 2013 2014 2015
30- Yr. Treasury
Value Line (b)4.5%4.9%5.2%5.5%6.0%
IHS Global Insight (c)4.5%4.7%5.0%5.1%6.0%
Blue Chip (d)4.5%4.8%5.2%5.4%5.5%
AAA Corporate
Value Line (b)5.1%5.6%6.0%6.3%6.5%
IHS Global Insight (c)5.1%5.2%6.0%6.2%6.8%
Blue Chip (d)5.1%5.4%5.8%6.1%6.3%
S&P (e)5.1%6.1%5.7%5.9%6.3%
AA Utility
IHS Global Insight (c)5.3%5.4%6.3%6.4%7.2%
EIA (f)5.3%5.5%6.4%7.0%7.4%
(a) Based on monthly average bond yields for the six-month period Nov. 2010 - Apr. 2011
reported at www.credittrends.moodys.com and
http://www.federalreserve.gov/releases/h15/data.htm.
(b) The Value Line Investment Survey, Forecast for the U.S. Economy (Feb. 25, 2011).
(c) IHS Global Insight, U.S. Economic Outlook at 19 (Feb. 2011).
(d) Blue Chip Financial Forecasts, VoL. 29, No. 12 (Dec. 1,2010).
(e) Standard & Poor's Corporation, "U.S. Economic Forecast: Pouring Water On Troubled
Oil," RatingsDirect (Mar. 8, 2011).
(f) Energy Information Administration, Annual Energy Outlook 2011 Early Release (Dec.
16,2010).
AVERA, DI 25
Idaho Power Company
1 As evidenced above, there is a clear consensus that
2 the cost of permanent capital will be higher in the 2012-
3 2015 time frame than it is currently. As a result, current
4 cost of capital estimates are likely to understate
5 investors' requirements at the time the outcome of this
6 proceeding becomes effective and beyond.
7 Q.What do these events imply with respect to the
8 ROE for Idaho Power?
9 A. No one knows the future of our complex global
10 economy. We know that the financial crisis had been
11 building for a long time, and few predicted that the economy
12 would fall as rapidly as it did, or that corporate bond
13 yields would fluctuate as dramatically as they have. While
14 condi tions in the economy and capital markets appear to have
15 stabilized significantly since 2009, investors continue to
16 react swiftly and negatively to any future signs of trouble
17 in the financial system or economy. The fact remains that
18 the electric utility industry requires significant new
19 capi tal investment. Gi ven the importance of reliable
20 utility service, it would be unwise to ignore investors'
21 increased sensitivity to risk and future capital market
22 trends in evaluating a fair ROE in this case. Similarly,
23 the Company's capital structure must also preserve the
24 financial flexibility necessary to maintain access to
25 capi tal even during times of unfavorable market conditions.
AVERA, DI 26
Idaho Power Company
1 III. CAITAL MAT ESTIMATES
2 Q.What is the purpose of this section?
3 A.This section presents capital market estimates
4 of the cost of equity. First, I examine the concept of the
5 cost of equity, along with the risk-return tradeoff
6 principle fundamental to capital markets. Next, I describe
7 DCF, CAPM, and risk premium analyses conducted to estimate
8 the cost of equity for benchmark groups of comparable risk
9 firms and evaluate comparable earned rates of return
10 expected for utilities. Finally, I examine other factors
11 (e.g., flotation costs) that are properly considered in
12 evaluating a fair ROE.
13 A.Overview.
14 Q.What role does the return on common equity
15 play in a utility's rates?
16 A.The return on common equity is the cost of
17 inducing and retaining investment in the utility's physical
18 plant and assets. This investment is necessary to finance
19 the asset base needed to provide utility service.
20 Competition for investor funds is intense and investors are
21 free to invest their funds wherever they choose. Investors
22 will commit money to a particular investment only if they
23 expect it to produce a return commensurate with those from
24 other investments with comparable risks.
AVERA, DI 27
Idaho Power Company
1 Q.What fundamental economic principle underlies
2 any evaluation of investors' required return on equity?
3 A.The fundamental economic principle underlying
4 the cost of equity concept is the notion that investors are
5 risk averse. In capital markets where relatively risk-free
6 assets are available (e.g., u.s. Treasury securities),
7 investors can be induced to hold riskier assets only if they
8 are offered a premium, or additional return, above the rate
9 of return on a risk-free asset. Because all assets compete
10 with each other for investor funds, riskier assets must
11 yield a higher expected rate of return than safer assets to
12 induce investors to invest and hold them.
13 Gi ven this risk-return tradeoff, the required rate
14 of return (k) from an asset (i) can be generally expressed
15 as:
16 ki = Rf + RP i
17 where:Rf = Risk-free rate of return; and
18 RPi = Risk premium required to hold risky asset
19 i.
20 Thus, the required rate of return for a particular
21 asset at any point in time is a function of:(1) the yield
22 on risk-free assets and (2) its relative risk, with
23 investors demanding correspondingly larger risk premiums for
24 assets bearing greater risk.
AVERA, DI 28
Idaho Power Company
1 Q.Is there evidence that the risk-return
2 tradeoff principle actually operates in the capital markets?
3 A.Yes. The risk-return tradeoff can be readily
4 documented in segments of the capital markets where required
5 rates of return can be directly inferred from market data
6 and where generally accepted measures of risk exist. Bond
7 yields, for example, reflect investors' expected rates of
8 return, and bond ratings measure the risk of individual bond
9 issues. Comparing the observed yields on government
10 securities, which are considered free of default risk, to
11 the yields on bonds of various rating categories
12 demonstrates that the risk-return tradeoff does, in fact,
13 exist.
14 Q.Does the risk-return tradeoff observed with
15 fixed income securities extend to common stocks and other
16 assets?
17 A.It is generally accepted that the risk-return
18 tradeoff evidenced with long-term debt extends to all
19 assets. Documenting the risk-return tradeoff for assets
20 other than fixed income securities, however, is complicated
21 by two factors. First, there is no standard measure of risk
22 applicable to all assets. Second, for most assets -
23 including common stock - required rates of return cannot be
24 directly observed. Yet there is every reason to believe
25 that investors exhibit risk aversion in deciding whether or
26 not to hold common stocks and other assets, just as when
27 choosing among fixed-income securities.
AVERA, DI 29
Idaho Power Company
1 Q.Is this risk-return tradeoff limited to
2 differences between firms?
3 A.No. The risk-return tradeoff principle
4 applies not only to investments in different firms, but also
5 to different securities issued by the same firm. The
6 securi ties issued by a utility vary considerably in risk
7 because they have different characteristics and priorities.
8 Long-term debt secured by a mortgage on property is senior
9 among all capital in its claim on a utility's net revenues
10 and is, therefore, the least risky. Following bonds are
11 other debt instruments also holding contractual claims on
12 the utility's net revenues, such as subordinated debentures.
13 The last investors in line are common shareholders. They
14 receive only the net revenues, if any, remaining after all
15 other claimants have been paid. As a result, the rate of
16 return that investors require from a utility's common stock,
17 the most junior and riskiest of its securities, must be
18 considerably higher than the yield offered by the utility's
19 senior, long-term debt.
20 Q.What does the above discussion imply with
21 respect to estimating the cost of equity for a utility?
22 A.Al though the cost of equity cannot be observed
23 directly, it is a function of the returns available from
24 other investment alternatives and the risks to which the
25 equity capital is exposed. Because it is unobservable, the
26 cost of equity for a particular utility must be estimated by
27 analyzing information about capital market conditions
AVERA, DI 30
Idaho Power Company
1 generally, assessing the relative risks of the company
2 specifically, and employing various quanti tati ve methods
3 that focus on investors' required rates of return. These
4 various quanti tati ve methods typically attempt to infer
5 investors' required rates of return from stock prices,
6 interest rates, or other capital market data.
7 Q.Did you rely on a single method to estimate
8 the cost of equity for Idaho Power?
9 A.No. In my opinion, no single method or model
10 should be relied on by itself to determine a utility's cost
11 of common equity because no single approach can be regarded
12 as defini ti ve. Therefore, I applied both the DCF and CAPM
13 methods to estimate the cost of common equity, and
14 considered the results of the risk premium and comparable
15 earnings approaches. In my opinion, comparing estimates
16 produced by one method with those produced by other
17 approaches ensures that the estimates of the cost of common
18 equity pass fundamental tests of reasonableness and economic
19 logic.
20 Q.Are you aware that the IPUC has traditionally
21 relied primarily on the DCF and comparable earnings methods?
22 A.Yes, although the Commission has also
23 evidenced a willingness to weigh alternatives in evaluating
24 an allowed ROE. For example, while noting that it had not
25 focused on the CAPM for determining the cost of equity, the
26 IPUC recognized in Order No. 29505 that ~methods to evaluate
27 a common equity rate of return are imperfect predictors" and
AVERA, DI 31
Idaho Power Company
1 emphasized ~that by evaluating all the methods presented in
2 this case and using each as a check on the other," the
3 Commission had avoided the pitfalls associated with reliance
4 on a single method.
30
5 B.Comparabie Risk Proxy Groups.
6 Q.How did you implement these quanti tati ve
7 methods to estimate the cost of common equity for Idaho
8 Power?
9 A.Application of the DCF model and other
10 quantitative methods to estimate the cost of equity requires
11 observable capital market data, such as stock prices.
12 Moreover, even for a firm with publicly traded stock, the
13 cost of equity can only be estimated. As a result, applying
14 quanti tati ve models using observable market data only
15 produces an estimate that inherently includes some degree of
16 observation error. Thus, the accepted approach to increase
17 confidence in the results is to apply the DCF model and
18 other quanti tati ve methods to a proxy group of publicly
19 traded companies that investors regard as risk comparable.
20 Q.What specific proxy group did you rely on for
21 your analysis?
22 A.In order to reflect the risks and prospects
23 associated with Idaho Power's jurisdictional utility
24 operations, my DCF analyses focused on a reference group of
25 other utilities composed of those companies included by
30 Order No. 29505 at 38 (emphasis added).
AVERA, DI 32
Idaho Power Company
1 Value Line in its Electric Utili ties Industry groups with:
2 (1) S&P corporate credit ratings of ~BBB-" to ~BBB+," (2) a
3 Value Line Safety Rank of ~2" or ~3," and (3) a Value Line
4 Financial Strength Rating of ~B+" to ~B++. ,,31 I refer to
5 this group as the ~Utility Proxy Group."
6 Q.What other proxy group did you consider in
7 evaluating a fair ROE for Idaho Power?
8 A.Under the regulatory standards established by
9 Hope and Bluefield, the salient criterion in establishing a
10 meaningful benchmark to evaluate a fair ROE is relative
11 risk, not the particular business acti vi ty or degree of
12 regulation. Wi th regulation taking the place of competi ti ve
13 market forces, required returns for utili ties should be in
14 line with those of non-utility firms of comparable risk
15 operating under the constraints of free competi tion.
16 Consistent with this accepted regulatory standard, I also
17 applied the DCF model to a select group of low-risk risk
18 companies in the non-utility sectors of the economy.I
19 refer to this group as the ~Non-Utility Proxy Group."
20 Q .What criteria did you apply to develop the
21 Non-Utili ty Proxy Group?
22 A.My comparable risk proxy group of non-utility
23 firms was composed of those U. S. companies followed by Value
31 In addition, I excluded three utilities (FirstEnergy Corp.,
Northeast Utili ties, and Progress Energy, Inc.) that otherwise wouldhave been in the proxy group, but are not appropriate for inclusion
because they are currently involved in a major merger or acquisition.
AVERA, DI 33
Idaho Power Company
1 Line that:(1) pay common dividends; (2) have a Safety Rank
2 of ~1"; (3) have a Financial Strength Rating of ~B++" or
3 greater; (4) have a beta of 0.85 or less; and (5) have
4 investment grade credit ratings from S&P.
5 Q.Do these criteria provide objective evidence
6 to evaluate investors' risk perceptions?
7 A.Yes. Credit ratings are assigned by
8 independent rating agencies for the purpose of providing
9 investors with a broad assessment of the creditworthiness of
10 a firm. Ratings generally extend from triple-A (the
11 highest) to D (in default). Other symols (e.g., ~A+") are
12 used to show relative standing wi thin a category. Because
13 the rating agencies' evaluation includes virtually all of
14 the factors normally considered important in assessing a
15 firm' s relative credit standing, corporate credit ratings
16 provide a broad, objective measure of overall investment
17 risk that is readily available to investors. Although the
18 credi t rating agencies are not immune to criticism, their
19 rankings and analyses are widely cited in the investment
20 communi ty and referenced by investors. 32 Investment
21 restrictions tied to credit ratings continue to influence
22 capi tal flows, and credit ratings are also frequently used
32 While the ratings agencies were faulted during the financial
crisis for failing to adequately assess the risk associated with
structured finance products, investors continue to regard corporate
credit ratings as a reliable guide to investment risks.
AVERA, DI 34
Idaho Power Company
1 as a primary risk indicator in establishing proxy groups to
2 estimate the cost of common equity.
3 While credit ratings provide the most widely
4 referenced benchmark for investment risks, other quality
5 rankings published by investment advisory services also
6 provide relative assessments of risks that are considered by
7 investors in forming their expectations for common stocks.
8 Value Line's primary risk indicator is its Safety Rank,
9 which ranges from ~1" (Safest) to ~5" (Riskiest). This
10 overall risk measure is intended to capture the total risk
11 of a stock, and incorporates elements of stock price
12 stabili ty and financial strength. Gi ven that Value Line is
13 perhaps the most widely available source of investment
14 advisory information, its Safety Rank provides useful
15 guidance regarding the risk perceptions of investors.
16 The Financial Strength Rating is designed as a guide
17 to overall financial strength and creditworthiness, with the
18 key inputs including financial leverage, business volatility
19 measures, and company size. Value Line's Financial Strength
20 Ratings range from ~A++" (strongest) down to ~C" (weakest)
2 1 in nine steps. Finally, Value Line's beta measures the
22 volatility of a security's price relative to the market as a
23 whole. A stock that tends to respond less to market
24 movements has a beta less than 1.00, while stocks that tend
25 to move more than the market have betas greater than 1.00.
26 Q.How do the overall risks of your proxy groups
27 compare with Idaho Power?
AVERA, DI 35
Idaho Power Company
1 A.Table WEA-2 compares the Utility Proxy Group
2 wi th the Non-Utility Proxy Group and Idaho Power across four
3 key indicators of investment risk. Because the Company does
4 not have publicly traded common stock, the Value Line risk
5 measures shown reflect those published for the Company's
6 parent, IDACORP:7 TABLE WE-2
8 COMPARISON OF RISK INDICATORSS&P Vaiue Line
Credit Safety Financiai ~Rating ~Strength
Utili ty Group BBB 3 B+0.76
Non-Utility Group A 1 A+O. 71
Idaho Power BBB 3 B+O. 70
9 Q.Do these comparisons indicate that investors
10 would view the firms in your proxy groups as risk-comparable
11 to Idaho Power?
12 A. Yes. Considered together, a comparison of
13 these obj ecti ve measures, which consider a broad spectrum of
14 risks, including financial and business position, and
15 exposure to firm-specific factors, indicates that investors
16 would likely conclude that the overall investment risks for
17 Idaho Power are generally comparable to those of the firms
18 in the Utility Proxy Group.
19 With respect to the Non-Utility Proxy Group, its
20 average credit ratings, Safety Rank, and Financial Strength
21 Rating suggest less risk than for Idaho Power, with its 0.71
22 average beta indicating essentially identical risk. While
23 the impact of differences in regulation is reflected in
AVERA, DI 36
Idaho Power Company
1 objective risk measures, my analyses conservatively focus on
2 a lower-risk group of non-utility firms.
3 C.Discounted Cash Fiow Anaiyses.
4 Q.What is the economic basis underlying the DCF
5 model?
6 A.The DCF model attempts to replicate the market
7 valuation process that sets the price investors are willing
8 to pay for a share of a company's stock. The model rests on
9 the assumption that investors evaluate the risks and
10 expected rates of return from all securities in the capital
11 markets. Given these expectations, the price of each stock
12 is adj usted by the market until investors are adequately
13 compensated for the risks they bear. Therefore, we can look
14 to the market to determine what investors believe a share of
15 common stock is worth. By estimating the cash flows
16 investors expect to receive from the stock in the way of
17 future dividends and capital gains, we can calculate their
18 required rate of return. In other words, the cash flows
19 that investors expect from a stock are estimated, and given
20 its current market price, we can ~back-into" the discount
21 rate, or cost of equity, that investors implicitly used in
22 bidding the stock to that price. Notationally, the general
23 form of the DCF model is as follows:
Po D¡ D2+
(l+ke)1 (l+ke)2
+ ... +Di
(1+ke)'
Pi+
(I + k e) i24
AVERA, DI 37
Idaho Power Company
1
2
3
4
5
where: Po
Pt
6
Dt
ke
Current price per share;
Expected future price per share inperiod t;
Expected dividend per share in period t;Cost of equity.
Q.What form of the DCF model is customarily used
7 to estimate the cost of equity in rate cases?
8 A.Rather than developing annual estimates of
9 cash flows into perpetuity, the DCF model can be simplified
10 to a ~constant growth" form: 33
P _ D1o -11 ke - g
12
13
14
15
16
where:
17
Po
Di
Current price per share;
Expected dividend per share in coming
year;
Cost of equity;
Investors' long-term growth expectations.
ke
g =
The cost of equity (Ke) can be isolated by
18 rearranging terms:
19
20
Dk =-l+ge p,
o
This constant growth form of the DCF model
21 recognizes that the rate of return to stockholders consists
22 of two parts:(1) dividend yield (Di/PO) and (2) growth
2 3 ~g. " In other words, investors expect to receive a portion
33 The constant growth DCF model is dependent on a number of strict
assumptions, which in practice are never strictly met. These include a
constant growth rate for both dividends and earnings; a stable dividend
payout ratio; the discount rate exceeds the growth rate; a constant
growth rate for book value and price; a constant earned rate of return
on book value; no sales of stock at a price above or below book value; a
constant price-earnings ratio; a constant discount rate (i. e., no
changes in risk or interest rate levels and a flat yield curve); and all
of the above extend to infinity.
AVERA, DI 38
Idaho Power Company
1 of their total return in the form of current dividends and
2 the remainder through price appreciation.
3 Q.What form of the DCF model did you use?
4 A.I applied the constant growth DCF model to
5 estimate the cost of equity for Idaho Power, which is the
6 form of the model most commonly relied on to establish the
7 cost of equity for traditional regulated utili ties and the
8 method most often referenced by regulators.
9 Q.How is the constant growth form of the DCF
10 model typically used to estimate the cost of equity?
11 A.The first step in implementing the constant
12 growth DCF model is to determine the expected dividend yield
13 (Di/Po) for the firm in question. This is usually
14 calculated based on an estimate of dividends to be paid in
15 the coming year divided by the current price of the stock.
16 The second, and more controversial, step is to estimate
17 investors' long-term growth expectations ~g" for the firm.
18 The final step is to sum the firm' s dividend yield and
19 estimated growth rate to arrive at an estimate of its cost
20 of equity.
21 Q.How was the dividend yield for the Utility
22 Proxy Group determined?
23 A.Estimates of dividends to be paid by each of
24 these utilities over the next twelve months, obtained from
25 Value Line, served as Di. This annual dividend was then
26 di vided by the corresponding stock price for each utility to
27 arrive at the expected dividend yield. The expected
AVERA, DI 39
Idaho Power Company
1 di vidends, stock prices, and resul ting dividend yields for
2 the firms in the Utility Proxy Group are presented on
3 Exhibi t No.2. As shown there, dividend yields for the
4 firms in the Utility Proxy Group ranged from 2.0 percent to
5 5.9 percent.
6 Q.What is the next step in applying the constant
7 growth DCF model?
8 A.The next step is to evaluate long-term growth
9 expectations, or ~g," for the firm in question. In constant
10 growth DCF theory, earnings, dividends, book value, and
11 market price are all assumed to grow in lockstep, and the
12 growth horizon of the DCF model is infinite. But
13 implementation of the DCF model is more than just a
14 theoretical exercise; it is an attempt to replicate the
15 mechanism investors used to arrive at observable stock
16 prices. A wide variety of techniques can be used to derive
17 growth rates, but the only ~g" that matters in applying the
18 DCF model is the value that investors expect.
19 Q.Are historical growth rates likely to be
20 representative of investors' expectations for utilities?
21 A.No. If past trends in earnings, dividends,
22 and book value are to be representative of investors'
23 expectations for the future, then the historical conditions
24 giving rise to these growth rates should be expected to
25 continue. That is clearly not the case for electric
26 utili ties, where structural and industry changes have led to
27 declining growth in dividends, earnings pressure, and, in
AVERA, DI 40
Idaho Power Company
1 many cases, significant write-offs. While these conditions
2 serve to depress historical growth measures, they are not
3 representati ve of long-term expectations for the electric
4 utili ty industry or the expectations that investors have
5 incorporated into current market prices. As a result,
6 historical growth measures for utili ties do not currently
7 meet the requirements of the DCF model.
8 Q.What are investors most likely to consider in
9 developing their long-term growth expectations?
10 A.While the DCF model is technically concerned
11 with growth in dividend cash flows, implementation of this
12 DCF model is solely concerned with replicating the forward-
13 looking evaluation of real-world investors.In the case of
14 electric utili ties , dividend growth rates are not likely to
15 provide a meaningful guide to investors' current growth
16 expectations. This is because utili ties have significantly
17 al tered their dividend policies in response to more
18 accentuated business risks in the industry. 34 As a result
19 of this trend towards a more conservative payout ratio,
20 dividend growth in the utility industry has remained largely
21 stagnant as utilities conserve financial resources to
22 provide a hedge against heightened uncertainties.
34 For example, the payout ratio for electric utilities fell from
approximately 80 percent historically to on the ord~r of 60 percent.
The Value Line Investment Survey (Sep. 15, 1995 at 161, Feb. 4, 2011 at
2237) .
AVERA, DI 41
Idaho Power Company
1 As payout ratios for firms in the electric utility
2 industry trended downward, investors' focus has increasingly
3 shifted from dividends to earnings as a measure of long-term
4 growth.Future trends in earnings, which provide the source
5 for future dividends and ultimately support share prices,
6 play a pivotal role in determining investors' long-term
7 growth expectations. The importance of earnings in
8 evaluating investors' expectations and requirements is well
9 accepted in the investment community. As noted in Finding
10 Reality in Reported Earnings published by the Association
11 for Investment Management and Research:
12 (EJ arnings, presumably, are the13 basis for the investment benefits14 that we all seek. 'Healthy earnings15 equal healthy investment benefits'16 seems a logical equation, but17 earnings are also a scorecard by18 which we compare companies, a filter
19 through which we assess management,20 and a crystal ball in which we try21 to foretell future performance. 35
22 Value Line's near-term proj ections and its
23 Timeliness Rank,36 which is the principal investment rating
24 assigned to each individual stock, are also based primarily
25 on various quantitative analyses of earnings. As Value Line
26 explained:
35 Association for Investment Management
Reali t y in Reported Earnings: An Overview," p. 1 and Research, "Finding
(Dec. 4, 1996).
36 The Timeliness Rank presents Value Line's assessment of relative
price performance during the next six to twelve months based on a fivepoint scale.
AVERA, DI 42
Idaho Power Company
1 The future earnings rank accounts2 for 65% in the determination of
3 relative price change in the future;4 the other two variables (current5 earnings rank and current price6 rank) explain 35%.37
7 The fact that investment advisory services focus on
8 growth in earnings indicates that the investment community
9 regards this as a superior indicator of future long-term
10 growth. Indeed, ~A Study of Financial Analysts: Practice
11 and Theory," published in the Financial Analysts Journal,
12 reported the results of a survey conducted to determine what
13 analytical techniques investment analysts actually use. 38
14 Respondents were asked to rank the relative importance of
15 earnings, dividends, cash flow, and book value in analyzing
16 securi ties. Of the 297 analysts that responded, only three
17 ranked dividends first while 276 ranked it last. The
18 article concluded that ~Earnings and cash flow are
19 considered far more important than book value and
20 di vidends . ,,39
21 More recently, the Financial Analysts Journal
22 reported the results of a study of the relationship between
23 valuations based on al ternati ve multiples and actual market
37 The Value Line Investment Survey, Subscriber's Guide, p. 53.
38 Block, Stanley B., "A Study of Financial Analysts: Practice and
Theory," Financial Analysts Journal (July/August 1999).
39 Id. at 88.
AVERA, DI 43
Idaho Power Company
1 prices, which concluded, ~In all cases studied, earnings
2 dominated operating cash flows and dividends. ,,40
3 Q.Do the growth rate proj ections of security
4 analysts consider historical trends?
5 A.Yes.Professional security analysts study
6 historical trends extensively in developing their
7 proj ections of future earnings. Hence, to the extent there
8 is any useful information in historical patterns, that
9 information is incorporated into analysts' growth forecasts.
10 Q.What are security analysts currently
11 projecting in the way of growth for the firms in the Utility
12 Proxy Group?
13 A.The earnings growth proj ections for each of
14 the firms in the Utility Proxy Group reported by Value Line,
15 Thomson Reuters (~IBES"), and Zacks Investment Research
16 (~Zacks") are displayed on Exhibit No.2. 41
17 Q. Some argue that analysts' assessments of
18 growth rates are biased.Do you believe these proj ections
19 are inappropriate for estimating investors' required return
20 using the DCF model?
21 A.No.In applying the DCF model to estimate the
22 cost of common equity, the only relevant growth rate is the
40 Liu, Jing, Nissim, Doron, & Thomas, Jacob, "Is Cash Flow King in
Valuations?," Financial Analysts Journal, VoL. 63, No.2 (March/April
2007) at 56.
41 Formerly I/B/E/S International, Inc., IBES growth rates are now
compiled and published by Thomson Reuters.
AVERA, DI 44
Idaho Power Company
1 forward-looking expectations of investors that are captured
2 in current stock prices. Investors, just like securities
3 analysts and others in the investment community, do not know
4 how the future will actually turn out. They can only make
5 investment decisions based on their best estimate of what
6 the future holds in the way of long-term growth for a
7 particular stock, and securities prices are constantly
8 adjusting to reflect their assessment of available
9 information.
10 Any claims that analysts' estimates are not relied
11 upon by investors are illogical given the reality of a
12 competi ti ve market for investment advice. If financial
13 analysts' forecasts do not add value to investors' decision
14 making, then it is irrational for investors to pay for these
15 estimates. Similarly, those financial analysts who fail to
16 provide reliable forecasts will lose out in competitive
17 markets relative to those analysts whose forecasts investors
18 find more credible. The reality that analyst estimates are
19 routinely referenced in the financial media and in
20 investment advisory publications (e. g., Value Line) implies
21 that investors use them as a basis for their expectations.
22 The continued success of investment services such as
23 Thompson Reuters and Value Line, and the fact that projected
24 growth rates from such sources are widely referenced,
25 provides strong evidence that investors give considerable
26 weight to analysts' earnings proj ections in forming their
27 expectations for future growth. While the proj ections of
AVERA, DI 45
Idaho Power Company
1 securi ties analysts may be proven optimistic or pessimistic
2 in hindsight, this is irrelevant in assessing the expected
3 growth that investors have incorporated into current stock
4 prices, and any bias in analysts' forecasts - whether
5 pessimistic or optimistic - is similarly irrelevant if
6 investors share the analysts' views. Earnings growth
7 projections of security analysts provide the most frequently
8 referenced guide to investors' views and are widely accepted
9 in applying the DCF model. As explained in New Regula tory
10 Finance:
11 Because of the dominance of12 insti tutional investors and their13 influence on individual investors,14 analysts' forecasts of long-run15 growth rates provide a sound basis16 for estimating required returns.17 Financial analysts exert a strong18 influence on the expectations of
19 many investors who do not possess20 the resources to make their own21 forecasts, that is, they are a cause22 of g (growthJ. The accuracy of23 these forecasts in the sense of24 whether they turn out to be correct25 is not an issue here, as long as26 they reflect widely held27 expectations. 42
28 Q.How else are investors' expectations of future
29 long-term growth prospects often estimated for use in the
30 constant growth DCF model?
31 A.In constant growth theory, growth in book
32 equi ty will be equal to the product of the earnings
42 Morin, Roger A., "New Regulatory Finance," Public Utilities
Reports, Inc., at 298 (2006).
AVERA, DI 46
Idaho Power Company
1 retention ratio (one minus the dividend payout ratio) and
2 the earned rate of return on book equity. Furthermore, if
3 the earned rate of return and the payout ratio are constant
4 over time, growth in earnings and dividends will be equal to
5 growth in book value. Despite the fact that these
6 conditions are seldom, if ever, met in practice, this
7 ~ sustainable growth" approach may provide a rough guide for
8 evaluating a firm's growth prospects and is frequently
9 proposed in regulatory proceedings.
10 Accordingly, while I believe that analysts'
11 forecasts provide a superior and more direct guide to
12 investors' growth expectations, I have included the
13 ~sustainable growth" approach for completeness. The
14 sustainable growth rate is calculated by the formula,
15 g = br+sv, where ~b" is the expected retention ratio, ~r" is
1 6 the expected earned return on equity, ~ s" is the percent of
1 7 common equity expected to be issued annually as new common
18 stock, and ~v" is the equity accretion rate.
19 Q.What is the purpose of the ~sv" term?
20 A.Under DCF theory, the ~sv" factor is a
21 component of the growth rate designed to capture the impact
22 of issuing new common stock at a price above, or below, book
23 value. When a company's stock price is greater than its
24 book value per share, the per-share contribution in excess
25 of book value associated with new stock issues will accrue
26 to the current shareholders. This increase to the book
27 value of existing shareholders leads to higher expected
AVERA, DI 47
Idaho Power Company
1 earnings and dividends, with the ~sv" factor incorporating
2 this additional growth component.
3 Q.What growth rate does the earnings retention
4 method suggest for the Utility Proxy Group?
5 A.The sustainable, ~br+sv" growth rates for each
6 firm in the Utility Proxy Group are summarized on Exhibit
7 No.2, with the underlying details being presented on
8 Exhibi t No.3. For each firm, the expected retention ratio
9 ~b" was calculated based on Value Line's proj ected dividends
10 and earnings per share. Likewise, each firm's expected
11 earned rate of return ~r" was computed by dividing proj ected
12 earnings per share by proj ected net book value. Because
13 Value Line reports end-of-year book values, an adj ustment
14 was incorporated to compute an average rate of return over
15 the year, consistent with the theory underlying this
16 approach to estimating investors' growth expectations.
17 Meanwhile, the percent of common equity expected to be
18 issued annually as new common stock ~s" was equal to the
19 product of the projected market-to-book ratio and growth in
20 common shares outstanding, while the equity accretion rate
21 ~v" was computed as 1 minus the inverse of the proj ected
22 market-to-book ratio.
23 Q.What cost of equity estimates were implied for
24 the Utility Proxy Group using the DCF model?
25 A.After combining the dividend yields and
26 respecti ve growth proj ections for each utility, the
AVERA, DI 48
Idaho Power Company
1 resul ting cost of equity estimates are shown on Exhibit No.
2 2.
3 Q.In evaluating the results of the constant
4 growth DCF model, is it appropriate to eliminate cost of
5 equity estimates that are extreme low or high outliers?
6 A.Yes. In applying quanti tati ve methods to
7 estimate the cost of equity, it is essential that the
8 resul ting values pass fundamental tests of reasonableness
9 and economic logic. Accordingly, DCF estimates that are
10 implausibly low or high should be eliminated when evaluating
11 the results of this method.
12 Q.How did you evaluate DCF estimates at the low
13 end of the range?
14 A.It is a basic economic principle that
15 investors can be induced to hold more risky assets only if
16 they expect to earn a return to compensate them for their
17 risk bearing. As a result, the rate of return that
18 investors require from a utility's common stock, the most
19 junior and riskiest of its securities, must be considerably
20 higher than the yield offered by senior, long-term debt.
21 Consistent with this principle, the DCF results must be
22 adj usted to eliminate estimates that are determined to be
23 extreme low outliers when compared against the yields
24 available to investors from less risky utility bonds.
25 Q.What does this test of logic imply with
26 respect to the DCF results for the Utility Proxy Group?
AVERA, DI 49
Idaho Power Company
1 A.As noted earlier, the average S&P corporate
2 credit rating for the Utility proxy Group is ~BBB," the same
3 as for Idaho Power. Companies rated ~BBB-," ~BBB," and
4 ~BBB+" are all considered part of the triple-B rating
5 category, with Moody's monthly yields on triple-B bonds
6 averaging approximately 6.0 percent in April 2011.43 It is
7 inconceivable that investors are not requiring a
8 substantially higher rate of return for holding common
9 stock. Consistent with this principle, the DCF results for
10 the Utility Proxy Group must be adjusted to eliminate
11 estimates that are determined to be extreme low outliers
12 when compared against the yields available to investors from
13 less risky utility bonds.
14 Q.Have similar tests been applied by regulators?
15 A.Yes. FERC has noted that adjustments are
16 justified where applications of the DCF approach produce
17 illogical results. FERC evaluates DCF results against
18 observable yields on long-term public utility debt and has
19 recognized that it is appropriate to eliminate estimates
20 that do not sufficiently exceed this threshold. In a 2002
21 opinion establishing its current precedent for determining
22 ROEs for electric utilities, for example, FERC noted:
23
24
25
26
27
An adj ustment to
appropriate in the
low-end return of
which is comparable
Moody' s ~A" grade
this data is
case of PG&E's8.42 percent,
to the averagepublic utility
43 Moody's Investors Service, www.credittrends.com.
AVERA, DI 50
Idaho Power Company
1 bond yield of 8.06 percent, for2 October 1999. Because investors
3 cannot be expected to purchase stock4 if debt, which has less risk than
5 stock, yields essentially the same6 return, this low-end return cannot7 be considered reliable in this8 case. 44
9 Similarly, in its August 2006 decision in Kern River
10 Gas Transmission Company, FERC noted that:
11 (TJ he 7.31 and 7.32 percent costs of12 equity for El Paso and Williams13 found by the ALJ are only 110 and14 122 basis points above that average15 yield for public utility debt. 45
16 The Commission upheld the opinion of Staff and the
1 7 Administrative Law Judge that cost of equity estimates for
18 these two proxy group companies ~were too low to be
19 credible." 46
20 The practice of eliminating low-end outliers has
21 been affirmed in numerous FERC proceedings,47 and in its
22 April 15, 2010, decision in SoCal Edison, FERC affirmed
23 that, ~it is reasonable to exclude any company whose low-end
44 Southern California Edison Company, 92 FERC 'l 61,070 at p. 22
(2000) .
45 Kern River Gas Transmission Company, Opinion No. 486, 117 FERC 'l
61,077 at P 140 & n. 227 (2006).
46 Id.
47 See, e.g., Virginia Electric Power Co., 123 FERC 'l 61,098 at P 64
(2008) .
AVERA, DI 51
Idaho Power Company
1 ROE fails to exceed the average bond yield by about 100
2 basis points or more. ,,48
3 Q.What else should be considered in evaluating
4 DCF estimates at the low end of the range?
5 A.As indicated earlier, while corporate bond
6 yields have declined substantially as the worst of the
7 financial crisis has abated, it is generally expected that
8 long-term interest rates will rise as the recession ends and
9 the economy returns to a more normal pattern of growth. As
10 shown in Table WEA-3 below, forecasts of IHS Global Insight
11 and the EIA imply an average triple-B bond yield of 7.15
12 percent over the period 2012-2015:13 TABLE WE-314 IMPLIED BBB BOND YIELD
2012-15
Projected AA Utilty Yield
IHS Global Insight (a)
EIA (b)
6.33%
6.58%
Average 6.45%
Current BBB - AA Yield Spread (c)
Implied Tnple-B Utilty Yield
0.70%
7.15%
(a) IHS Global Insight, U.S. Economic Outlook at 19 (Feb. 2011).
(b) Energy Information Administration, Annual Energy Outlook
2011 Earli¡ Release (Dec. 16,2010).
(c) Based on monthly average bond yields for the six-month
period Nov. 2010 - Apr. 2011.
15 The increase in debt yields anticipated by IHS
16 Global Insight and EIA is also supported by the widely-
48 Southern California Edison co., 131 FERC e¡ 61,020 at P 55 (2010)
(" SoCal Edison").
AVERA, DI 52
Idaho Power Company
1 referenced Blue Chip Financial Forecasts, which proj ects
2 that yields on corporate bonds will climb more than 100
3 basis points through the period 2012-2016.49
4 Q.What does this test of logic imply with
5 respect to the DCF results for the Utility Proxy Group?
6 A.As shown on Exhibit No.2, eight low-end DCF
7 estimates ranged from 2.4 percent to 7.0 percent. Three of
8 these values were below current utility bond yields, with
9 cost of equity estimates of 7.0 percent or below being less
10 than the yield on triple-B utility bonds expected during the
11 period 2012-2015. In light of the risk-return tradeoff
12 principle and the test applied in SoCal Edison, it is
13 inconcei vable that investors are not requiring a
14 substantially higher rate of return for holding common
15 stock, which is the riskiest of a utility's securities. As
16 a result, consistent with the test of economic logic applied
17 by FERC and the upward trend expected for utility bond
18 yields, these values provide little guidance as to the
19 returns investors require from utility common stocks and
20 should be excluded.
21 Q.Do you also recommend excluding estimates at
22 the high end of the range of DCF results?
23 A.Yes. The upper end of the cost of common
24 equity range produced by the DCF analysis presented in
49 Blue Chip Financial Forecasts, Vol. 29, No. 12 (Dec. 1, 2010) &
Vol. 30, No.3 (Mar. 1, 2011).
AVERA, DI 53
Idaho Power Company
1 Exhibi t No. 2 was set by five cost of equity estimates
2 ranging from 17.0 percent to 23.3 percent. When compared
3 wi th the balance of the remaining estimates, these values
4 are clearly implausible and should be excluded in evaluating
5 the results of the DCF model for the Utility Proxy Group.
6 This is also consistent with the precedent adopted by FERC,
7 which has established that estimates found to be ~extreme
8 outliers" should be disregarded in interpreting the results
9 of the DCF model. 50
10 Q.What cost of equity is implied by your DCF
11 resul ts for the Utility Proxy Group?
12 A.As shown on Exhibit No.2 and summarized in
13 Table WEA-4, below, after eliminating illogical low- and
14 high-end values, application of the constant growth DCF
15 model resulted in the following cost of equity estimates:
16 TABLE WEA-4
1 7 DCF RESULTS - UTILITY PROXY GROUP
Growth Rate Average Cost of Equity
Value Line 11. 4%
IBES 10.5%
Zacks 10.4%
br+sv 9.1%
18 Q.What were the results of your DCF analysis for
19 the Non-Utility Proxy Group?
20 A.I applied the DCF model to the Non-Utility
21 Proxy Group in exactly the same manner described earlier for
50 See, e.g., iso New England, Inc., 109 FERC 'I 61,147 at P 205
(2004) .
AVERA, DI 54
Idaho Power Company
1 the Utility Proxy Group. The results of my DCF analysis for
2 the Non-Utility Proxy Group are presented in Exhibit No.4,
3 with the sustainable, ~br+sv" growth rates being developed
4 on Exhibit No.5. As shown on Exhibit No. 4 and summarized
5 in Table WEA-5, below, after eliminating illogical low- and
6 high-end values, application of the constant growth DCF
7 model resulted in cost of common equity estimates on the
8 order of at least 12 percent:
9
10
TABLE WE-S
DCF RESULTS NON-UTILITY PROXY GROUP
IBES
Zacks
br+sv
Average Cost of Equity
11. 9%
12.4%
12.5%
12.1%
Growth Rate
Value Line
11 As discussed earlier, reference to the Non-Utility
12 Proxy Group is consistent with established regulatory
13 principles and required returns for utili ties should be in
14 line with those of non-utility firms of comparable risk
15 operating under the constraints of free competition.
16 D.Capi tai Asset Pricing Modei.
17 Q.Please describe the CAPM.
18 A.The CAPM is generally considered to be the
19 most widely referenced method for estimating the cost of
20 equity both among academicians and professional
21 practitioners, with the pioneering researchers of this
22 method receiving the Nobel Prize in 1990. The CAPM is a
23 theory of market equilibrium that measures risk using the
AVERA, DI 55
Idaho Power Company
1 beta coefficient. Assuming investors are fully diversified,
2 the relevant risk of an individual asset (e.g., common
3 stock) is i ts volatility relative to the market as a whole,
4 wi th beta reflecting the tendency of a stock's price to
5 follow changes in the market. The CAPM is mathematically
6 expressed as:
7
8
9
10
11
12
13
Rj Rf +ßj (Rm - Rf)
where: Rj
Rf
Rm
required rate of return for stock j;risk-free rate;
expected return on the market portfolio;
and,
ßj beta, or systematic risk, for stock j.
14 Like the DCF model, the CAPM is an ex-ante, or
15 forward-looking model based on expectations of the future.
16 As a result, in order to produce a meaningful estimate of
17 investors' required rate of return, the CAPM must be applied
18 using estimates that reflect the expectations of actual
19 investors in the market, not with backward-looking,
20 historical data.
21 Q.How did you apply the CAPM to estimate the
22 cost of equity?
23 A.Application of the CAPM to the Utility Proxy
24 Group based on a forward-looking estimate for investors'
25 required rate of return from common stocks is presented on
26 page 1 of Exhibit No.6. In order to capture the
27 expectations of today's investors in current capital
28 markets, the expected market rate of return was estimated by
AVERA, DI 56
Idaho Power Company
1 conducting a DCF analysis on the dividend paying firms in
2 the S&P 500 Composite Index.
3 The dividend yield for each firm was calculated
4 based on the annual indicateq dividend payment obtained from
5 Value Line, increased by one-years' growth using the rate
6 discussed subsequently (1 + g) to convert them to year-ahead
7 di vidend yields presumed by the constant growth DCF model.
8 The growth rate was equal to the consensus earnings growth
9 proj ections for each firm published by IBES, with each
10 firm' s dividend yield and growth rate being weighted by its
11 proportionate share of total market value. Based on the
12 weighted average of the proj ections for the 354 individual
13 firms, current estimates imply an average growth rate over
14 the next five years of 10.5 percent. Combining this average
15 growth rate with a year-ahead dividend yield of 2.3 percent
16 results in a current cost of common equity estimate for the
17 market as a whole (Rm) of approximately 12.8 percent.
18 Subtracting a 4.5 percent risk-free rate based on the
19 average yield on 30-year Treasury bonds produced a market
20 equi ty risk premium of 8.3 percent.
21 Q.What was the source of the beta values you
22 used to apply the CAPM?
23 A.I relied on the beta values reported by Value
24 Line, which in my experience is the most widely referenced
25 source for beta in regulatory proceedings. As noted in New
26 Regulatory Finance:
AVERA, DI 57
Idaho Power Company
1
2
3
4
5
6
7
8
9
10
11
12
Value Line is the largest and most
widely circulated independent
investment advisory service, and
influences the expectations of a
large number of institutional and
individual investors. Value
Line betas are computed on a
theoretically sound basis using a
broadly based market index, and they
are adjusted for the regression
tendency of betas to converge to
1. 00.51
13 Q.What else should be considered in applying the
14 CAPM?
15 A.As explained by Morningstar:
16 One of the most remarkable17 discoveries of modern finance is18 that of a relationship between firm19 size and return. The relationship20 cuts across the entire size
21 spectrum but is most evident among22 smaller companies, which have23 higher returns on average than24 larger ones. 52
25 Because empirical research indicates that the CAPM
26 does not fully account for observed differences in rates of
27 return attributable to firm size, a modification is required
28 to account for this size effect.
29 According to the CAPM, the expected return on a
30 security should consist of the riskless rate, plus a premium
31 to compensate for the systematic risk of the particular
32 securi ty. The degree of systematic risk is represented by
51 Morin, Roger A., "New Regulatory Finance," Public Utilities
Reports at 71 (2006).
52 Morningstar, "Ibbotson SBBI 2011 Valuation Yearbook," at p. 83
(footnote omitted).
AVERA, DI 58
Idaho Power Company
1 the beta coefficient. The need for the size adj ustment
2 arises because differences in investors' required rates of
3 return that are related to firm size are not fully captured
4 by beta. To account for this, Morningstar has developed
5 size premiums that need to be added to the theoretical CAPM
6 cost of equ~ ty estimates to account for the level of a
7 firm's market capitalization in determining the CAPM cost of
8 equity. 53 Accordingly, my CAPM analyses incorporated an
9 adjustment to recognize the impact of size distinctions, as
10 measured by the average market capitalization for the
11 respective proxy groups.
12 Q.What cost of equity estimate was indicated for
13 the Utility Proxy Group based on this forward-looking
14 application of the CAPM?
15 A.The average market capitalization of the
16 Utili ty Proxy Group is $5.3 billion. Based on data from
17 Morningstar, this means that the theoretical CAPM cost of
18 equity estimate must be increased by 101 basis points to
19 account for the industry group' s relative size. As shown on
20 Exhibit No.6, adjusting the theoretical CAPM result to
21 incorporate this size adjustment results in an average
22 indicated cost of common equity of 11.8 percent.
53 Id. at Table C-1.
AVERA, DI 59
Idaho Power Company
1 Q.What cost of common equity was indicated for
2 the Non-Utility Proxy Group based on this forward-looking
3 application of the CAPM?
4 A.As shown on page 2 of Exhibit No.6, applying
5 the forward-looking CAPM approach to the firms in the Non-
6 Utili ty Proxy Group results in an average implied cost of
7 common equity of 10.0 percent.
8 Q.Is it appropriate to consider anticipated
9 capi tal market changes in applying THE CAPM?
10 A.Yes. As discussed earlier, there is
11 widespread consensus that interest rates will increase
12 materially as the economy continues to strengthen. As a
13 resul t, current bond yields are likely to understate capital
14 market requirements at the time the outcome of this
15 proceeding becomes effective. Accordingly, in addition to
16 the use of current bond yields, I also applied the CAPM
17 based on the forecasted long-term Treasury bond yields
18 developed based on projections published by Value Line, IHS
19 Global Insight and Blue Chip.
20 Q.What cost of equity was produced by the CAPM
21 after incorporating forecasted bond yields?
22 A.As shown on page 1 of Exhibit No.7,
23 incorporating a forecasted yield for 2012-2015 implied a
24 cost of equity of approximately 12.0 percent for the Utility
25 Proxy Group, or 10.2 percent for the group of non-utility
26 firms (page 2 of Exhibit No.7).
AVERA, DI 60
Idaho Power Company
1 Q.Should the CAPM approach be applied using
2 historical rates of return?
3 A.No. The CAPM cost of common equity estimate
4 is calibrated from investors' required risk premium between
5 Treasury bonds and common stocks. In response to heightened
6 uncertainties, investors have repeatedly sought a safe haven
7 in U. S. government bonds and this ~flight to safety" has
8 pushed Treasury yields significantly lower while yield
9 spreads for corporate debt have widened. This distortion
10 not only impacts the absolute level of the CAPM cost of
11 equity estimate, but it affects estimated risk premiums.
12 Economic logic would suggest that investors' required risk
13 premium for common stocks over Treasury bonds has also
14 increased.
15 Meanwhile, backward-looking approaches incorrectly
16 assume that investors' assessment of the required risk
17 premium between Treasury bonds and common stocks is
18 constant, and equal to some historical average. At no time
19 in recent history has the fallacy of this assumption been
20 demonstrated more concretely than it is today. This
21 incongruity between investors' current expectations and
22 historical risk premiums is particularly relevant during
23 periods of heightened uncertainty and rapidly changing
AVERA, DI 61
Idaho Power Company
1 capi tal market conditions, such as those experienced
2 recently. 54
3 E. Risk Premium Approach.
4 Q. Briefly describe the risk premium method.
5 A. The risk premium method of estimating
6 investors' required rate of return extends to common stocks
7 the risk-return tradeoff observed with bonds. The cost of
8 equity is estimated by first determining the additional
9 return investors require to forgo the relative safety of
10 bonds and to bear the greater risks associated with common
11 stock, and by then adding this equity risk premium to the
12 current yield on bonds. Like the DCF model, the risk
13 premium method is capital market oriented. However, unlike
14 DCF models, which indirectly impute the cost of equity, risk
15 premium methods directly estimate investors' required rate
16 of return by adding an equity risk premium to observable
17 bond yields.
18 Q.How did you implement the risk premium method?
19 A.I based my estimates of equity risk premiums
20 for electric utilities on surveys of previously authorized
21 rates of return on common equity. Authorized returns
22 presumably reflect regulatory commissions' best estimates of
23 the cost of equity, however determined, at the time they
54 FERC has previously rej ected CAPM methodologies based on
historical data because whatever historical relationships existed
between debt and equity securities may no longer hold. See Orange &
Rockland Utils., Inc., 40 F.E.R.C. P63,053, at pp. 65,208 -09 (1987),
aff'd, Opinion No. 314, 44 F.E.R.C. P61,253 at 65,208.
AVERA, DI 62
Idaho Power Company
1 issued their final order. Such returns should represent a
2 balanced and impartial outcome that considers the need to
3 maintain a utility's financial integrity and ability to
4 attract capital. Moreover, allowed returns are an important
5 consideration for investors and have the potential to
6 influence other observable investment parameters, including
7 credit ratings and borrowing costs. Thus, this data
8 provides a logical and frequently referenced basis for
9 estimating equity risk premiums for regulated utilities.
10 Q.How did you implement the risk premium
11 approach using surveys of allowed rates of return?
12 A.Surveys of previously authorized rates of
13 return on common equity are frequently referenced as the
14 basis for estimating equity risk premiums. The rates of
15 return on common equity authorized utilities by regulatory
16 commissions across the U. S. are compiled by Regulatory
17 Research Associates and published in its Regula tory Focus
18 report. In Exhibit No.8, the average yield on public
19 utility bonds is subtracted from the average allowed rate of
20 return on common equity for electric utilities to calculate
21 equity risk premiums for each year between 1974 and 2010.
22 Over this 37-year period, these equity risk premiums for
23 electric utilities averaged 3.36 percent, and the yield on
24 public utility bonds averaged 9.01 percent.
AVERA, DI 63
Idaho Power Company
1 Q.Is there any capital market relationships that
2 must be considered when implementing the risk premium
3 method?
4 A.Yes. There is considerable evidence that the
5 magnitude of equity risk premiums is not constant and that
6 equity risk premiums tend to move inversely with interest
7 rates. In other words, when interest rate levels are
8 relatively high, equity risk premiums narrow, and when
9 interest rates are relatively low, equity risk premiums
10 widen. The implication of this inverse relationship is that
11 the cost of equity does not move as much as, or in lockstep
12 wi th, interest rates. Accordingly, for a 1 percent increase
13 or decrease in interest rates, the cost of equity may only
14 rise or fall, say, 50 basis points. Therefore, when
15 implementing the risk premium method, adjustments may be
16 required to incorporate this inverse relationship if current
17 interest rate levels have changed since the equity risk
18 premiums were estimated.
19 Finally, it is important to recognize that the
20 historical focus of the risk premium studies almost
21 certainly ensures that they fail to fully capture the
22 significantly greater risks that investors now associate
23 with providing electric utility service. As a result, they
24 are likely to understate the cost of equity for a firm
25 operating in today's electric power industry.
AVERA, DI 64
Idaho Power Company
1 Q.What cost of equity is implied by surveys of
2 allowed rates of return on equity?
3 A.Based on the regression output between the
4 interest rates and equity risk premiums displayed on page 3
5 of Exhibit No.8, the equity risk premium for electric
6 utilities increased approximately 41 basis points for each
7 percentage point drop in the yield on average public utility
8 bonds. As illustrated on page 1 of Exhibit No.8, with the
9 yield on average public utility bonds in April 2011 being
10 5.62 percent, this implied a current equity risk premium of
11 4. 75 percent for electric utili ties. Adding this equity
12 risk premium to the average yield on triple-B utility bonds
13 of 5.98 percent produces a current cost of equity of
14 approximately 10. 7 percent.
15 Q.What cost of equity was produced by the risk
16 premium approach after incorporating forecasted bond yields?
17 A.As shown on page 2 of Exhibit No.8,
18 incorporating a forecasted yield for 2012-2015 and adjusting
19 for changes in interest rates since the study period implied
20 an equity risk premium of 4.21 percent for electric
21 utili ties. Adding this equity risk premium to the average
22 implied yield on triple-B public utility bonds for 2012-2015
23 of 7.15 percent resulted in an implied cost of equity of
24 approximately 11.4 percent.
25 F.Comparabie Earnings Approach.
26 Q.What other benchmarks did you develop to
27 evaluate the ROE for Idaho Power?
AVERA, DI 65
Idaho Power Company
1 A.As I noted earlier, I also evaluated the ROE
2 by reference to expected rates of return for electric
3 utili ties . Reference to rates of return available from
4 alternative investments of comparable risk can provide an
5 important benchmark in assessing the return necessary to
6 assure confidence in the financial integrity of a firm and
7 its ability to attract capital. This approach is consistent
8 wi th the economic underpinnings for a fair rate of return,
9 as reflected in the comparable earnings test established by
10 the Supreme Court in Hope and Bl uefield. Moreover, it
11 avoids the complexities and limitations of capital market
12 methods and instead focuses on the returns earned on book
13 equi ty, which are readily available to investors.
14 Q.What economic premise underlies the comparable
15 earnings approach?
16 A.The simple, but powerful concept underlying
17 the expected earnings approach is that investors compare
18 each investment al ternati ve with the next best opportunity.
19 If the utility is unable to offer a return similar to that
20 available from other opportunities of comparable risk,
21 investors will become unwilling to supply the capital on
22 reasonable terms. For existing investors, denying the
23 utility an opportunity to earn what is available from other
24 similar risk alternatives prevents them from earning their
25 opportunity cost of capital. In this situation the
26 government is effectively taking the value of investors'
27 capi tal without adequate compensation.
AVERA, DI 66
Idaho Power Company
1 Q.How is the comparison of opportunity costs
2 typically implemented?
3 A.The traditional comparable earnings test
4 identifies a group of companies that are believed to be
5 comparable in risk to the utility. The actual earnings of
6 those companies on the book value of their investment are
7 then compared to the allowed return of the utility. While
8 the traditional comparable earnings test is implemented
9 using historical data taken from the accounting records, it
10 is also common to use proj ections of returns on book
11 investment, such as those published by recognized investment
12 advisory publications (e. g., Value Line). Because these
13 expected returns on book value equity are analogous to the
14 allowed return on a utility's rate base, this measure of
15 opportunity costs results in a direct, ~apples to apples"
16 comparison. My application of the expected earnings
17 approach was focused exclusively on forward-looking
18 proj ections, not historical data.
19 Moreover, regulators do not set the returns that
20 investors earn in the capital markets - they can only
21 establish the allowed return on the value of a utility's
22 investment, as reflected on its accounting records. As a
23 result, the comparable earnings approach provides a direct
24 guide to ensure that the allowed ROE is similar to what
25 other utilities of comparable risk will earn on invested
26 capi tal. This opportunity cost test does not require
27 theoretical models to indirectly infer investors'
AVERA, DI 67
Idaho Power Company
1 perceptions from stock prices or other market data. As long
2 as the proxy companies are similar in risk, their expected
3 earned returns on invested capital provide a direct
4 benchmark for investors' opportunity costs that is
5 independent of fluctuating stock prices, market-to-book
6 ratios, debates over DCF growth rates, or the limitations
7 inherent in any theoretical model of investor behavior.
8 Q.What rates of return on equity are indicated
9 for electric utili ties based on the comparable earnings
10 approach?
11 A.Value Line reports that its analysts
12 anticipate an average rate of return on common equity for
13 the electric utility industry of 10.5 percent over its
14 forecast horizon. 55 Meanwhile, for the firms in the Utility
15 Proxy Group specifically, the returns on common equity
16 proj ected by Value Line over its forecast horizon are shown
17 on Exhibit No.9. Consistent with the rationale underlying
18 the development of the br+sv growth rates, these year-end
19 values were converted to average returns using the same
20 adjustment factor discussed earlier and developed on Exhibit
21 No.3. As shown on Exhibit No.9, Value Line's proj ections
22 for the Utility Proxy Group suggest an average ROE of 10.4
23 percent after eliminating outliers.
24
25
55 The Value Line Investment Survey at 901 (Mar. 25, 2011).
AVERA, DI 68
Idaho Power Company
1 G.Fiotation Costs.
2 Q.What other considerations are relevant in
3 determining the ROE for Idaho Power?
4 A.The common equity used to finance the
5 investment in utility assets is provided from either the
6 sale of stock in the capital markets or from retained
7 earnings not paid out as dividends. When equity is raised
8 through the sale of common stock, there are costs associated
9 wi th ~ floating" the new equity securities. These flotation
10 costs include services such as legal, accounting, and
11 printing, as well as the fees and discounts paid to
12 compensate brokers for selling the stock to the public.
13 Also, some argue that the ~market pressure" from the
14 additional supply of common stock and other market factors
15 may further reduce the amount of funds that a utility nets
16 when it issues common equity.
17 Q.Is there an established mechanism for a
18 utili ty to recognize equity issuance costs?
19 A.No. While debt flotation costs are recorded
20 on the books of the utility, amortized over the life of the
21 issue, and thus increase the effective cost of debt capital,
22 there is no similar accounting treatment to ensure that
23 equity flotation costs are recorded and ultimately
24 recognized. Alternatively, no rate of return is authorized
25 on flotation costs necessarily incurred to obtain a portion
26 of the equity capital used to finance plant. In other
27 words, equity flotation costs are not included in a
AVERA, DI 69
Idaho Power Company
1 utili ty' s rate base because neither that portion of the
2 gross proceeds from the sale of common stock used to pay
3 flotation costs is available to invest in plant and
4 equipment, nor are flotation costs capitalized as an
5 intangible asset. Unless some provision is made to
6 recognize these issuance costs, a utility's revenue
7 requirements will not fully reflect all of the costs
8 incurred for the use of investors' funds. Because there is
9 no accounting convention to accumulate the flotation costs
10 associated with equity issues, they must be accounted for
11 indirectly, with an upward adj ustment to the cost of common
12 equi ty being the most logical mechanism.
13 Q.What is the magnitude of the adjustment to the
14 ~bare bones" cost of common equity to account for issuance
15 costs?
16 A.While there are a number of ways in which a
17 flotation cost adj ustment can be calculated, one of the most
18 common methods used to account for flotation costs in
19 regulatory proceedings is to apply an average flotation-cost
20 percentage to a utility's dividend yield. Based on a review
21 of the finance literature, New Regulatory Finance concluded:
22 The flotation cost allowance23 requires an estimated adjustment to24 the return on equity of25 approximately 5% to 10%, depending26 on the size and risk of the issue. 56
56 Roger A. Morin, "New Regulatory Finance," Public Utilities
Reports, Inc. at 323 (2006).
AVERA, DI 70
Idaho Power Company
1 Al ternati vely, a study of data from Morgan Stanley
2 regarding issuance costs associated with utility common
3 stock issuances suggests an average flotation cost
4 percentage of 3.6 percent. 57
5 Issuance costs are a legitimate consideration in
6 setting the ROE for a utility, and applying these expense
7 percentages to a representative dividend yield for a utility
8 of 4.5 percent implies a flotation cost adjustment on the
9 order of 15 to 45 basis points.
10 Q.Has the IPUC Staff previously considered
11 flotation costs in establishing a fair ROE for Idaho Power?
12 A.Yes. For example, in Case No. IPC-E-08-10,
13 IPUC Staff witness Terri Carlock noted that she had adj usted
14 her DCF analysis to incorporate an allowance for flotation
15 costs. 58
16 iv. RETUR ON EQUITY FOR IDAHO POWER COMPAN
17 Q. What is the purpose of this section?
18 A. In addition to presenting the conclusions of
19 my evaluation of a fair rate of return on equity for Idaho
20 Power, this section also discusses the relationship between
21 ROE and preservation of a utility's financial integrity and
57 Application of Yankee Gas Services Company for a Rate Increase,
DPUC Docket No. 04-06-01, Direct Testimony of George J. Eckenroth (Jul.
2, 2004) at Exhibit GJE-11.1. Updating the results presented by Mr.
Eckenroth through April 2005 also resulted in an average flotation cost
percentage of 3. 6 percent.
58 Case No. IPC-E-08-10, Direct Testimony of Terri Carlock at 12-13
(Oct. 24, 2008).
AVERA, DI 71
Idaho Power Company
1 the ability to attract capital. In addition, I evaluate the
2 reasonableness of Idaho Power's requested capital structure.
3 A.Impiications for Financiai Inteqri ty.
4 Q.Why is it important to allow Idaho Power an
5 adequate authorized ROE?
6 A.Given the importance of the utility industry
7 to the economy and society, it is essential to maintain
8 reliable and economical service to all consumers. While
9 Idaho Power remains committed to deliver reliable service, a
10 utili ty' s ability to fulfill its mandate can be compromised
11 if it lacks the necessary financial wherewithal or is unable
12 to earn a return sufficient to attract capital.
13 As documented earlier, the major rating agencies
14 have warned of exposure to uncertainties associated with
15 capital expenditure requirements, uncertain economic and
16 financial market conditions, future environmental compliance
17 costs, and the potential for continued energy price
18 volatility. As discussed earlier, Idaho Power faces a
19 number of 'potential challenges that might require the
20 relatively swift commitment of significant capital resources
21 in order to maintain the high level of service to which
22 customers have become accustomed.
23 Investors understand how swiftly unforeseen
24 circumstances can lead to deterioration in a utility's
25 financial condition, and stakeholders have discovered first
26 hand how difficult and complex it can be to remedy the
27 si tuation after the fact. While providing the
AVERA, DI 72
Idaho Power Company
1 infrastructure necessary to enhance the power system and
2 meet the energy needs of customers is certainly desirable,
3 it imposes additional financial responsibilities on Idaho
4 Power. For a utility with an obligation to provide reliable
5 service, investors' increased reticence to supply additional
6 capital during times of crisis highlights the necessity of
7 preserving the flexibility necessary to overcome periods of
8 adverse capital market conditions. These considerations
9 heighten the importance of allowing Idaho Power an adequate
10 return on its investment.
11 Q.What role does regulation play in ensuring
12 Idaho Power's access to capital?
13 A.The maj or rating agencies have warned
14 investors of the exposure to uncertainties associated with
15 poli tical and regulatory developments. Investors recognize
16 that constructive regulation is a key ingredient in
17 supporting utility credit ratings and financial integrity,
18 particularly during times of adverse conditions . Fitch
19 noted that a weak economic backdrop ~could result in
20 poli tical push-back to rate increase requests. ,,59 Fitch
21 concluded, ~ (GJ iven the lingering rate of unemployment and
22 voter concerns about the economy, there could well be
23 pockets of adverse rate decisions, and those companies with
59 Fitch Ratings Ltd., "U.S. Utilities, Power and Gas 2009 Outlook,"
Global Power North America Special Report (Dec. 22, 2008).
AVERA, DI 73
Idaho Power Company
1 li ttle financial cushion could suffer adverse effects. ,,60
2 S&P has also emphasized the need for regulatory support,
3 concluding, ~the quality of regulation is at the forefront
4 of our analysis of utility creditworthiness. ,,61 Similarly,
5 Moody's concluded:
6 For the longer term, however, we7 are becoming increasingly concerned8 about possible changes to our9 fundamental assumptions about10 regulatory risk, particularly the11 prospect of a more adversarial12 poli tical (and therefore13 regulatory) environment. A14 prolonged recessionary climate with15 high unemployment, or an intense16 period of inflation, could make17 cost recovery more uncertain. ~
18 Moody's concluded that political risks associated with
19 ~growing consumer intolerance for steadily increasing rates"
20 was a key longer-term challenge for utilities that would be
21 intensified by prolonged unemployment. 63 With respect to
22 Idaho Power specifically, the maj or bond rating agencies
23 have noted the importance of constructive regulatory
24 decisions in mitigating financial pressures, while observing
60 Fitch Ratings Ltd., "U.S. Utilities, Power and Gas 2010 Outlook,"
Global Power North America Special Report (Dec. 4, 2009).
61 Standard & Poor's Corporation, "Assessing U. S. Utility Regulatory
Environments," RatingsDirect (Nov. 7, 2008).
~ Moody's Investors Service, "U. S. Regulated Electric Utilities,Six-Month Update," Industry Outlook (July 2009) .
63 Moody's Investors Service, "U. S. Electric Utilities Face
Challenges Beyond Near-Term," Industry Outlook (Jan. 2010).
AVERA, DI 74
Idaho Power Company
1 that waning support would likely lead to a deterioration in
2 the Company's credit standing. 64
3 Q.Do customers benefit by enhancing the
4 utili ty' s financial flexibility?
5 A.Yes. While providing an ROE that is
6 sufficient to maintain Idaho Power's ability to attract
7 capi tal, even in times of financial and market stress, is
8 consistent with the economic requirements embodied in the
9 Supreme Court's Hope and Bluefield decisions, it is also in
10 customers' best interests. Customers and the service area
11 economy enjoy the benefits that come from ensuring that the
12 utili ty has the financial wherewithal to take whatever
13 actions are required to ensure reliable service.
14 B.Capi tai Structure.
15 Q.Is an evaluation of the capital structure
16 maintained by a utility relevant in assessing its return on
1 7 equity?
18 A.Yes. Other things equal, a higher debt ratio,
19 or lower common equity ratio, translates into increased
20 financial risk for all investors. A greater amount of debt
21 means more investors have a senior claim on available cash
22 flow, thereby reducing the certainty that each will receive
23 his contractual payments. This increases the risks to which
24 lenders are exposed, and they require correspondingly higher
64 See, e. g., Moody's Investors Service, "Credit Opinion: Idaho Power
Company," Global Credit Research (Mar. 9, 2011).
AVERA, DI 75
Idaho Power Company
1 rates of interest. From common shareholders' standpoints, a
2 higher debt ratio means that there are proportionately more
3 investors ahead of them, thereby increasing the uncertainty
4 as to the amount of cash flow, if any, that will remain.
5 Q.What common equity ratio is implicit in Idaho
6 Power's requested capital structure?
7 A.Idaho Power's capital structure is presented
8 in the testimony of Mr. Keen. As summarized in his
9 testimony, the common equity ratio used to compute Idaho
10 Power's overall rate of return was approximately 51 percent
11 in this filing.
12 Q.What was the average capitalization maintained
13 by the Utility Proxy Group?
14 A.As shown on Exhibit No. 10, for the firms in
15 the Utility Proxy Group, common equity ratios at December
16 31, 2010, ranged from 25.3 percent to 63.8 percent and
17 averaged 46.4 percent.
18 Q.What capitalization is representative for the
19 proxy group of utilities going forward?
20 A.As shown on Exhibit No. 10, Value Line expects
21 an average common equity ratio for the proxy group of
22 utilities of 48.9 percent for its three-to-fi ve year
23 forecast horizon, with the individual common equity ratios
24 ranging from 29.0 percent to 67.5 percent.
25 Q.What implication do the uncertainties facing
26 the utility industry have for the capital structures
27 maintained by electric utili ties?
AVERA, DI 76
Idaho Power Company
1 A.As discussed earlier, utili ties are facing
2 energy market volatility, rising cost structures, the need
3 to finance significant capital investment plans, changing
4 environmental mandates, uncertainties over accommodating
5 economic and financial market uncertainties, and ongoing
6 regulatory risks. Taken together, these considerations
7 warrant a stronger balance sheet to deal with an
8 increasingly uncertain environment. A more conservative
9 financial profile, in the form of a higher common equity
10 ratio, is consistent with increasing uncertainties and the
11 need to maintain the continuous access to capital under
12 reasonable terms that is required to fund operations and
13 necessary system investment, even during times of adverse
14 capi tal market conditions.
15 Moody's has repeatedly warned investors of the risks
16 associated with debt leverage and fixed obligations and
17 advised utili ties not to squander the opportunity to
18 strengthen the balance sheet as a buffer against future
19 uncertainties. 65 More recently, Moody's concluded:
20
21
22
23
24
From a credit perspective, we
believe a strong balance sheet
coupled with abundant sources ofliquidi ty represents one of the
best defenses against business and
65 Moody's Investors Service, "Storm Clouds Gathering on the Horizon
for the North American Electric Utility Sector," Special Comment (Aug.
2007); "U.S. Electric Utility Sector," Industry Outlook (Jan. 2008).
AVERA, DI 77
Idaho Power Company
1 operating risk and potential
2 negative ratings actions. 66
3 Similarly, S&P noted that, ~we generally consider a
4 debt to capital level of 50% or greater to be aggressive or
5 highly leveraged for utilities. ,,67 Fitch affirmed that it
6 expects regulated utilities ~to extend their conservative
7 balance sheet stance," and employ ~a judicious mix of debt
8 and equity to finance high levels of planned investments. ,,68
9 This is especially the case for electric utili ties that are
10 exposed to potential significant fluctuations in power
11 supply costs, such as Idaho Power.
12 Q.What other factors do investors consider in
13 their assessment of a company's capital structure?
14 A.Depending on their specific attributes,
15 contractual agreements or other obligations that require the
16 utility to make specified payments may be treated as debt in
17 evaluating Idaho Power's financial risk.PPAs and other
18 contractual commitments typically obligate the utility to
19 make specified minimum payments akin to those associated
20 with traditional debt financing, and investors consider a
21 portion of these obligations as debt in evaluating total
22 financial risks.
66 Moody's Investors Service, "U. S. Electric Utili ties Face
Challenges Beyond Near-Term," Industry Outlook (Jan. 2010).
67 Standard & Poor's Corporation, "Ratings Roundup:
Utility Sector Maintained Strong Credit Quality in a
RatingsDirect (Jan. 26, 2010).
U. S. Electric
Gloomy 2009,"
68 Fitch Ratings Ltd., "u. S. Utilities, Power, and Gas 2010 Outlook,"
Global Power North America Special Report (Dec. 4, 2009).
AVERA, DI 78
Idaho Power Company
1 Similarly, when a utility enters into a mandated PPA
2 wi th a Qualifying Facility (~QF") under PURPA, the fixed
3 charges associated with the contract increase the utility's
4 financial risk in the same way that long-term debt and other
5 financial obligations increase financial leverage. As
6 discussed in the testimony of Mr. Keen, Idaho Power's
7 obligations under PPAs with QFs have expanded dramatically
8 in recent years. Because investors consider the debt impact
9 of such fixed obligations in assessing a utility's financial
10 position, they imply greater risk and reduced financial
11 flexibility.
12 In order to offset the debt equivalent associated
13 with commitments under PPAs with QF developers and other
14 fixed obligations, Idaho Power must rebalance its capital
15 structure by increasing its common equity in order to
16 restore i ts effective capitalization ratios to previous
17 levels. These commitments have been repeatedly cited by
18 major bond rating agencies in connection with assessments of
19 utility financial risks.69 For example, S&P reported that
20 it adjusts Idaho Power's capitalization to include
21 approximately $327 million in imputed debt from PPAs,
69 See, e. g., Standard & Poor's Corporation, "Standard & Poor's
Methodology For Imputing Debt For U. S. Utili ties' Power Purchase
Agreements," RatingsDirect (May 7, 2007); Standard & Poor's Corporation,"Implications of Operating Leases on Analysis of U. S. Electric
Utilities," RatingsDirect (Jan. 15, 2008); Standard & Poor'sCorporation, "Top 10 Investor Questions: U. S. Regulated Electric
Utilities," RatingsDirect (Jan. 22, 2010).
AVERA, DI 79
Idaho Power Company
1 leases, and postretirement benefit obligations. 70 The
2 capital structure ratios presented earlier do not include
3 imputed debt associated with power purchase agreements or
4 the impact of other off-balance sheet obligations. Unless
5 Idaho Power takes action to offset this additional financial
6 risk by maintaining a higher equity ratio, the resulting
7 leverage will weaken the Company' s creditworthiness,
8 implying a higher required rate of return to compensate
9 investors for the greater risks. 71
10 Q.What did you conclude with respect to the
11 Company's capital structure?
12 A.Based on my evaluation, I concluded that Idaho
13 Power's requested capital structure represents a reasonable
14 mix of capital sources from which to calculate the Company's
15 overall rate of return.Idaho Power's requested common
16 equity ratio of approximately 51 percent is consistent with
17 the range of capitalizations implied for the Utility Proxy
18 Group based on year-end 2010 data and Value Line's near-term
19 proj ections.
20 While industry averages provide one benchmark for
21 comparison, each firm must select its capitalization based
22 on the risks and prospects it faces, as well its specific
70 Standard & Poor's Corporation, "Idaho Power Co.," RatingsDirect
(May 14, 2010).
71 Apart from the immediate impact that the fixed obligation of
purchased power costs has on the utility's financial risk, higher fixed
charges also reduce ongoing financial flexibility, and the utility may
face other uncertainties, such as potential replacement power costs in
the event of supply disruption.
AVERA, DI 80
Idaho Power Company
1 needs to access the capital markets. A public utility with
2 an obligation to serve must maintain ready access to capital
3 under reasonable terms so that it can meet the service
4 requirements of its customers. Idaho Power's proposed
5 capi tal structure is consistent with industry benchmarks and
6 reflects the Company's ongoing efforts to maintain its
7 credi t standing and support access to capital on reasonable
8 terms. The reasonableness of the Company's requested
9 capi tal structure is reinforced by the ongoing uncertainties
10 associated with the utility industry, the magnitude of the
11 Company's fixed obligations, including QF contracts, and the
12 importance of supporting continued investment in system
13 improvements, even during times of adverse industry or
14 market conditions.
15 c.Return on Equity Recommendation.
16 Q.Please summarize the results of your analyses.
17 A.Reflecting the fact that investors' required
18 ROE is unobservable and no single method should be viewed in
19 isolation, I used the DCF, CAPM, and risk premium methods
20 and evaluated comparable earned rates of return expected for
21 utilities. In order to reflect the risks and prospects
22 associated with Idaho Power's jurisdictional electric
23 utility operations, my analyses focused on a proxy group of
24 comparable risk electric utilities. Consistent with the
25 fact that utilities must compete for capital with firms
26 outside their own industry, I also referenced a proxy group
AVERA, DI 81
Idaho Power Company
1 of low-risk companies in the non-utility sectors of the
2 economy.
3 My application of the constant growth DCF model
4 considered three al ternati ve growth measures based on
5 proj ected earnings growth, as well as the sustainable,
6 ~br+sv" growth rate for each firm in the respective proxy
7 groups. In addition, I evaluated the reasonableness of the
8 resul ting DCF estimates and eliminated low- and high-end
9 outliers that failed to meet threshold tests of economic
10 logic. My CAPM analyses focused on forward-looking data
11 that best reflects the underlying assumptions of this
12 approach, and my applications of the risk premium and
13 comparable earnings methods focused directly on electric
14 utili ties. The results of my al ternati ve analyses are
15 summarized below in Table WEA-6:16 TABLE WE-6
1 7 SUMY OF QUANTITATIVE RESULTS
DCF
Earnings Growth
Value Line
IBES
Zacks
br + sv~
Current Bond Yields
Proj ected Bond Yields
Electric Utility Risk Premium
Current Bond Yields
Proj ected Bond Yields
Expected Earnings
Value Line 2014-16
Utili ty Proxy Group
utility Non-Utility
11. 4%11. 9%
10.5%12.4%
10.4%12.5%
9.1%12.1%
11. 8%10.0%
12.0%10.2%
10.7%
11. 4%
10.5%
10.4%
AVERA, DI 82
Idaho Power Company
1 Q.What then is your conclusion as to a fair ROE
2 range for Idaho Power?
3 A.Based on my assessment of the relative
4 strengths and weaknesses inherent in each method, and
5 conservatively giving less emphasis to the upper- and lower-
6 most boundaries of the range of results, I concluded that
7 the cost of common equity indicated by my analyses is in the
8 10.4 percent to 11.4 percent range. After incorporating a
9 minimal adjustment for flotation costs of 15 basis points to
10 my ~bare bones" cost of equity range, I concluded that my
11 analyses indicate a fair ROE in the 10.55 percent to 11.55
12 percent range. As discussed in the testimony of Mr. Keen,
13 Idaho Power Energy is requesting an ROE of 10.50 percent in
14 this case. Because the Company's requested ROE falls near
15 the bottom end of my ~bare bones" cost of equity range, it
16 represents a conservative compromise between balancing the
17 impact on customers and the need to provide Idaho Power with
18 a return that is adequate to compensate investors, maintain
19 financial integrity, and attract capital.
20 Apart from the results of the quantitative methods
21 summarized above, it is crucial to recognize the importance
22 of supporting the Company's financial position so that Idaho
23 Power remains prepared to respond to unforeseen events that
24 may materialize in the future. Recent challenges in the
25 economic and financial market environment highlight the
26 imperative of maintaining the Company's financial strength
27 in attracting the capital needed to secure reliable service
AVERA, DI 83
Idaho Power Company
1 at a lower cost for customers. The reasonableness of the
2 Company's requested ROE is reinforced by the fact that
3 current cost of capital estimates are likely to understate
4 investors' requirements at the time the outcome of this
5 proceeding becomes effective and beyond.
6 Q.Does this conclude your direct testimony?
7 A.Yes.
AVERA, DI 84
Idaho Power Company
RECEIVED
BEFORE THE ZOIL JUN -I PH 2= ~3
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IDAHO PUBLIC UTiliTIES COMMISSIONi:' '_"j'",WV v ~
CASE NO. IPC-E-11-08
IDAHO POWER COMPANY
AVERA, 01
TESTIMONY
EXHIBIT NO.1
FINCAP, INC.
Financial Concepts and Applications
Economic and Financial Counsel
WilLIAM E. AVERA
3907 Red River
Austin, Texas 78751
[phone]
FAX [phone]
fincap~texas.net
Summary of Qualifications
Ph.D. in economics and finance; Charered Financial Analyst (CF A 4ì) designation; extensive expert
witness testimony before cours, alternative dispute resolution panels, regulatory agencies and
legislative committees; lectued in executive education programs around the world on ethics,
investment analysis, and regulation; undergrduate and graduate teaching in business and economics;
appointed to leadership positions in governent, industry, academia, and the milita.
Employment
Principal,
FINCAP, Inc.
(Sep. 1979 to present)
Director, Economic Research
Division,
Public Utilty Commission of Texas
(Dec. 1977 to Aug. 1979)
Manager, Financial Education,
International Paper Company
New York City
(Feb. 1977 to Nov. 1977)
Financial, economic and policy consulting to business
and governent. Perform business and public policy
research, cost!enefit analyses and financial modeling,
valuation of businesses (almost 200 entities valued),
estimation of damages, statistical and industr studies.
Provide strategy advice and educational services in public
and private sectors, and serve as expert witness before
regulatory agencies, legislative committees, arbitration
panels, and courts.
Responsible for research and testimony preparation on
rate of return, rate strcture, and econometric analysis
dealing with energy, telecommunications, water and
sewer utilties. Testified in major rate cases and appeared
before legislative committees and served as Chief
Economist for agency. Administered state and federal
grant funds. Communicated frequently with political
leaders and representatives from consumer groups,
media, and investment community.
Directed corporate education programs in accounting,
finance, and economics. Developed course materials,
recruited and trained instrctors, liaison within the
company and with academic institutions. Prepared
operating budget and designed financial controls for
corporate professional development program.
Exhibit No. 1
Case No. IPC-E-11-08
W. Avera, IPC
Page 1 of6
Lecturer in Finance,
The University of Texas at Austin
(Sep. 1979 to May 1981)
Assistant Professor of Finance,
(Sep. 1975 to May 1977)
Assistant Pro.fssor of Business,
University of North Carolina at
Chapel Hil
(Sep. 1972 to Jui. 1975)
Education
Ph.D., Economics and Finance,
University of North Carolina at
Chapel Hil
(Jan. 1969 to Aug. 1972)
B.A., Economics,
Emory University, Atlanta, Georgia
(Sep. 1961 to Jun. 1965)
Taught graduate and undergraduate courses in financial
management and investment theory. Conducted research
in business and public policy. Named Outstading
Graduate Business Professor and received various
administrative appointments.
Taught in BBA, MBA, and Ph.D. programs. Created
project course in finance, Financial Management for
Women, and paricipated in developing Small Business
Management sequence. Organized the North Carolina
Institute for Investment Research, a group of financial
institutions that supported academic research. Faculty
advisor to the Media Board, which funds student
publications and broadcast stations.
Elective courses included financial management, public
finance, monetary theory, and econometrics. Awarded
the Stonier Fellowship by the American Baners'
Association and University Teaching Fellowship. Taught
statistics, macroeconomics, and microeconomics.
Disserttion: The Geometric Mean Strategy as a
Theory of Multiperiod Portfolio Choice
Active in extracurricular activities, president of the
Barkley Forum (debate team), Emory Religious
Association, and Delta Tau Delta chapter. Individual
awards and team championships at national collegiate
debate tournaments.
Professional Associations
Received Chartered Financial Analyst (CF A) designation in 1977; Vice President for Membership,
Financial Management Association; President, Austin Chapter of Planning Executives Institute;
Board of Directors, North Carolina Society of Financial Analysts; Candidate Curiculum Committee,
Association for Investment Management and Research; Executive Committee of Southern Finance
Association; Vice Chair, Staff Subcommittee on Economics and National Association of Regulatory
Utility Commissioners (NARUC); Appointed to NARUC Technical Subcommittee on the National
Energy Act.
Exhibit No. 1
Case No. IPC-E-11-08
W. Avera, IPC
Page 2 of6
Teaching in Executive Education Programs
University-Sponsored Programs: Central Michigan University, Duke University, Louisiana State
University, National Defense University, National University of Singapore, Texas A&M University,
University of Kansas, University of North Carolina, University of Texas.
Business and Government-Sponsored Programs: Advanced Seminar on Earings Regulation,
American Public Welfare Association, Association for Investment Management and Research,
Congressional Fellows Program, Cost of Capital Workshop, Electricity Consumers Resource
Council, Financial Analysts Association of Indonesia, Financial Analysts Review, Financial Analysts
Seminar at Northwestern University, Governor's Executive Development Program of Texas,
Louisiana Association of Business and Industr, National Association of Purchasing Management,
National Association of Tire Dealers, Planning Executives Institute, School of Baning of the South,
State of Wisconsin Investment Board, Stock Exchange of Thailand, Texas Association of State
Sponsored Computer Centers, Texas Bankers' Association, Texas Bar Association, Texas Savings
and Loan League, Texas Society ofCPAs, Tokyo Association of Foreign Banks, Union Bank of
Switzerland, U.S. Departent of State, U.S. Navy, U.S. Veterans Administration, in addition to
Texas state agencies and major corporations.
Presented papers for Mils B. Lane Lectue Series at the University of Georgia and Heubner Lectues
at the University of Pennsylvania. Taught graduate courses in finance and economics for evening
program at S1. Edward's University in Austin from Januar 1979 through 1998.
Expert Witness Testimony
Testified in over 300 cases before regulatory agencies addressing cost of capital, regulatory policy,
rate design, and other economic and financial issues.
Federal Agencies: Federal Communications Commission, Federal Energy Regulatory Commission,
Surface Transportation Board, Interstate Commerce Commission, and the Canadian
Radio-Television and Telecommunications Commission.
State Regulatory Agencies: Alaska, Arizona, Arkansas, California, Colorado, Connecticut,
Delaware, Florida, Georgia, Hawaii, Idaho, Ilinois, Indiana, Iowa, Kansas, Kentucky, Marland,
Michigan, Missouri, Nevada, New Mexico, Montana, Nebraska, North Carolina, Ohio,
Oklahoma, Oregon, Pennsylvania, South Carolina, South Dakota, Texas, Utah, Virginia,
Washington, West Virginia, Wisconsin, and Wyoming.
Testified in 42 cases before federal and state cours, arbitration panels, and alternative dispute
tribunals (89 depositions given) regarding damages, valuation, antitrst liabilty, fiduciar duties, and
other economic and financial issues.
Board Positions and Other Professional Activities
Audit Committee and Outside Director, Georgia System Operations Corporation (electric system
operator for member-owned electric cooperatives in Georgia); Chairman, Board of Print Depot, Inc.
and FINCAP, Inc.; Co-chair, Synchronous Interconnection Committee, appointed by Public Utility
Commission of Texas and approved by governor; Appointed by Hays County Commission to
Citizens Advisory Committee of Habitat Conservation Plan, Operator of AA Ranch, a certified
organic producer of agricultural products; Appointed to Organic Livestock Advisory Committee by
Exhibit No. 1
Case No. IPC-E-11-08
W. Avera, IPC
Page 30f6
Texas Agricultural Commissioner Susan Combs; Appointed by Texas Railroad Commissioners to
study group for The UP/SP Merger: An Assessment of the Impacts on the State of Texas; Appointed
by Hawaii Public Utilties Commission to team reviewing affliate relationships of Hawaiian Electrc
Industries; Chairman, Energy Task Force, Greater Austin-San Antonio Corridor Council; Consultat
to Public Utilty Commission of Texas on cogeneration policy and other matters; Consultant to
Public Service Commission of New Mexico on cogeneration policy; Evaluator of Energy Research
Grant Proposals for Texas Higher Education Coordinating Board.
Community Activities
Board of Directors, Sustainable Food Center; Chair, Board of Deacons, Finance Committee, and
Elder, Central Presbyterian Church of Austin; Founding Member, Orange-Chatham County (N.C.)
Legal Aid Screening Committee.
Military
Captain, U.S. Naval Reserve (retired after 28 years service); Commanding Offcer, Naval Special
Warfare Engineering (SEAL) Support Unit; Officer-in-Charge of SWIFT patrol boat in Vietnam;
Enlisted service as weather analyst (advanced to second class pett officer).
Bibliography
Monographs
Ethics and the Investment Professional (video, workbook, and instructor's guide) and Ethics
Challenge Today (video), Association for Investment Management and Research (1995)
"Definition of Industr Ethics and Development of a Code" and "Applying Ethics in the Real
World," in Good Ethics: The Essential Element of a Firm's Success, Association for Investment
Management and Research (1994)
"On the Use of Security Analysts' Growth Projections in the DCF Model," with Bruce H. Fairchild
in Earnings Regulation Under Iriation, J. R. Foster and S. R. Holmberg, eds. Institute for Study
of Regulation (1982)
An Examination of the Concept of Using Relative Customer Class Risk to Set Target Rates of Return
in Electric Cost-of-Service Studies, with Bruce H. Fairchild, Electricity Consumers Resource
Council (ELCON) (1981); portions reprinted in Public Utilties Fortnightly (Nov. 11, 1982)
"Usefulness of Current Values to Investors and Creditors," Research Study on Current-Value
Accounting Measurements and Utilty, George M. Scott, ed., Touche Ross Foundation (1978)
"The Geometric Mean Strategy and Common Stock Investment Management," with Henr A.
Lataé in Life Insurance Investment Policies, David Cummins, ed. (1977)
Investment Companies: Analysis of Current Operations and Future Prospects, with 1. Finley Lee
and Glenn L. Wood, American College of Life Underwiters (1975)
Articles
"Should Analysts Own the Stocks they Cover?" The Financial Journalist, (March 2002)
"Liquidity, Exchange Listing, and Common Stock Performance," with John C. Groth and Kerr
Cooper, Journal of Economics and Business (Spring 1985); reprinted by National Association of
Security Dealers
Exhibit No. 1
Case No. IPC-E-11-08
W. Avera, IPC
Page 4 of6
"The Energy Crisis and the Homeowner: The Grief Process," Texas Business Review (Jan.-Feb.
1980); reprinted in The Energy Picture: Problems and Prospects, J. E. Pluta, ed., Bureau of
Business Research (1980)
"Use ofIPPS at the Public Utilty Commission of Texas," Proceedings of the IFPS Users Group
Annual Meeting (1979)
"Production Capacity Allocation: Conversion, CWI, and One-Armed Economics," Proceedings of
the NARUC Biennial Regulatory Information Conference (1978)
"Some Thoughts on the Rate of Return to Public Utilty Companies," with Bruce H. Fairchild in
Proceedings of the NARUC Biennial Regulatory Information Conference (1978)
"A New Capital Budgeting Measure: The Integration of Time, Liquidity, and Uncertinty," with
David Cordell in Proceedings of the Southwestern Finance Association (1977)
"Usefulness of Current Values to Investors and Creditors," in Inflation Accounting/Indexing and
Stock Behavior (1977)
"Consumer Expectations and the Economy," Texas Business Review (Nov. 1976)
"Portfolio Performance Evaluation and Long-ru Capital Growt," with Henr A. Latané in
Proceedings of the Eastern Finance Association (1973)
Book reviews in Journal of Finance and Financial Review. Abstracts for CFA Digest. Articles in
Carolina Financial Times.
Selected Papers and Presentations
"Economic Perspective on Water Marketing in Texas," 2009 Water Law Institute, The University of
Texas School of Law, Austin, IX (Dec. 2009).
"Estimating Utilty Cost of Equity in Financial Turmoil," SNL EXNT 15th Anual FERC Bnefing,
Washington, D.C. (Mar. 2009)
"The Who, What, When, How, and Why of Ethics," San Antonio Financial Analysts Society (Jan.
16,2002). Similar presentation given to the Austin Society of Financial Analysts (Jan. 17,2002)
"Ethics for Financial Analysts," Sponsored by Canadian Council of Financial Analysts: delivered in
Calgar, Edmonton, Regina, and Winnipeg, June 1997. Similar presentations given to Austin
Society of Financial Analysts (Mar. 1994), San Antonio Society of Financial Analysts (Nov.
1985), and St. Louis Society of Financial Analysts (Feb. 1986)
"Cost of Capital for Multi-Divisional Corporations," Financial Management Association, New
Orleans, Louisiana (Oct. 1996)
"Ethics and the Treasury Function," Government Treasurers Organization of Texas, Corpus Chnsti,
Texas (Jun. 1996)
"A Cooperative Future," Iowa Association of Electric Cooperatives, Des Moines (December 1995).
Similar presentations given to National G & T Conference, Iring, Texas (June 1995), Kentucky
Association of Electric Cooperatives Anual Meeting, Louisvile (Nov. 1994), Virginia,
Marland, and Delaware Association of Electric Cooperatives Annual Meeting, Richmond (July
1994), and Carolina Electric Cooperatives Annual Meeting, Raleigh (Mar. 1994)
"Information Superhighway Warnings: Speed Bumps on Wall Street and Detours from the
Economy," Texas Society of Certified Public Accountats Natual Gas, Telecommunications and
Electric Industries Conference, Austin (Apr. 1995)
Exhibit No. 1
Case No. IPC-E-11-08
W. Avera, IPC
Page 5 of6
"Economic/Wall Street Outlook," Carolinas Council of the Institute of Management Accountants,
Myrle Beach, South Carolina (May 1994). Similar presentation given to Bell Operating Company
Accounting Witness Conference, Santa Fe, New Mexico (Apr. 1993)
"Regulatory Developments in Telecommunications," Regional Holding Company Financial and
Accounting Conference, San Antonio (Sep. 1993)
"Estimating the Cost of Capital During the 1990s: Issues and Directions," The National Society of
Rate of Return Analysts, Washington, D.C. (May 1992)
"Making Utility Regulation Work at the Public Utility Commission of Texas," Center for Legal and
Regulatory Studies, University of Texas, Austin (June 1991)
"Can Regulation Compete for the Hears and Minds of Industrial Customers," Emerging Issues of
Competition in the Electric Utilty Industr Conference, Austin (May 1 988)
"The Role of Utilties in Fostering New Energy Technologies," Emerging Energy Technologies in
Texas Conference, Austin (Mar. 1988)
"The Regulators' Perspective," Bellcore Economic Analysis Conference, San Antonio (Nov. 1987)
"Public Utilty Commissions and the Nuclear Plant Contractor," Constrction Litigation
Superconference, Laguna Beach, California (Dec. 1986)
"Development of Cogeneration Policies in Texas," University of Georgia Fift Annual Public
Utilities Conference, Atlanta (Sep. 1985)
"Wheeling for Power Sales," Energy Bureau Cogeneration Conference, Houston (Nov. 1985).
"Asymmetric Discounting of Information and Relative Liquidity: Some Empirical Evidence for
Common Stocks" (with John Groth and Kerr Cooper), Southern Finance Association, New
Orleans (Nov. 1982)
"Used and Useful Planning Models," Planning Executive Institute, 27th Corporate Planning
Conference, Los Angeles (Nov. 1979)
"Staff Input to Commission Rate of Return Decisions," The National Society of Rate of Return
Analysts, New York (Oct. 1979)
""Discounted Cash Life: A New Measure ofthe Time Dimension in Capital Budgeting," with David
Cordell, Southern Finance Association, New Orleans (Nov. 1978)
"The Relative Value of Statistics of Ex Post Common Stock Distributions to Explain Variance,"
with Charles G. Marin, Southern Finance Association, Atlanta (Nov. 1977)
"An ANOV A Representation of Common Stock Returns as a Framework for the Allocation of
Portfolio Management Effort," with Charles G. Martin, Financial Management Association,
Montreal (Oct. 1976)
"A Growt-Optimal Portfolio Selection Model with Finite Horizon," with Henr A. Latané,
American Finance Association, San Francisco (Dec. 1974)
"An Optimal Approach to the Finance Decision," with Henry A. Latané, Southern Finance
Association, Atlanta (Nov. 1974)
"A Pragmatic Approach to the Capital Structue Decision Based on Long-Run Growth," with Henr
A. Latané, Financial Management Association, San Diego (Oct. 1974)
"Growth Rates, Expected Retus, and Variance in Portolio Selection and Performance Evaluation,"
with Henry A. Latané, Econometric Society, Oslo, Norway (Aug. 1973)
Exhibit No. 1
Case No. IPC-E-11-08
W. Avera, IPC
Page 6 of6
RECEIVED
BEFORE THE 20U JUN -I PM 2: 43
IDAHO PUBLIC UTILITIES COMMI~~~i6~i¡ÎÀ!ssloN
CASE NO. IPC-E-11-08
IDAHO POWER COMPANY
AVERA, 01
TESTIMONY
EXHIBIT NO.2
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BEFORE THE 20" JUN -I PM 2= 43
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IDAHO PUBLIC UTiliTIES COMMISSÎON""¡~¡¡0d¡d!'%
CASE NO. IPC-E-11-08
IDAHO POWER COMPANY
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EXHIBIT NO.3
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~..I0 CO
BEFORE THE
RECEIVED
2011 JUN -I PM 2: ll:
'n í; :,1('I b..";"'' j ....l
IDAHO PUBLIC UTiliTIES COMMISSIONJT1u"m::s
î.(i .
CASE NO. IPC-E-11-08
IDAHO POWER COMPANY
AVERA, 01
TESTIMONY
EXHIBIT NO.4
DCFMODEL
NON.UT PROXY GROup
(a)(a)(b)(c)(d)(e)(e)(e)(e)
Dividend Growt Rates Cost of Equity Estites
Company Xi ~!!~!i V Line !!~!i
1 3M Company 239%7.0%11.9%113%12.9%9.4%143%13.7%153%
2 Abbott Labs. 3.67%10.0%8.9%9.0%15.0%13.7%12.6%12.7%1 ),8.7%1
3 Alberto-Culver 1.02%15.0%9.4%12.5%8.4%16.0%10.4%13.5%9.4%
4 AT&T Inc. 6.09%5.5%5.7%7.0%5.4%11.6%11.8%13.1%11.5%
5 Automatic Data Proe.2,93%8.0%10.6%10.8%95%10.9%13.5%13.7%12,4%
6 Bard (C.R.)0.77%9.5%10.9%11.8%18.1%10.3%11.7%12.6%
7 Baxter Intl Inc.2.45%10.0%9.6%93%15.5%12.5%\21%11.8%
8 Becton, Dickison 1.97"k 9.5%9.9%10.8%9.0%11.5%11.9%12.8%11.0%
9 Bristol-Myers Squibb 5.11%8.5%1.8%2.0%5.7%13.6%I .6.9%11 7.1%1 108%
10 Brown-Forman 'B'1.90%7.5%10.9%130%10.6%9.4%12.8%14.9%12.5%
11 Chubb Corp. 2.55%2.5%8.7%9.8%8.0%~11.3%12,4%10.5%
12 Church & Dwighl 0.97%12.0%11.8%12.0%10.3%13.0%12.8%13.0%113%
13 Coca-Cola 2.80%9.5%8.7%9.0%9.9%12.3%11.5%11.8%12.7%
14 ColgatePalmolive 2,76%11.0%93%9.2%18.1%13.8%12.1%12.0%I. 20.8%1
15 Commerce Bancshs.2.22%7.0%7.0%7.0%7.9%9.2%9.2%92%10.1%
16 ConAgra Foods 3.92%10.5%7.7%8.0%8.1%14.4%11.6%11.9%12.0%
17 Castro Wholesale 1.24%7.5%13.3%12.9%82%8.7%14.5%14.1%9.5%
18 CuUen/Frost Banke 2.96%4.5%8.5%8.0%5.7%1 7.5%1 11.5%11.0%8.6%
19 CVS Caremark Corp.1.42%9.5%10.1%\20%7.8%10.9%11.5%13.4%92%
20 Ecolab Inc.1.1%12.0%132%13.2%19.6%13.4%14.6%14,6%1 2.1.0%1
21 Exxon Mobil Corp.226%6.0%12.1%8.4%13.5%83%14.4%10.7%15.7%
22 Ge'lMils 3.02%9.5%7.7%8.0%9.3%12.5%10.7%11.0%123%
23 Heinz (H.j.)3.85%6.5%7.0%8.0%13.9%10A%10.9%11.9%1.178%1
24 Hormel Foods 2.01%105%100%93%10.7%12.5%12.0%11.3%12.7%
25 Intl Business Mach.1.77%13.0%11.5%93%20.4%14.8%13.3%11.1%I .22.2%1
26 johnson & johnson 3.44%4.5%6.0%5.8%10.8%7.9%9.4%92%14,2%
27 Kellogg 3.14%9.5%8.6%9.0%9.7%12.6%11.7%12.1%12.9%
28 Kiberly-Clark 4.09%6.5%7.5%8.7%18.6%10.6%11.6%12.8%1..22.7%1
29 Kraft Foods 3.71%8.0%8.4%8.0%10.7%11.7%12.1%11.7%14.4%
30 Lily (Eli) 5.64%-2.5%-6.4%-5.3%8.4%~ I -0.8%11. 03%1 14.0%
31 Lockheed Martn 3.78%10.0%8.1%6.8%20.3%13.8% 11.9% 10.6% 124.1%1
32 McCormick & Co.2.24%8.5%9.6%9.5%13.3%10.7%11.8%11.7%15.6%
33 McDonald's Corp.3.25%9.5%9.8%9.3%10.7%12.8%13.1%12.6%13.9%
34 McKesson Corp.0.98%10.0%14.2%11.0%11.7%11.0%15.2%12.0%12.7%
35 Medtrnic, Inc.2.47%7.5%8.8%8.4%11.7%10.0%11.3%10.9%14.1%
36 Microsoft Corp.2.26%12.5%11.3%11.7%15.3%14.8%13.6%14.0%1 17.5%137NIKE, Inc. 'B'1.49%9.5%10.9%12.5%12.2%11.0%12.4%14.0%13.7%
38 Northrop Grumman 2.82%12.5%11.0%11.%7.9%15.3%13.8%13.9%10.7%
39 PepsiCo, Inc.2.91%11.0%8.9%9.5%14.5%13.9%11.8%12.4%I. 17.4%1
40 Pfizer, Inc.4.50%5.0%2.8%3.5%7.0%9.5%1 7.3%1 8.0%11.5%
41 Procter & Gamble 3.01%8.0%8.9%9.2%7,2%11.0%11.9%12.2%10.3%
42 Rayteon Co.3.02%10.0%8.0%10.0%8.6%13.0%11.0%13.0%11.6%
43 Strker Corp.1.26%12.5%10.9%11.4%13.6%13.8%12.2%12.7%14.9%
44 SyscCorp.3.47%8.0%10.0%9.7%14.2%11.5%13.5%13.2%1.17.6%1
45 nX Companies 1.28%13.5%14.5%14.4%11.1%14.8%15.8%15.7%12A%
46 United Parcel Serv.2.59%9.0%11.7%11.5%17.9%11.6%14.3%14.1% I 20.5%1
47 Veron CommunIC.5.63%4.0%6.2%14.9%5.7%9.6%11.8%1 20.5%1 11.3%48 Walgree Co.1.68%11.5%13.4%13.0%8.4%13.2%15,1%14.7%10.1%
49 Wal-Mart Store 2.16%10.0%10.7%11.3%9.9%12.2%12.9%13.5%12.1%
50 Waste Management 3.52%5.5%9.6%11.0%52%9.0%13.1% 14.5% 8.7%----Average (f)11.9%12.4%12.5%12.1%
(a)ww.valueline.com(retrevedjan.28,2011).
(b)Thomson Reuters Company in Context Reort Oan. 28, 2011).
(c)ww.zacks.com (reteved jan. 31, 2011).
(d)Se Exhibit No.5.
(e)Sum of dividend yield and respectve grwt rate.
(f)Excludes highlighted figure.
Exhibit NO.4
Case No. IPC-E-11-08
WAvera,IPC
Page 1 of 1
BEFORE THE
RECEIVED
2011 JUN -I PM 2: 1+3
IDAHO PUBLIC UTILITIES COMMISS/~lJ¡O¿;1J¡~!ŠsioN
CASE NO. IPC-E-11-08
IDAHO POWER COMPANY
AVERA, 01
TESTIMONY
EXHIBIT NO.5
BR+SV GROWTH RATE
NON-UTLIT PROXY GROUP
(a)(a)(a)(b)(c)(d)(e)--2014-Adjust.--- "sv" Factor --
Company EPS DPS BVPS -l -L fu Adj.r .--L -.~br+sv
1 3M Company $7.60 $3.10 $40.05 592%19.0%1.0818 20.5%12.2%0.0106 0.6731 0.71%12.9%
2 Abbott Labs.$5.70 $2.18 $22.05 61.8%25.9%1.0384 26.8%16.6%(0.0197)0,7900 -1.56%15.0%
3 Albeo-Culver $2.35 $0.55 $17,85 76.6%13.2%1.0315 13.6%10.4%(0.030)0.603 -1.99%8.4%
4 AT&T Inc $3.25 $2.00 $24.05 38.5%13.5%1.0327 14.0%5.4%(0.001)0.466 -0.01%5.4%
5 Automatic Data Proc.$3.45 $1.60 $22.95 53.6%15.0%1.0786 16.2%8.7"k 0.0111 0.7039 0.78%9.5%
6 Bard (C.R.)$7.75 $0.85 $31.45 89.0%24.6%1,255 25.3%22.5%(0.0564)0.7754 -4.37%18.1%
7 Baxter Intl Inc.$5.85 $1.50 $22.90 74.4%25.5%1.0560 27.0%20.1%(0.063)0.724 -4.57%15.5%
8 Becton, Dickinson $7.65 $2.20 $3.10 71.2%22.4%1.0306 23.1%16.5%(0.1030)0.7216 -7.43%9.0%
9 Bristol-Myers Sqibb $2.35 $1.54 $11.65 34.5%20.2%1.0263 20.7%7.1%(0.0212)0.6671 -1.42%5.7%
10 Brown-Forman 'B'$4.50 $1.48 $20.40 67.1%22.1%1.0372 22.9%15.4%(0.06)0.7368 -4.71%10.6%
11 Chubb Corp. $7.00 $1.60 $6.85 77.1%10.8%1.0184 11.0%8.5%(0.0319)0.1632 -0.52%8.0%
12 Church & Dwght $5.80 $1.00 $39.25 82.8%14.8%1.0465 15.5%12.8%(0.0414)0.6075 -2.52%10.3%
13 Coca-Cola $4.95 $2.48 $18.20 49.9%27.2%1.0479 28.5%14.2%(0.0526)0.8267 -4.34%9.9%
14 Colgate-Palmolive $7.20 $3.20 $13.25 55.6%54.3%1.0671 58.0%32.2%(0.1557)0.9086 -14.15%18.1%
15 Commerce Bancshs.$3.35 $1.5 $32.10 65.7"k 10.4%1.040 10.9%7.2%0,0240 0.2867 0.69%7.9%
16 ConAgra Foods $2.35 $1.00 $15.00 57.4%15.7"k 1.0288 16.1%9.3%(0.0217)0.5385 -1.17"1.8.1%
17 Costro Wholesale $4.20 $0.95 $33.50 77.4%12.5%1.0315 12.9%10.0%(0,001)0.5939 -1.79%8.2%
18 Cullenrost Bankers $4.35 $2.10 $4.00 51.7"k 9.9%1.0382 10.3%5.3%0.0132 0.2667 0.35%5.7"1.
19 CVS Caremark Corp.$4.00 $0.56 $38.15 86.0%10.5%1.0268 10.8%9.3%(0.0395)0.3642 -1.4%7.8%
20 Ecolab Inc.$3.60 $0.85 $14.45 76.4%24.9%1.0530 26.2%20.0%(0.0056)0.7592 -0.43%19.6%
21 Exxon Mobil Corp.$9.35 $2.05 $45.50 78.1%20.5%1.0546 21.7%16.9%(0.0578)0.5956 -3.44%13.5%
22 Ge'IMills $3.15 $1.36 $11.95 56.8%26.%1.0318 27.2%15.5%(0.0809)0.7610 -6.16%9.3%
23 Heinz (H.J.)$4.10 $2.32 $14.65 43.4%28.0%1.0908 30.5%13.3%0.0085 0.7830 0.66%13.9%
24 Hormel Foods $2.10 $0.70 $13.55 66.7"1.15.5%1.0527 16.3%10.9%(0.0025)0.6387 -0.16%10.7"/.
25 Intl Business Mach.$18.00 $3.60 $48.75 80.0%36.9%1.0856 40.1%32.1%(0.1501)0,7759 -11.65%20.4%
26 Johnn & Johnson $5.85 $2.65 $27.60 54.7"k 21.2%1.0378 22.0%12.0%(0.0185)0.6846 -1.26%10.8%
27 Kellogg $5.10 $1.88 $9.95 63.1%51.3%1.0352 53.1%33.5%(0.2690)0,8829 -23.75%9.7"1.
28 Kimberly-Oark $6.25 $2,75 $15.55 56.0%40.2%1.0140 40,8%22.8%(0.0506)0.8363 -4.24%18.6%
29 Kraft Foods $3.00 $1.40 $24,00 53.3%12.5%1.0480 13.1%7.0%0.0716 0.5200 3.72%10.7%
30 Lily (Eli) $3.40 $2.20 $15.60 35.3%21.8%1.0636 23.2%8.2%0.0032 0.6716 0.21%8.4%
31 Lockhee Mart $13.25 $3.50 $31.25 73.6%42.4%1.0882 46.1%34.0%(0.1663)0.8188 -13.62%20.3%
32 McCormick & Co.$3.50 $1.36 $18.95 61.%18.5%1,649 19.7"k 12.0%0.0178 0.7293 1.30%13.3%
33 McDonald's Corp.$6.05 $3.00 $19.00 50.4%31.8%1.0303 32.8%16.5%(0,073)0.8000 -5.87%10.7"k
34 McKesson Corp.$6.80 $0.72 $46.65 89.4% 14.6%1.041 15.2%13.6%(0.0380)0.4957 -1.88%11.7"1.
35 Medtronic, Inc.$4.50 $1.8 $25.95 73.8% 17.3%1.0597 18.4%13.6%(0.0326)0.5848 -1.91%11.7"1.
36 Micrsoft Corp.$3.35 $0.96 $10.75 71.3% 31.2%1.0763 33.5%23.9%(0.1104)0.7850 -8.66%15.3%
37 NIKE, Inc. 'B'$5.65 $1.50 $34.60 73.5% 16.3%1.0643 17.4%12.8%(0.0085)0.638 -0.54%12.2%
38 Nortrop Grumman $10.25 $2.50 $68.00 75.6% 15.1%1.0293 15.5%11.7"k (0.0783)0.4868 -3.81%7.9%
39 PepsiCo, Inc.$6.40 $2.34 $24.00 63.4% 26.7"1.1.0724 28.6%18.1%(0,049)0.8118 -3.64%14.5%
40 Pfizer, Inc.$2.05 $1.6 $13.00 43.4% 15.8%1.0154 16.0%7.0%0.5273 0.00%7.0%
41 Procter & Gamble $5.25 $2.18 $29.45 58.5% 17.8%1.0230 18.2%10.7%(0.0495)0.6900 -3.41%7.2%
42 Raytheon Co.$7.20 $2.00 $38.65 72.2% 18.6%1.0231 19.1%13.8%(0.0870)0.5932 -5.16%8.6%
43 Strker Corp.$5.35 $0.84 $32.75 84.3%16.3%1.066 17.4%14.7%(0.0144)0.7213 -1.04%13.6%
44 Sysco Corp.$2.75 $1.0 $lO10 60.0%27.2%1.0502 28,6%17.2%(0.0385)0.7756 -2.98%14.2%
45 TJX Companies $4.80 $0.80 $12,75 83.3%37.6%1.0374 39.1%32.5%(0.25)0.8355 -21.43%11.1%
46 Unite Parcel Serv.$5.50 $2.20 $19.30 60.0%28.5%1.0912 31.1%18.7"k (0.000)0.8245 -0.75%17.9%
47 Verion Communic.$3.05 $1.96 $18.95 35.7%16.1%1.0250 16.5%5.9%(0.002)0.6555 -0.21%5.7%
48 Walgr Co.$3.65 $1.00 $21.15 72.6%17.3%1,252 17.7%12.8%(0.06)0.6475 -4.43%8.4%
49 Wal-Mart Stores $6.05 $1.75 $23.40 71.%25.9%1.0072 26.0%18.5%(0.1157)0.7400 -8.56%9.9%
50 Waste Management $2.90 $1.60 $15.30 44.8%19.0%1.0079 19.1%8.6%(0.0515)0.660 -3.40%5.2%
Exhibit NO.5
Case NO.IPC-E-11-08
W. Avera, IPC
Page 1 of2
BR+SV GROWTH RATE
NON-UTILITY PROXY GROUP
(a)(a)(f)(a)(a)(g)(a)(a)(f)
-- Common Equity -- 2014 Price-- Common Shares -
Company 2009 2014 Qi Hi Low Ay Mf 200 2014 Growth
1 3M Company $12,764 $28,975 17.8%$135.00 $110.00 $122.50 3.059 710.60 723.00 0.35%
2 Abbott Labs.$22,856 $33,550 8.0%$115.00 $95.00 $105.00 4.762 1,551.90 1,520.00 -0.41%
3 Albero-Culver $1,197 $1,64 6.5%$50.00 $40.00 $45.00 2.521 98.26 92.00 -1.31%
4 AT&T Inc. $102,339 $141,895 6.8%$50.00 $40.00 $45.00 1.871 5,901.90 5,900.00 -0,01%
5 Automatic Data Prc.$5,323 $11,700 17.1%$8.00 $70.00 $77.50 3.377 501.70 510.00 0.33%
6 Bard (C.R.)$2,194 $2,83 5.2%$155.00 $125.00 $140.00 4.452 95.92 90.00 -1.27"k
7 Baxter IntIInc.$7,191 $12,60 11.9%$90,00 $75.00 $82.50 3.6æ 60.97 550.00 -1.76%
8 Becton, Dicknson $5,143 $6,98 6.3%$135.00 $110.00 $122.50 3.592 237.08 205.00 -2.87"k
9 Bristol-Myers Squibb $14,785 $19,230 5.4%$40.00 $30.00 $3.00 3.004 1,709.50 1,650.00 -0,71%
10 Brown-Form 'B'$1,895 $2,750 7.7%$85.00 $70.00 $77.50 3.79 146.96 135.00 -1.68%
11 Chubb Corp. $15,634 $18,800 3.8%$85.00 $70.00 $77.50 1.95 332.01 290.00 -2.67%
12 Church & Dwight $1,602 $2,550 9.7"k $110.00 $90.00 $100.00 2.548 70.55 65.00 -1.63%
13 Coca-Cola $24,799 $40,æ5 10.1%$115.00 $95.00 $105.00 5.769 2,3æ.00 2,200.00 -0.91%
14 Colgate-Palmolive $3,116 $6,100 14.4%$160.00 $130.00 $145.00 10.943 494.17 460.00 -1.42%
15 Commerce Bancshs.$1,886 $3,050 10.1%$50.00 $4.00 $45.00 1.402 87.26 95.00 1.71%
16 ConAgra Foods $4,721 $6,300 5.9%$35.00 $30.00 $32.50 2.167 441.66 420.00 -1.00%
17 Costco Wholesale $10,018 $13,72 6.5%$90.00 $75.00 $82.50 2.463 435.97 410.00 -1.22%
18 Cullen/rost Banker $1,894 $2,77 7.9%$6.00 $55.00 $60.00 1.364 60.04 63.00 0.97"k
19 CVS Caremark Corp.$3,768 $4,750 5.5%$6.00 $55.00 $60.00 1.573 1,391.00 1,225.00 -2.51%
20 Ecolab Inc.$2,001 $3,40 11.2%$6.00 $55.00 $60.00 4.152 236.60 235.00 -0,14%
21 Exxon Mobil Corp,$110,569 $191.000 11.6%$125.00 $100.00 $112.50 2.473 4,727.00 4,200.00 -2.34%
22 Ge'IMils $5,175 $7,115 6.6%$55.00 $4.00 $50.00 4.184 656.00 595.00 -1.93%
23 Heinz (H.J.)$1,891 $4,70 20.0%$75.00 $6.00 $67.50 4.608 318.06 321.00 0.18%
24 Hormel Foods $2,124 $3,60 11.1%$40.00 $35.00 $37.50 2.768 267.19 266.00 -0.09%
25 Intl Business Mach.$22,755 $53,650 18,7%$240.00 $195.00 $217.50 4.462 1,305.30 1,100.00 -336%
26 Johnson & Johnson $50,588 $73,850 7.9%$95.00 $80.00 $87.50 3.170 2,754.30 2,675.00 -0.58%
27 Kellogg $2,272 $3,230 7.3%$95.00 $75.00 $85,00 8.543 381.38 325.00 -3.15%
28 Kimberly-Clark $5,406 $6,220 2.8%$105.00 $85.00 $95.00 6.109 417.00 400.00 -0.83%
29 Kraft Foods $25,972 $42,000 10.1%$55.00 $45.00 $50.00 2.083 1,477.90 1,750.00 3.4%
30 Lily (Eli) $9,524 $18,000 13.6%$50.00 $45.00 $47.50 3.045 1,149.00 1,155.00 0.10%
31 Lockheed Marti $4,129 $10,000 19.4%$190.00 $155.00 $172.50 5.520 37290 320.00 -3.01%
32 McCormick & Co.$1,335 $2,555 13.9%$75.00 $6.00 $70.00 3.694 131.80 135.00 0.48%
33 McDonald's Corp.$14,æ4 $19,00 6.2%$105.00 $85.00 $95.00 5.000 1,076.70 1,000.00 -1.47"/.
34 McKesson Corp.$7,532 $11,480 8.8%$100.00 $85.00 $92.50 1.983 271.00 246.00 -1.92%
35 Medtronic, Inc.$14,629 $26,600 12.7"k $70.00 $55.00 $62.50 2.408 1,097.30 1,025.00 -1.35%
36 Micrsoft Corp.$39,558 $85,000 16.5%$55.00 $4.00 $50.00 4.651 8,908.00 7,900.00 -237%
37 NIKE, Inc. 'B'$8,693 $16,550 13.7"/0 $105.00 $8.00 $95.00 2.746 485.50 478.00 -0.31%
38 Nortrop Grumma $12,687 $17,000 6.0%$145,00 $120.00 $132.50 1.949 306.87 250.00 -4.02%
39 PepsiCo, Inc.$17,442 $36,015 15.6%$140.00 $115.00 $127.50 5.313 1,565.00 1,500.00 -0.84%
40 Pfizer, Inc.$90,014 $105,000 3.1%$30.00 $25.00 $27.50 2.115 8,070.00 8,070.00 0.00%
41 Procter & Gamble $63,099 $79,455 4.7"k $105.00 $85.00 $95.00 3.226 2,917.00 2,700.00 -1.53%
42 Raytheon Co.$9,827 $12,375 4.7%$105.00 $85.00 $95.00 2.458 383.20 320.00 -3.54%
43 Strker Corp.$6,595 $12,775 14.1%$130.00 $105.00 $117.50 3.588 397.90 390.00 -0.40%
44 SyscoCorp.$3,450 $5,700 10.6%$50.00 $40.00 $45.00 4.455 590.æ 565.00 -0.86%
45 TJX Companies $2,88 $4,200 7.8%$85.00 $70.00 $77.50 6.078 4039 330.00 -4.22%
46 United Parcel Serv.$7,630 $19,æ5 20.1%$120.00 $100.00 $110.00 5.699 992.85 985.00 -0.16%
47 Verion Communic.$41,600 $53,439 5.1%$60.00 $50.00 $55.00 2.902 2,835.70 2,820.00 -0.11%
48 Walgreen Co.$14,376 $18,500 5.2%$6.00 $55.00 $60,Q 2.837 988.56 875.00 -2.41%
49 Wal-Mart Stores $70,749 $76,025 1.4%$100.00 $80.00 $90.00 3.846 3,786.00 3,250.00 -3.01%
50 Waste Management $6,285 $6,80 1.6%$50.00 $40.00 $45.00 2.941 48.12 445.00 -1.75%
(a)www.valueline.com (retreved Jan. 28, 2011).
(b)Compute using the formula 2'(1+5-Yr. Change in Equity)/(2+5 Yr. Change in Equity).
(c)Product of year..nd "r" for 2014 and Adjustmen1 Factr.
(d)Product of change in common shares outstanding and M/B Ratio.
(e)Computed as 1 - BIM Ratio.
(f)Five-year rate of change.
(g)Average of High and Low expecte market prices divided by 2013-15 BVPS.
Exhibit No. 5
Case No. IPC-E-11-08
W. Avera, fPC
Page 2 of2
CASE NO. IPC-E-11-08
IDAHO POWER COMPANY
AVERA, 01
TESTIMONY
EXHIBIT NO.6
CAPM - CURRENT BOND YIELD
UTILITY PROXY GROUP
Market Rate of Return
Dividend Yield (a)
Growth Rate (b)
Market Return (c)
2.3%
10.5%
12.8%
Less: Risk-Free Rate Cd)
Long-term Treasury Bond Yield
Market Risk Premium (e)
4.5%
8.3%
Utility Proxy Group Beta (f)
Utiity Proxy Group Risk Premium (g)
0.76
6.3%
Plus: Risk-free Rate (d)
Long-term Treasury Bond Yield
Unadjusted CAPM (h)
4.5%
10.8%
Size Adjustment (i)1.01%
Implied Cost of Equity (j)11.8%
(a) Weighted average dividend yield for the dividend paying firms in the S&P 500 from
www.valueline.com(retrievedJan.28.2011).
(b) Weighted average of IBES earnngs growth rates for the dividend payig firms in the S&P 500
(retrieved Feb. 23, 2011).
(c) (a) + (b)
(d) Average yield on 3D-year Treasury bonds for April 2011 from the Federal Reserve Board at
http://www .federalreserve.gov/releases/h15/data/Monthly /HIS _ TCMNOM_ Y20. txt.
(e) (c) - (d).
(f) www.valueline.com (retrieved Apr. 20, 2011).
(g) (e) x (f).
(h) (d) + (g).
(i) Morningstar, "Ibbotson SBBI 2010 Valuation Yearbook," at Table C-L (2010).
(j) (h) + (i).
Exhibit No. 6
Case No. IPC-E-11-08
W. Avera, IPC
Page 1 of2
CAPM - CURRENT BOND YIELD
NON-UTILITY PROXY GROUP
Market Rate of Return
Dividend Yield (a)
Growth Rate (b)
Market Return (c)
2.3%
10.5%
12.8%
Less: Risk-Free Rate (d)
Long-term Treasury Bond Yield
Market Risk Premium (e)
4.5%
8.3%
Non-Utility Proxy Group Beta (f
Utilty Proxy Group Risk Premium (g)
0.71
5.9%
Plus: Risk-free Rate (d)
Long-term Treasury Bond Yield
Unadjusted CAPM (h)
4.5%
10.4%
Size Adjustment (i)-0.38%
Implied Cost of Equity (j)10.0%
(a) Weighted average dividend yield for the dividend paying firms in the S&P 500 from
www.valueline.com (retrieved Jan. 28, 2011).
(b) Weighted average of IBES eamings growth rates for the dividend paying firms in the S&P 500
(retrieved Feb. 23, 2011).
(c) (a) + (b)
(d) Average yield on 3D-year Treasury bonds for April 2011 from the Federal Reserve Board at
http://www .federalreserve.gov /releases/h15/data/Monthly/H15 _ TCMNOM_ Y20. txt.
(e) (c) - (d).
(f) www.valueline.com (retrieved Jan. 28, 2011).
(g) (e) x (f).
(h) (d) + (g).
(i) Morningstar, "Ibbotson SBBI 2010 Valuation Yearbook," at Table C-L (2010).
(j) (h) + (i).
Exhibit No.6
Case No.IPC-E-11-08
w. Avera, IPC
Page 2 of2
CASE NO. IPC-E-11-08
IDAHO POWER COMPANY
AVERA, 01
TESTIMONY
EXHIBIT NO.7
RECEIVED
CAPM - PROJECTED BOND YIELD
UTILITY PROXY GROUP
Market Rate of Return
Dividend Yield (a)
Growth Rate (b)
Market Return (c)
2.3%
10.5%
12.8%
Less: Risk-Free Rate Cd)
Projected Long-term Treasury Bond Yield
Market Risk Premium (e)
5.3%
7.5%
Utility Proxy Group Beta (f)
Utilty Proxy Group Risk Premium (g)
0.76
5.7%
Plus: Risk-free Rate (d)
Projected Long-term Treasury Bond Yield
Unadjusted CAPM (h)
5.3%
11.0%
Size Adjustment (i)1.01%
Implied Cost of Equity (j)12.0%
(a) Weighted average dividend yield for the dividend paying firms in the S&P 500 from
www.valueline.com(retrievedJan.28. 2011).
(b) Weighted average of IBES earnings growth rates for the dividend paying firms in the S&P 500
(retrieved Feb. 23, 2011).
(c) (a) + (b)
(d) Average projected 30-year Treasury bond yield for 2012-2015 based on data from the Value
Line Investment Survey, Forecast for the U.s. Economy (Feb. 25, 2011), IHS Global Insight, U.S.
Economic Outlook at 19 (Feb. 2011), Blue Chip Financial Forecasts, VoL. 29, No. 12 (Dec. 1,
2010), as shown on Table WEA-L.
(e) (c) - (d).
(f) www.valueline.com (retrieved Apr. 20, 2011).
(g) (e) x (f).
(h) (d) + (g).
(i) Morningstar, "Ibbotson SBBI 2011 Valuation Yearbook," at Table C-L (2011).
G) (h) + (i).
Exhibit No. 7
Case No. IPC-E-11-08
W. Avera, IPC
Page 1 of2
CAPM - PROJECTED BOND YIELD
NON-UTILITY PROXY GROUP
Market Rate of Return
Dividend Yield (a)
Growth Rate (b)
Market Return (c)
2.3%
10.5%
12.8%
Less: Risk-Free Rate (d)
Projected Long-term Treasury Bond Yield
Market Risk Premium (e)
5.3%
7.5%
Non-Utility Proxy Group Beta CO
Utility Proxy Group Risk Premium (g)
0.71
5.3%
Plus: Risk-free Rate (d)
Projected Long-term Treasury Bond Yield
Unadjusted CAPM (h)
5.3%
10.6%
Size Adjustment (i)-0.38%
Implied Cost of Equity (j)10.2%
(a) Weighted average dividend yield for the dividend paying firms in the S&P 500 from
www.valueline.com(retnevedJan. 28, 2011).
(b) Weighted average of IBES earnings growth rates for the dividend paying firms in the S&P 500
(retrieved Feb. 23, 2011).
(c) (a) + (b)
(d) Average projected 30-year Treasury bond yield for 2012-2015 based on data from the Value
Line Investment Survey, Forecast for the U.S. Economy (Feb. 25, 2011), IHS Global Insight, U.s.
Economic Outlook at 19 (Feb. 2011), Blue Chip Financial Forecasts, VoL. 29, No. 12 (Dec. 1,
2010), as shown on Table WEA-L.
(e) (c) - (d).
(f) www.valueline.com (retneved Jan. 28, 2011).
(g) (e) x (f).
(h) (d) + (g).
(i) Morningstar, "Ibbotson SBBI 2010 Valuation Yearbook," at Table C-L (2010).
G) (h) + (i).
Exhibit NO.7
Case No. IPC-E-11-08
W. Avera, IPC
Page 2 of2
RECEIVED
BEFORE THE 200 Jmi-I PH 2: 43
,. ¡tr~i,,':¡ddP( ,~~~J.~X~ (,::; .~~ i
IDAHO PUBLIC UTiliTIES COMMrSSION,""L v',
CASE NO. IPC-E-11-08
IDAHO POWER COMPANY
AVERA, 01
TESTIMONY
EXHIBIT NO.8
ELECTRIC UTILITY RISK PREMIUM
CURRENT BOND YIELDS
Current Equity Risk Premium
(a) A vg. Yield over Study Period
(b) April 2011 Average Utility Bond Yield
Change in Bond Yield
9.01%
5.62%
-3.39%
(c) Risk Premium/lnterest Rate Relationship
Adjustment to Average Risk Premium
-0.4095
1.39%
(a) Average Risk Premium over Study Period
Adjusted Risk Premium
3.36%
4.75%
Implied Cost of Equity
(b) April 2011 BBB Utility Bond Yield
Adjusted Equity Risk Premium
Risk Premium Cost of Equity
5.98%
4.75%
10.73%
(a) Exhibit No.8, page 3.
(b) Moody's Investors Service, www.creditrends.com.
(c) Exhibit No.8, page 4.
Exhibit No.8
Case No. IPC-E-11-08
W. Avera, IPC
Page 1 of4
ELECTRIC UTILITY RISK PREMIUM
PROJECTED BOND YIELDS
Current Equity Risk Premium
(a) Avg. Yield over Study Period
(b) Projected Avg. A/BBB Utility Bond Yield 2012-15
Change in Bond Yield
9.01%
6.93%
-2.08%
(c) Risk Premium/lnterest Rate Relationship
Adjustment to Average Risk Premium
-0.4095
0.85%
(a) Average Risk Premium over Study Period
Adjusted Risk Premium
3.36%
4.21%
Implied Cost of Equity
(d) Projected BBB Utility Bond Yield 2012-15
Adjusted Equity Risk Premium
Risk Premium Cost of Equity
7.15%
4.21%
11.37%
(a) Exhibit No.8, page 3.
(b) Average of the implied yields on utilty bonds rated "A" and "Baa" for 2012-15 based on data from
IHS Global Insight, U.S. Economic Outlook at 19 (Feb. 2011), Energy Information Administration,
Annual Energy Outlook 2011 Early Release (Dec. 16, 2010), and Moody's Investors Service at
www.credittrends.com.
(c) Exhbit No.8, page 4.
(d) Table WEA-3.
Exhibit NO.8
Case No. IPC-E-11-08
W. Avera, IPC
Page 2 of4
ELECTRIC UTILITY RISK PREMIUM
AUTORIZED RETUNS
la)(b)
Allowed Average Utility Risk
Year ROE Bond Yield Premium
1974 13.10%9.27%3.83%
1975 13.20%9.88%3.32%
1976 13.10%9.17%3.93%
1977 13.30%8.58%4.72%
1978 13.20%9.22%3.98%
1979 13.50%10.39%3.11%
1980 14.23%13.15%1.08%
1981 15.22%15.62%-0.40%
1982 15.78%15.33%0.45%
1983 15.36%13.31%2.05%
1984 15.32%14.03%1.29%
1985 15.20%12.29%2.91%
1986 13.93%9.46%4.47%
1987 12.99%9.98%3.01%
1988 12.79%10.45%2.34%
1989 12.97%9.66%3.31%
1990 12.70%9.76%2.94%
1991 12.55%9.21%3.34%
1992 12.09%8.57%3.52%
1993 11.41%7.56%3.85%
1994 11.34%8.30%3.04%
1995 11.55%7.91%3.64%
1996 11.9%7.74%3.65%
1997 11.40%7.63%3.77%
1998 11.66%7.00%4.66%
1999 10.77%7.55%3.22%
2000 11.43%8.09%3.34%
2001 11.09%7.72%3.37%
2002 11.6%7.53%3.63%
2003 10.97%6.61%4.36%
2004 10.75%6.20%4.55%
2005 10.54%5.67%4.87%
2006 10.36%6.08%4.28%
2007 10.36%6.11%4.25%
2008 10.46%6.65%3.81%
2009 10.48%6.28%4.20%
2010 10.34%5.56%4.78%
Average 12.38%9.01%3.36%
(a)Major Rate Case Decisions, Regulatory Focus, Regulatory Research Associates; UtilityScape
Regulatory Service, Argus.
(b)Moody's Investors Service.
Exhibit NO.8
Case NO.IPC-E-11-08
W. Avera, IPC
Page 3 of4
ELECTRIC UTLITY RISK PREMIUM
REGRESSION RESULTS
SUMY OUTPUT
Regression Statistics
Multiple R 0.9007749
R Square 0.8113955
Adjusted R Square 0.8060068
Standard Error 0.0052509
Observations 37
ANOVA
df
Regression
Residual
Total
1
35
36
SS MS F Signifcance F
0.004151593 0.004152 150.5735 3.1021E-14
0.00965016 2.76E-05
0.005116609
Intercept
X Variable 1
Coefficients
0.0705528
-0.409496
Standard Error t Stat P-value Loer 95% Upper 95% Lor 95.0% Upper 95.0%
0.003129538 22.54415 L.99E-22 0.06419946 0.07690607 0.064199459 0.076906074
0.033371508 -12.2708 3.1E-14 -0.47724424 -0.34174854 -0.47724424 -0.34174854
Exhibit NO.8
Case NO.IPC-E-11-08
W. Avera, IPC
Page 4 of4
BEFORE THE
RECEIVED
iOn Jml - i PM 2= 43
IDAHO PUBLIC UTILITIES COMMlsi§æ~C¿;j¡lf;¡!~81
CASE NO. IPC-E-11-08
IDAHO POWER COMPANY
AVERA, 01
TESTIMONY
EXHIBIT NO.9
COMPARABLE EARNINGS APPROACH
UTILITY PROXY GROUP
(a)(b)(c)
Expected Retur Adjustment Adjusted Return
Company on Common Equity Factor on Common Equity
1 Ameren Corp.7.0%1.0188 1 7.1%1
2 American Elec Pwr 10.5%1.028674 10.8%
3 Avista Corp.9.0%1.01767 9.2%
4 Black Hils Corp.8.0%1.012476 8.1%
5 CenterPoint Energy 14.0%1.025337 14.4%
6 Cleco Corp.10.0%1.026528 10.3%
7 CMS Energy 12.5%1.030038 12.9%
8 Constellation Energy 7.0%1.025032 7.1%1
9 DTE Energy Co.9.0%1.020027 9.2%
10 Edison International 5.5%1.019842 5.6%
11 Empire District Elec 10.5%1.011911 10.6%
12 Great Plains Energy 8.0%1.023109 8.2%
13 Hawaiian Elec.10.5%1.018344 10.7%
14 IDA CORP, Inc.8.5%1.023006 8.7%
15 Integrys Energy Group 9.5%1.014113 9.6%
16 ITC Holdings Corp.15.5%1.055318 16.4%
17 Oter Tail Corp.8.5%1.035333 8.8%
18 Pepco Holdings 7.0%1.021046 7.1%1
19 PG&ECorp.12.0%1.030584 12.4%
20 Pinnacle West Capital 8.5%1.022676 8.7%
21 Portland General Elec.8.5%1.02908 8.7%
22 TECOEnergy 13.0%1.02892 13.4%
23 UIL Holdings 9.0%1.081864 9.7%
24 Westar Energy 10.0%1.020723 10.2%
25 Wisconsin Energy 13.0%1.021472 13.3%
Average (d)10.4%
(a) The Value Line Investment Survey (Feb. 4, Feb. 25, & Mar. 25, 2011).
(b) Adjustment to convert year-end return to an average rate of return from Exhibit No.3.
(c) (a) x (b).
(d) Excludes highlighted figures.
Exhibit NO.9
Case No. IPC-E-11-Qa
W. Avera, IPC
Page 1 of 1
RECEIVED
BEFORE THE 2011 JUH-I Pt~ 2= 43
IDAHO PUBLIC UTILITIES COMI'~~ra~¡'šsioN
CASE NO. IPC-E-11-08
IDAHO POWER COMPANY
AVERA, 01
TESTIMONY
EXHIBIT NO. 10
CAPITAL STRUCTURE
UTILITY PROXY GROUP
At Fiscal Year-End 2010 (a)Value Line Projected (b)
Common Common
Company Debt Preferred Equity Debt Other Equity
1 Ameren Corp.47.1%0.0%52.9%46.0%1.0%53.0%
2 American Elec Pwr 55.1%0.2%44.7%49.5%0.0%50.5%
3 Avista Corp.47.4%2.2%50.4%48.0%0.0%52.0%
4 Black Hils Corp.52.0%0.0%48.0%50.5%0.0%49.5%
5 CenterPoint Energy 74.7%0.0%25.3%71.0%0.0%29.0%
6 Cleco Corp.51.7%0.0%48.2%44.5%0.5%55.0%
7 CMSEnergy 71.7%0.0%28.3%65.5%0.5%34.0%
8 Constellation Energy 34.7%1.5%63.8%31.5%1.0%67.5%
9 DTE Energy Co.49.9%2.1%48.0%52.5%0.0%47.5%
10 Edison International 51.9%3.8%44.3%52.0%3.0%45.0%
11 Empire District Elec 51.3%0.0%48.7%48.0%0.0%52.0%
12 Great Plains Energy 54.0%0.6%45.4%51.0%0.5%48.5%
13 Hawaiian Elec.47.3%1.2%51.5%47.0%1.0%52.0%
14 IDACORP, Inc.51.2%0.0%48.8%49.5%0.0%50.5%
15 Integrys Energy Group 47.6%0.0%52.4%45.0%1.0%54.0%
16 ITC Holdings Corp.69.1%0.0%30.9%66.5%0.0%33.5%
17 Otter Tail Corp.40.2%1.4%58.3%39.0%0.0%61.0%
18 Pepco Holdings 46.6%0.0%53.4%52.0%0.0%48.0%
19 PG&ECorp.50.4%1.1%48.5%45.0%1.0%54.0%
20 Pinacle West Capital 49.3%0.0%50.7%46.5%0.0%53.5%
21 Portland General Elec.53.1%0.0%46.9%50.0%0.0%50.0%
22 TECOEnergy 59.4%0.0%40.6%52.5%0.0%47.5%
23 UIL Holdings 60.7%0.0%39.2%58.5%0.0%41.5%
24 Westar Energy 54.3%0.4%45.3%54.0%0.5%45.5%
25 Wisconsin Energy 53.5%0.4%46.2%51.5%0.5%48.0%
Average 53.0%0.6%46.4%50.7%0.4%48.9%
(a) Company Form lO-K and Annual Reports.
(b) The Value Line Investment Survey (Feb. 4, Feb. 25, & Mar. 25, 2011).
Exhibit No. 10
Case No. IPC-E-11-08
W. Avera, IPC
Page 1 of 1