20070608Hadaway direct.pdf

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BEFORE THE IDAHO PUBLIC UTILITIES COMMISSION
IN THE MATTER OF THE
APPLICATION OF ROCKY
MOUNTAIN POWER FOR
APPROVAL OF CHANGES TO ITS
ELECTRIC SERVICE SCHEDULES
CASE NO. PAC-07-
Direct Testimony of Samuel C. Hadaway
ROCKY MOUNTAIN POWER
CASE NO. P AC-07-
June 2007
Introduction and Qualifications
Please state your name, occupation, and business address.
My name is Samuel C. Hadaway. I am a Principal in FINANCO, Inc., Financial
Analysis Consultants, 3520 Executive Center Drive, Austin, Texas 78731.
On whose behalf are you testifying?
I am testifying on behalf of Rocky Mountain Power (hereinafter the Company).
Please state your educational background and describe your professional
training and experience.
I have an economics degree from Southern Methodist University and MBA and
Ph.D. degrees in fmance from the University of Texas at Austin (UT Austin).
serve as an adjunct professor in the McCombs School of Business at UT Austin.
have taught economics and finance courses and I have conducted research and
directed graduate students writing in these areas. I was previously Director of the
Economic Research Division at the Public Utility Commission of Texas, where I
supervised the Commission s finance, economics, and accounting staff and served
as the Commission s chief financial witness in electric and telephone rate cases. I
have taught courses in various utility conferences on cost of capital, capital
structure, utility fmancial condition, and cost allocation and rate design issues. I
have made presentations before the New York Society of Security Analysts, the
National Rate ofRetum Analysts Forum, and various other professional and
legislative groups. I have served as a vice president and on the board of directors
of the Financial Management Association.
A list of my publications and testimony I have given before various
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Rocky Mountain Power
regulatory bodies and in state and federal courts is contained in my resume, which
is included as Exhibit No.
Purpose and Summary of Testimony
What is the purpose of your testimony?
The purpose of my testimony is to estimate Rocky Mountain Power s market
required rate of return on equity (ROE).
Please outline and describe the testimony you will present.
My testimony is divided into three additional sections. Following this
introduction, I review various methods for estimating the cost of equity. In this
section, I discuss comparable earnings methods, risk premium methods, and
discounted cash flow (DCF) methods. In the following section, I review general
capital market costs and conditions and discuss recent developments in the
electric utility industry that may affect the cost of capital. In the final section, I
discuss the details of my cost of equity studies and summarize my ROE
recommendations.
Please describe your cost of equity studies and state your ROE
recommendation.
My ROE estimate is based on alternative versions of the constant ,growth and
multistage growth DCF model and is confirmed by my risk premium analysis and
my review of economic conditions expected to prevail during the coming year.
Rocky Mountain Power s cost of equity cannot be estimated directly from its own
market data because Rocky Mountain Power is a division ofPacifiCorp, which is
a wholly-owned subsidiary of MidAmerican Energy Holdings Company. As such
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Rocky Mountain Power
Rocky Mountain Power does not have publicly traded common stock or other
independent market data that would be required to estimate its cost ofequity
directly. I apply the DCF models to a conservative sample of electric utilities
selected from the Value Line Investment Survey. To be included in my
comparable company group, companies were required to have a single-A bond
rating by either Moody s or Standard & Poor s (S&P), to derive at least 65 percent
of revenues from regulated utility sales,l to have consistent financial records not
affected by recent mergers or restructuring, and to have a consistent dividend
record as required by the DCF model.
To test my DCF results, I provide a bond yield plus equity risk premium
analysis based on Moody s single-A cost of utility debt. This is the appropriate
basis for the risk premium analysis since the Company s senior debt is rated
single-A by both Moody s and S&P (A3 by Moody s and A- by S&P).
I also present S&P's forecasts for economic .growth and for expected
interest rates over the next year. The S&P forecasts indicate continuing economic
growth and higher interest rates. Under current economic, market, and electric
utility industry conditions, this combination approach is the most appropriate for
estimating the fair cost of equity capital. The data sources and the details of my
rate of return analysis are contained in Exhibits Nos. 2 through 6.
1 In prior cases, a 70 percent regulated revenue filter was applied. In the updated comparable
company 10-Ks for 2006, the percentage of regulated revenues for four companies dropped to
between 65 percent and 70 percent of total revenues. To retain these companies, so as to maintain
a large, statistically reliable sample, the regulated revenues filter was reduced to 65 percent.
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Rocky Mountain Power
My DCF analysis indicates that an ROE range of 10.5 percent to 10.
percent is appropriate. As I will explain in more detail later, the DCF results from
the traditional constant growth DCF model fail to meet basic checks of
reasonableness and, therefore, those results are not included in the estimated DCF
range. The traditional constant growth DCF results do not reasonably reflect the
current cost of equity because those results depend on historically low dividend
yields and pessimistic analysts' growth forecasts. Under these circumstances, the
traditional constant growth DCF model, with growth rates based on traditional
analysts' growth rate sources , does not adequately reflect the market's required rate
of return. My risk premium analysis serves as a check of reasonableness for the
DCF results. That analysis indicates an ROE of 10.72 percent with other risk
premium approaches indicating ROEs as high as 11.4 percent.
Because recent interest rate and stock price data have a significant effect
on the ROE estimation models, analytical results should be evaluated carefully.
Particularly for the traditional constant growth DCF model, extreme market
volatility for utility shares and low analyst growth rate estimates should be
considered. In my DCF analysis, I offer several alternatives for estimating the
long-term DCF growth rate and an extensive review of recent changes in analysts
growth rate projections. These data demonstrate that a more general approach
based on projected increases in interest rates and other capital market costs, is
appropriate for estimating the cost of equity capital. With further consideration
for my risk premium analysis and review of projected interest rate for the coming
year, my point .estimate for Rocky Mountain Power is 10.75 percent.
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Rocky Mountain Power
Estimating the Cost of Equity Capital
What is the purpose of this section of your testimony?
The purpose of this section is to present a general definition of the cost of equity
and to compare the strengths and weaknesses of several of the most widely used
methods for estimating the cost of equity. Estimating the cost of equity is
fundamentally a matter of informed judgment. The various models provide a
concrete link to actual capital market data and assist with defining the various
relationships that underlie the ROE estimation process.
Please define the term "cost of equity capital" and provide an overview of
the cost estimation process.
The cost of equity capital is the rate of return that equity investors expect to
receive. In concept it is no different than the cost of debt or the cost of preferred
stock. The cost of equity is the rate of return that common stockholders expect,
just as interest on bonds and dividends on preferred stock are the returns that
investors in those securities expect. Equity investors expect a return on their
capital commensurate with the risks they take and consistent with returns that
might be available from other similar investments. Unlike returns from debt and
preferred stocks, however, the equity return is not directly observable in advance
and, therefore, it must be estimated or inferred from capital market data and
trading activity.
An example helps to illustrate the cost of equity concept. Assume that an
investor buys a share of common stock for $20 per share. If the stock's expected
dividend is $1.00, the expected dividend yield is 5.0 percent ($1.00 / $20 = 5.
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Rocky Mountain Power
percent). If the stock price is also expected to increase to $21.20 after one year
this one dollar and 20 cent expected gain adds an additional 6.0 percent to the
expected total rate ofretum ($1.20 / $20 = 6.0 percent). Therefore, buying the
stock at $20 per share, the investor expects a total return of 11.0 percent: 5.
percent dividend yield, plus 6.0 percent price appreciation. In this example, the
total expected rate ofretum at 11.0 percent is the appropriate measure of the cost
of equity capital, because it is this rate of return that caused the investor to commit
the $20 of equity capital in the first place. If the stock were riskier, or if expected
returns from other investments were higher, investors would have required a
higher rate of return from the stock, which would have resulted in a lower initial
purchase price in market trading.
Each day market rates of return and prices change to reflect new investor
expectations and requirements. For example, when interest rates on bonds and
savings accounts rise, utility stock prices usually fall. This is true, at least in part
because higher interest rates on these alternative investments make utility stocks
relatively less attractive, which causes utility stock prices to decline in market
trading. This competitive market adjustment process is quick and continuous, so
that market prices generally reflect investor expectations and the relative
attractiveness of one investment versus another. In this context, to estimate the
cost of equity one must apply informed judgment about the relative risk of the
company in question and knowledge about the risk and expected rate of return
characteristics of other available investments as well.
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Rocky Mountain Power
How does the market account for risk differences among the various
investments?
Risk-return tradeoff's among capital market investments have been the subject of
extensive financial research. Literally dozens of textbooks and hundreds of
academic articles have addressed the issue. Generally, such research confirms the
common sense conclusion that investors will take additional risks only if they
expect to receive a higher rate of return. Empirical tests consistently show that
returns from low risk securities, such as U.S. Treasury bills, are the lowest; that
returns from longer-term Treasury bonds and corporate bonds are increasingly
higher as risks increase; and generally, returns from common stocks and other
more risky investments are even higher. These observations provide a sound
theoretical foundation for both the DCF and risk premium methods for estimating
the cost of equity capital. These methods attempt to capture the well founded
risk-return principle and explicitly measure investors' rate of return requirements.
Can you illustrate the capital market risk-return principle that you just
described?
Yes. The following graph depicts the risk-return relationship that has become
widely known as the Capital Market Line (CML). The CML offers a graphical
representation of the capital market risk-return principle. The graph is not meant
to illustrate the actual expected rate of return for any particular investment, but
merely to illustrate in a general way the risk-return relationship.
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Risk-Return Tradeoffs
The Capital Market Line
'C 10%
Common
Stocks
....
:J 20%
15%
.....
Investment
Grade Bonds
Higher Risk
As a continuum, the CML can be viewed as an available opportunity set for
investors. Those investors with low risk tolerance or investment objectives that
mandate a low risk profile should invest in assets depicted in the lower left-hand
portion of the graph. Investments in this area, such as Treasury bills and short-
maturity, high quality corporate commercial paper, offer a high degree of investor
certainty. In nominal terms (before considering the potential effects of inflation),
such assets are virtually risk-free.
Investment risks increase as one moves up and to the right along the CML.
A higher degree of uncertainty exists about the level of investment value at any
point in time and about the level of income payments that may be received.
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Rocky Mountain Power
Among these investments, long-term bonds and preferred stocks, which offer
priority claims to assets and income payments, are relatively low risk, but they are
not risk-free. The market value oflong-term bonds, even those issued by the U.
Treasury, often fluctuates widely when government policies or other factors cause
interest rates to change.
Farther up the CML continuum, common stocks are exposed to even more
risk, depending on the nature of the underlying business and the financial strength
of the issuing corporation. Common stock risks include market-wide factors, such
as general changes in capital costs, as well as industry and company specific
elements that may add further to the volatility of a given company s performance.
As I will illustrate in my risk premium analysis, common stocks typically are
more volatile (have higher risk) than high quality bond investments and, therefore
they reside above and to the right of bonds on the CML graph. Other more
speculative investments, such as stock options and commodity futures contracts
offer even higher risks (and higher potential returns). The CML's depiction of the
risk-return tradeoffs available in the capital markets provides a useful perspective
for estimating investors' required rates of return.
How is the fair rate of return in the regulatory process related to the
estimated cost of equity capital?
The regulatory process is guided by fair rate of return principles established in the
S. Supreme Court cases Bluefield Water Works and Hope Natural Gas:
A public utility is entitled to such rates as will permit it to earn a
return on the value of the property which it employs for the
convenience of the public equal to that generally being made at the
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same time and in the same general part of the country on
investments in other business undertakings which are attended by
corresponding risks and uncertainties; but it has no constitutional
right to profits such as are realized or anticipated in highly
profitable enterprises or speculative ventures. Bluefield Water
Works Improvement Company v. Public Service Commission of
West Virginia 262 U.S. 679, 692-693 (1923).
From the investor or company point of view, it is important that
there be enough revenue not only for operating expenses, but also
for the capital costs of the business. These include service on the
debt and dividends on the stock. By that standard the return to the
equity owner should be commensurate with returns on investments
in other enterprises having corresponding risks. That return
moreover, should be sufficient to assure confidence in the financial
integrity of the enterprise, so as to maintain its credit and to attract
capital. Federal Power Commission v. Hope Natural Gas Co., 320
S. 591 , 603 (1944).
Based on these principles, the fair rate of return should closely parallel investor
opportunity costs as discussed above. If a utility earns its market cost of equity,
neither its stockholders nor its customers should be disadvantaged.
What specific methods and capital market data are used to evaluate the cost
of equity?
Techniques for estimating the cost of equity normally fall into three groups:
comparable earnings methods, risk premium methods, and DCF methods. The
first set of estimation techniques, the comparable earnings methods, has evolved
over time. The original comparable earnings methods were based on book
accounting returns. This approach developed ROE estimates by reviewing
accounting returns for unregulated companies thought to have risks similar to
those of the regulated company in question. These methods have generally been
rejected because they assume that the unregulated group is earning its actual cost
of capital, and that its equity book value is the same as its market value. In most
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situations these assumptions are not valid, and, therefore, accounting-based
methods do not generally provide reliable cost of equity estimates.
More recent comparable earnings methods are based on historical stock
market returns rather than book accounting returns. While this approach has some
merit, it too has been criticized because there can be no assurance that historical
returns actually reflect current or future market requirements. Also, in practical
application, earned market returns tend to fluctuate widely from year to year. For
these reasons, a current cost of equity estimate (based on the DCF model or a risk
premium analysis) is usually required.
The second set of estimation techniques is grouped under the heading of
risk premium methods. These methods begin with currently observable market
returns, such as yields on government or corporate bonds, and add an increment to
account for the additional equity risk. The capital asset pricing model (CAPM)
and arbitrage pricing theory (APT) model are more sophisticated risk premium
approaches. The CAPM and APT methods estimate the cost of equity directly by
combining the "risk-free" government bond rate with explicit risk measures to
determine the risk premium required by the market. Although these methods are
widely used in academic cost of capital research, their additional data
requirements and their potentially questionable underlying assumptions have
detracted from their use in most regulatory jurisdictions. The basic risk premium
methods provides a useful parallel approach with the DCF model and assures
consistency with other capital market data consistency in the cost of equity cost
estimation process.
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Rocky Mountain Power
The third set of estimation techniques, based on the DCF model, is the
most widely used regulatory cost of equity estimation method. Like the risk
premium approach, the DCF model has a sound basis in theory, and many argue
that it has the additional advantage of simplicity. I will describe the DCF model
in detail below, but in essence its estimate of ROE is simply the sum of the
expected dividend yield and the expected long-term dividend (or price) growth
rate. While dividend yields are easy to obtain, estimating long-term growth is
more difficult. Because the constant growth DCF model also requires very long-
term growth estimates (technically to infinity), some argue that its application is
too speculative to provide reliable results, resulting in the preference for the
multistage growth DCF analysis.
Of the three estimation methods, which do you believe provides the most
reliable results?
From my experience, a combination of discounted cash flow and risk premium
methods provides the most reliable approach. While the caveat about estimating
long-term growth must be observed, the DCF model's other inputs are readily
obtainable, and the model's results typically are consistent with capital market
behavior. The risk premium methods provide a good parallel approach to the
DCF model and further ensure that current market conditions are accurately
reflected in the cost of equity estimate.
Please explain the DCF model.
The DCF model is predicated on the concept that stock prices represent the
present value or discounted value of all future dividends that investors expect to
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receive. In the most general form, the DCF model is expressed in the following
formula:
Po = D1/(1 +k) + D2/(1 +k)2 + ... +
DooI(1 +k)OO (1)
where Po is today s stock price; Dl, D2, etc. are all future dividends and k is the
discount rate, or the investor s required rate of return on equity. Equation (1) is a
routine present value calculation based on the assumption that the stock's price is
the present value of all dividends expected to be paid in the future.
Under the additional assumption that dividends are expected to grow at a
constant rate "" and that k is strictly greater than g, equation (1) can be solved for
k and rearranged into the simple form:
k=D1IPO+ g (2)
Equation (2) is the familiar constant growth DCF model for cost of equity
estimation, where D1IPO is the expected dividend yield and g is the long-term
expected dividend growth rate.
Under circumstances when growth rates are expected to fluctuate or when
future growth rates are highly uncertain, the constant growth model may not give
reliable results. Although the DCF model itself is still valid (equation (1) is
mathematically correct), under such circumstances the simplified form of the
model must be modified to capture market expectations accurately.
Recent events and current market conditions in the electric utility industry
as discussed later appear to challenge the constant growth assumption of the
traditional DCF model. Since the mid-1980s, dividend growth expectations for
many electric utilities have fluctuated widely. In fact, over one-third of the
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electric utilities in the U.S. have reduced or eliminated their common dividends
over this time period. Some of these companies have reestablished their
dividends, producing exceptionally high growth rates. Under these circumstances
long-term growth rate estimates may be highly uncertain, and .estimating a reliable
constant" growth rate for many companies is often difficult.
Can the DCF model be applied when the constant growth assumption is
violated?
Yes. When growth expectations are uncertain, the more general version of the
model represented in equation (1) should be solved explicitly over a finite
transition" period while uncertainty prevails. The constant growth version of the
model can then be applied after the transition period, under the assumption that
more stable conditions will prevail in the future. There are two alternatives for
dealing with the nonconstant growth transition period.
Under the "terminal price" nonconstant growth approach, equation (1) is
written in a slightly different form:
Po = D1/(1 +k) + D2/(1 +ki + ... + PT/(l +kl (3)
where the variables are the same as in equation (1) except that PT is the estimated
stock price at the end of the transition period T. Under the assumption that
normal growth resumes after the transition period, the price PT is then expected to
be based on constant growth assumptions. With the terminal price approach, the
estimated cost of equity, k, is just the rate of return that investors would expect to
earn if they bought the stock at today s market price, held it and received
dividends through the transition period (until period T), and then sold it for price
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Rocky Mountain Power
PT. In this approach, the analyst's task is to estimate the rate of return that
investors expect to receive given the current level of market prices they are
willing to pay.
Under the "multistage" nonconstant growth approach, equation (1) is
simply expanded to incorporate two or more growth rate periods, with the
assumption that a permanent constant growth rate can be estimated for some point
in the future:
Po = Do(1 +gl)/(1 +k) + ... + Do(1+g2)D/(1 +kt+
... +Do(1 +gT)(T+l)/(k-gT)(4)
where the variables are the same as in equation (1), but gl represents the growth
rate for the first period, g2 for a second period, and gT for the period from year T
(the end of the transition period) to infinity. The first two growth rates are simply
estimates for fluctuating growth over "" years (typically 5 or 10 years) and gT is a
constant growth rate assumed to prevail forever after year T. The difficult task for
analysts in the multistage approach is determining the various growth rates for
each period.
Although less convenient for exposition purposes, the nonconstant growth
models are based on the same valid capital market assumptions as the constant
growth version. The nonconstant growth approach simply requires more explicit
data inputs and more work to solve for the discount rate, k. Fortunately, the
required data are available from investment and economic forecasting services
and computer algorithms can easily produce the required solutions. Both constant
and nonconstant growth DCF analyses are presented in the following section.
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Rocky Mountain Power
Please explain the risk premium methodology.
Risk premium methods are based on the assumption that equity securities are
riskier than debt and, therefore, that equity investors require a higher rate of
return. This basic premise is well supported by legal and economic distinctions
between debt and equity securities, and it is widely accepted as a fundamental
capital market principle. For example, debt holders' claims to the earnings and
assets of the borrower have priority over all claims of equity inv.estors. The
contractual interest on mortgage debt must be paid in full before any dividends
can be paid to shareholders, and secured mortgage claims must be fully satisfied
before any assets can be distributed to shareholders in bankruptcy. Also, the
guaranteed, fixed-income nature of interest payments makes year-to-year returns
from bonds typically more stable than capital gains and dividend payments on
stocks. All these factors demonstrate the more risky position of stockholders and
support the equity risk premium concept.
Are risk premium estimates of the cost of equity consistent with other
current capital market costs?
Yes. The risk premium approach is especially useful because it is founded on
current market interest rates, which are directly observable. This feature assures
that risk premium estimates of the cost of equity begin with a sound basis, which
is tied directly to current capital market costs.
Is there similar consensus about how risk premium data should be
employed?
No. In regulatory practice, there is often considerable debate about how risk
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10 -
premium data should be interpreted and used. Since the analyst's basic task is to
gauge investors' required returns on long-term investments
, '
some argue that the
estimated equity spread should be based on the longest possible time period.
Others argue that market relationships between debt and equity from several
decades ago are irrelevant and that only recent debt-equity observations should be
given any weight in estimating investor requirements. There is no consensus on
this issue. Since analysts cannot observe or measure investors' expectations
directly, it is not possible to know exactly how such expectations are formed or
therefore, to know exactly what time period is most appropriate in a risk premium
analysis.
The important point is to answer the following question: "What rate of
return should equity investors reasonably expect relative to returns that are
currently available from long-term bonds?" The risk premium studies and
analyses I discuss later address this question. My risk premium recommendation
is based on an intermediate position that avoids some of the problems and
concerns that have been expressed about both very long and very short periods of
analysis with the risk premium model.
Please summarize your discussion of cost of equity estimation techniques.
Estimating the cost of equity is one of the most controversial issues in utility
ratemaking. Because actual investor requirements are not directly observable
several methods have been developed to assist in the estimation process. The
comparable earnings method is the oldest but perhaps least reliable. Its use of
accounting rates of return, or even historical market returns, mayor may not
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Rocky Mountain Power
reflect current investor requirements. Differences in accounting methods among
companies and issues of comparability also detract from this approach.
The DCF and risk premium methods have become the most widely
accepted in regulatory practice. A combination of the DCF model and a review of
risk premium data provides the most reliable cost of equity estimate. While the
DCF model does require judgment about future growth rates, the dividend yield is
straightforward, and the model's results are generally consistent with actual capital
market behavior. For these reasons, twill rely on a combination of the DCF
model and a risk premium analysis in the cost of equity studies that follow.
Fundamental Factors That Affect the Cost of Equity
What is the purpose of this section of your testimony?
In this section, I review recent capital market conditions and industry and
company-specific factors that should be reflected in the cost of capital estimate.
What has been the recent experience in the U.S. capital markets?
Exhibit No., page 1 , provides a review of annual interest rates and rates of
inflation in the U.S. economy over the past ten years. During that time, inflation
and capital market costs have declined and, generally, have been lower than rates
that prevailed in the previous decade. Inflation, as measured by the Consumer
Price Index, until 2005 had remained at historically low levels not seen
consistently since the early 1960s. Inflation rates for 2005 and 2006 were similar
to longer-term historical averages in excess of 3 percent. With improving
economic conditions, since mid-2004, the Federal Reserve System has increased
the short-term Federal Funds interest rate 17 times, raising it from 1 percent to a
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present level of 5.25 percent. Although long-term interest rates have been slower
to increase up, they are currently about 40 basis points above their lowest levels
reached in mid-2005. Estimates for the next 12 months are for continued
economic growth and for higher interest rates.
Exhibit No., page 2, provides a summary of Moody s Average Utility
and Single-A Utility Bond Yields for the past two years. The Average Utility and
Single-A Utility rates at March 2007 were 5.87 percent and 5.84 percent
respectively. These levels represent increases of 40 to 50 basis points from mid-
2005 levels.
ExhibitNo. 2, page 3, provides Standard and Poor Trends Projections
forecasts for April 19, 2007. The forecast data show expectations for continuing,
albeit slower, economic growth. Growth in real GrossDomestic Product (GDP)
for 2007 is projected at 2.4 percent and nominal GDP (real GDP plus inflation) is
projected at 5.0 percent. These projected GDP growth rates compare to a nominal
rate for 2006 at a level of 6.4 percent and a real growth rate of 3.3 percent. S&P
also forecasts that interest rates will rise from current levels. The 10-year
Treasury Note is projected to increase from its current level of about 4.7 percent
to 4.9 percent by the 2nd quarter of 2008 and to average 5.0 percent for the
coming year. Long-term Treasury Bonds are projected to increase from current
levels of about 4.8 percent to and average of 5.2 percent for 2008, and Corporate
Bonds are projected to increase from current levels of about 5.5 percentto 5.
percent for 2008. These increasing interest rate trends offer important perspective
for judging the cost of capital in the present case.
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How have utility stocks performed during the past several years?
Utility stock prices have fluctuated widely. After reaching a level of 31 0 in April
2002, the Dow Jones Utility Average (DJUA) dropped to below 180 by October
2002. Since late 2002, the Average has trended upward. Its current level at over
500 is near a record high level. The wider fluctuations in more recent years are
vividly illustrated in the following graph ofDJUA prices over the past 25 years.
Dow Jones Utility Average
(Monthly Closing Prices)
600
500
400
300
200
100
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These factors, and continuing concerns for the more competitive markets for all
utility services, will likely create further uncertainties and market volatility for
utility shares. In this environment, investors' return expectations and
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requirements for providing capital to the utility industry remain high relative to
the longer-term traditional view of the utility industry.
What is the industry s current fundamental position?
Many electric utilities are attempting to return to their core businesses and hope to
see more stable results over the next several years. S&P reflects this sentiment
its most recent Electric Utility Industry Survey:
Standard & Poor slndustrv Surveys
Although we expect the performance of both the electric utility
sector and the individual companies within the sector to remain
volatile over the next several years, we expect the stocks to
become less volatile than they have been in the past few years.
(Standard & Poor Industry Surveys Electric Utilities
February 15 2007, p. 5)
In a recent edition covering electric utilities Value Line also reflected concerns
about interest rates and utility operating risks:
Value Line Investors' Service
Economists have assigned a low probability to the likelihood
an easing of the Federal Reserve s monetary policy in early
2007. (Rate cuts usually lend a boost to utility stocks.) We
expect 2007 to be a fairly good year for the eastern electrics....
Still, the utilities' capital budgets have increased because of the
need for more capacity and improved service reliability.
Recovery of these outlays (and high fuel costs) via electricity
tariffs poses some risk. (Value Line December 1 2006, p. 157)
Extreme price volatility for utility shares and expectations for rising interest rates
make it more difficult to estimate the fair, on-going cost of capital. Analysts
near-term growth estimates for utilities reflect the issues described by Value Line
and current three-to-five-year projections are low. As lwill discuss in more detail
later, this feature raises significant questions about using analysts' current growth
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projections as proxies for long-term growth in the DCF model.
Over the past several years, the greatest consideration for utility investors
has been the industry's transition to competition. With the passage of the National
Energy Policy Act (NEP A) in 1992 and the Federal Energy Regulatory
Commission s (FERC) Order 888 in 1996, the stage was set for vastly increased
competition in the electric utility industry. NEP A's mandate for open access to
the transmission grid and FERC's implementation through Order 888 effectively
opened the market for wholesale electricity to competition. Previously protected
utility service territory and lack of transmission access in some parts of the
country had limited the availability of competitive bulk power prices. NEP A and
Order 888 have essentially eliminated such constraints for incremental power
needs.
In addition to wholesale issues at the federal level, many states
implemented retail access and have opened their retail markets to competition.
Prior to the Western energy crisis, investors' concerns had focused principally on
appropriate transition mechanisms and the recovery of stranded costs. More
recently, however, provisions for dealing with power cost adjustments have
become a larger concern. The Western energy crisis refocused market concerns
and contributed significantly to increased market risk perceptions for companies
without power cost recovery provisions. As expected, the opening of previously
protected utility markets to competition, and the uncertainty created by the
removal of regulatory protection, has raised the level of uncertainty about
investment returns across the entire industry.
Hadaway, Di - 22
Rocky Mountain Power
Is Rocky Mountain Power affected by these same market uncertainties and
increasing utility capital costs?
Yes. To some extent all electric utilities are being affected by the industry'
transition to competition. Although deregulation has not occurred in Wyoming,
Rocky Mountain Power s power costs and other operating activities have been
significantly affected by transition and restructuring events around the country.
fact, the uncertainty associated with the changes that are transforming the utility
industry as a whole, as viewed from the perspective of the investor, remain a
factor in assessing any utility's required ROE, including the ROE from Rocky
Mountain Power s operations in Idaho. For Rocky Mountain Power specifically,
its use of long-term purchased power agreements can significantly impact the
Company s credit quality and perceived financial risk because credit rating
agencies view such contracts as debt equivalents. The Company s equity infusions
and its efforts to strengthen the equity component of its capital structure are
constructive efforts to mitigate this debt equivalent risk caused by its long-term
power contracts.
How do capital market concerns and financial risk perceptions affect the cost
of equity capital?
As I discussed previously, equity investors respond to changing assessments of
risk and financial prospects by changing the price they are willing to pay for a
given security. When the risk perceptions increase or financial prospects decline
investors refuse to pay the previously existing market price for a company
securities and market supply and demand forces then establish a new lower price.
Hadaway, Di - 23
Rocky Mountain Power
The lower market price typically translates into a higher cost of capital through a
higher dividend yield requirement as well as the potential for increased capital
gains if prospects improve. In addition to market losses for prior shareholders, the
higher cost of capital is transmitted directly to the company by the need to issue
more shares to raise any given amount of capital for future investment. The
additional shares also impose additional future dividend requirements and reduce
future earnings per share growth prospects.
How have regulatory commissions responded to these changing market and
industry conditions?
On balance, allowed rates of return have changed less than interest rates over the
past five years. The following table summarizes the overall average ROEs
allowed for electric utilities since 2003:
Authorized Electric Utility Equity Returns2003 2004 200511.47% 11.00% 10.51%
11.16% 10.54% 10.05%
95% 10.33% 10.84%
11.09% 10.91% 10.75%
10.97% 10.75% 10.54%
1 st Quarter
2nd Quarter
3rd Quarter
th uarter
Full Year Average
Average Utility
Debt Cost
Indicated Average
Risk Premium
2006
10.38%
10.69%
10.06%
10.39%
10.36%
2007
10.30%
10.30%
61%20%67%08%92%
4.36%55%87%28%4.38%
Source: Regulatory Focus Regulatory Research Associates, Inc., Major Rate
Case Decisions, April 3 , 2007.
Over the past five years, as interest rates have declined, allowed equity returns
have followed the interest rate decline, but declined by a smaller amount.
Since 2003 , equity risk premiums (the difference between allowed equity
Hadaway, Di - 24
Rocky Mountain Power
returns and utility interest rates) have ranged from 4.28 percent to 4.87 percent.
At the low end of this risk premium range, with an allowed equity risk premium
of about 4.3 percent, the indicated cost of equity is 10.6 percent (6.3% projected
single-A interest rate + 4.3% risk premium = 10.6%). At the upper end of this
risk premium range, with an allowed equity risk premium of about 4.9 percent, the
indicated cost of equity is 11.2 percent (6.3% projected single-A interest rate +
9% risk premium = 11.2%).
Cost of Equity Capital for Rocky Mountain Power
What is the purpose of this section of your testimony?
The purpose of this section is to present my quantitative studies of the cost of
equity capital for Rocky Mountain Power and to discuss the details and results
my analysis.
How are your studies organized?
In the fIrst part of my analysis, I apply three versions of the DCF model to a 15-
company group of electric utilities based on the selection criteria discussed
previously. In the second part of my analysis, I apply various risk premium
models and review projected economic conditions and projected capital costs for
the coming year.
My DCF analysis is based on three versions of the DCF model. In the fIrst
version of the DCF model, I use the constant growth format with long-term
expected growth estimated from an equally weighted, four-part average of (1)
Value Line and (2) Zacks earnings per share growth projections for the coming
three to five years, (3) a sustainable growth ("b" times ") estimate based on
Hadaway, Di - 2S
Rocky Mountain Power
Value Line s projected retention rates and earned rates of return for the next three
to five years, and (4) a long-term estimate of nominal growth in GDP. In the
second version of the DCF model, for the estimated growth rate, I use only the
long-term estimated GDP growth rate. In the third version of the DCF model, I
use a two-stage growth approach, with stage one based on Value Line s three-to-
five-year dividend projections and stage two based on long-term projected growth
in GDP. The dividend yields in all three of the annual models are from Value
Line s projections of dividends for the coming year and stock prices are from the
three-month average for the months that correspond to the Value Line editions
from which the underlying fmancial data are taken.
Why do you believe the long-term GDP growth rate should be used to
estimate long-term growth expectations in the DCF model?
Growth in nominal GDP (real GDP plus inflation) is the most general measure of
economic growth in the U.S. economy. For long time periods, such as those used
in the Ibbotson Associates rate of return data, GDP growth has averaged between
5 percent and 8 percent per year. From this observation, Professors Brigham and
Houston offer the following observation concerning the appropriate long-term
growth rate in the DCF Model:
Expected growth rates vary somewhat among companies, but
dividends for mature firms are often expected to grow in the future
at about the same rate as nominal gross domestic product (real
GDP plus inflation). On this basis, one might expect the dividend
of an average, or "normal," company to grow at a rate of 5 to 8
percent a year. (Eugene F. Brigham and Joel F. Houston
Fundamentals of Financial Management 11 th Ed. 2007, page
298.
Hadaway, Di - 26
Rocky Mountain Power
Other academic research on corporate growth rates offers similar .conclusions
about GDP growth as well as concerns about the long-term adequacy of analysts
forecasts:
Our estimated median growth rate is reasonable when compared to
the overall economy s growth rate. On average over the sample
period, the median growth rate over 10 years for income before
extraordinary items is about 10 percent for all firms. ... After
deducting the dividend yield (the median yield is 2.5 percent per
year), as well as inflation (which averages 4 percent per year over
the sample period), the growth in real income before extraordinary
items is roughly 3.5 percent per year. This is consistent with the
historical growth rate in real gross domestic product, which has
averaged about 3.4 percent per year over the period 1950-1998.
(Louis K. C. Chan, Jason Karceski, and Josef Lakonishok
, "
The
Level and Persistence of Growth Rates," The Journal of Finance
April 2003, p. 649)
IBES long-term growth estimates are associated with realized
growth in the immediate short-term future. Over long horizons
however, there is little forecastability in earnings, and analysts
estimates tend to be overly optimistic. .
. .
On the whole, the
absence of predictability in growth fits in with the economic
intuition that competitive pressures ultimately work to correct
excessively high or excessively low profitability growth. (Ibid
page 683)
These fmdings support the notion that long-term growth expectations are more
closely predicted by broader measures of economic growth than by near-term
analysts' estimates. Especially for the very long-term growth rate requirements of
the DCF model, the growth in nominal GDP should be considered an important
input. For Wyoming specifically, the economy is expected to grow more rapidly
than the national average as coal mining other energy extraction activities respond
to the jump in commodity market prices.
Hadaway, Di - 27
Rocky Mountain Power
How have analysts' three-to-five year growth projections changed over the
past five years?
Analysts' forecasted growth rates for electric utilities declined precipitously
following the Western energy crisis and industry turmoil. While analysts' growth
projections have increased somewhat during the past year, they are still
significantly lower than they were in 2002. In Exhibit No., I compare current
forecasts from Value Line for my comparable group companies to those that
existed in 2002. During 2002, Value Line s projected three-to-five year earnings
growth rate was 6.21 percent per year. In the most recent Value Line editions, the
average projected earnings growth rate is 5.82 percent. The "b times r
sustainable growth rate based on Value Line s projected retention rates and earned
ROEs shows an even larger decline. During 2002, for the comparable electric
group the average "b times r" growth rate was 5.52 percent per year. Currently,
the "b times r" growth rate from the three most recent Value Line editions is only
15 percent. These comparisons further illustrate that analysts' growth rate
projections are more volatile than one would expect for perpetual growth rate
expectations, and that current projections are very low as compared to those used
just five years ago. These results strongly support using more general long-term
economic growth rates, such as GDP, in the DCF model.
How did you estimate the expected long-run GDP growth rate?
I developed my long-term GDP growth forecast from nominal GDP data
contained in the St. Louis Federal Reserve Bank data base. That data for the
period 1947 through 2006 is summarized in my Exhibit No.4. As shown at the
Hadaway, Di - 28
R~cky Mountain Power
bottom of that exhibit, the overall average for the period was 7.0 percent. The
data also show, however, that in the more recent years since 1980, lower inflation
has resulted in lower overall GDP growth. For this reason I gave more weight to
the more recent years in my GDP forecast. This approach is consistent with the
concept that more recent data should have a greater effect on expectations and
with generally lower near- and intermediate-term growth rate forecasts that
presently exist. Based on this approach, my overall forecast for long-term GDP
growth is 40 basis points lower than the long-term average, at a level of 6.
percent.
Please summarize the results of your electric utility DCF analyses.
The DCF results for my comparable company group are presented in Exhibit No.
5. As shown in the first column of page 1 of that exhibit, the traditional constant
growth model indicates an ROE of only 9.0 percent to 9.4 percent. Because this
result falls more than 100 basis points below my risk premium checks
reasonableness, it is excluded from my final DCF range. In the second column of
page 1 , I recalculate the constant growth results with the growth rate based on
long-term forecasted growth in GDP. With the higher GDP growth rate, the
constant growth model indicates an ROE range of 10.8 percent to 10.9 percent.
Finally, in the third column of page 1 , I present the results from the multistage
DCF model. The multistage model indicates an ROE range of 10.5 per-cent to
10.6 percent. The results from the DCF model, therefore, indicate a reasonable
ROE range of 10.5 percent to 10.9 percent for the comparable company group.
Hadaway, Di - 29
Rocky Mountain Power
What are the results of your risk premium studies?
The details and results of my risk premium studies are shown in my Exhibit No.
These studies and other risk premium data indicate an ROE range oflO.7 percent
to 11.4 percent.
How are your risk premium studies structured?
My risk premium studies are divided into two parts. First, I compare electric
utility authorized ROEs for the period 1980-2006 to contemporaneous long-term
utility interest rates. The differences between the average authorized ROEs and
the average interest rate for the year is the indicated equity risk premium. I then
add the indicated equity risk premium to the forecasted single-A utility bond
interest rate to estimate ROE. Because there is a strong inverse relationship
between risk premiums and interest rates (when interest rates are high, risk
premiums are low and vice versa), further analysis is required to estimate the
current risk premium level.
The inverse relationship between risk premiums and interest rate levels is
well documented in numerous, well-respected academic studies. These studies
typically use regression analysis or other statistical methods to predict or measure
the risk premium relationship under varying interest rate conditions. On page 2 of
Exhibit No., I provide regression analyses of the allowed annual equity risk
premiums relative to interest rate levels. The negative and statistically significant
regression coefficients confirm the inverse relationship between risk premiums
and interest rates. This means that when inter.est rates rise by one percentage
point, the cost of equity increases, but by a smaller amount. Similarly, when
Hadaway, Di - 30
Rocky Mountain Power
interest rates decline by one percentage point, the cost of equity declines by less
than one percentage point. I use this negative interest rate change coefficient in
conjunction with current interest rates to establish the appropriate current equity
risk premium.
How do the results of your risk premium study compare to levels found in
other published risk premium studies?
Based on my risk premium studies, I am conservatively recommending a lower
risk premium than is often found in other published risk premium studies. For
example, the most widely followed risk premium data are provided in studies
published annually by Morningstar, InC.2 (Morningstar, Inc., Stocks, Bonds, Bills
and Inflation 2007 Yearbook). These data, for the period 1926-2006, indicate an
arithmetic mean risk premium of 6.1 percent for common stocks versus long-term
corporate bonds. Under the assumption of geometric mean compounding, the
Morningstar risk premium for common stocks versus corporate bonds is 4.
percent. Based on the more conservative geometric mean risk premium, the
Morningstar data indicate a cost of equity of 10.8 percent (6.3% forecasted debt
cost + 4.5% risk premium = 10.8%). Based on the arithmetic risk premium, the
Morningstar data indicate a cost of equity of 12.4 percent (6.3% forecasted debt
cost + 6.1 % risk premium = 12.4%).
2 Formerly Ibbotson Associates.
Hadaway, Di - 31
Rocky Mountain Power
Harris and Marston (H&M) also provide specific equity risk premium
estimates.3 Using analysts' growth estimates to estimate equity returns, H&M
found equity risk premiums of 6.47 percent relative to U.S. Government bonds
and 5.13 percent relative to yields on corporate debt. H&M's equity risk premium
relative to corporate debt also indicates a current cost of equity of 11.4 percent
(6.3% debt cost + 5.13% risk premium = 11.43%). Although the Ibbotson and
Harris and Marston results should not be extrapolated directly as stand-alone
estimates of the cost of equity for regulated utilities, their results provide a
reasonable long-term perspective on capital market expectations for debt and
equity rates of return.
Please summarize the results of your cost of equity analysis.
The following table summarizes my results:
3 Robert S. Harris and Felicia C. Marston
, "
Estimating Shareholder Risk Premia Using Analysts'
Growth Forecasts Financial Management Summer 1992.
Hadaway, Di - 32
Rocky Mountain Power
Summa" of Cost of Equity Estimates
DCF Analysis
Constant Growth (GDP Growth)
Multistage Growth Model
Reasonable DCF Range
Indicated Cost
10.8%-10.
10.5%-10.
10.5%-10.
Risk Premium Analysis
Utility Debt + Risk Premium
Risk Premium (6.3% + 4.4%)
Ibbotson Risk Premium Analysis
Risk Premium (6.3% +4.5%)
Harris-Marston Risk Premium
Risk Premium (6.3%+ 5.1%)
Indicated Cost
10.
10.
11.4%
Rocky Mountain Power Estimated ROE 10.75%
How should these results be interpreted to determine the fair cost of equity
for Rocky Mountain Power?
Caution should be exercised in interpreting the basic quantitative DCF and risk
premium results, because they are based on recent historically low points in the
economic cycle. Under such conditions, economic projections should also be
considered. Continuing economic growth and higher expected interest rates show
that less weight should be given to recent economic history. Additionally, use of a
lower DCF range would fail to recognize the ongoing risks and uncertainties that
continue to exist in the electric utility industry business as well as the
uncertainties Rocky Mountain Power is currently facing. From this perspective
and with consideration of for the Company s large on-going capital requirements
Rocky Mountain Power s estimated cost of equity is 10.75 percent.
Does this conclude your testimony?
Yes, it does.
Hadaway, Di - 33
Rocky Mountain Power
3 ;,,
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S~iL.
Case No. PAC-07-
Exhibit No.
Witness: Samuel C. Hadaway
BEFORE THE IDAHO PUBLIC UTILITIES COMMISSION
ROCKY MOUNTAIN POWER
Exhibit Accompanying Direct Testimony of Samuel C. Hadaway
Resume
June 2007
Rocky Mounlain Power
-Exhibit No, I page I of
CASE NO, PAC-E-O7-OS
Witness Samuel C, Hadaway
SAMUEL C. HADAWAY
FINANCO, Inc.
Financial Analysis Consultants
3520 Executive Center Drive, Suite 124
Austin, Texas 78731
[phone]
SUMMARY OF QUALIFICATIONS
. Principal, Financial Analysis Consultants (FINANCO, Inc.
. Ph.D. in Finance and Econometrics.
Extensive expert witness testimony in court and before regulatory agencies.
Management of professional research staff in academic and regulatory organizations.
Professional presentations before executive development groups, the National Rate
Return Analysts' Forum, and the New York Society of Security Analysts.
Financial Management Association, Vice President for Practitioner Services.
EDUCATION
The University of Texas at Austin
Ph.D., Finance and Econometrics
January 1975
The University of Texas at Austin
MBA, Finance
June 1973
Southern Methodist University
BA, Economics
June 1969
OTHER EXPERIENCE
University of Texas at Austin
Adjunct Associate Professor
1985-1988,2004-Present
Texas State University San Marcos
Associate Professor of Finance
1983-1984 2003-2004
Public Utility Commission of Texas
Chief Economist and Director of
Economic Research Division
August 1980-August 1983
Assistant Professor of Finance
Texas Tech University
July 1978-July 1980
University of Alabama
January 1975-June 1978
Dissertation: An Evaluation of the
Original and Recent Variants of the
Capital Asset Pricing Model.
Thesis: The Pricing of Risk on the
New York Stock Exchange.
Honors program. Departmental
distinction.
Corporate Financial Management
Investments, and Integrative Finance
Cases.
Graduate and undergraduate courses
in Financial Management, Managerial
Economics, and Investment Analysis.
Lead financial witness. Supervised
Commission staff in research and
testimony on rate of return, financial
condition, and economic analysis.
Member of graduate faculty. Conducted
Ph.D. seminars and directed doctoral
dissertations in capital market theory.
Served as consultant to industry,
church and governmental organizations.
KOCky Mounlain Power
Exhibit No. I page 2 of 9
CASE NO, PAC-E-O7-OS
Witness Samuel C. Hadaway
FINANCIAL AND ECONOMIC TESTIMONY IN REGULATORY
PROCEEDINGS (Clli:!!!jn parenthesw
Cost of Money Testimony:
Kansas Corporation Commission, Docket No. 07-KCPE- -RTS, February 25 , 2007
(Kansas City Power & Light Company). . New Mexico Public Regulation Commission, Case No. 07- -, February 21 , 2007
(Public Service Company of New Mexico).
Missouri Public Service Commission, Case No. ER-2006-January 31 2007
(Kansas City Power & Light Company).
Texas pur Docket Nos. 33734, January 22, 2007 (Electric Transmission TexasLLC).
Texas PUC Docket Nos. 33309 and 33310, November 2006, (AEP Texas Central
Company and AEP Texas North Company). ,
Louisiana Public Service Commission, Docket No. U-23327, October 2006 and
January 2005 (Southwestern Electric Power Company, American Electric Power
Company)
Missouri Public Service Commission, Case No. ER-2007-0004, July 3 , 2006 (Aquila
Inc.
. New Mexico Public Regulation Commission, Case No. 06-00258-, June 30, 2006
(El Paso Electric Company).
. New Mexico Public Regulation Commission, Case No. 06-00210-, May 30 2006
(Public Service Company of New Mexico).
Texas Public Utility Commission, Docket No. 32093 , April 14, 2006 (CenterPoint
Energy-Houston Electric, LLC).
Utah Public Service Commission, Docket No. 06-035-, March 7 2006
(PacifiCorp ).
Oregon Public Utility Commission, Case No. UE-179, February 23 2006
(PacifiCorp ).
Kansas Corporation Commission, Docket No. 06-KCPE-828-RTS, January 31 , 2006
(Kansas City Power & Light Company).Missouri Public Service Commission, Case No. ER-2006-0314, January 27,2006
(Kansas City Power & Light Company).
. California Public Utilities Commission, Docket No. 05-11-022, November 29, 2005
(pacifiCorp ).
Texas Public Utility Commission, Docket No. 31994, November 5, 2005 (Texas-New
Mexico Power Company).
. New Hampshire Public Utilities Commission, Docket No. DE 05-178, November 4
2005 (Unitil Energy Systems).
Wyoming Public Service Commission, Docket No. 20000-ER-05-230, October 14
2005 (pacifiCorp).
Minnesota Public Utilities Commission, Docket. No. G-008/GR-05-1380, October
2005 (CenterPoint Energy Minnegasco).
Texas Railroad Commission, Gas Utilities Division No. 9625, September 2005
(CenterPoint Energy Entex).
Illinois Commerce Commission, Docket No. 05-0597, August 31 , 2005
(Commonwealth Edison Company).
Washington Utilities and Transportation Commission, Docket ,UE-050684/General
Rate Case, May 2005 (PacifiCorp).
Missouri Public Service Commission, Case No. ER-2005-0436, May 2005 (Aquila
Inc.
Idaho Public Utilities Commission, Case No. PAC-05-, January 14 2005(PacifiCorp).
Arkansas Public Service Commission, Docket No. 04-121-, December 3, 2004
(CenterPoint Energy Arkla).
Oregon Public Utility Commission, Case No. UE-170, November 12,2004
(PacifiCorp ).
Rocky Mounlain Power
Exhibit No, 1 page 3 of 9
CASE NO, PAC-E-O7-
Witness ~amuel C. Hadaway
Texas Public Utility Commission, Docket No. 29206, November 8, 2004 (Texas-New
Mexico Power Company).
Texas Railroad Commission, Gas Utilities Division Nos. 9533 and 9534, October 13
2004 (CenterPoint Energy Entex).
Texas Public Utility Commission, Docket No. 29526, August 18 and September 2
2004 (CenterPoint Energy Houston Electric).
Utah Public Service Commission, Docket No. 04-2035-, August 4 2004 (pacifiCorp).
Oklahoma Corporation Commission, Cause No. PUD-200400187, July 2 2004
(CenterPoint Energy Arkla).
Minnesota Public Utilities Commission, Docket No. G-008/GR-04-901, July 2004
(CenterPoint Energy Minnegasco).
Washington Utilities and Transportation Commission, Docket ,UE-032065/General
Rate Case, December 2003 (pacifiCorp).
Washington Utilities and Transportation Commission, Docket ,UG-031885
November 2003 (Northwest Natural Gas Company.
Wyoming Public Service Commission, Docket No. 20000-ER-03-198, May 2003
(pacifiCorp ).
Public Service Commission of Utah, Docket No. 03-2035-, May 2003 (pacifiCorp).
Public Utility Commission of Oregon, Case. UE-147, March 2003 (pacifiCorp).
Wyoming Public Service Commission, Docket No. 20000-ER-00-162, May 2002
(PacifiCorp ).
Public Utility Commission of Oregon, UG-152, November 2002 (Northwest Natural).
Massachusetts Department of Telecommunications and Energy, D.E. 02-24/24
May 2002 (Fitchburg Gas and Electric Light Company).
. New Hampshire Public Utilities Commission, Docket No. DE 01-247, January 2002
(Unitil Corporation).Washington Utilities and Transportation Commission, Docket UE-011569,UG-
011571, November 2001 (puget Sound Energy, Inc.
California Public Utilities Commission, Docket No. 01-03'-026 , September and
December 2001 (pacifiCorp).
. New Mexico Public Regulation Commission, Docket No. 3643, July 2001 (Texas-
New Mexico Power Company).
Texas Natural Resources Conservation Commission, Docket No. 2001-1O74/5-URC
May 2001 (AquaSource Utility, Inc.
Massachusetts Department of Telecommunications and Energy, Docket No. 99-118
May 2001 (Fitchburg Gas and Electric Light Company).
Public Service Commission of Utah, Docket No. 01-035-, January 2001
(pacifiCorp )
Federal Energy Regulatory Commission, Docket No. ER-01-651, January 2001
(Southwestern Electric Power Company).
Wyoming Public Service Commission, Docket No. 20000-ER-00-162, December
2000 (pacifiCorp).
Public Utility Commission of Oregon, Case. UE-116, November 2000, (pacifiCorp)
Public Utility Commission of Texas, Docket No. 22344, September 2000, (AEP
Texas Companies, Entergy Gulf States, Inc., Reliant Energy HL&P, Texas-New
Mexico Power Company, TXU Electric Company)
Public Utility Commission of Oregon, Case UE-lll , August 2000, (pacifiCorp)
Texas Public Utility Commission, Docket Nos. 22352 , March 2000 (Central
Power and Light Co., Southwestern Electric Power Co., West Texas Utilities Co.
Texas Public Utility Commission, Docket No. 22355, March 2000 (Reliant Energy,
Inc.
Texas Public Utility Commission, Docket No. 22349, March 2000 (Texas-New
Mexico Power Co.
Texas Public Utility Commission, Docket No. 22350, March 2000 (TXU Electric).
Washington Utilities and Transportation Commission, Docket UE-991831, November
1999 (PacifiCorp).
Kocky Mounlain Power
Exhibit No, I page 4 of 9
CASE NO, PAC-O7-
Witness Samuel C. Hadaway
Public Service Commission of Utah, Docket No. 99-035-, September 1999
(PacifiCorp )
Louisiana Public Service Commission Docket No. U-23029, August 1999
(Southwestern Electric Power Company)
Wyoming Public Service Commission, Docket No. 2000-ER-99-145, July 1999
January 2000 (pacifiCorp, dba Pacific Power and Light Company).
Texas PUC Docket No. 20150, March 1999 (Entergy Gulf States, Inc.
Federal Energy Regulatory Commission Docket No. ER-98-3177-00, May and
December 1998 (Southwestern Electric Power Company).
Public Service Commission of Utah, Docket No. 97-035-, June 1998 (pacifiCorp,
dba Utah Power and Light Company).
Massachusetts Dept. of Telecommunications and Energy, Docket No. DTE 98-
May 1998, (Fitchburg Gas and Electric Light Company, a subsidiary ofUnitil Corp.
Texas PUC, Docket No. 18490, March 1998, (Texas Utilities Electric Company)
Texas PUC DocketNo. 17751 , March 1998 and July 1997 (Texas-New Mexico
Power Company).
Federal Energy Regulatory Commission Docket No. RP-, February 1998 and May
1997 (Koch Gateway Pipeline Company).
Federal Energy Regulatory Commission Docket No. ER-97-4468-000, December
1997 (puget Sound Power & Light).
Oklahoma Corporation Commission, Cause No. PUD 960000214, August 1997
(Public Service Company of Oklahoma).
Oregon Public Utility Commission Docket No. UE-, April 1996, (pacifiCorp).
Texas PUC Docket No. 15643, May and September 1996, (Central Power and Light
and West Texas Utilities Company).
Federal Energy Regulatory Commission Docket No. ER-, April 1996 (puget Sound
Power & Light).
Federal Energy Regulatory Commission Docket No. ER96, February 1996, (Central
and South West Corporation).
Washington Utilities & Transportation Commission Docket No. UE-951270
November 1995 (Puget Sound Power & Light).
Texas PUC Docket No. 14965, November 1995, (Central Power and Light).
Texas PUC Docket No. 13369, February 1995 (West Texas Utilities).
Texas PUC Docket No. 12065, July and December 1994, (Houston Lighting &
Power).
Texas PUC, Docket No. 12820, July and November 1994, (Central Power and Light).
Texas PUC Docket No. 12900, March 1994, and New Mexico PUC Case No. 2531
August 1993, (TNP Enterprises).
Texas PUC, Docket No. 12815, March 1994, (pedernales Electric Cooperative).
Florida Public Service Commission, Docket No. 930987-EI, December 1993, (TECO
Energy).
Iowa Department of Commerce, Docket No. RPU-93-, December 1993 , (US West
Communications).
Texas PUC Dkt. No. 11735, May and September 1993, (Texas Utilities Electric
Company)
Oklahoma Corporation Commission, Cause No. PUD 001342, October 1992 (Public
Service Company of Oklahoma).
Texas PUC Dkt. No. 9983, November 1991 , (Southwest Texas Telephone Company).
Texas PUC Dkt. No. 9850, November 1990, Houston Lighting & Power Company).
Texas PUC Dkt. Nos. 8480/8482, January 1989; City of Austin Dkt. No., August
1988 and July 1987, (City of Austin Electric Department).
Missouri Public Service Commission Case No. ER-90-101 , July 1990 (Utili Corp).
Texas PUC Dkt. No. 9945, December 1990; Texas PUC Dkt. No. 9165, November
1989, (El Paso Electric Company).
Texas PUC Dkt. No. 9427, July 1990, (Lower Colorado River Authority Association
of Wholesale Customers).
Oregon Public Utility Commission, Mar~h 1990, (pacific Power & Light Company).
KOCKY Mounlain Power
Exhibit No, I page 5 of 9
CASE NO, PAC-E-O7-OS
Witness Samuel C. Hadaway
Utah Public Service Commission, November 1989, (Utah Power & Light Company).Texas PUC Dkt. No. 5610, September 1988, (GTE Southwest).
Iowa State Utilities Board, September 1988, (Northwestern Bell Telephone
Company).
Texas Water Commission, Dkt. Nos. RC-022 and RC-023, November 1986, (City of
Houston Water Department).
Pennsylvania PUC Dkt. Nos. R-842770 and R-842771 , May 1985, (Bethlehem Steel).
Capital Structure Testimony:
Federal Energy Regulatory Commission Docket No. RP-, May 1997 (Koch
Gateway Pipeline Company).
Illinois Commerce Commission Dkt. No. 93-0252 Remand, July 1996, (Sprint).
California PUC (Appl. No. 92-05-004) April 1993 and May 1993 , (pacific Telesis).
Montana PSC, Dkt. No. 90.12., November 1991 , (US West Communications).
Massachusetts PUC Dkt. No. 86-33, June 1987, (New England Telephone Company).Maine PUC Dkt. No. 85-159, February 1987, (New England Telephone Company).
. New Hampshire PUC Dkt. No. 85-181 , September 1986, (New England Telephone
Company).
Maine PUC Dkt. No. 83-213, March 1984, (New England Telephone Company).
Regulatory Policy and Other Regulatory Issues:
Texas PUC Docket No.31056, September 16 2005, (AEP Texas Central Company).
. New Hampshire PUC Docket No. DE 03-086, May 2003, (Unitil Corporation).
Texas PUC Docket No. 26194, May 2003 (El Paso Electric Company)
Texas PUC Docket No. 22622, June 15 2001 (TXU Electric)
Texas PUC Docket No. 20125, November 1999 (Entergy Gulf States, Inc.
Texas PUC Docket No. 21112, July 1999 and New Mexico Public Regulation
Commission Case No. 3103, July 1999 (Texas-New Mexico Power Company)
Texas PUC Docket No. 20292, May 1999 (Central Power .and Light Co.
Texas PUC Docket No. 20150, November 1998 (Entergy Gulf States, Inc.
. New Mexico PUC Case No. 2769, May 1997, (Texas-New Mexico Power Company).
Texas PUC Dkt. No. 15296, September 1996, (City of College Station, Texas).
Texas PUC Dkt. No. 14965 Competitive Issues Phase, August 1996 (Central Power
and Light Company).
Texas PUC Dkt. No. 12456, May 1994, (Texas Utilities Electric Company).
Texas PUC, Dkt. No. 12700/12701 and Federal Energy Regulatory Commission
Docket No. EC94-000, January 1994, (El Paso Electric Company).
Florida Public Service Commission Generic Purchased Power Proceedings, October
1993 (TECO Energy).
Texas PUC, Docket No. 11248, December 1992 (Barbara Faskins).
Texas PUC Dkt. No. 10894, January and June 1992, (Gulf States Utilities Company).
State Corporation Commission of Kansas, Dkt. No. 175,456-U, August 1991
(UtiliCorp United).Texas PUC Dkt. No. 9561 , May 1990; Texas PUC Dkt. Nos. 6668/8646, July 1989
and February 1990, (Central Power and Light Company).
Texas PUC Dkt. No. 9300, April 1990 and June 1990, (Texas Utilities Electric Co.
Texas PUC Dkt. No. 10200, August 1991 , (Texas-New Mexico Power Company).
Texas PUC Dkt. No. 7289, May 1987, (West Texas Utilities Company).
Texas PUC Dkt. No. 7195 , January 1987, (North Star Steel Texas).
. New Mexico PSC Case No. 1916, April 1986, (public Service Company of New
Mexico).
Texas PUC Dkt. No. 6525, March 1986, (North Star Steel Texas).Texas PUC Dkt. No. 6375, November 1985, (Valley Industrial Council).Texas PUC Dkt. No. 6220, April 1985, (North Star Steel Texas).
Texas PUC Dkt. No. 5940, March 1985, (West Texas Municipal Power Agency).
Rocky Mountain Power
Exhibi~ No, I page 6 of 9
CASE NO. PAC-E-O7-
Witness Samuel C. Hadaway
Texas PUC Dkt. No. 5820, October 1984, (North Star Steel Texas).
Texas PUC Dkt. No. 5779, September 1984, (Texas Industrial Energy Consumers).
Texas PUC Dkt. No. 5560, April 1984, (North Star Steel Texas).
Arizona PSC Dkt. No. U-1345-83-155, January 1984 and May 1984 (Arizona Public
Service Company Shareholders Association).
Insurance Rate Testimony:
Texas Department of Insurance, Docket No. 2601 , December 2006, (Texas Land Title
Association).
Texas Department of Insurance, Docket No. 2394, November 1999, (Texas Title
Insurance Agents).
Senate Interim Committee on Title Insurance of the Texas Legislature, February 6
1998
Texas Department ofInsurance, Docket No. 2279, October 1997, (Texas Title
Insurance Agents).
Texas Department of Insurance, January 1996, (Independent Metropolitan Title
Insurance Agents of Texas).
Texas Insurance Board, January 1992, (Texas Land Title Association).
Texas Insurance Board, December 1990, (Texas Land Title Association).
Texas Insurance Board, November 1989, (Texas Land Title Association).
Texas Insurance Board, December 1987, (Texas Land Title Association).
Testimony On Behalf Of Texas PUC Staff:
Texland Electric Cooperative, Dkt. No. 3896, February 1983
El Paso Electric Company, Dkt. No. 4620, September 1982.
Southwestern Bell Telephone Company, Dkt. No. 4545, August 1982.
Central Power and Light Company, Dkt. No. 4400, May 1982.
. Texas-New Mexico Power Company, Dkt. 4240, March 1982.
Texas Power and Light Company, Dkt. No. 3780, May 1981.
General Telephone Company of the Southwest, Dkt. No. 3690, April 1981.
. Mid-South Electric Cooperative, Dkt. No. 3656, March 1981.
West Texas Utilities Company, Dkt. No. 3473, December 1980.
Houston Lighting & Power Company, Dkt. No. 3320, September 1980.
ECONOMIC ANALYSIS AND TESTIMONY
Antitrust Litigation:
Marginal Cost Analysis of Concrete ProductionlPredatory Pricing (Stiles)
Analysis of Lost Business Opportunity due to denial of Waste Disposal Site Permit
(Browning-Ferris Industries, Inc.
Analysis of Electric Power Transmission Costs in Purchased Power Dispute (City of
College Station, Texas).
Contract Litigation:
Analysis of Cogeneration Contract/Economic Viability Issues(Texas-New Mexico
Power Company)
Definition of Electric Sales/Franchise Fee Contract Dispute (Reliant Energy HL&P)
Analysis of Purchased Power Agreement/Breach of Contract (Texas-New Mexico
Power Company)
Regulatory Commission Provisions in Franchise Fee Ordinance Dispute (Central
Power & Light Company)
Rocky Mountain Power
Exhibit No. I page 7 of 9
CA'SE NO. PAC-E-O7-OS
Wib1ess Samuel C. Hadaway
Analysis of Economic Damages resulting from attempted Acquisition of Highway
Construction Company (Dillingham Construction Corporation).
Analysis of Economic Damages due to Contract Interference in Acquisition
Electric Utility Cooperative (PacifiCorp).
Analysis of Economic Damages due to Patent Infringement of Boiler Cleaning
Process (Dowell-Schlumberger/The Dow Chemical Company).
Lender Liability/Securities Litigation:
ERISA Valuation of Retail Drug Store Chain (Sommers Drug Stores Company).
Analysis of Lost Business Opportunities in Failed Businesses where Lenders Refused
to Extend or Foreclosed Loans (FirstCity Bank Texas, McAllen State Bank, General
Electric Credit Corporation).
Usury and Punitive Damages Analysis based on Property Valuation in Failed Real
Estate Venture (Tomen America, Inc.
Personal InjurylWrongful DeathILost Earnings Capacity Litigation:
Analysis of Lost Earnings Capacity and Punitive Damages due to Industrial Accident
(Worsham, Forsythe and Wooldridge).
Analysis of Lost Earnings Capacity due to Improper Termination (Lloyd Gosselink
Ryan & Fowler).
Present Value Analysis of Lost Earnings and Future Medical Costs due to Medical
Malpractice (Sierra Medical Center).
Product WarrantylLiability Litigation:
Analysis of Lost Profits due to Equipment Failure in Cogeneration Facility (WF
Energy/Travelers Insurance Company).
Analysis of Economic Damages due to Grain Elevator Explosion (Degesch Chemical
Company).
Analysis of Economic Damages due to failure of Plastic Pipe Water Lines (Western
Plastics, Inc.
Analysis of Rail Car Repair and Maintenance Costs in Product Warranty Dispute
(Youngstown Steel Door Company).
Property Tax Litigation:
Evaluation of Electric Utility Distribution System (Jasper-Newton Electric
Cooperative).
Evaluations of Electric Utility Generating Plants (West Texas Utilities Company).
Various Valuations of Closely Held Businesses in Domestic Affairs Proceedings and
for Federal Estate Tax Planning Purposes.
PROFESSIONAL PRESENTATIONS
Fundamentals of Financial Management and Reporting for Non-Financial Managers
Austin Energy, July 2000.
Fundamentals of Finance and Accounting," the IC2 Institute, University of Texas at
Austin, December 1996 and 1997.
Fundamentals of Financial Analysis and Project Evaluation " Central and South West
Companies, April, May, and June 1997.
Rocky Mountain Power
Exhibit No, I page 8 of 9
CASE NO, PAC-E.Q7-
Witness Samuel C. Hadaway
Fundamentals of Financial Management and Valuation " West Texas Utilities Company,
November 1995.
Financial Modeling: Testing the Reasonableness of Regulatory Results " University of
Texas Center for Legal and Regulatory Studies Conference, June 1991.
Estimating the Cost of Equity Capital " University of Texas at Austin Utilities
Conference, June 1989, June 1990.
Regulation: The Bottom Line " Texas Society of Certified Public Accountants, Annual
Utilities Conference, Austin, Texas, April 1990.
Alternative Treatments of Large Plant Additions -- Modelingthe Alternatives
University of Texas at Dallas Public Utilities Conference, July 1989.
Industrial Customer Electrical Requirements " Edison Electric Institute Financial
Conference, Scottsdale, Arizona, October 1988.
Acquisitions and Consolidations in the Electric Power Industry," Conference on
Emerging Issues of Competition in the Electric Utility Industry, University of
Texas at Austin, May 1988.
The General Fund Transfer - Is It A Tax? Is It A Dividend Payout? Is It Fair?" The
Texas Public Power Association Annual Meeting, Austin, May 1984.
Avoiding 'Rate Shock' - Preoperational Phase-In Through CWIP in Rate Base," Edison
Electric Institute, Finance Committee Annual Meeting, May 1983.
A Cost-Benefit Analysis of Alternative Bond Ratings Among Electric Utility Companies
in Texas " (with B.L. Heidebrecht and J.L. Nash), Texas Senate Subcommittee on
Consumer Affairs, December 1982.
Texas PUC Rate of Return and Construction Work in Progress Methods " New York
Society of Security Analysts, New York, August 1982.
In Support of Debt Service Requirements as a Guide to Setting Rates of Return for
Subsidiaries " Financial Forum, National Society of Rate of Return Analysts
Washington, D., May 1982.
PUBLICATIONS
Institutional Constraints on Public Fund Performance " (with B.L. Hadaway) Journal of
Portfolio Management, Winter 1989.
Implications of Savings and Loan Conversions in a Deregulated Wodd, " (with B.L.
Hadaway) Journal of Bank Research Spring 1984.
Regulatory Treatment of Construction Work in Progress " abstract, (with B.L.
Heidebrecht and J. L. Nash), Rate Regulation Review Edison Electric Institute
December 20, 1982.
Financial Integrity and Market-to-Book Ratios in an Efficient Market " (with W. L.
Beedles), Gas Pricing Ratemaking, December 7, 1982.
An Analysis of the Performance Characteristics of Converted Savings and Loan
Associations " (with B.L. Hadaway) Journal of Financial Research Fall 1981.
Rocky Moun1ain Power
Exhibit No, I page 9 of 9
CASE NO, PAC-E-O7-OS
Witness Samuel C. Hadaway
Inflation Protection from Multi-Asset Sector Investments: A Long-Run Examination of
Correlation Relationships with Inflation Rates 1I (with B.lo Hadaway), Review of
Business and Economic Research Spring 1981.
Converting to a Stock Company-Association Characteristics Before and After
Conversion, II (with B.lo Hadaway), Federal Home Loan Bank Board Journal
October 1980.
A Large-Sample Comparative Test for Seasonality in Individual Common Stocks, II (with
P. Rochester), Journal of Economics and Business Fall 1980.
Diversification Possibilities in Agricultural Land Investments 1I Appraisal Journal
October 1978.
Further Evidence on Seasonality in Common Stocks, II (with D.P. Rochester), Journal of
Financial and Quantitative Analysis March 1978.
, ~
i '"
" ", ..
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J ~Case No. PAC-07-
Exhibit No.
Witness: Samuel C. HadawaylJr\
~(\\,:,,: ,,\,
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BEFORE THE IDAHO PUBLIC UTILITIES COMMISSION
ROCKY MOUNTAIN POWER
Exhibit Accompanying Direct Testimony of Samuel C. Hadaway
Market Trends
June 2007
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Long-Term Interest Rate Trends
Average Long-Term 10-Year
Utility Utility Treasury Treasury
Month Rates Rates Rates Rates
Jun-5.40%39%35%00%
Jul-51%50%4.48%18%
Aug-50%51%53%26%
Sep-52%54%51%20%
Oet-79%79%74%4.46%
Nav-88%88%83%54%
Dee-80%83%73%47%
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Feb-82%83%73%57%
Mar-98%98%91%72%
Apr-29%28%22%99%
May-6.42%39%35%11%
Jun-6.40%39%29%11%
Jul-37%37%25%09%
Aug-20%20%08%88%
Sep-00%03%93%72%
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Nov-80%82%78%130%
Dee-81%83%78%56%
Jan-96%97%95%76%
Feb-90%91%93%72%
Mar-84%87%81%56%
Sources: Mergent Bond Record (Utility Rates);
www.federaireserve.gov (Treasury Rates).
Rocky Mountain Power
Exhibit No,2 page 2 of3
CASE NO, PAC-E..Q7-
Witness Samuel C, Hadaway
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BEFORE THE IDAHO PUBLIC UTILITIES COMMISSION
ROCKY MOUNTAIN POWER
Exhibit Accompanying Direct Testimony of Samuel C. Hadaway
Comparison of Analysts' Growth Rates
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June 2007
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Case No. PAC-07-
Exhibit No.
Witness: Samuel C. Hadaway
BEFORE THE IDAHO PUBLIC UTILITIES COMMISSION
ROCKY MOUNTAIN POWER
Exhibit Accompanying Direct Testimony of Samuel C. Hadaway
GDP Growth Rate Forecast
June 2007
Rocky Moun1ain Power
Exhibit No.
CASE NO, PAC-E-O7-OS
Witness Samuel C. Hadaway
Rocky Mountain Power
GDP Growth Rate Forecast
Nominal GDP Price
GDP Chan Deflator Chan CPI Chan
1947 244.15.22.
1948 269.10.16.24.
1949 267.16.23.
1950 293.16.24.
1951 339.15.17.26.
1952 358.18.26.
1953 379.18.26.
1954 380.18.26.
1955 414.18.26.-0.
1956 437.19.4 27.
1957 461.20.28.
1958 467.20.28.
1959 506.20.29.
1960 526.4 21.1.4%29.
1961 544.21.29.
1962 585.21.30.
1963 617.21.30.
1964 663.7.4%22.31.
1965 719.22.31.
1966 787.23.32.
1967 832.23.33.
1968 910.24.34.
1969 984.26.36.5.4%
1970 1038.27.38.
1971 1127.28.40.
1972 1238.30.41.
1973 1382.11.31.44.
1974 1500.34.49.11.
1975 1638.38,53.
1976 1825.11.40,56.
1977 2030.11.42.60.
1978 2294.13.45.65.
1979 2563.11.49.72.11.
1980 2789.54.82.13.
1981 3128.4 12.59.9.4%90.10.
1982 3255.62.96.
1983 3536.65.99.
1984 3933.11.67.103.4.4%
1985 4220.69.107.
1986 4462.71.109.
1987 4739.73.113.
1988 5103.75.118.
1989 5484.78.123.
1990 5803.81,130.
1991 5995.84.4 136.
1992 6337.86,140.
1993 6657.88.4 144.
1994 7072.90.148.
1995 7397.92.152.4
1996 7816.93.156.
1997 8304.95.160.
1998 8747.96.163.
1999 9268.4 97.166.
2000 9817.100.172.
2001 10128.102.4 177.
2002 10469.104.179.
2003 10960.106.4 184.
2004 11712.109.188.
2005 12455.112.195.
2006 13246.116.201.
10-Year Average
20-Year Average
30-Year Average
40-Year Average
50-Year Average
59-Year Average
Average of Periods
Source: St. .Louis Federal Reserve Bank. Economic Data - FRED II (www.resear(;h.stiouisfed.org).
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Exhibit Accompanying Direct Testimony of Samuel C. Hadaway
Discounted Cash Flow Analysis
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June 2007
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Case No. PAC-07-
Exhibit No.
Witness: Samuel C. Hadaway
i,;:;
j '
J .,1' . 3'
BEFORE THE IDAHO PUBLIC UTILITIES COMMISSION
ROCKY MOUNTAIN POWER
Exhibit Accompanying Direct Testimony of Samuel C. Hadaway
Risk Premium Analysis
1980 to 2006
June 2007
Rocky Moun1am t'ower
Exhibit No,6 page 1 of 2
CASE NO, PAC-Q7-
Wimess Samuel C. Hadaway
Page 1 of 2
Rocky Mountain Power
Risk Premium Analysis
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
AVERAGE
MOODY'S AVERAGE
PUBLIC UTILITY
BOND YIELD (1)
13.15%
15.62%
15.33%
13.31%
14.03%
12.29%
46%
98%
10.45%
66%
76%
21%
57%
56%
30%
91%
74%
63%
00%
55%
14%
72%
53%
61%
20%
67%
08%
35%
AUTHORIZED
ELECTRIC
RETURNS
14.23%
15.22%
15.78%
15.36%
15.32%
15.20%
13.93%
12.99%
12.79%
12.97%
12.70%
12.55%
12.09%
11.41 %
11.34%
11.55%
11.39%
11.40%
11.66%
10.77%
11.43%
11.09%
11.16%
10.97%
10.75%
10.54%
10.36%
12.48%
INDICATED
RISK
PREMIUM
08%
40%
45%
05%
29%
91%
47%
01%
34%
31%
94%
34%
52%
85%
04%
64%
3..65%
77%
66%
22%
29%
37%
63%
36%
55%
87%
28%
13%
INDICATED COST OF EQUITY
PROJECTED SINGLE-A UTILITY BOND YIELD"
MOODY'S AVG ANNUAL YIELD DURING STUDY
INTEREST RATE DIFFERENCE
INTEREST RATE CHANGE COEFFICIENT
ADUSTMENT TO AVG RISK PREMIUM
BASIC RISK PREMIUM
INTEREST RATE ADJUSTMENT
EQUITY RISK PREMIUM
30%
35%
05%
-42.18%
29%
13%
29%
42%
30%
10.72%
PROJECTED SINGLE-A UTILITY BOND YIELD"
INDICATED EQUITY RETURN
Sources:
(1) Moody s Investors Service
(2) Regulatory Focus, Regulatory Research Associates, Inc.
The projected single-A bond yield is equal to the projected 30-year Treasury bond rate (5.2 percent) from
S&P's Trends & Projections (Exhibit 2, p. 3) plus 110 basis points. The average single-
spread over Treasuries for 2006 was 108 basis points.
, ..., ",vw"."11 .-uwer
Exhibit No, 6 page 2 of 2
CASE NO, PAC-O7-Witness Samuel C, Hadaway
Page 2 of 2
Rocky Mountain Power
Risk Premium Analysis
Authorized Equity Risk Premiums vs. Utility Interest
Rates (1980-2006)
D..
.:.:
CI"
y = -
4218x + 0.0707
2 = 0.8575
13%15%11%
Average Utility Interest Rates