20070928Gorman direct 2.pdf

luG1 SEP 28 AI'\ 9: 46
10l\\-10 PUBLIC;
UTiL\TIES. COMMISS!()i'
Before the
Idaho Public Utilities Commission
In the Matter of the Application of
PacifiCorp DBA Rocky Mountain
Power for Approval of Changes to
its Electric Service Schedules
Case No. PAC-O7-
Direct Testimony and Exhibits of
Michael Gorman
Volume 2 - Cost of Capital
On behalf of
Monsanto Company
Project 8819
September 28, 2007
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BRUBAKER & AsSOCIATEs, INc.
ST. LOUIS. MO 63141-2000
PUBLIC
Before the Idaho Public Utilities Commission
In the Matter of the Application of
PacifiCorp DBA Rocky Mountain
Power for Approval of Changes to
its Electric Service Schedules
Case No. PAC-O7-
Table of Contents to the Direct Testimonv of Michael Gorman
Electric Utility Industry Market Perspective ........................................................................
RMP Risk Factors ................................................................................................................... 4
Projected Interest Rates and Capital Market Costs ............................................................ 6
RMP's Proposed Capital Structure .......................................................................................
Return on Common Equity ....................................................................................................
Discounted Cash Flow Model .............................................................................................
Two-Stage DCF Model........................... ............... ................... ................... ......................... 18
Risk Premium Model............................................................................................................
Capital Asset Pricing Model................................................................................................
Return on Equity Summary .................................................................................................
Financial Integrity...................................... ...........................................................................
Response to RMP Witness, Dr. Samuel Hadaway.............................................................
Exhibits:
Exhibit 221 (MPG-
Exhibit 222 (MPG-
Exhibit 223 (MPG-10)
Exhibit 224 (MPG-11)
Exhibit 225 (MPG-12)
Exhibit 226 (MPG-13)
Exhibit 227 (MPG-14)
Exhibit 228 (MPG-15)
Exhibit 229 (MPG-16)
Exhibit 230 (MPG-17)
Exhibit 231 (MPG-18)
Exhibit 232 (MPG-19)
Exhibit 233 (MPG-20)
Exhibit 234 (MPG-21)
Exhibit 235 (MPG-22)
Exhibit 236 (MPG-23)
Public Exhibit 237 (MPG-24)
Exhibit 238 (MPG-25)
Testimony of Michael Gorman - Page 1 BRUBAKER & ASSOCIATES, INC.
Michael Gorman
Page 1
Before the Idaho Public Utilities Commission
Case No. PAC-O7-
In the Matter of the Application of
PacifiCorp DBA Rocky Mountain
Power for Approval of Changes to
its Electric Service Schedules
Direct Testimonv of Michael Gorman
PLEASE STATE YOUR NAME AND BUSINESS ADDRESS.
My name is Michael Gorman and my business address is 1215 Fern Ridge Parkway,
Suite 208, St. Louis, MO 63141-2000.
WHAT IS YOUR OCCUPATION?
I am an energy advisor and a consultant in the field of public utility regulation and a
managing principal in the firm of Brubaker & Associates, Inc. (BAI).
PLEASE SUMMARIZE YOUR EDUCATIONAL BACKGROUND AND EXPER-
IENCE.
These are set forth in Appendix A to my Volume 1 direct testimony.
ON WHOSE BEHALF ARE YOU APPEARING IN THIS PROCEEDING?
I am appearing on behalf of Monsanto Company.
WHAT IS THE SUBJECT OF YOUR TESTIMONY?
I will recommend a fair return on common equity and overall rate of return for Rocky
Mountain Power (RMP or Company).
Testimony of Michael Gorman - Page 1 BRUBAKER & ASSOCIATES, INC.
Michael Gorman
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PLEASE SUMMARIZE YOUR RATE OF RETURN RECOMMENDATIONS.
I recommend the Idaho Public Utilities Commission (IPUC or the Commission) award
RMP a return on common equity of 10.0%.
My recommended return on equity for RMP is based on a constant growth
Discounted Cash Flow (DCF) model, a two-stage growth DCF model, Risk Premium
(RP) model and Capital Asset Pricing Model (CAPM) analyses. These analyses
estimate a fair return on equity based on observable market information for a group of
publicly traded electric utility companies that proxy RMP's investment risk.
I also show that my proposed return on equity provides RMP an opportunity to
earn cash flows that support its credit metrics, and that will support its current bond
rating. This illustration proves that a 10% return on equity will support RMP'
financial integrity and access to capital.
As such, my recommended return on equity is fair compensation and will
maintain RMP's financial integrity.
Electric Utili Market Pers ective
PLEASE DESCRIBE THE MARKET'S PERCEPTION OF THE ELECTRIC UTILITY
INDUSTRY OVER THE LAST SEVERAL YEARS.
Standard & Poor s (S&P) I believe captures the sentiment of the investment market
toward the electric utility industry experienced over the last several years. In 2001,
S&P stated it recorded 81 downgrades to utility credit ratings, with only 29 upgrades.
S&P stated in 2002 that the credit rating activity in the electric utility industry was
negative due to: (1) weakening financial profiles, (2) loss of investor confidence which
affected the industry s liquidity and financial flexibility, (3) heightened business risk
derived from more investments outside the traditional regulated utility business,
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(4) corporate restructuring and mergers and acquisitions, and (5) certain regulatory
difficulties.
S&P attributed most of the 2002 liquidity and credit erosion in the industry to
heavy debt funded investments in higher risk non-regulated activities, and the loss of
management credibility due to accounting and trading irregularities.
Importantly, this negative perception of the energy industry over the last
several years has been improved considerably because the industry has reverted to a
back-to-basics" business model. As part of the back-to-basics business model
utilities have been shedding non-regulated activities and using the asset sale
proceeds to retire debt. Also, utilities have adopted corporate governance policies
that have helped regain the confidence of the market.
In 2005, S&P revised its industry outlook by stating that the industry s leading
indicators of credit rating tend to show that there are nearly twice as many stable
outlooks as negative outlooks. S&P credits improved credit quality and liquidity
enhancement for improving credit rating metrics resulting primarily from a reduction of
high cost debt and elimination of higher risk non-utility investments, and the industry
shift to a back-to-basics business model, which concentrates on core competencies
debt reduction and risk management (Standard & Poor s: Industry Report Card: U.
Electric/Water/Gas, January 4 , 2005).
In 2006 , S&P confirmed the stable credit quality of the industry, which is
expected to continue in the future despite increasing capital spending. Further, the
industry focus on strengthening its balance sheet by divesting non-core business
operations has improved utilities' ability to withstand the pressure of substantial
1 S&P Utilities & Perspectives, Global Utilities Rating Service, October 14, 2002.
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capital expeditures. (Standard & Poor s: Industry Report Card, January 12 , 2007). In
the second quarter of 2007, S&P identified the principal drivers of credit upgrades to
be improving financial conditions , due to significant debt reduction, stronger free cash
flow, cost reductions, regulatory support and reduced business risk (Standard &
Poor s Industry Survey, Electric Utilities, August 9, 2007 at 6).
RMP Risk Factors
WHAT IS THE. RELATIONSHIP BETWEEN RMP AND PACIFICORP?
Rocky Mountain Power is a division of PacifiCorp. PacifiCorp is a wholly owned
subsidiary of MidAmerican Energy Holdings Company (MEHC). PacifiCorp operates
utilities in Oregon , Washington and California as Pacific Power. PacifiCorp s utility
operations in Utah , Wyoming and Idaho operate as Rocky Mountain Power (RMP).
PLEASE PROVIDE AN OVERVIEW OF PACIFICORP'S INVESTMENT RISK.
PacifiCorp has a business profile score of '5' and an investment bond rating of "
from S&P and "A3" from Moody s. The majority of the U.S. electric utility companies
have a credit rating of "BBB"2 PacifiCorp s bond rating is two notches above the
industry average. For integrated utility companies, S&P's business profile scores
typically fall within the range of '4' to '3 PacifiCorp s business profile score of '5' is
comparable to the risk of a typical integrated electric utility company.
2 Standard & Poor s Ratings Direct: Pace of U.S. Utility Rating Activity Moderated in 2006.
January 23, 2007.
Standard & Poor s: New Business Profile Score Assigned for U.S. Utility and Power
Companies; Financial Guidelines Revised, June 2, 2004, Chart 4.
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IS PACIFICORP'S CREDIT QUALITY IMPACTED BY ITS PARENT COMPANY?
PacifiCorp s affiliation with its parent and other subsidiaries impacts its credit quality
because S&P determines PacifiCorp s credit rating on a consolidated basis with its
parent and affiliated companies. S&P stated as follows:
The '' corporate credit rating on PacifiCorp reflects MEHC'
consolidated credit profile. The rating incorporates MEHC's strong
business risk position, fairly aggressive financial profile, and both
explicit and implicit support from Berkshire Hathaway.
MEHC owns PacifiCorp through PPW Holdings LLC, a special-purpose
entity that ring-fences PacifiCorp from MEHC as required by the
Oregon Public Utilities Commission. The ring-fencing includes
structural protections, covenants, a pledge of stock, and
independent director. PacifiCorp also agreed to refrain from making
dividends to MEHC unless it maintains a common equity ratio of
48.25% through 2008, decreasing annually to 44% by 2012. These
factors serve to protect PPW Holdings LLC and PacifiCorp from an
MEHC bankruptcy. Due to the ring-fencing, PacifiCorp s corporate
credit rating could potentially be as high as three notches above
MEHC's rating, provided its stand-alone credit quality supported such
an elevation. Currently, the utility s stand-alone credit metrics are in
the 'BBB' category and do not warrant a rating above MEHC'
As such, PacifiCorp s bond rating is reasonably protected from MEHC through
constructive ring-fence protections. Nevertheless, MEHC's financial position and
investment risk can impact PacifiCorp s corporate credit rating and financial integrity.
As such, the Commission should be concerned about the impact on PacifiCorp
ability to attract capital under reasonable terms and conditions due to unsuccessful or
failed investments at MEHC, including acquisitions that may create undue financial
distress on the parent company. However, at this time, MEHC does not appear to be
creating any negative credit rating implications on PacifiCorp.
4 Standard & Poor s: PacifiCorp s $600 Million Bonds Rated ", March 14 2007.
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Projected Interest Rates and Capital Market Costs
SHOULD THE COMMISSION PLACE HEAVY RELIANCE ON PROJECTED
INTEREST RATES AND FUTURE CAPITAL MARKET COSTS RELATIVE TO
TODA Y'S OBSERVABLE CAPITAL MARKET COSTS?
No.While projected interest rates should be given some consideration, the
determination of RMP's cost of capital today should be based primarily on observable
and verifiable actual current market costs. This is appropriate because projected
changes to interest rates are highly uncertain and their accuracy is at best
problematic. Indeed, this is clearly evident by a review of projected changes to
interest rates made over the last five years, in comparison to how accurate these
projections turned out to be. This analysis clearly illustrates that observable interest
rates today are as accurate as are economists ' consensus projections of future
interest rates.
An analysis supporting this conclusion is illustrated on Exhibit 221 (MPG-8).
On this exhibit, under Columns 1 and 2, I show the actual market yield at the time a
projection is made for Treasury bond yields two years in the future. In Column 1, I
show the actual Treasury yield and, in Column 2, I show the projected yield two years
out. As shown in Columns 1 and 2, over the last five years, Treasury yields were
projected to increase relative to the actual Treasury yields at the time of the
projection. In Column 4, I show what the Treasury yield actually turned out to be two
years after the forecast. Under Column 5, I show the actual yield change at the time
of the projections relative to the projected yield change.
As shown on this exhibit, over the last five years, economists have been
consistently projecting increases to interest rates. However, as demonstrated under
Column 5, those yield projections have turned out to be overstated in virtually every
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case. Indeed, actual Treasury yields have decreased or remained flat over the last
five years, rather than increase as the economists' projections indicated.
This review of the experience with projected interest rates clearly illustrates
that interest rate projection accuracy is highly problematic.Indeed, current
observable interest rates are just as likely a reasonable projection of future interest
rates as are economists' projections. Accordingly, while I will use projected interest
rates to provide some sense of the market's expectations of future capital market
costs, I will not use them exclusively. Rather, my analyses will be based on the
combination of current observable interest rates and projected interest rates. Thus,
my analyses will capture a return on equity range reflecting a broad range of potential
actual capital market costs during the period rates determined in this proceeding will
be in effect.
ARE THERE OTHER REASONS NOT TO RELY EXCLUSIVELY ON UNCERTAIN
PROJECTED INCREASES TO INTEREST RATES?
Yes. The ratemaking process itself provides utilities protection against the increasing
cost of capital. Indeed, if RMP's rate of return is set based on today s market cost of
capital, and capital costs increase in the future, then RMP is free to file for a rate
change to reflect higher capital costs in the future when, or if, costs change. Hence
the regulatory mechanism itself provides utilities a hedge against increasing capital
costs. Depriving ratepayers of today s low cost capital market environment is
prejudicial and unreasonably tilts the regulatory balance in favor of investors.
Testimony of Michael Gorman - Page 7 BRUBAKER & ASSOCIATES, INC.
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RMP's Proposed Capital Structure
WHAT CAPITAL STRUCTURE IS THE COMPANY REQUESTING TO USE TO
DEVELOP ITS OVERALL RATE OF RETURN FOR ELECTRIC OPERATIONS IN
THIS PROCEEDING?
RMP's proposed capital structure, as supported by Mr. Bruce N. Williams, is shown
below in Table 1.
TABLE 1
RMP's ReQuested CaDital Structure
Description
Percent of
Total Capital
Long-Term Debt
Preferred Stock
Common Equity
Total Regulatory Capital Structure
49.
50.4%
100.
Source: Williams Direct at
ARE YOU PROPOSING ANY ADJUSTMENTS MR.WILLIAMS'
RECOMMENDED CAPITAL STRUCTURE TO SET RMP'S OVERALL RATE OF
RETURN IN THIS PROCEEDING?
No. The proposed capital structure represents the Company s pro forma capital
structure as of December 31,2007, which is reasonably comparable to RMP's actual
capital structure in 2006.
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WHAT OVERALL RATE OF RETURN DO YOU RECOMMEND FOR RMP IN THIS
PROCEEDING?
As shown on Exhibit 222 (MPG-9), based on my proposed return on equity and
RMP's proposed capital structure, I recommend the Commission set RMP's overall
rate of return at 8.14%.
Return on Common Eauitv
PLEASE DESCRIBE THE FRAMEWORK FOR DETERMINING A REGULATED
UTILITY'S COST OF COMMON EQUITY.
In general , determining a fair cost of common equity for a regulated utility has been
framed by two decisions of the U.S. Supreme Court, in Bluefield Water Works &
Improvement Co. v. Public Servo Comm n of West Virainia, 26 U.S. 679 (1923) and
Federal Power Comm n v. Hope Natural Gas Co., 320 U.S. 591 (1944).
These decisions identify the general standards to be considered in
establishing the cost of common equity for a public utility. Those general standards
are that the authorized return should: (1) be sufficient to maintain financial integrity;
(2) attract capital under reasonable terms; and (3) be commensurate with returns
investors could earn by investing in other enterprises of comparable risk.
PLEASE DESCRIBE WHAT IS MEANT BY "UTILITY'S COST OF COMMON
EQUITY.
A utility's cost of common equity is the return investors expect, or require, in order to
make an investment.Investors expect to achieve their return requirement from
receiving dividends and stock price appreciation.
Testimony of Michael Gorman - Page 9 BRUBAKER & ASSOCIATES, INC.
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PLEASE DESCRIBE THE METHODS YOU HAVE USED TO ESTIMATE THE COST
OF COMMON EQUITY FOR RMP.
I have used several models based on financial theory to estimate RMP's cost of
common equity. These models are: (1) a constant growth Discounted Cash Flow
(DCF) model , (2) a two-stage growth DCF model , (3) a Risk Premium (RP) model
and (4) a Capital Asset Pricing Model (CAPM). I have applied these models to a
group of publicly traded utilities that I have determined represent the investment risk
of RMP.
PLEASE DESCRIBE THE PROXY GROUP YOU USED TO ESTIMATE RMP'
RETURN ON EQUITY IN THIS PROCEEDING.
I relied on the same risk proxy group used by RMP witness, Dr. Samuel Hadaway.
HOW DOES THIS PROXY GROUP RISK COMPARE TO RMP?
My proposed proxy group is shown on Exhibit 223 (MPG-10). My proxy group has an
average bond rating from S&P and Moody s of "" and "A2," respectively. My proxy
group average bond ratings are reasonably comparable to RMP's credit ratings from
S&P and Moody s of "" and "A3," respectively.
My proxy group has an average common equity ratio of 51 % from Value Line
and 47% from AUS. In comparison, RMP's requested common equity ratio is 50%,
which is approximately identical to the Company s actual common equity ratio. As
such, my proxy group has reasonably comparable financial risk to RMP.
Finally, my proxy group has a S&P's business profile score of '4' compared to
RMP score of '. This S&P business profile score indicates the proxy group has
slightly lower business risk than RMP, albeit comparable. Hence, my proxy group
Testimony of Michael Gorman - Page 10 BRUBAKER & ASSOCIATES, INC.
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has comparable business and financial risks to RMP. Based on this assessment, I
believe my proxy group has reasonably comparable investment risk to RMP.
Discounted Cash Flow Model
PLEASE DESCRIBE THE DCF MODEL.
The DCF model posits that a stock price is valued by summing the present value of
expected future cash flows discounted at the investor s required rate of return (ROR)
or cost of capital. This model is expressed mathematically as follows:
Po =....Q.L +
....
Dco where
(1+K)1 (1+K)2 (1+K)co
Po= Current stock price
D = Dividends in periods 1 -
K = Investor s required return
(Equation 1)
This model can be rearranged in order to estimate the discount rate or
investor required return, "K."If it is reasonable to assume that earnings and
dividends will grow at a constant rate, then Equation 1 can be rearranged as follows:
K = D1/Po + G (Equation 2)
K = Investor s required return
D1 = Dividend in first year
Po = Current stock price
G = Expected constant dividend growth rate
Equation 2 is referred to as the annual "constant growth" DCF model.
PLEASE DESCRIBE THE INPUTS TO YOUR CONSTANT GROWTH DCF MODEL.
As shown under Equation 2 above, the DCF model requires a current stock price,
expected dividend, and expected growth rate in dividends.
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WHAT STOCK PRICE AND DIVIDEND HAVE YOU RELIED ON IN YOUR
CONSTANT GROWTH DCF MODEL?
I relied on the average of the weekly high and low stock prices over a 13-week period
ended September 7,2007. An average stock price is less susceptible to market price
variations than is a spot price. Therefore, an average stock price is less susceptible
to aberrant market price movements, which may not be reflective of the stock's long-
term value.
13-week average stock price is short enough to contain data that
reasonably reflects current market expectations, but is not too short a period to
susceptible to market price variations that may not be reflective of the security s long-
term value.Therefore, in my judgment, a 13-week average stock price is a
reasonable balance between the need to reflect current market expectations and to
capture sufficient data to smooth out aberrant market movements.
I used the most recently paid quarterly dividend, as reported in the Value Line
Investment Survey. This dividend was annualized (multiplied by 4) and adjusted for
next year s growth to produce the D1 factor for use in Equation 2 above.
WHAT DIVIDEND GROWTH RATES HAVE YOU USED IN YOUR CONSTANT
GROWTH DCF MODEL?
There are several methods one can use in order to estimate the expected growth in
dividends. However, for purposes of determining the market required return on
common equity, one must attempt to estimate investors' consensus about what the
dividend or earnings growth rate will be, and not what an individual investor or analyst
may use to form individual investment decisions.
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Security analysts' growth estimates have been shown to be more accurate
predictors of future returns than growth rates derived from historical data5 because
they are more reliable estimates, and assuming the market generally makes rational
investment decisions, analysts' growth projections are the most likely growth
estimates considered by the market that influence observable stock prices.
For my constant growth DCF analysis, I have relied on a consensus, or mean
of professional security analysts' earnings growth estimates as a proxy for the
investor consensus dividend growth rate expectations. I used the average of three
sources of ratepayer growth rate estimates: lack's, Reuters, and SNL Financial. All
consensus analyst projections used were available on September 13, 2007, as
reported on-line.
Each consensus growth rate projection is based on a survey of security
analysts.The consensus estimate is a simple arithmetic average, or mean, of
surveyed analysts' earnings growth forecasts.A simple average of the growth
forecasts gives equal weight to all surveyed analysts' projections. It is problematic as
to whether any particular analyst's forecast is most representative of general market
expectations. Therefore, a simple average, or arithmetic mean, analyst forecast is a
good proxy for market consensus expectations. The growth rates I used in my DCF
analysis are shown on Exhibit 224 (MPG-11).
WHAT ARE THE RESULTS OF YOUR CONSTANT GROWTH DCF MODEL?
As shown on Exhibit 225 (MPG-12), the constant growth DCF return for
comparable group is 10.0%.
See e.David Gordon, Myron Gordon, and Lawrence Gould
, "
Choice Among Methods of
Estimating Share Yield,The Journal of Portfolio Manaqement, Spring 1989.
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DO YOU HAVE ANY COMMENTS CONCERNING THE RESULTS OF YOUR
CONSTANT GROWTH DCF ANALYSIS?
Yes. The average three- to five-year growth rate for my comparable group is 5.54%.
This growth rate is slightly above the rational estimate of long-term sustainable
growth. '
WHY DO YOU BELIEVE THE PROXY GROUP'S THREE- TO FIVE-YEAR
GROWTH RATE NOT A RATIONAL ESTIMATE OF LONG-TERM
SUSTAINABLE GROWTH?
The proxy group s three- to five-year growth rate exceeds the growth rate of the
overall U.S. economy. Based on consensus economic projections, as published by
Blue Chip Economic Indicators, the five and ten-year GDP growth is estimated at a
nominal rate of 5.1 %.6 A company cannot grow, indefinitely, at a faster rate than the
market in which it sells its products. The U.S. economy, or GDP, growth projection
represents a ceiling, or high end, sustainable growth rate for a utility over an indefinite
period of time.
Utilities cannot sustain a growth rate that exceeds the growth rate of the
overall economy, because utilities' earnings/dividend growth is created by increased
utility investment, which in turn is driven by service area economic growth. In other
words, utilities invest in plant to meet sales demand growth , and sales growth in turn
is tied to economic growth in their service areas. Hence, nominal GDP growth is a
proxy for sales growth, utility rate base growth, and earnings growth. Therefore, GDP
growth is the highest sustainable long-term growth rate of a utility.
6 Blue Chip Economic Indicators, March 10, 2007 at 15.
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Moreover, the proxy group s projected growth rate of 5.54% is higher than the
historical growth rates the proxy group has achieved over the last five to ten years,
and that is projected over the next three to five years. As shown on Exhibit 226
(MPG-13), the historical growth of my proxy group s dividend is substantially lower
than the nominal GDP growth, and actually less than the projected inflation growth.
Importantly, this growth rate exceeds the projected growth of inflation and the
projected growth of nominal GDP. Therefore, this growth rate estimate does not
reflect investors' rational expectations.
Further, the current and projected payout ratios of my group are 72% and
64%, respectively. This indicates utilities are retaining a large percentage of their
earnings, which will help support future growth through earnings and dividends.
Finally, the current and projected dividend-to-book ratios of my comparable
utility group are both 7.2%. This indicates that the dividend is affordable in today
low-cost capital market environment, and utilities could support that dividend at an
authorized return on equity well under 10% and still retain adequate earnings to fund
future growth.
WHY DO YOU BELIEVE GROWTH RATES FOR ELECTRIC UTILITY COMPANIES
ARE PROJECTED TO BE HIGHER OVER THE NEXT THREE TO FIVE YEARS?
Electric utility companies are in the midst of major construction programs, which are
significantly increasing their outstanding capital and net plant investment. In fact, in
the fourth quarter 2006, the Edison Electric Institute (EEl), a utility company trade
organization, published a financial update for electric utilities.portion of the
highlights identified by EEl is as follows:
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Shareholder-owned electric utilities brought 5,857 MW of new
capacity online in 2006, 42% less than in 2005. Natural gas
generation has dropped from 98% of new plant construction in 2002 to
64% in 2006. In contrast, wind has increased from 1 % to 32% over
the same time period.
. With reserve margins shrinking in several key regional electricity
markets and nationwide power demand growing steadily, the industry
is now planning a new round of plant construction. Announced new
capacity additions totaled 33,998 MW in 2006, surpassing the total for
each of the last four years, and over twice that of 2005.
. EEl survey results indicate that the industry is planning to invest
$31.billion in the transmission system from 2006-2009, a 58%
increase over the amount invested from 2002-2005. Transmission
investment in 2005 totaled $5.8 billion, an 18% increase over the
$4.9 billion invested in 2004. (EEl , Construction, Q4 2006 Financial
Update).
In the second quarter of 2007, EEl confirmed the large capital expenditure
programs undertaken by U.S. utilities.
S. electricity demand is growing slowly but steadily and the utility industry is
in the early stages of a sizeable long-term capital investment cycle that includes rising
spending on emissions control equipment, transmission and distribution upgrades
and, over the longer term, a new round of base load generation. Much of this will
likely be built in rate base.
EEl's recent construction survey shows that industry-wide capital spending is
set to rise from $48.4 billion in 2005 to $73.1 billion in 2007, a 51.1 % increase. And
Wall Street analysts forecast strong investment by the industry beyond the end of the
decade. The prospect of carbon regulation adds to the potential longevity of the
current build cycle, should carbon capture and sequestration become the most
economically viable way of complying with future carbon limits.
Thus, the projected increase in utility earnings and dividend paying ability is
not a sustainable trend, but rather is the result of an abnormally high period of
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industry construction expenditures. Once generation reserve margins are increased
to or above target levels, transmission capacity investments are made to alleviate
transmission constraints and environmental upgrades are complete, it is reasonable
to expect that capital expenditures by utilities will decline to a more normal and
sustainable growth level. This will cause utility earnings also to drop to a sustainable
growth level.
EEl's assessment supports the use of a two-stage growth DCF model in this
case, because three- to five-year earnings growth projections will be unsustainably
high after the current abnormally high construction expenditure period comes to an
end.
SINCE YOU HAVE CONCLUDED THAT THE GROWTH RATES USED IN YOUR
CONSTANT GROWTH DCF MODEL ARE SLIGHTLY HIGHER THAN THE
LONG-TERM SUSTAINABLE GROWTH, DO YOU BELIEVE THAT THE RESULT
OF YOUR CONSTANT GROWTH DCF MODEL FOR YOUR PROXY GROUP IS
REASONABLE?
Yes, the result of my constant growth DCF model is reasonable albeit high, because
the growth rate used in this study is slightly higher than the maximum sustainable
growth rate of 5.1 %. However, my constant growth DCF is based on consensus
analysts' growth rate projections , so it is a reasonable reflection of rational investment
expectations over the next three to five years. The limitation on the constant growth
DCF model is that it cannot reflect a rational expectation that a period of high/low
short-term growth can be followed by a change in growth to a rate that is more
reflective of long-term sustainable growth. Hence, I will perform a two-stage DCF
analysis to reflect this outlook of changing growth expectations.
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Two-Staae DCF Model
WHY DO YOU PROPOSE TO USE A TWO-STAGE DCF MODEL TO TEST THE
RESULTS OF YOUR CONSTANT GROWTH DCF STUDY?
I propose to use a two-stage DCF model because the growth rates used in my
constant growth model are higher than a reasonable estimate of long-term
sustainable growth. As noted above, utilities cannot grow faster than the economies
in which they sell their services. Historically, utility sales have grown at a rate that
trails the growth in the overall U.S. economy.
As such, a two-stage DCF model can capture the expectation of abnormally
high growth over the next five years, followed by a decline of long-term sustainable
growth.
PLEASE DESCRIBE YOUR TWO-STAGE DCF MODEL.
The two-stage DCF growth model reflects the possibility of non-constant growth to a
company over time. The two-stage model reflects two growth periods: (1) a short-
term growth period, which consists of the first five years; and (2) a long-term growth
period, which consists of each year starting in year six through perpetuity. For the
short-term growth period, I relied on the consensus analysts' growth projections
described above in relationship to my constant growth DCF model. For the long-term
growth period, I assumed each company s growth would increase toward the
maximum sustainable growth rate for a utility company as proxied by the consensus
analysts' projected growth for the U.S. GDP.
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WHAT STOCK PRICE AND DIVIDEND DID YOU USE IN YOUR TWO-STAGE DCF
ANALYSIS?
I relied on the same 13-week stock price, the most recent quarterly dividend payment,
and consensus analysts' growth rate projections discussed above in my constant
growth DCF model. For the long-term sustainable growth rate starting in year six, I
used the consensus economists' five to ten-year projected nominal GDP growth rate
of 5.1%.
WHAT ARE THE RESU L TS OF YOUR TWO-STAGE GROWTH DCF MODEL?
As shown on Exhibit 227 (MPG-14), the DCF return on equity for my proxy group is
6%.
Risk Premium Model
PLEASE DESCRIBE YOUR BOND YIELD PLUS RISK PREMIUM MODEL.
This model is based on the principle that investors require a higher ROR to assume
greater risk. Common equity investments have greater risk than bonds because
bonds have more security of payment in bankruptcy proceedings than common
equity and the coupon payments on bonds represent contractual obligations. In
contrast, companies are not required to pay dividends on common equity, or to
guarantee returns on common equity investments.Therefore common equity
securities are considered to be more risky than bond securities.
This risk premium model is based on two estimates of an equity risk premium.
First, I estimated the difference between the required return on utility common equity
investments and Treasury bonds. The difference between the required return on
common equity and the bond yield is the risk premium. I estimated the risk premium
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on an annual basis for each year over the period 1986 through June 2007. The
common equity required returns were based on regulatory commission-authorized
returns for electric utility companies. Authorized returns are typically based on expert
witnesses' estimates of the contemporary investor required return.
The second equity risk premium method is based on the difference between
regulatory commission-authorized returns on common equity and contemporary
A-rated utility bond yields. This time period was selected because over the period
1986 through June 2007, public utility bond yields have consistently traded at a
premium to book value. This is illustrated on Exhibit 228 (MPG-15), where the
market to book ratio since 1986 for the electric utility industry was consistently above
0. Therefore, over this time period, regulatory authorized returns were sufficient to
support market prices that at least exceeded book value. This is an indication that
regulatory authorized returns on common equity supported a utility s ability to issue
additional common stock, without diluting existing shares. This is an indication that
utilities were able to access equity markets without a detrimental impact on current
shareholders.
Based on this analysis, as shown on Exhibit 229 (MPG-16), the average
indicated equity risk premium of authorized electric utility common equity returns over
S. Treasury bond yields has been 5.04%. Of the 22 observations, 18 indicated risk
premiums fall in the range of 4.4% to 5.9%. Since the risk premium can vary
depending upon market conditions and changing investor risk perceptions, I believe
using an estimated range of risk premiums provides the best method to measure the
current return on common equity using this methodology.
As shown on Exhibit 230 (MPG-17), the average indicated authorized electric
utility common equity return over contemporary Moody s utility bond yields was 3.67%
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over the period 1986 through June 2007. The equity risk premium estimates based
on this analysis primarily fall in the range of 3.0% to 4.4% over this time period.
BASED ON HISTORICAL DATA, WHAT RISK PREMIUM HAVE YOU USED TO
ESTIMATE RMP'S COST OF EQUITY IN THIS PROCEEDING?
The equity risk premium should reflect the relative market perception of risk in the
utility industry today. I have gauged investor perceptions in utility risk today on
Exhibit 231 (MPG-18). On that exhibit, I show the yield spread between utility bonds
and Treasury bonds over the last 27 years. As shown on this exhibit, the 2007 utility
bond yield spreads over Treasury bonds for "A" rated and "Baa" rated utility bonds
are 1.11 % and 1.34%, respectively. These utility bond yield spreads over Treasury
bond yields are among the lowest yield spreads in the last 27 years, and are below
the 27-year average "A" and "Baa" yield spreads of 1.56% and 1.92%, respectively.
Hence, this comparison of utility bond yield spreads indicates the market perception
of utility risk to be below the average industry risk over this historical time period.
Recognizing the robust nature and the current market's low-risk valuation of
utility investments, I believe it is appropriate to use an average market equity risk
premium to estimate the current market-required return on equity. Hence, I relied on
a Treasury bond risk premium of 5.2% (midpoint of the 4.4% to 5.9% range), and an
equity risk premium over utility bond yields of 3.7% (midpoint of the 3.0% to 4.4%
range), as described above.
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HOW DID YOU ESTIMATE RMP'S COST OF COMMON EQUITY WITH THIS
MODEL?
I added a projected long-term Treasury bond yield to my estimated equity risk
premium over Treasury yields. Blue Chip Financial Forecasts projects the 30-year
Treasury bond yields to be 5.2%, and a 10-year Treasury bond to be 5.0% (Blue Chip
Financial Forecast, September 1, 2007 at 2). Using the projected 30-year bond yield
of 5.2%, and a Treasury bond risk premium of 4.4% to 5.9%, produces an estimated
common equity return in the range of 9.6% to 11.1 %, with a midpoint estimate of
10.4%.
I next added my equity risk premium over utility bond yields to a current
13-week average yield on "A" rated utility bonds for the period ending September 7,
2007 of 6.25%. This current "A" utility bond yield is developed on Exhibit 232
(MPG-19). Adding the utility equity risk premium of 3.0% to 4.4% to a "A" rated bond
yield of 6.25%, produces a cost of equity in the range of 9.3% to 10.7%, with a
midpoint of 10.0%.
My risk premium analyses produce a return estimate in the range of 10.0% to
10.4%, with a midpoint estimate of 10.2%.
Capital Asset Pricina Model
PLEASE DESCRIBE THE CAPM.
The CAPM method of analysis is based upon the theory that the market required rate
of return (ROR) for a security is equal to the risk-free ROR, plus a risk premium
associated with the specific security. This relationship between risk and return can be
expressed mathematically as follows:
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Ri = Rf + Bi X (Rm - Rf) where:
Ri = Required return for stock i
Rf = Risk-free rate
Rm = Expected return for the market portfolioBi = Beta - Measure of the risk for stock
The stock-specific risk term in the above equation is beta. Beta represents the
investment risk that cannot be diversified away when the security is held in a
diversified portfolio. When stocks are held in a diversified portfolio, firm-specific risks
can be eliminated by balancing the portfolio with securities that react in the opposite
direction to firm-specific risk factors (e., business cycle , competition , product mix
and production limitations).
The risks that cannot be eliminated when held in a diversified portfolio are
nondiversifiable risks. Nondiversifiable risks are related to the market in general and
are referred to as systematic risks. Risks that can be eliminated by diversification are
regarded as nonsystematic risks. In a broad sense, systematic risks are market risks,
and nonsystematic risks are business risks. The CAPM theory suggests that the
market will not compensate investors for assuming risks that can be diversified away.
Therefore, the only risk that investors will be compensated for are systematic or
nondiversifiable risks. The beta is a measure of the systematic or nondiversifiable
risks.
PLEASE DESCRIBE THE INPUTS TO YOUR CAPM.
The CAPM requires an estimate of the market risk-free rate, the company s beta, and
the market risk premium.
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WHAT DID YOU USE AS AN ESTIMATE OF THE MARKET RISK-FREE RATE?
The Blue Chip Financial Forecasts' projected 30-year Treasury bond yield is 5.2%.
The current 30-year bond yield is 5.0% (Blue Chip Financial Forecast, September 1,
2007 at 2). I used the Blue Chip Financial Forecasts' projected 30-year Treasury
bond yield of 5.2% for my CAPM analysis.
WHY DID YOU USE LONG-TERM TREASURY BOND YIELDS AS AN ESTIMATE
OF THE RISK-FREE RATE?
Treasury securities are backed by the full faith and credit of the United States
government. Therefore, long-term Treasury bonds are considered to have negligible
credit risk. Also, long-term Treasury bonds have an investment horizon similar to that
of common stock. As a result, investor-anticipated long-run inflation expectations are
reflected in both common stock required returns and long-term bond yields.
Therefore, the nominal risk-free rate (or expected inflation rate and real risk-free rate)
included in a long-term bond yield is a reasonable estimate of the nominal risk-free
rate included in common stock returns.
Treasury bond yields, however, do include risk premiums related to
unanticipated future inflation and interest rates. Therefore, a Treasury bond yield is
not a risk-free rate. Risk premiums related to unanticipated inflation and interest rates
are systematic or market risks. Consequently, for companies with betas less than
0, using the Treasury bond yield as a proxy for the risk-free rate in the CAPM
analysis can produce an overstated estimate of the CAPM return.
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WHAT BETA DID YOU USE IN YOUR ANALYSIS?
As shown on Exhibit 233 (MPG-20), my proxy group average and median Value Line
beta estimates are 0.86 and 0.85, respectively. Based on this data, I will use a beta
of 0.85 for my CAPM analysis.
DO YOU RECOMMEND A CAREFUL CONSIDERATION OF A UTILITY BETA FOR
USE IN A CAPM STUDY?
Yes.Utility betas have been increasing over the last five years, as shown on
Exhibit 233 (MPG-20), largely because electric utility stocks have outperformed the
overall market. While this increasing beta gives the impression of increasing risk, that
interpretation is incorrect.
Indeed , electric utility risk factors have been decreasing as these companies
revert to a back-to-basics investment strategy that lowers their operating risks , and
they have been divesting non-regulated businesses to reduce debt and strengthen
balance sheets, which is lowering risk. Value Line notes this in a recent review of the
electric utility industry. Value Line states as follows:
Better Finances
This decade, utilities have distanced themselves from risky
unregulated business forays, including commodities
trading, foreign energy operations, water services and
aircraft leasing. Currently, Dominion Resources plans to
sell its oil and gas production business, Duke is spinning
its mid-stream gas operations to shareholders, Northeast
Utilities is divesting its merchant power generation
business, and Progress Energy is shedding power plant
and natural gas assets. Such actions have improved
earnings performance and strengthened capital ratios.
Companies are targeting a nearly equal weighting of debt
and equity on their balance sheets, a goal that should be
met by 2009-2011.
Revenue-backed and tax-exempt bonds will provide
economical funding for planned capital improvements.
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This will further support overall finances. (The Value Line
Investment Survey, Electric Utility (East) Industry,
December 1 , 2006, p. 157).
Further, Value Line notes an increase in the common equity ratio and fixed
charge coverage ratio over the last three to five years. These Value Line parameters
indicate lower financial risk and stronger earnings and cash flow coverages of
financial obligations. This reduces utilities' risk and limits the variability to market
factors that can inhibit the utilities' ability to meet investors ' earnings and cash flow
expectations.
These risk reductions have resulted in robust stock return performance for
electric utility stocks, as shown on Exhibit 234 (MPG-21). As illustrated on this
exhibit, electric utility stocks have outperformed the market over the last five years.
This utility stock performance has contributed to an increase in betas and given the
impression that electric utility stock variability is comparable to the overall market, but
other risk factors clearly show that that is a false indication.
Reliance on the group median beta, which is a beta that is stronger than the
beta has been over the last five years, is more reflective of the majority of the
individual company betas included in my proxy group.
HOW DID YOU DERIVE YOUR MARKET PREMIUM ESTIMATE?
I derived two market premium estimates, a forward-looking estimate and one based
on a long-term historical average.
The forward-looking estimate was derived by estimating the expected return
on the market (S&P 500) and subtracting the risk-free rate from this estimate. I
estimated the expected return on the S&P 500 by adding an expected inflation rate to
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the long-term historical arithmetic average real return on the market. The real return
on the market represents the achieved return above the rate of inflation.
The Ibbotson and Associates Stocks, Bonds. Bills and Inflation 2007 Year
Book publication estimates the historical arithmetic average real market return over
the period 1926-2006 as 9.1 %. A current consensus analyst inflation projection, as
measured by the Consumer Price Index, is 2.1 % (Blue Chip Financial Forecasts,
September 1 , 2007 at 2). Using these estimates, the expected market return is
11.4%.7 The market premium then is the difference between the 11.4% expected
market return, and my 5.2% risk-free rate estimate, or 6.2%.
The historical estimate of the market risk premium was also estimated by
Ibbotson and Associates in Stocks, Bonds, Bills and Inflation. 2007 Year Book. Over
the period 1926 through 2006, Ibbotson s study estimated that the arithmetic average
of the achieved total return on the S&P 500 was 12.3%, and the total return on long-
term Treasury bonds was 5.8%. The indicated equity risk premium is 6.5% (12.3% -
8% = 6.5%).
WHAT ARE THE RESULTS OF YOUR CAPM ANALYSIS?
As shown on Exhibit 235 (MPG-22), based on the average of my prospective market
risk premium of 6.2% and my historical risk premium of 6.5%, a beta of 0.85 and a
risk-free rate of 5.2% produces a CAPM return of 10.6%.
7 ( ((1 + 0.091) * (1 + 0.021) ) - 1 n * 100.
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HAVE YOU DONE ANY TEST ON THE RESULTS OF YOUR CURRENT CAPM
ANALYSIS?
Yes. As noted above, utility beta estimates are abnormally high currently due to a
robust performance of utility stocks over the last five years. The current proxy group
beta of 0.85 is much higher than the five-year actual beta for this group of 0.75.
Hence, to test the impact on the CAPM estimate for my proxy group, I have also
constructed a CAPM study using the five-year historical beta of 0.75 and the same
risk-free rate and market risk premiums, as shown on Exhibit 236 (MPG-23). This
alternative would produce a CAPM estimate of 10.0%. Use of this historical beta
estimate produces a CAPM risk premium estimate that is reasonably comparable to
my risk premium study described above.
BIDurn on 5.9Yltv Summary
BASED ON THE RESULTS OF YOUR RATE OF RETURN ON COMMON EQUITY
ANALYSES DESCRIBED ABOVE, WHAT RETURN ON COMMON EQUITY DO
YOU RECOMMEND FOR RMP?
Based on my analyses, I estimate RMP's current market cost of equity to be 10.0%.
TABLE 2
Return on Common Equity Summarv
Description Results
Constant Growth DCF
Two-Stage DCF
Risk Premium
CAPM
10.
10.
10.
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My recommended return on equity of 10.0% is at the midpoint of my estimated
return on equity range for RMP of 9.6% to 10.4%. The high end of my estimated
range is based on my CAPM and risk premium studies analyses. The low end of my
estimated range is based on my DCF analyses.
WILL YOUR RECOMMENDED OVERALL RATE OF RETURN SUPPORT RMP'
CURRENT BOND RATING FROM S&P?
Yes. I have reached this conclusion by comparing the key credit rating financial
ratios for RMP at the Company s proposed capital structure and my return on equity
to S&P's benchmark financial ratios for an "A" rated utility and a "BBB" rated utility
with an S&P business profile score of ', RMP's profile score.
PLEASE DESCRIBE S&P'S USE OF THE FINANCIAL BENCHMARK RATIOS IN
ITS CREDIT RATING REVIEW.
S&P evaluates a utility s credit rating based on an assessment of its financial and
business risks. A combination of financial and business risks equates to the overall
assessment of the Company total credit risk exposure. S&P publishes a matrix of
financial ratios that defines the level of financial risk as a function of the level of
business risk.
S&P rates a utility s business risk based on a business profile score of '
lowest risk, up to '10', highest risk.Integrated electric utilities typically have a
business profile score from S&P of '
, '
5' or ', while transmission and distribution
electric utilities' profile scores primarily range from '2' to '
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S&P publishes ranges for three primary financial ratios that it uses as
guidance in its credit review for utility companies. The three primary financial ratio
benchmarks it relies on in its credit rating process include: (1) funds from operations
(FFO) to debt interest expense, (2) FFO to total debt, and (3) total debt to total
capital.
HOW DID YOU APPLY S&P'FINANCIAL RATIOS TO TEST THE
REASONABLENESS OF YOUR RATE OF RETURN RECOMMENDATIONS?
I calculated each of S&P's financial ratios based on RMP's cost of service for retail
operations. While S&P would normally look at consolidated RMP corporate financial
ratios in its credit review process, my investigation in this proceeding is to judge the
reasonableness of my proposed cost of capital for RMP's Idaho utility regulated
operations. Hence, I am attempting to determine whether the rate of return and cash
flow generation opportunity reflected in my proposed cost of capital for RMP will
support its investment grade bond ratings and financial integrity.
HAVE YOU INCLUDED ANY OFF-BALANCE SHEET (OBS) DEBT EQUIVALENTS
IN CALCULATING THE FINANCIAL RATIOS FOR RMP?
Yes. At page 8 of his direct testimony, Mr. Williams stated that S&P included
$537 million of additional debt and related interest expenses when adjusting the
benchmark credit metrics, to reflect PacifiCorp s purchased power agreements.
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HOW DID YOU ADJUST THE CREDIT METRICS FOR OBS DEBT EQUIVALENTS
AND SHORT-TERM DEBT?
I developed a financial capital structure using the ratemaking capital structure but I
added the OBS debt equivalents and short-term debt balances. The short-term debt
and OBS balances were provided by the Company in response to Monsanto Data
Request No. 2.51. This financial capital structure produced the adjusted total debt to
total capitalization ratios needed to compare RMP's total debt ratio to S&P's credit
metric benchmark.
The OBS imputed debt interest was calculated based on the OBS debt
equivalents and the discount rate of 6.26%, or RMP's embedded debt cost. The
implied OBS amortization expense was calculated based on the 2008 capacity
payment for purchased power agreements less the OBS debt interest expense. This
is consistent with the S&P methodology as outlined in the report attached to RMP
witness William s testimony as Exhibit No.9, page 3.
PLEASE DESCRIBE THE RESULTS OF THIS CREDIT METRICS ANALYSIS FOR
RMP.
The S&P financial metric calculation for RMP is developed on Confidential
Exhibit 237 (MPG-24). In constructing this analysis, I reflected my recommended
10.0% return on equity and the Company s recommended capital structure.
As shown on Confidential Exhibit 237 (MPG-24), based on an equity return of
10.0%, RMP will be provided an opportunity to produce a Funds From Operations
(FFO) to debt interest expense ratio of 4.4x. This FFO to interest coverage ratio falls
in the high end of the range of S&P's benchmark ratio guideline of 4.5x to 3.8x for an
A" rated utility company with a business profile score of '
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RMP's total debt ratio to total capital is 53% at the Company s proposed
capital structure. This is in the lower end of S&P's "BBB" rated utility range of 50% to
60%, which supports a strong "BBB" rating.
Finally, RMP's retail operations FFO to total debt coverage at a 10.0% equity
return would be 21 %, which is near the top (strong) of S&P's financial metric range of
15% to 22% for a "BBB" rated utility company.
At my proposed capital structure and return on equity, RMP's financial metrics
are supportive of a weak "A" utility bond rating. Therefore, my recommended return
on equity of 10.0% will support RMP's financial integrity, its current bond rating and
fairly compensate investors for its financial risk.
~esponse tQ...RMP Witness. Dr. Samuel Hadawav
WHAT RETURN ON COMMON EQUITY IS RMP PROPOSING FOR THIS
PROCEEDING?
RMP is proposing to set rates based on a return on equity of 10.75% based on
Dr. Hadaway s proxy group of electric utility companies and his analyses summarized
at page 33 of his direct testimony.
DO YOU HAVE ANY GENERAL COMMENTS CONCERNING DR. HADAWAY'
OUTLOOK AND PRINCIPLES IN ESTABLISHING A FAIR RETURN ON EQUITY
FOR RMP IN THIS PROCEEDING?
Yes. At page 4 of his direct testimony, Dr. Hadaway takes issue with the constant
growth DCF model because he asserts that it depends on historically low dividend
yields and pessimistic growth forecasts.He believes that these near-term
circumstances do not reasonably reflect his longer-term expectations for higher
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capital costs. As such, he makes several adjustments to increase current capital
market estimates to reflect his belief that capital costs will increase in the long term.
DO YOU BELIEVE IT IS REASONABLE FOR DR. HADAWAY TO INCREASE HIS
RETURN ON EQUITY ESTIMATES BECAUSE OF HIS BELIEF THAT CAPITAL
COSTS WILL INCREASE OVER THE LONG TERM?
No. This is unreasonable and a biased assessment for several reasons:
1. Dr. Hadaway has not provided any corroborating evidence that any market
participant shares his expectation of increases to current market capital
costs.
2. The accuracy of projected changes to capital market costs are at very best
problematic. Utility rates should not be set based on costs that are not
known and measurable.
3. If capital costs do increase, as Dr. Hadaway believes, RMP can file to
adjust rates, to reflect an increase to these costs. Rates in this regulatory
proceeding should be set based on known and measurable costs.
4. Return on equity estimates should be based on an assessment of the
market'capital cost requirements, not an assessment of the expected
return of the individual analyst.Dr. Hadaway s return on equity estimates
are based on his own belief and risk assessment. He is not attempting to
measure RMP's cost of capital in the marketplace today. This is
significant, because RMP will attract capital from the market, not from Dr.
Hadaway. Hence, it is appropriate to develop an authorized return on
equity based on the demands of the marketplace, not the individual
opinion of Dr. Hadaway.
DO DR. HADAWAY'S METHODOLOGIES SUPPORT HIS 10.75% RETURN ON
EQUITY FOR HIS PROXY GROUP?
No.As discussed in detail below, reflecting current market data and properly
applying his models, Dr. Hadaway s own analyses would support a return on equity of
10.0%.
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PLEASE DESCRIBE DR. HADAWAY'S METHODOLOGY SUPPORTING HIS
RETURN ON COMMON EQUITY RECOMMENDATION.
Dr. Hadaway develops his return on common equity recommendation using three
versions of the DCF analysis and a utility risk premium analysis. Further, he tests his
results using risk premium analyses conducted by Ibbotson & Associates and a study
published by Harris & Marston (H&M). The results of Dr. Hadaway s return on equity
analysis are shown at page 33 of his direct testimony. I have summarized Dr.
Hadaway s results below in Table 3 under Column 1. Under Column 2, I show the
results of Dr. Hadaway s analyses adjusted for updated data and more reasonable
application of the models.
As shown below in Table 3, using updated information and more reasonable
estimates of GDP growth, Dr. Hadaway s own analyses would support a return on
equity for RMP of 10.0%. The update and corrections to Dr. Hadaway s cost of equity
models prove that a 10.0% equity return is reasonable. This is discussed in detail
below.
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TABLE 3
Summary of Hadawav s ROE Estimate
Adjusted
Hadaway Hadaway
Description Results Results
(1)(2)
Constant Growth DCF (Traditional)*0% - 9.4%
Constant Growth (GDP Growth)10.8% -10.
Two-Stage Growth DCF 10.5% -10.
Estimated DCF*10.5% - 10.
Risk Premium Utility 10.10.
Ibbotson Risk Premium 10.10.
Harris-Marston Risk Premium 11.4%10.
Estimated ROE 10.75%10.
Source: Hadaway Direct at 33.
* The constant growth DCF model was excluded from Dr. Hadaway s range.
PLEASE DESCRIBE DR. HADAWAY'S CONSTANT GROWTH DCF ANALYSIS.
Dr. Hadaway s constant growth DCF analysis is shown on his Exhibit No.
page 2 of 5. As shown on that exhibit, Dr. Hadaway s constant growth DCF analysis
is based on a recent price and an average of three growth rates: (1) Zacks; (2) Value
Line; and (3) Dr. Hadaway s estimate of GDP growth.
IN WHAT WAY DID DR. HADAWAY OVERSTATE HIS DCF ESTIMATES?
Dr. Hadaway used a GDP growth rate of 6.6% as one of three growth rates. This
GDP growth is excessive and not reflective of current market expectations.
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HOW DID DR. HADAWAY DEVELOP HIS GDP GROWTH RATE?
He states that the GDP growth rate is based on the achieved GDP growth over the
last 10, 20, 30, 40, 50, and 59-year periods. Dr. Hadaway s projected GDP growth
rate is unreasonable. Historical GDP growth over the last 20 and 40-year periods
was strongly influenced by the actual inflation rate experienced over that time period.
WHY IS DR. HADWAY'S DCF ESTIMATE EXCESSIVE IN COMPARISON TO THAT
OF PUBLISHED MARKET ANALYSTS?
The consensus economists' projected GDP growth rate is much lower than the GDP
growth rate used by Dr. Hadaway in his DCF analysis.comparison of
Dr. Hadaway s GDP growth rates and consensus economists' projected GDP growth
over the next five and ten years is shown below in Table 4. As shown in the table
below, Dr. Hadaway s GDP rate of 6.6% reflects real GDP of 3.2% and an inflation
GDP of 3.3%. However, consensus economists' projections of nominal GDP include
real GDP and GDP inflation expectations over the next five and ten years of 3.0%,
and 2.1 %, respectively.
As is clearly evident in the table below, Dr. Hadaway s historical GDP growth
reflects historical inflation, which is much higher than, and not representative of
consensus market expected forward-looking inflation.
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TABLE 4
GDP Proiections
Description
GDP
Inflation
Real
GDP
Nominal
GDP
Dr. Hadaway
Consensus 5-Year Projection
Consensus 10- Year Projection
Source: Blue Chip Economic Forecast, March 10 2007.
As such, Dr. Hadaway s 6.6% nominal GDP growth rate is not reflective of
consensus market expectations, and should be rejected.
HOW WOULD DR. HADAWAY'S DCF ANALYSES CHANGE IF CURRENT
MARKET -BASED GDP GROWTH RATE PROJECTIONS ARE INCLUDED IN HIS
ANALYSIS RATHER THAN HIS EXCESSIVE GDP GROWTH RATE?
As shown on Exhibit 238 (MPG-25), I updated Dr. Hadaway s DCF analyses using a
GDP growth rate of 5.1 %. This is the consensus five-year projected growth rate of
the GDP. As shown on page 1 of my Exhibit 238 (MPG-25), using this consensus
projected GDP growth rate reduces his constant growth DCF result from 9.4% to
0%.
Using a GDP growth rate of 5.1 % would reduce his long-term GDP growth
rate from 10.8% to 9.3% as shown on page 2 of Exhibit 238 (MPG-25), and his two-
stage growth DCF model from 10.5% to 9.1% as shown on page 3 of Exhibit 238
(MPG-25).
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WITH THESE ADJUSTMENTS, WHAT RETURN EQUITY WOULD
DR. HADAWAY'S DCF MODELS SUGGEST IS A FAIR RETURN ON EQUITY FOR
RMP IN THIS PROCEEDING?
Reflecting a consensus economists ' GDP growth forecast would produce an average
DCF result using Dr. Hadaway s models of 9.2% similar to, but lower than my
estimated DCF return on equity of 9.6%.
PLEASE DESCRIBE DR. HADAWAY'S UTILITY RISK PREMIUM ANALYSIS.
Dr. Hadaway s utility bond yield versus authorized return on common equity risk
premium is shown on his Exhibit No.6, page As shown on this exhibit,
Dr. Hadaway compares the contemporary Moody s average bond yield for utility
companies and the authorized regulatory commission return on common equity over
the period 1980 through 2006. Based on this analysis, Dr. Hadaway estimates an
average indicated equity risk premium over contemporary utility bond yields of 3.13%.
Dr. Hadaway then adjusts this average equity risk premium using a regression
analysis based on an expectation that there is an ongoing inverse relationship
between interest rates and equity risk premiums. Based on this regression analysis,
Dr. Hadaway increases his equity risk premium from 3.13%, as reflected in his
analysis, up to 4.42%. He then adds this inflated equity risk premium to a projected
A" bond yield of 6.30% to produce a return on equity of 10.72% for RMP.
IS DR. HADAWAY'S UTILITY RISK PREMIUM ANALYSIS REASONABLE?
No. Dr. Hadaway has unreasonably attempted to create a forward-looking specific
risk premium point estimate using this historical data. This is not reasonable because
the data and model are not that precise. For example, interest rate volatility and
Testimony of Michael Gorman - Page 38 BRUBAKER & ASSOCIATES, INC.
Michael Gorman
Page 39
inflation uncertainty in the 1980s and early 1990s are not reasonably representative
of interest rate volatility and inflation outlooks currently and going forward. Inflation
volatility or uncertainty over this historical time period had an impact on utility bond
yields, valuations and equity risk premiums. This inflation volatility, however, is not
characteristic of the current capital markets.
IS IT APPROPRIATE TO USE ONLY FORECASTED INTEREST RATES IN A RISK
PREMIUM ANALYSIS AS DR. HADAWAY HAS DONE?
No. As indicated above, the accuracy of projected interest rates is highly problematic.
Indeed, while interest rates have been projected to increase over the last five years,
those increased interest rate projections have turned out to be wrong and significantly
inflated.Despite economists' continued pessimistic projections of increases to
interest rates over the last five years, interest rates have actually either stayed flat or
have declined. Accordingly, Dr. Hadaway s analysis should be performed based on
current interest rates, with some consideration given to forecasted interest rates.
DOES DR. HADAWAY'S RISK PREMIUM ANALYSIS SUPPORT A RETURN ON
EQUITY OF 10.75% IN THIS PROCEEDING?
No. His equity risk premium estimate of 4.42% is overstated. As discussed in my
direct testimony, since the spread between utility bond yields and Treasury bond
yields is currently relatively low, an average equity risk premium of 3.1 % based on
Dr. Hadaway s study applied to a current "A" bond yield of 6.25% would indicate a fair
return on equity for RMP of 9.4%.In any case, the reasonable application of
Dr. Hadaway s model , and observation of current real capital market costs for utility
companies, indicate a risk premium in the range of 3.1 % to 4.5%, excluding the two
Testimony of Michael Gorman - Page 39 BRUBAKER & ASSOCIATES, INC.
Michael Gorman
Page 40
highest estimates and all estimates below the midpoint. This risk premium range
would indicate a fair return on equity for RMP in the range of 9.4% to 10.8%, with a
midpoint of 10.1 %. This range supports my recommended return on equity of 10.
for RMP in this proceeding.
DID DR. HADAWAY PERFORM ANY TESTS OF HIS RISK PREMIUM ANALYSIS
RESULTS?
Yes. Dr. Hadaway compared his utility risk premium analysis to studies performed by
Ibbotson & Associates and H&M. Dr. Hadaway states that Ibbotson & Associates
studied the return on common stocks versus corporate bonds for the period 1926
through 2005. The Ibbotson study found that the arithmetic mean risk premium was
1 %, and the geometric mean return was 4.5%. He states that using the geometric
mean return and a debt cost of 4.5%, and his projected 6.3% "Baa" utility bond yield
would produce an indicated equity return of 10.80% for RMP. (Hadaway Direct at
31 ).
According to Dr. Hadaway, the H&M study found an equity risk premium over
S. Government bonds of 6.47%, and the equity risk premium over corporate bonds
to be 5.13%. Dr. Hadaway finds that the H&M study would support an equity risk
premium over an A-rated corporate debt of 11.43% (6.30% debt cost and 5.13% risk
premium). (ld. at 32).
Testimony of Michael Gorman - Page 40 BRUBAKER & ASSOCIATES, INC.
Michael Gorman
Page 41
DO THE INDICATED RISK PREMIUM RESULTS FROM THE IBBOTSON &
ASSOCIATES AND H&M STUDIES SUPPORT A RETURN ON COMMON EQUITY
FOR RMP OF 10.80% AND 11.43%, RESPECTIVELY, AS ESTIMATED BY
DR. HADAWAY?
No. There are several flaws in this analysis. First, the Ibbotson & Associates and
H&M studies are based on common equity returns and equity risk premiums for the
overall market. Both of these studies are based on the returns for the S&P 500.
Dr. Hadaway did not, and cannot, show that the S&P 500 is risk comparable to RMP
as a regulated electric utility.
In fact, it is widely recognized that electric utility risk is considerably lower than
that of the overall market. This is evident by a review of the beta coefficients
measured by Value Line for utility companies , as illustrated on Exhibit 233 (MPG-20),
discussed above. As I noted earlier with respect to my CAPM analysis, utility
company stock market risk is approximately 85% of that of the overall market.
Hence, while the equity risk premiums derived from these two studies may be
appropriate for the overall market, they overstate significantly a reasonable equity risk
premium for a low risk regulated electric utility such as RMP.Therefore
Dr. Hadaway s use of the Ibbotson and H&M studies' equity risk premiums to produce
a return on common equity for RMP is unreasonable and should be rejected.
Second, as noted above, Dr. Hadaway projected bond yields are not
reflective of current market expectations. Hence, his return on equity estimate from
this analysis does not reflect the current capital markets' conditions.
Testimony of Michael Gorman - Page 41 BRUBAKER & ASSOCIATES, INC.
Michael Gorman
Page 42
CAN THE RISK PREMIUM STUDIES PUBLISHED BY IBBOTSON AND H&M BE
USED TO DEVELOP A COMMON EQUITY ESTIMATE FOR RMP?
Only generally. By recognizing RMP's much lower risk than that of the overall
market, the equity risk premiums developed by Ibbotson and H&M, of 4.5%, and
13%, respectively, should be adjusted by a factor of approximately 85%. This 85%
represents the current estimate of a utility beta as published by the Value Line
Investment Survey. Using a 85% adjustment factor to reflect RMP's lower than
market risk, these studies' equity risk premiums adjusted for the lower risk would be
reduced to 3.8% (4.5% x 85%) in the case of Ibbotson, and 4.4% (5.13% x 85%) in
the case of H&M. Comparing a 3.8% and 4.4% equity risk premium to the current
cost of an "A" rated electric utility bond of 6.3% would indicate a return on common
equity of 10.1% to 10.7%.
DOES THIS CONCLUDE YOUR DIRECT TESTIMONY?
Yes.
\\H"oy\S"'~\PLD=\ME"""9\T."m,"y -""'9863.00C
Testimony of Michael Gorman - Page 42 BRUBAKER & ASSOCIATES, INC.
Case No. PAC-07-
Exhibit 221 (MPG-
ROCKY MOUNTAIN POWER
Accuracy of Interest Rate Forecasts
lon Term Treasu Bond Yields - Pro ected Vs. Actua
Publication Data Actual Yield Projected Yield Actual
Actual Projected in Projected Higher (Lower)Yields
Line Date Yield Yield For Quarter Quarter Than Actual Yield*Differential**
(1)(2)(3)(4)(5)(6)
Dec-10,
Mar-20,
Jun-30,
Sep-40,
Dec-10,
Mar-20,
Jun-30,0.4%
Sep-40,
Dec-10,
Mar-20,
Jun-30,
Sep-40,
Dec-10,
Mar-20,
Jun-30,
Sep-40,
Dec-10,0.4%
Mar-20,
Jun-30,
Sep-40,
Dec-10,
Mar-20,
Apr-N/A 30,
May-5.2%30,
Jun-30,
Jul-40,
Aug-40,
Sep-40,
Oct-10,
Nov-10,
Dec-10,
Jan-20,
Feb-20,
Mar-20,
Apr-30,
May-30,
Jun-30,
Jul-5.4%40,
August 5.2%40,
Source:
Blue Chip Financial Forecasts, Various Dates.
* Col. 2 - Col. 4.
** Col. 1 - Col. 4.
Case No. PAC-07-
Exhibit 222 (MPG-
ROCKY MOUNTAIN POWER
Proposed Rate of Return
Weighted
Line Descriction Amount Weiaht Cost Cost
(1)(2)(3)(4)
Long-Term Debt 523 205,000 49.26%07%
Preferred Stock 41 ,463,300 5.41%02%
Common Equity 645 280 50.10.00%04%
Total 210,068,580 100.14%
Source:
Williams Direct at 3 and Attach Monsanto 1.6. b.
Case No. PAC-07-
Exhibit 223 (MPG-10)
ROCKY MOUNTAIN POWER
Com arable Grou
Business
Bond RatinQs Profile Common Eauitv Ratios
Line Electric Utili S&p MoodY s 1 RatinQ AUs Value Line
(1)(2)(3)(5)(4)
ALLETE Baa1 63%65%
Alliant Energy 59%63%
CH Energy 55%59%
Consolidated Edison 47%49%
DTE Energy BBB+40%44%
Energy East Corp.BBB+44%43%
IDACORP 49%55%
MGE Energy Aa2 56%61%
NSTAR 36%40%
PPL Corporation 39%42%
Progress Energy BBB+47%48%
SCANA Corp.44%47%
Southern Co.42%46%
Vectren Corp.44%49%
Xcel Energy Inc.BBB+44%47%
Average 47%51%
Rocky Mountain Power (Idaho)50%
Sources:1 AUS Utility Reports; August 2007.2 The Value Line Investment Survey; June 29 , August 10,August 31 2007.
3 U.S. Utilities and Power Ranking List, May 4 2007.
4 Williams Direct at 3.
Case No. PAC-07-
Exhibit 224 (MPG-11)
ROCKY MOUNTAIN POWER
Growth Rate Estimates
Zacks Zacks Reuters Reuters SNL SNL AVG of
Estimated Number of Estimated Number of Estimated Number of Growth
Line Electric Utility Growth %Estimates 1 Growth %Estimates Growth %Estimates Rates
(1)(2)(3)(4)(5)(6)(7)
ALLETE 00%75%00%25%
Alliant Energy 00%67%00%22%
CH Energy N/A N/A N/A N/A N/A N/A N/A
Consolidated Edison 50%95%00%3.48%
DTE Energy 67%00%00%89%
Energy East Corp.50%00%00%83%
IDACORP.00%67%00%56%
MGE Energy N/A N/A N/A N/A N/A N/A N/A
NSTAR 25%75%00%33%
PPL Corporation 13.00%11.86%13.00%12.62%
Progress Energy 25%50%00%58%
SCANA Corp.50%32%00%27%
Southern Co.43%69%00%71%
Vectren Corp.33%33%00%22%
Xcel Energy, Inc.83%29%00%04%
Average 48%75%38%54%
Sources:1 www.zacksadvisor.com, Detailed Research on September 13, 2007.
2 www.investor.reuters.com, Earnings Estimates on September 13, 2007.
3 http://www.snl.com, Long-term Growth Rate Estimates on September 13, 2007.
Case No. PAC-07-
Exhibit 225 (MPG-12)
ROCKY MOUNTAIN POWER
Constant Growth DCF Model
13-Week AVG AVG (%)Annual Adjusted Constant
Line Electric Utility Stock Price Growth Dividend Yield Growth DCF
(1)(2)(3)(4)(5)
ALLETE $45.25%$1.86%10.11 %
Alliant Energy $38.22%$1.50%72%
CH Energy $46.N/A $2.N/A N/A
Consolidated Edison $45.3.48%$2.25%73%
DTE Energy $48.89%$2.56%9.45%
Energy East Corp.$25.44 83%$1.90%73%
IDACORP $32.56%$1.94%9.49%
MGE Energy $32.46 N/A $1.N/A N/A
NSTAR $32.33%$1.24%10.58%
PPL Corporation $47.12.62%$1.87%15.49%
Progress Energy $45.58%$2.44 56%10.14%
SCANA Corp.$38.47 27%$1.77%04%
Southern Co.$34.71%$1.83%54%
Vectren Corp.$27.22%$1.85%07%
Xcel Energy, Inc.$20.04%$0.67%71%
Average $37.54%$1.45%10.
Sources:1 http://moneycentral.msn.com, downloaded on September 13, 2007.
2 The Value Line Investment Survey; June 29, August 10, August 31 2007.
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Exhibit 227 (MPG-14)
ROCKY MOUNTAIN POWER
Two-Staae Growth DCF Model
13-Week AVG Annual First Stage Second Stage Two-Stage
Line Electric Utility Stock Price Dividend Growth Growth Growth DCF
(1)(2)(3)(4)(5)
ALLETE $45.$1.25%10%12%
Alliant Energy $38.$1.22%10%73%
CH Energy $46.$2.N/A 10%N/A
Consolidated Edison $45.$2.3.48%10%10.07%
DTE Enrgy $48.$2.89%10%62%
Energy East Corp.$25.44 $1.83%10%79%
IDACORP $32.$1.56%10%10%
MGE Energy $32.46 $1.N/A 10%N/A
NSTAR $32.$1.33%10%53%
PPL Corporation $47.$1.12.62%10%80%
Progress Energy $45.$2.44 58%10%10.56%
SCANA Corp.$38.47 $1.27%10%74%
Southern Co.$34.$1.71%10%86%
Vectren Corp.$27.$1.22%10%81%
Xcel Energy, Inc.$20.$0.04%10%76%
Average $37.$1.54%10"10 6"10
Sources:1 http://moneycentral.msn.com, downloaded on September 13, 2007.
2 The Value Line Investment Survey; June 29, August 10, August 31 , 2007.
3 Blue Chip Economic Indicators, March 10, 2007.
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Case No. PAC-07-
Exhibit 229 (MPG-16)
ROCKY MOUNTAIN POWER
):auitv B!!,.k Premium - Treasury Bond
Authorized Indicated
Treasury Electric Risk
Line Date Bond Yield Returns Premium
(1)(2)(3)
1986 78%13.93%15%
1987 59%12.99%40%
1988 96%12.79%83%
1989 45%12.97%52%
1990 61%12.70%09%
1991 14%12.55%4.41 %
1992 67%12.09%4.42%
1993 59%11.41 %82%
1994 37%11.34%97%
1995 88%11.55%67%
1996 71%11.39%68%
1997 61%11.40%79%
1998 58%11.66%08%
1999 87%10.77%90%
2000 94%11.43%5.49%
2001 5.49%11.09%60%
2002 5.43%11;16%73%
2003 96%10.97%01%
2004 05%10.75%70%
2005 65%10.54%89%
2006 91%10.36%5.45%
2007 89%10.27%38%
Average 60%11.64%04%
Sources:
1 Economic Report of the President 2007: Table 73 at 316. The yields from 2002 to 2005
represent the 20-Year Treasury yields obtained from the Federal Reserve Bank.
2 Regulatory Research Associates, Inc., Regulatory Focus, Jan. 85 - Dec. 06.
3 The data for 2007 includes the period January - June 2007.
Case No. PAC-07-
Exhibit 230 (MPG-17)
ROCKY MOUNTAIN POWER
E uit Risk Premium - Utili Bond
Average Authorized Indicated
A" Rating Utility Electric Risk
Line Date Bond Yield Returns Premium
(1)(2)(3)
1986 58%13.93%35%
1987 10.10%12.99%89%
1988 10.49%12.79%30%
1989 77%12.97%20%
1990 86%12.70%84%
1991 36%12.55%19%
1992 69%12.09%3.40%
1993 59%11.41%82%
1994 31%11.34%03%
1995 89%11.55%66%
1996 75%11.39%64%
1997 60%11.40%80%
1998 04%11.66%62%
1999 62%10.77%15%
2000 24%11.43%19%
2001 76%11.09%33%
2002 37%11.16%79%
2003 58%10.97%39%
2004 16%10.75%59%
2005 65%10.54%89%
2006 07%10.36%29%
2007 00%10.27%27%
Average 98%11.64%67%
Sources:1 Mergent Public Utility Manual, Mergent Weekly News Reports, 2003. The utility
yields for the period 2001-2006 were obtained from the Mergent Bond Record.
2 Regulatory Research Associates, Inc., Regulatory Focus, Jan. 85 - Dec. 06.
3 The data for 2007 includes the period January - June 2007.
Case No. PAC-07-
Exhibit 231 (MPG-18)
ROCKY MOUNTAIN POWER
Annual Avera e Yields
Public Utility Bond Yields Corporate Bond Yields
Y!!!Bond Baa Bond Baa-Bond Aaa Baa Aaa-Bond Baa-Bond
Yield Spread Spread Spread Spread
(1)(2)(3)(4)(5)(6)(7)(8)(9)
1980 11.27%13.34%13.95%07%68%11.94%13.67%73%40%
1981 13.45%15.95%16.60%50%15%14.17%16.04%87%59%
1982 12.76%15.86%16.45%10%69%13.79%16.11%32%35%
1983 11.18%13.66%14.20%48%02%12.04%13.55%51%37%
1984 12.41%14.03%14.53%62%12%12.71%14.19%1.48%78%
1985 10.79%12.47%12.96%68%17%11.37%12.72%35%93%
1986 78%58%10.00%80%22%02%10.39%37%61%
1987 59%10.10%10.53%51%94%38%10.58%20%99%
1988 96%10.49%11.00%53%04%71%10.83%12%87%
1989 8.45%77%97%32%52%26%10.18%92%73%
1990 61%86%10.06%25%1.45%32%10.36%04%75%
1991 14%36%55%22%1.41%77%80%03%66%
1992 67%69%86%02%19%14%98%84%31%
1993 59%59%91%00%32%22%93%71%34%
1994 37%31%63%94%1.26%96%62%66%25%
1995 88%89%29%01%41%59%20%61%32%
1996 71%75%17%04%1.46%37%05%68%34%
1997 61%60%95%99%34%26%86%60%25%
1998 58%04%26%1.46%68%53%22%69%64%
1999 87%62%88%75%01%04%87%83%00%
2000 94%8.24%36%30%2.42%62%36%74%2.42%
2001 5.49%78%02%2.29%53%08%95%87%2.46%
2002 5.42%36%02%94%60%6.49%80%31%38%
2003 96%57%83%61%87%67%77%10%81%
2004 05%14%37%09%32%63%39%58%34%
2005 65%66%93%01%29%24%06%59%1.41%
2006 91%07%32%16%1.41%59%6.48%68%57%
2007 89%00%23%11%34%47%6.40%58%51%
Average 75%31%67%56%92%55%62%04%87%
Yield Spreads
Treasury Vs. Corporate Treasury Vs. Utility
00%
50%
00%
50%
00%
50%
00%
50%
00%
1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006
-A-Bond Utility Spread -Baa.Bond Utility Spread
Aaa-Bond Corporate Stread . Baa-Bond Corporate Spread
Notes:
1 Economic Report of the President 2007: Table 73 at 316. The yields from 2002 to 2005
represent the 20-Year Treasury yields obtained from the Federal Reserve Bank.2 Mergent Public Utility Manual 2003. Moodys Daily News Reports.
3 The data for 2007 includes the period January - June 2007.
ROCKY MOUNTAIN POWER
Series "A" and "Baa" Utility Bond Yields
A" Rating Utility Baa" Rating Utility
Line Date Bond Yield Bond Yield
(1)(2)
09/07/07 05%33%
08/31/07 17%45%
08/24/07 6.23%51%
08/17/07 36%63%
08/10/07 28%54%
08/03/07 11%40%
07/27/07 6.20%6.46%
07/20/07 19%43%
07/13/07 31%54%
07/06/07 39%62%
06/29/07 24%46%
06/22/07 36%59%
06/15/07 39%65%
Average 25%51%
Source:
www.moodys.com, Bond Yields and Key Indicators.
Case No. PAC-07-
Exhibit 232 (MPG-19)
Case No. PAC-07-
Exhibit 233 (MPG-20)
ROCKY MOUNTAIN POWER
Com arable Grou Beta
Historical Current
Line Electric Utilitv 2002 2003 2004 2005 2006 Yr. AVG Beta
(1)(2)(3)(4)(5)(6)(7)
ALLETE N/A N/A N/A N/A
Alliant Energy
CH Energy
Consolidated Edison
DTE Energy
Energy East Corp.
IDACORP
MGE Energy
NSTAR
PPL Corporation
Progress Energy N/A
SCANA Corp.
Southern Co.N/A
Vectren Corp.
Xcel Energy, Inc.
Average
Median
Source:
The Value Line Investment Survey; June 29, August 10, August 31 2007.
RO
C
K
Y

M
O
U
N
T
A
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N

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R
Ca
s
e

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o
.

P
A
C
-
07
-
Ex
h
i
b
i
t

2
3
4

(
M
P
G
-
21
)
Case No. PAC-07-
Exhibit 235 (MPG-22)
ROCKY MOUNTAIN POWER
CAPM Return Estimate
Historical
Line Descri tion Premium
(1)
Risk-Free Rate 1
Risk premium
Beta
CAPM 10.
Prospective
Line Descri tion Premium
(1)
Risk-Free Rate 1 5.2%
Risk premium
Beta
CAPM 10.
CAPM Average 10.
Sources:
1 Blue Chip Financial Forecasts; September 1 , 2007 at 2.
2 SBBI; 2007 at pp. 31 & 120.
3 The Value Line Investment Survey; June 29, August 10, August 31 2007.
Case No. PAC-07-
Exhibit 236 (MPG-23)
ROCKY MOUNTAIN POWER
CAPM Return Estimate
Historical
Line Descri tion Premium
(1)
Risk-Free Rate 1
Risk Premium
Beta
CAPM 10.
Prospective
Line Descri tion Premium
(1)
Risk-Free Rate 1
Risk premium
Beta
CAPM
CAPM Average 10.
Sources:
1 Blue Chip Financial Forecasts; September 1 , 2007 at 2.
2 SBBI; 2007 at pp. 31 & 120.
3 The Value Line Investment Survey; June 29 , August 10, August 31 2007.
Case No. PAC-07-
Public Exhibit 237 (MPG-24)
ROCKY MOUNTAIN POWER
S&P Credit Ratina Financial Ratios at ROE of 10.
S&P S&P
A" Rating BBB" Rating
Ratio at 10.(BP:5)(BP:5)
Line Descri tion Eauitv Return Benchmark'Benchmark'Reference
(1)(2)(3)(4:
Rate Base 494,597 902 McDougal, Exh. 11 Page. 2.
Weighted Common Return 04%Exhibit 222 (MPG-9), Line 3, Co!. 4.
Income to Common 946 668 Line1 x Line 2.
Depreciation & Amortization 27,926,641 McDougal, Exh. 11 Page. 2.
OBS Imputed Amortization (REDACTED)Monsanto Data Response 2.
Deferred Taxes + ITC 750,562 McDougal, Exh. 11 Page. 2.
Funds from Operations (FFO)027,509 Sum of Line 3 though Line 5.
Total Interest (REDACTED)Monsanto Data Request 2.
FFO Plus Interest 755,544 Line 7 + Line 8.
FFO Interest Coverage 5x - 3.8x - 2.Line 9 / Line 8
Total Debt Ratio 53%42% - 50%50% - 60%Monsanto Data Request 2.
FFO to Total Debt 21%30% - 22%22% - 15%Line 7/ Monsanto Data Response 2.
Source:
, Standard and Poors. New Business Profile Scores Assigned to U.S. Utility and Power Companies; Financial
Guidelines Revised; June 2, 2004.
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