20100323Avera Di.pdf

DAVID J. MEYER
VICE PRESIDENT AN CHIEF COUNSEL OF
REGULATORY & GOVERNTAL AFFAIRS
AVISTA CORPORATION
P . O. BOX 3727
1411 EAST MISSION AVENE
SPOKA, WASHINGTON 99220-3727TELEPHONE: [phone]FACSIMILE: [phone]
f: '::"",~~ 'l'. r r-.í
10 trr i" II1;4 j -;¡" 11.(j? ')~,l 'I ~ c. J
II: 04
BEFORE TH IDAO PUBLIC UTILITIES COMMISSION
IN THE MATTER OF THE APPLICATION
OF AVISTA CORPORATION FOR THE
AUTHORITY TO INCREASE ITS RATES
AN CHAGES FOR ELECTRIC AND
NATUL GAS SERVICE TO ELECTRIC
AN NATUL GAS CUSTOMERS IN THE
STATE OF IDAHO
CASE NO. AVU-E-10-01
CASE NO. AVU-G-10-01
DIRECT TESTIMONY
OF
WILLIAM E. AVERA
FOR AVISTA CORPORATION
(ELECTRIC AN NATURA GAS)
DIRECT TESTIMONY OF WILLIAM E. AVERA
TABLE OF CONTENS
I. INTRODUCTION.......................................... 1
A. Overview..........................................1B. Sumary of Conclusions............ . ~ . . . . . . . . . . . . . .4
II. RISKS OF AVISTA..... . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7
A. Operating Risks. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7B. Implications of Attrition......... . . . . . . . . . . . . . . .16C. Impact of Capital Market Condi tions . . . . . . . .. ~ . . . . 20
D. Support For Avista's Credit Standing............ .25
E . Capi tal S truc ture . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29
III CAPITAL MAET ESTIMATES. . . . . . . . . . . . . . . . . . . . . . . . . . . . .35
A. Overview......................................... 35B. Results of Quantitative Analyses. . . . . . . . . . . . . . . . .37C. Flotation Costs. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .46
IV. RETURN ON EQUITY FOR AVISTA CORP. ... . . . . . . . . . . . . . . . . . 49
A. Implications for Financial Integrity............. 49B. Return on Equity Recommendation. . . . . . . . . . . . . . . . ..53
EXHIBIT No.3
Schedule -1 - Qualifications of william E. Avera
Schedule -2 - Description of Quantitative Analyses
Schedule -3 - Capital Structure .
Schedule -4 - Constant Growth DCF Model - Utility Proxy
Group
Schedule -5 - Sustainable Growth Rate - Utility Proxy Group
Schedule -6 - Constant Growth OCF Model - Non-Utility Proxy
Group
Schedule -7 - Sustainable Growth Rate - Non-Utility Proxy
Group
Schedule -8 - Forward-looking CAPM - Utility Proxy Group
Schedule -9 - Forward-looking CAPM - Non-Utility Proxy
Group
Schedule -10- Comparable Earnings Approach
1
2 Q.
I. INTRODUCTION
Please state your na an business addess.
3 ,A.william E. Avera, 3907 Red River, Austin, Texas,
4 78751.
5
6
Q.In what capacity are you emloyed?
A.I am the President of FINCAP, Inc. , a firm
7 providing financial,economic,and policy consulting
8 services to business and government.
9 Q.Please describe your educational backgroun and
10 professional exerience.
11 A.A description of my background and
12 qualifications, including a resume containing the details
13 of my experience, is attached as Schedule 1 of Exhibit No.
14 3.
15
16 Q.
A. Overview
What is the purpose of your testimony in this
17 case?
18 A.The purpose of my testimony is to present to the
19 Idaho Public Utilities Commission (the uCommission" or
20 UIPUC") my independent evaluation of the fair rate of
21 return on equity (UROE") for the jurisdictional electric
22 and gas utility operations of Avista Corp. (UAvista" or
23 U the Company").In addition,I also examined the
24 reasonableness of Avista' s capital structure, considering
Avera, Di 1
Avista Corporation
1 both the specific risks faced by the Company and other
2 industry guidelines.
3 Q.Please sumrize the informtion an materials
4 you relied on to support the opinions an conclusions
5 contained in your testimny.
6 A.To prepare my testimony, I used information from
7 a variety of sources that would normally be relied upon by
8 a person in my capaci ty .I am familiar with the
9 organization, finances, and operations of Avista from my
10 participation in prior proceedings before the I
PUC , the
11 washington Utilities and Transportation Commission, and the
12 Oregon Public Utility Commission.In connection with the
13 present filing, I considered and relied upon corporate
14 disclosures, publicly available financial reports and
15 filings, and other published information relating to
16 Avista. I also reviewed information relating generally to
17 current capital market conditions and specifically to
current investor perceptions,requiremen ts ,and18
19 expectations for Avista' s utility operations.These
20 sources, coupled with my experience in the fields of
21 finance and utility regulation, have given me a working
22 knowledge of the issues relevant to investors' required
23 return for Avista, and they form the basis of my analyses
24 and conclusions.
Avera, Di 2
Avista Corporation
1 Q.Wht is the role of the rate of return on comn
2 equity in setting a utility's rates?
3 A.The ROE serves to compensate common equity
4 investors for the use of their capital to finance the plant
5 and equipment necessary to provide utility service.
6 Inves tors commi t capi tal only if they expect to earn a
7 return on their investment commensurate with returns
8 available from alternative investments with comparable
9 risks.To be consistent with sound regulatory economics
LO and the standards set forth by the U. S. Supreme Court in
11 the Bluefield' and Hope2 cases, a utility's allowed ROE
12 should be sufficient to: 1) fairly compensate the utility'S
13 investors, 2) enable the utility to offer a return adequate
14 to attract new capital on reasonable terms, and 3) maintain
15 the utility's financial integrity.
16 Q.How did you go abut developing your conclusions
17 regarding a fair rate of return for Avista?
18 A.I first reviewed the operations and finances of
19 Avista and industry-specific risks and capital market
20 uncertainties perceived by investors.Wi th this as a
21 background, I conducted various well-accepted quantitative
22 analyses to estimate the current cost of equity, including
23 alternative applications of the discounted cash flow
1 Bluefield Water Works & Improvement Co. v. Pub. Servo Comm 'n, 262
U.S. 679 (1923).2 Fed. Power Comm'n v. Hope Natural Gas Co., 320 U.S. 591 (1944).
Avera, Di 3
Avista Corporation
1 (UDCF") model and the Capital Asset Pricing Model (UCAPM"),
2 as well as reference to exected earned rates of return for
3 utilities. Based on the cost of equity estimates indicated
4 by my analyses, the Company's ROE was evaluated taking into
5 account the specific risks and potential challenges for
6 Avista' s utility operations in Idaho.
7
8 Q.
B. Sumry of Conclusions
What are your findings regarding the 10.9 percent
9 ROE requested by Avista?
10 A.Based on the resul ts of my analyses and the
11 economic requirements necessary to support continuous
12 access to capital under reasonable terms, I determined that
13 10.9 percent is a conservative estimate of investors'
14 required ROE for Avista. The bases for my conclusion are
15 sumarized below:
16 . In order to reflect the risks and prospects17 associated with Avista's jurisdictional utility18 operations, my analyses focused on a proxy group of19 seventeen other utilities with comparable
20 investment risks. Consistent with the
fact that21 utilities must compete for capital with firms22 outside their own industry, I also referenced a23 proxy group of comparable risk companies in the24 non-utility sector of the economy¡
25 . Because inves tors' required return on equi ty is
26 unobservable and no single method should be viewed
27 in isolation, I applied both the DCF and CAPM28 methods, as well as the comparable earnings29 approach, to estimate a fair ROE for Avista¡
30 . Based on my evaluation of the strength of the31 various methods, I concluded that the cost of32 equity for the proxy groups of utilities and non-33 utility companies is in the 10.9 percent to 12.5
Avera, Di 4
Avista Corporation
1 percent range, or 11.1 percent to 12.7 percent
2 after incorporating an adjustment to account for
3 the impact of common equity flotation costs;
4 . Because Avista' s requested ROE of 10.9 percent
5 falls at the very bottom of my ubare bones" cost of
6 equity range, it represents a conservative estimate7 of investors' required rate of return.
8 Q. Wht other evidence did YO consider in
9 evaluating your ROE recomndation in this case?
10 A.My recommendation is reinforced by the following
11 findings:
12 . The reasonableness of a 10.9 percent minimum ROE13 for Avista is supported by the need to consider the14 Company's credit standing, which remains relatively15 weak:
16 0 The pressure of funding significant capital17 expenditures of $420 million3 in the next two18 years, given that the Company's rate base is19 $2.1 billion, coupled with increased operating20 risks, heighten the uncertainties associated21 .' with Avista;22 0 Because of Avista' s reliance on hydroelectric23 generation and increasing dependence on24 natural gas fueled capacity, ,the Company is25 exposed to relatively greater risks of power26 cost volatility, even with the Power Cost27 Adjustment Mechanism (UPCA");28 0 Given that Avista's credit ratings already29 fall at the very bottom of the investment30 grade scale, and considering the potential for31 continued regulatory lag, an inadequate rate32 of return imposed in this proceeding would33 further pressure the Company's financial34 flexibility and credit standing;35 0 My conclusion that a 10.9 percent ROE for36 Avista is a conservative estimate of37 investors' required return is also reinforced38 by the Company's relatively greater risks as39 compared wi th the proxy groups, the grea ter
3 Excluding investment for federal stimulus projects involving .smart
grid" .
Avera, Di 5
Avista Corporation
1
2
3
4
5
uncertainties associated with Avista's
relatively small size, and the economic
reality that Avista' s actual returns have
fallen systematically short of the allowed
ROE.
6
7
8
9
10
11
12
13
14
15
16
. Sensitivity to financial market and regulatory
uncertainties has increased dramatically and
investors recognize that constructive regulation isa key ingredient in supporting utility credit
standing and financial integrity; and,
. Providing Avista with the opportunity to earn a
return that reflects these realities is an
essential ingredient to support the Company's
financial position, which ultimately benefits
customers by ensuring reliable service at lowerlong-run costs.
17 . Regula tory support, incl uding a reasonable ROE,18 will be a key driver in securing additional
19 progress towards continued improvement in the20 Company's financial health. Further strengthening21 Avista's financial integrity is imperative to22 ensure that the Company has the capability to23 maintain an investment grade rating while24 confronting potential challenges associated with25 funding infrastructure development necessary to26 meet the needs of its customers.
27 Q. What is your conclusion as to the reasonaleness
28 of the Comany's capital structure?
29 A.Based on my evaluation, I concluded that a common
30 equity ratio of 50.0 percent represents a reasonable basis
31 from which to calculate Avista' s overall rate of return.
32 This conclusion was based on the following findings:
33 . Avista' s requested capitalization is consistent34 with the Company's need to strengthen its credit35 standing and financial flexibility as it seeks to36 raise additional capital to fund significant system37 investments and meet the requirements of its38 service territory;
39 . Avista's proposed common equity ratio is entirely40 consistent with the range of common equity ratios
Avera, Di 6
Avista Corporation
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
maintained by the proxy group of utilities. It is
also in-line with the 48.3 percent and 49.7 percentaverage equity ratios for the proxy utilities,
based on year-end 2009 data and near-term
expecta tions , respectively;
. My conclusion is reinforced by the investment
community's focus on the need for a greater equity
layer to accommodate higher operating risks and thepressures of funding significant capital
investments. This is reinforced by the need to
consider the impact of uncertain capital markets
conditions, as well as off-balance sheet
commi tments such as purchased power agreements,
which carry with them some level of imputed debt.
Q.
II. RISKS OF AVISTA
Wht is the purpose of this section?
17 A.As a predicate to my capital market analyses,
18 this section examines the investment risks that investors
19 consider in evaluating their required rate Ç)f return for
20 Avista.
21
22 Q.
A. Operating Risks
How does Avista' s generating resource mix affect
23 investors' risk perceptions?
24 A.Because over 40 percent of Avista' s total energy
25 requirements are provided by hydroelectric facilities, the
26 Company is exposed to a level of uncertainty not faced by
27 most utilities.While hydropower confers advantages in
28 terms of fuel cost savings and diversity,reduced
29 hydroelectric generation due to below-average water
30 conditions forces Avista to rely more heavily on wholesale
31 power markets or more costly thermal generating capacity to
Avera, Di 7
Avista Corporation
1 meet its resource needs. As Standard & Poor's Corporation
2 (US&P") has observed:
3
4
5
6
7
8
9
10
11
12
13
14
A reduction in hydro generation typically
increases an electric utility's costs by
requiring it to buy replacement power or run more
expensive generation to serve customer loads.
Low hydro generation can also reduce utilities'
opportunity to make off-system sales. At thesame time, low hydro years increase regional
wholesale power prices, creating potentially a
double impact - companies have to buy more powerthan under normal condi tions, paying higher. 4prices.
Investors recognize that volatile energy markets,
15 unpredictable stream flows, and Avista' s reliance on
16 wholesale purchases to meet a significant portion of its
17 resource needs can expose the Company to the risk of
18 reduced cash flows and unrecovered power supply costs. S&P
19 noted that Avista, along with Idaho Power Company, uface
20 the most substantial risks despite their PCAs and cost-
21 update mechanisms,"s and concluded that Avista' s uchief
22 risk is the electric utility's exposure to replacement
23 power costs,particularly in 6low water years."Fitch
24 Ratings Ltd. (UFitch") concluded, uAvista' s earnings and
25 cash flows are adversely affected when hydroelectric
26 generation production falls below levels factored into
4 Standard & Poor's Corporation, .Pacific Northwest Hydrology And Its
Impact On Investor-Owed Utilities' Credit Quality," RatingsDirect
(Jan. 28, 2008).5 Id.
6 Standard & Poor's Corporation, · Avista Corp.," RatingsDirect (Aug.
21, 2009).
Avera, Di 8
Avista Corporation
1 commission -approved rates due to lower-than-projected
2 streamflows. "7
3 Additionally, Avista has become increasingly reliant
4 on natural gas fired generating capacity to meet base-load
5 needs.Given the significant price fluctuations
6 experienced in energy markets discussed subsequently,
7 increasing reliance on natural gas heightens Avista' s
8 exposure to fuel cost volatility.
9 Q.Does Avista anticipate the need to access the
10 capital markets going forward?
11 A.Most definitely.Avista will require capital
12 investment to meet customer growth, provide for necessary
13 maintenance and replacements of its natural gas utility
14 systems, as well as fund new investment in electric
15 generation, transmission and distribution facilities.As
16 discussed by Company witness. Mr. Thies, planned capital
17 additions for 2010-2011 alone total approximately $420
18 million, with $1. 2 billion in expenditures being expected
19 through 2014.This represents a substantial investment
20 given Avista' s rate base was $2.1 billion as of year-end
21 2009.
22 Continued support for Avista' s financial integrity and
23 flexibility will be instrumental in attracting the capital
7 Fitch Ratings, Ltd., -Avista Corp., R Global Power U.S. Credit
Analysis (Jul. 31, 2009).
Avera, Di 9
Avista Corporation
1 necessary to fund these projects in an effective maner.
2 Avista' s reliance on purchased power to meet shortfalls in
3 hydroelectric generation magnifies the importance of
4 strengthening financial flexibility, which is essential to
5 guarantee access to the cash resources and interim
6 financing required to cover inadequate operating cash
7 flows, as well as fund required investments in the utility
8 system.
9 Q.IS the potential for energy market volatility an
10 ongoing concern for investors?
11 A.Yes.In recent years utilities and their
12 customers have had to contend with dramatic fluctuations in
13 energy costs due to ongoing price volatility in the spot
14 markets, and investors recognize the prospect of further
15 turmoil in energy markets.Moody's Investors Service
16 (UMoody's") has warned investors of ongoing exposure to
17 uextremely volatile" energy commodity costs, including
18 purchased power prices, which are heavily influenced by
19 fuel costs,8 and Fitch noted that rapidly rising energy
20 costs created vulnerability in the utility industry. 9
8 Moody's Investors Service, .Storm Clouds Gathering on the Horizon for
the North American Electric Utility Sector," Special Comment at 6
(Aug. 2007).9 Fitch Ratings Ltd., .Staying Afloat: Downstream Liquidity in the
Energy and Power Sectors, ROil & Gas / Global Power Special Report
(June 16, 2008).
Avera, Di 10
Avista Corporation
.
1 For example, the utility industry and its customers
2 have had to contend with dramatic fluctuations in gas costs
3 due to ongoing price volatility in the spot markets. Fitch
4 has highlighted the challenges that fluctuations in energy
5 prices can have for utili ties and noted that:
6
7
8
9
10
11
The sharp run-up and subsequent collapse
natural gas prices in 2008 is emlematic of
extreme price volatility that characterizes
commodity and is likely to persist in
future.
10
ofthethethe
Moody'S concluded that natural gas uremains highly
12 volatile," and warned that such price fluctuations ucould
13 have a significant impact on a utility's liquidity
14 profile. "11
15 While expectations for significantly lower energy
16 prices reflect weaker fundamentals affecting current load
17 and fuel prices, investors recognize the potential that
18 such trends could quickly reverse.As Fi tch recently
19 noted, uuncertainty regarding fuel prices, in particular
20 natural gas costs, has made planning for the future even
21 more problematic. "12 Besides discouraging potential
22 customers from choosing natural gas, causing certain
23 existing users to substitute alternative fuels, and leading
10 Fitch Ratings, Ltd., .U.S. Utilities, Power and Gas 2009 Outlook, R
Global Power North American Special Report (Dec. 22, 2008).11 Moody's Investors Service, .Carbon Risks Becoming More Imminent for
U. S. Electric Utility Sector," Special Comment (March 2009) .12 Fitch Ratings, Ltd., .Electric Utility Capital Spending: The Show
Will Go On," Global Power U.S. and Canada Special Report (Oct. 14,
2009) .
Avera, Di 11
Avista corporation
1 to decreased customer usage, volatile natural gas prices
2 have increased the risks of investing in natural gas
3 distribution utilities and placed additional pressure on
4 their bond ratings.The rapid rise in customers' bills
5 that can result from higher wholesale energy prices has
6 also heightened investor concerns over the implications for
7 regulatory uncertainty.Moody's concluded that political
8 risks associated with Ugrowing consumer intolerance for
9 steadily increasing rates" was a key longer-term challenge
10 for utilities that would be intensified by prolonged
11 unemployment. 13
12 Q.What other financial pressures impact investors'
13 risk assessmnt of Avista?
14 A.Investors are aware of the financial and
15 regulatory pressures faced by utilities associated with
16 rising costs and the need to undertake significant capital
17 investments. As Moody's observed:
18
19
20
21
22
Utilities remain exposed to large, long-term
capital investment challenges, volatile commodity
prices and legal judgments that can wreak havoc
on even the strongest liquidity profiles. 14
Similarly, S&P noted that cost increases and capital
23 proj ects , along wi th uncertain load growth, were a
13 Moody's Investors Service, .U. S. Electric Utilities Face Challenges
Beyond Near-Term, R Industry Outlook (Jan. 2010).14 Id.
Avera, Di 12
Avista Corporation
significant challenge to the utility industry. lS
2 echoed this assessment, concluding:
1 Fitch
3 The combination of high capital expenditures and
4 relatively weak electricity demand will continue
5 to pressure credit quality and require base rate
6 increases in 2010 and beyond.
16
7 While providing the infrastructure necessary to meet
8 the energy needs of customers is certainly desirable, it
9 imposes additional financial responsibilities on Avista.
10 As noted earlier, the Company's plans include electric
11 utility capital expenditures of approximately $420 million
12 just over the 2010-2011 period, and Moody's has noted that
13 Avista u is continuing its high level of investment. "17
14 Investors are aware of the challenges posed by rising costs
15 and burdensome capital expenditure requirements, especially
16 in light of Avista' s relatívely weak credit standing and
17 ongoing capital market and economic uncertainties.
18 Q.Wht other considerations affect investors'
19 evaluation of Avista?
20 A.Utilities are confronting increased environmental
21 pressures that could impose significant uncertainties and
22 costs.In early 2007 S&P cited environmental mandates,
23 including emissions, conservation, and renewable resources,
lS Standard & Poor's Corporation, .Industry Economic And Ratings
Outlook, R RatingsDirect (Feb. 2, 2010).16 Fitch Ratings Ltd., .U. S. Utilities, Power, and Gas 2010 Outlook,"
Global Power North America Special Report (Dec. 4, 2009).17 Moody's Investors Service, .Credi t Opinion: Avista Corp.,' Global
Credit Research (Aug. 13, 2009).
Avera, Di 13
Avista Corporation
1 as one of the top ten credit issues facing U. S. utilities. 18
2 Similarly, Moody's noted that Uthe prospect for new
3 environmental emission legislation particularly
4 concerning carbon dioxide - represents the biggest emerging
5 issue for electric utili ties, "19 while Fitch observed that
6 "the structure,timing and implementation is still
7 uncertain."w
8 Compliance with evolving standards will undoubtedly
9 require significant capital expenditures, with S&P recently
10 concluding, "Although we expect the cap-and-trade program
11 to be economywide and affect a variety of sectors, it will
12 disproportionately affect the power sector.,,21 S&P recently
13 emphasized that because of uncertainty over the details and
14 timing of future limits on CO2 emissions, existing ratings
15 do not fully reflect the impact of carbon risks. 22
16 Q.Would investors consider Avista' s relative size
17 in their assessment of the Comany's risks and prospects?
18
19
A.Yes.A firm's relative size has important
implications for investors in their evaluation of
20 alternative investments, and it is well established that
18 Standard & Poor's Corporation, .Top Ten Credit Issues Facing U. S.
Utilities," RatingsDirect (Jan. 29, 2007).19 Moody's Investors Service, .U.S. Investor-Owed Electric Utilities,"
Industry Outlook (Jan. 2009).20 Fitch Ratings, Ltd., .U.S. Utilities, Power and Gas 2009 Outlook,"
Global Power North America Special Report (Dec. 22, 2008).21 Standard & Poor's Corporation, .The Potential Credit Impact Of
Carbon Cap-And-Trade Legislation On U. S. Companies," RatingsDirect
(Sep. 14, 2009).22 Id.
Avera, Di 14
Avista Corporation
1 smaller firms are more risky than larger firms.with a
2 market capitalization of approximately $1.1 billion, Avista
3 is one of the smallest publicly traded electric utilities
4 followed by Value Line,which have an average
5 capitalization of approximately $6.7 billion.23
6 The magnitude of the size disparity between Avista and
7 other firms in the utility industry has important practical
8 implications with respect to the risks faced by investors.
9 Al 1 else being equal, it is wel 1 accepted that smal ler
10 firms are more risky than their larger counterparts, due in
11 part to their relative lack of diversification and lower
12 f. . 1 . l' 24inancia resi iency.These greater risks imply a higher
13 required rate of return, and there is ample empirical
14 evidence that investors in smaller firms realize higher
15 f . 1 f' 2Srates 0 return than in arger irms.Common sense and
16 accepted financial doctrine hold that investors require
17 higher returns from smaller companies, and unless that
18 compensation is provided in the rate of return allowed for
19 a utility, the legal tests embodied in the Hope and
20 Bluefield cases canot be met.
23 ww.valueline.com (retrieved Mar. 5, 2010).
24 It is well established in the financial literature that smaller
firms are more risky than larger firms. See, e.g., Eugene F. Fama and
Kenneth R. French, -The Cross-Section of Expected Stock Returns", The
Journal of Finance (June 1992); George E. Pinches, J. Clay Singleton,
and Ali Jahankhani, -Fixed Coverage as a Determinant of Electric
Utility Bond Ratings", Financial Maagement (Sumer 1978).25 See for example Rolf W. Banz, -The Relationship Between Return and
Market Value of Common Stocks", Journal of Financial Economics(Septemer 1981) at 16.
Avera, Di 15
Avista Corporation
1
2
3
Q.
B. Implications of Attrition
Wht causes attrition?
A.Attrition is the deterioration of actual return
4 below the allowed return that occurs when the relationships
5 between revenues, costs, and rate base used to establish
6 rates (e.g., using a historical test year without adequate
7 adjustments) do not reflect the actual costs incurred to
8 serve customers during the period that rates are in effect.
9 For example, if external factors are driving costs to
10 increase more than revenues, then the rate of return will
11 fall short of the allowed return even if the utility is
12 operating efficiently.Similarly, when growth in the
13 utility's investment outstrips the rate base used for
14 ratemaking, the earned rate of return will fall below the
15
16
allowed return through no faul t of the utility's
management.These imbalances are exacerbated as the
17 regulatory lag increases between the time when the data
18 used to establish rates is measured and the date when the
19 rates go into effect.
20 Q.Why is it necessary to address the impact of
21 attrition?
22 A.Investors are concerned with what they can expect
23 in the future, not what they might expect in theory if a
24 historical test year were to repeat.To be fair to
25 investors and to benefit customers, a regulated utility
26 must have an opportunity to actually earn a return that
Avera, Di 16
Avista Corporation
1 will maintain financial integrity,facilitate capital
2 attraction, and compensate for risk. In other words, it is
3 the end result in the future that determines whether or not
4 the Hope and Bluefield standards are met.S&P observed
5 that its risk analysis focuses on the utility's ability to
6 consistently ~ a reasonable return:
7 Notably, the analysis does not revolve around
8 uauthorized" returns, but rather on actual earned
9 returns. We note the many examples of utilities10 with healthy authorized returns that, we believe,11 have no meaningful expectation of actually12 earning that return because of rate case lag,13 expense disallowances, etc. 26
14 Similarly, Moody's concluded, "we evaluate the framework
15 and mechanisms that allow a utility to recover its costs
16 and investments and earn allowed returns. We are less
17 concerned with the official allowed return on equity,
18 instead focusing on the earned returns and cash flows.
"27
19 Q.Has the investment comity recognized the risks
20 associated with attrition and lag in its evaluation
of
21 Avista?
22
23
A.Yes. As discussed in the testimony of Mr. Thies,
Avista is experiencing regulatory lag.S&P confirmed that
24 attrition has acted as a drag on Avista' s finances:
25 Regulatory lag has been a consistent issue for26 Avista's utilities, with the utility operations ...
26 Standard & Poor's Corporation, -Assessing U.S. Utility Regulatory
Environments," RatingsDirect (Nov. 7, 2008).27 Moody's Investors Service, -Electric Utilities Face Challenges
Beyond Near-Term," Industry Outlook (Jan. 2010).
Avera, Di 17
Avista Corporation
1 collectively unable to earn the company's2 authorized return on equity (ROE) on a
3 consolidated basis. On a consolidated basis,
4 average earned ROE over the pas t three years has
5 been just under 7%, based on Standard & Poor's
6 Ratings Services' calculations. 28
7 Similarly, Value Line recently noted that the effects of
8 regula tory lag were hampering Avis ta ' s abi 1 i ty to earn its
9 allowed ROE, which is expected to be an ongoing issue for
10 the Company. 29
11
12
Q.Wht are the ways to deal with attrition?
A.For many utilities, the widespread adoption of
13 pass-through clauses for fuel, purchased power, and other
14 costs that were rising rapidly in the late 1970' s and early
15 1980' s helped to partially offset the impact of attrition.
16 The use of future test years and other forward-looking
17 adjustments and mechanisms is also useful in ameliorating
18 the impact of attrition, as is accelerated depreciation and
19 inclusion of CWIP in rate base, particularly where
20 financing an expensive generating plant addition is
21 undermining a utility's financial indicators.Many
22 jurisdictions have developed methods to attenuate
23 regulatory lag, such as allowing interim rates, putting
24 rates into effect subject to refund,as well as
28 Standard & Poor's Corporation, -Sumary: Avista Corp.,"
RatingsDirect (Feb. 18, 2010).29 The Value Line Investment Survey at 2232 (Feb. 5, 2010).
Avera, Di 18
Avista Corporation
1 accelerating the administrative process to allow faster
2 rate decisions.
3 Q.Is it reasonable to consider the imact of
4 Avista's expsure to attrition?
5 A.Yes. Setting rates at a level that considers the
6 impact of attrition and allows the utility an opportunity
7 to actually earn its authorized ROE is consistent with
8 fundamental regulatory principles.Central to the
9 determination of reasonable rates for utility service is
10 the notion that owners of public utility properties are
11 protected from confiscation.The Supreme Court has
12 reaffirmed that the end result test must be applied to the
13 actual returns that investors expect if they put their
14 money at risk to finance utilities. 30 This end result can
15 only be achieved for Avista if the allowed return is
16 sufficient to offset the impact of attrition.That end
17 result would maintain the utility'S financial integrity,
18 ability to attract capital and offer investors fair
19 compensation for the risk they bear.Attrition will
20 continue to result in under-earning the allowed ROE if the
30 Verizon Communications, et al v. Federal Communications Commission,
et aI, 535 U. S. 467 (2002). While I canot comment on the legal
significance of this case, I found the economic wisdom of looking to
the reasonable expectations of actual investors compelling. Economic
logic and common sense confirm that a utility canot attract capital
on reasonable terms if investors expect future returns to fall short
of those offered by comparable investments.
Avera, Di 19
Avista Corporation
1 impact of regulatory lag and rising capital requirements
2 are ignored.
3 In real world capital markets, investors have many
4 competing places to put their money. If the money that is
5 dedicated to utility public service does not have an
6 opportunity to earn a return commensurate with that
7 available from alternatives of equivalent risk in the
8 capi tal markets,investors are not being adequately
9 compensated for the use of their money and bearing risk.
10 Since the capital dedicated to utility service cannot be
11 withdrawn from public service, its economic value to
12 investors is reduced by the amount necessary to make the
13 utility investment competitive with alternative investments
14 on the open market.This reduction in economic value
15 necessary to bring the rate of earnings on utility
16 investment into line with market opportuni ties of
17 commensurate risk constitutes a taking of investors'
18 capital by the governmental authority setting rates.
19 C. Impact of capital Market Conditions
20 Q.Wht are the implications of recent capital
21 market conditions?
22 A.The financial and real estate crisis that
23 accelerated during the third quarter of 2008 led to
24 unprecedented price fluctuations in the capital markets as
25 investors dramatically revised their risk perceptions and
Avera, Di 20
Avista Corporation
1 required returns. As a result of investors' trepidation to
2 commit capital, stock prices declined sharply while the
3 yields on corporate bonds experienced a dramatic increase.
4 with respect to utilities specifically, as of Decemer
5 2009, the Dow Jones utility Average stock index remained
6 almost 30 percent below the level in June 2008. This sell-
7 off in common stocks and sharp fluctuations in utility bond
8 yields reflect the fact that the utility industry was not
9 immune to the impact of financial market turmoil and the
10 ongoing economic downturn.As the Edison Electric
11 Institute (UEEI") noted in a letter to congressional
12 representatives as the financial crisis intensified,
13 capital market uncertainties have serious implications for
14 utilities and their customers:
15 In the wake of the continuing upheaval on Wall16 Street, capital markets are all but immobilized,17 and short-term borrowing costs to utili ties have18 already increased substantially. If the19 financial crisis is not resolved quickly,20 financial pressures on utilities will intensify21 sharply, resulting in higher costs to our
22 customers and, ultimately, could compromise23 service reliability. 31
24 Similarly, an October 1, 2008, Wall Street Journal
25 report confirmed that utilities had been forced to delay
26 borrowing or pursue more costly alternatives to raise
31 Letter to House of Representatives, Thomas R. Kuhn, President,
Edison Electric Institute (Sep. 24, 2008).
Avera, Di 21
Avista Corporation
1 funds. 32 In December 2008, Fitch confirmed usharp repricing
2 of and aversion to risk in the investment community," and
3 noted that the disruptions in financial markets and the
4 fundamental shift in investors' risk perceptions had
5 increased the cost of capital for utilities.33:
6 More recently, Fitch concluded,UWhile utilities
7 maintained relatively good market access during the credit
8 crisis, the cost of capital is higher than prior to the
9 credit crisis, and bank credit remains relatively tight."34
10 Similarly, S&P confirmed that utilities are expected to
11 maintain access to credit in 2010,ualbeit at more
12 demanding terms than in the previous cycle, "3S with Moody's
13 noting that Ucosts associated with credit facilities have
14 increased significantly. ,,36
15 Q.How do current interest rates on long-te~ bonds
16 comare with those projected for the next few of years?
17 A.Table WEA-1 below compares current interest rates
18 on 30-year Treasury bonds, double-A rated utility bonds,
19 and triple-A rated corporate bonds with those projected for
32 Smith, Rebecca, -Corporate News: Utilities' Plans Hit by Credit
Markets, R Wall Street Journal at B4 (Oct. 1, 2008).33 Fitch Ratings Ltd., -U.S. Utilities, Power and Gas 2009 Outlook,"
Global Power North America Special Report (Dec. 22. 2008).34 Fitch Ratings Ltd., -Electric Utility Capital Spending: The Show
Will Go On," Global Power U.S. and Canada Special Report (Oct. 14,
2009) .35 Standard & Poor's Corporation, -Industry Report Card: U. S. Regulated
Electric Utilities Head Into 2010 With Familiar Concerns,"
RatingsDirect (Dec. 28, 2009).36 Moody's Investors Service, -U. S. Electric Utilities Face Challenges
Beyond Near-Term," Industry Outlook (Jan. 2010).
Avera, Di 22
Avista Corporation
1 2010 through 2014 by the Value Line Investment Survey
2 (UValue Line"), IHS Global Insight, the Energy Information
3 Administration ("EIA"), a statistical agency of the U. S.
4 Department of Energy (UDOE"):
5 'lABLE WD-16 IR'BUS'l RAB 'lS
30 - Yr. 'lreasury
Value Line (a)
IHS GlobalAA Corprate
Value Line (b)
IHS GlobalInsight (c)
S&P (d)
AA Utility
IHS Global
EÌA" '(e)'
2010 2011 2012 2013
Feb.
20102014
4.6% 4.9% 5.3%
4.6% 4.6% 4.9%
5.8%
5.2%
(a)
6.3% 4.6%
5.8% 4.6%
5.8% 6.0% 6.4%
5.3% 5.5% 5.9%
5.8% 6.8% 7.5%
6.7%
6.2%
7.6%
7.0% 5.4%
6.7% 5.4%
5.4%
5.6% 5.8% 6.3%
6.7% 6.4% 6.5%
6.6%
6.8%
7.2% 5.7%
7.2% 5.7%
(a) Based on monthly average bond yields for January
2010 reported at ww. credi t trends. moodys. com and
http://ww. federalreserve.gov/releases/h15/data.h
tm.
(b) The Value Line Investment Survey, Forecast for
the U.S. Economy (Feb. 26, 2010).
(c) IHS Global Insight, The U.S. Economy: The 3D-YearFocus" (Third-Quarter 2009) at Table 34.
(d) Standard & Poor's Corporation, -U. S. Economic
Forecast: To A Prosperous New Year,"
RatingsDirect (Jan. 11, 2009).
(e) Energy Informtion Administration, Anual EnergyOutlook 2010, Early Release (Dec. 5, 2009) at
Table 20.
7 As evidenced above, there is a clear consensus that the
8 cost of permanent capital will be higher in the 2010-2014
9 timeframe than it is currently. As a result, current cost
10 of capital estimates are likely to understate investors'
Avera, Di 23
Avista Corporation
1 requirements at the time the outcome of this proceeding
2 becomes effective and beyond.
3 Q.Wht do these events imply with respect to the
4 ROE for Avista?
5 A.No one knows the future of our complex global
We know that the financial crisis had been6economy.
7 building for a long time and few predicted that the economy
8 would fall as rapidly as it has, or that corporate bond
9 yields would fluctuate as dramatically as they did~ While
10 conditions in the economy and capital markets appear to
11 have stabilized, investors are apt to react swiftly and
12 negatively to any future signs of trouble in the financial
13 sys tem or economy.As the Wall Street Journal recently
14 noted:
15 Stocks pulled out of a 167-point hole with a late16 rally Friday, capping a wild week reminiscent of17 the most volatile days of the credit crisis. ... It18 was a return to the unusual relationships, or19 correlations, seen at major flash points over the20 past two years when investors fled risky assets
21 and jumped into safe havens. This market22 behavior, which has reasserted itself repeatedly23 since the financial crisis began, suggests that24 investment decisions are still being driven more25 by government support and liquidity concerns than
26 market fundamentals. 37
27 Given the importance of reliable electric and gas utility
28 service for customers and the economy, it would be unwise
37 Gongloff, Mark, -Stock Rebound Is a Crisis Flashback - Late Surge
Recalls Market's Volatility at Peak of Credit Difficulties; Unusual
Correlations, R Wall Street Journal at B1 (Feb. 6, 2010).
Avera, Di 24
Avista Corporation
1 to ignore investors' increased sensitivity to risk in
2 evaluating Avista' s ROE.
3 D. Support For Avista's Credit Staning
4 Q.Wht credit ratings have been assigned to Avista?
5 A.Avista has been assigned a corporate credit
6 rating of "BBB-" by S&P and an issuer default rating of
7 UBBB-"by Fitch. Moody's has assigned the Company an issuer
8 rating of "Baa3".S&P and Moody's have revised their
9 credit outlook on Avista to upositive", indicating the
10 potential for higher ratings going forward.
38 The current
11 ratings assigned by S&P, Moody'S, and Fitch represent the
12 lowest rung on the ladder of the investment grade scale.
13 Q.How have investors' risk perceptions for firms
14 involved in the utility industr, evolved?
15 A.The past decade witnessed steady erosion in
16 credit quality throughout the utility industry, both as a
17 result of revised perceptions of the risks in the industry
18 and the weakened finances of the utilities themselves. S&P
19 recently reported that the majority of the companies in the
38 Standard & Poor's Corporation i -Research Update: Outlook On Avista
Corp. Credit Rating Revised To positive; Ratings Affirmed,"
RatingsDirect (Aug. 10, 2009); Moody'S Investors Service, -Ratings
Action: Avista Corp.,. Global Credi t Research Ratings Action (Aug. 12,
2009) .
Avera, Di 25
Avista Corporation
1 utili ty sector now fall in the triple-B rating category. 39
2 Going forward, S&P observed that:
3 Looming costs associated with environmental
4 compliance, slack demand caused by economic
5 weakness, the potential for permanent demand
6 destruction caused by changes in consumer
7 behavior and closing of manufacturing facilities,
8 and numerous regulatory filings seeking recovery
9 of costs are some of the significant challenges10 the indus try has to deal wi th . 40
11 Q.How does Avista's relative credit staning
12 comare with others in the utility industry?
13 A.Avista IS credit ratings remain at the very bottom
14 of the investment grade scale, and in a recent report by
15 S&P ranking U. S. regulated utilities from strongest to
16 weakest, Avista was ranked 145 out of the total 181
17 companies with investment grade credit . 41ratings.
18 Meanwhile, in a ranking of electric and gas utility parent
19 companies, Fitch placed Avista at 34th position out of 49
20 . 42companies.
39 Standard & Poor's Corporation, -Issuer Ranking: U. S. Regulated
Electric Utilities, Strongest To Weakest," RatingsDirect (Mar. 2,
2010) .40 Standard & Poor's Corporation, -U. S. Regulated Electric Utilities
Head Into 2010 With Familiar Concerns," RatingsDirect (Dec. 28, 2009).41 Standard & Poor's Corporation, - Issuer Ranking: U. S. Regulated
Electric Utilities, Strongest To Weakest," RatingsDirect (Mar. 2,2010) .42 Fitch Ratings Ltd., -U.S. Utilities, Power, and Gas 2010 Outlook, R
Global Power North America Special Report (Dec. 4, 2009).
Avera, Di 26
Avista Corporation
1 Q.Wht are the implications of Avista' s relative
2 credit standing,given the potential for further
3 dislocations in the capital markets?
4 A.As documented earlier and in the testimony of Mr.
5 Mark Thies, investors' concerns are magnified by the fact
6 that its credit standing remains relatively weak.The
7 Company's efforts to regain investment grade credit ratings
8 have been success ful ,but Avista' s finances remain
9 pressured.
10 Fitch observed that when credit market conditions are
11 unsettled, \\ \ flight to quality' is selective within the
12 (utili ty) sector, favoring companies at higher rating
13 levels. "43 Because Avista' s ratings are at the very bottom
14 of the investment grade barrel, there is no backstop in the
15 event of a recurring capital market crisis and reduced
16 flexibility to respond to other challenges, such as a
17 continuation of poor hydro conditions or increased capital
18 outlays.As Mr. Thies confirms in his testimony,
19 regulatory support will be a key driver in securing
20 additional progress towards restoring the Company's
21 financial health. Further strengthening Avista' s financial
22 integrity and continued progress in raising the Company's
23 credit standing is imperative to ensure the capability to
43 Id.
Avera, Di 27
Avista Corporation
1 maintain an investment grade rating while confronting
2 potential challenges.
3 Moreover, the negative impact of declining credit
4 quality on a utility's capital costs and financial
5 flexibility becomes more pronounced as debt ratings move
6 down the scale from investment to non-investment grade. As
7 the Chairman of the New York State Public Service
8 Commission noted in his role as spokesman for the National
9 Association of Regulatory Utility Commissioners:
10 While there is a large difference between A and11 BBB, there is an even brighter line between
12 Investment Grade (BBB- /Baa3 bond ratings by
13 S&P/Moody's, and higher) and non-Investment Grade14 (Junk) (BB+/Ba1 and lower). The cost of issuing15 non-investment grade debt, assuming the market is16 receptive to it, has in some cases been hundreds17 of basis points over the yield on investment18 grade securities. To me this suggests that you19 do not want to be rated at the lower end of the
20 BBB range because an unexpected shock could move
21 you outside the investment grade range.
44
22 The pressures of significant capital expenditure
continued improvement in Avista' s credit
supporting
standing.
23
24
requirements reinforce the importance of
25 Investors understand from past experience in the utility
26 industry that large capital needs can lead to significant
27 deterioration in financial integrity that can constrain
28 access to capital, especially during times of unfavorable
44 Brown, George, -Credit and Capital Issues Affecting the Electric
Power Industry," Federal Energy Regulatory Commission Technical
Conference (Jan. 13, 2009).
Avera, Di 28
Avista Corporation
1 capital market conditions. Considering the weakened state
2 of financial markets, competition with other investment
3 alternatives, and investors' sensitivity to the potential
4 for market volatility, greater credit strength is a key
5 ingredient in maintaining access to capital at reasonable
6 cost. with Avista 1 s credit ratings poised on the precipice
7 between investment grade and junk bond status, the stakes
8 associated with an inadequate rate of return are increased
9 dramatically. In turn, the need for supportive regulation
10 and an adequate ROE may never have been greater.
11
12 Q.
E. Capital Structure
IS an evaluation of the capital structure
13 maintained by a utility relevant in assessing its return on
14 equity?
15 A.Yes. Other things equal, a higher debt ratio, or
16 lower common equity ratio, translates into increased
17 financial risk for all investors. A greater amount of debt
18 means more investors have a senior claim on available cash
19 flow, thereby reducing the certainty that each will receive
20 his contractual payments.This increases the risks to
21 which lenders are exposed, and they require correspondingly
22 higher rates of interest.From common shareholders'
23 standpoint, a higher debt ratio means that there are
24 proportionately more investors ahead of them, thereby
25 increasing the uncertainty as to the amount of cash flow,
26 if any, that wiii remain.
Avera, Di 29
Avista Corporation
1 Q.What comn equity ratio is implicit in Avista's
2 requested capital structure?
3
4
A.Avista's capital structure is presented in the
testimony of Mr. Thies.As sumarized in his testimony,
5 the pro-forma common equity ratio used to compute Avista's
6 overall rate of return was 50.0 percent in this filing .
7 Q.What was the average capitalization maintained by
8 the utility proxy group?
9 A.As shown on Schedule 3, for the 17 firms in the
10 utility proxy group, common equity ratios at Decemer 31,
11 2009 ranged between 42.8 percent and 63.4 percent and
12 averaged 48.3 percent.
13 Q.Wht capitalization is representative for the
14 proxy group of utilities going forward?
15 A.As shown on Schedule 3, The Value Line Investment
16 Survey ("Value Line") expects an average common equity
1 7 ratio for the proxy group of utilities of 49.7 percent for
18 its three-to-five year forecast horizon,with the
19 individual common equity ratios ranging from 41.0 percent
20 to 59.5 percent.
21 Q.How does Avista's comn equity ratio comare
22 with those maintained by the reference group of utilities?
23 A. The 50.0 percent common equity ratio requested by
24 Avista is entirely consistent with the range of equity
25 ratios maintained by the firms in the Utility Proxy Group
Avera, Di jo
Avista Corporation
1 and is in-line with the 48.3 percent and 49.7 percent
2 average equity ratios at year-end 2009 and based on Value
3 Line's near-term expectations, respectively.
4 Q.Wht implication does the increasing risk of the
5 utility industry have for the capital structures maintained
6 by utilities?
7 A.As discussed earlier, the average credit rating
8 associated with firms in the electric industry has fallen
9 to triple-B, with Avista' s UBBB-" rating occupying the
10 lowest rung on the ladder of the investment grade scale.
11 At the same time, utilities are facing uncertainties on a
12 numer fronts, including the need to finance significant
13 capital investment plans and ongoing regulatory risks.
14 Coupled with the potential for further turmoil in capital
15 markets, these considerations warrant a stronger balance
16 sheet to deal with an increasingly uncertain environient.
17 A more conservative financial profile, in the form of a
18 higher common equity ratio, is consistent with increasing
19 uncertainties and the need to maintain the continuous
20 access to capital that is required to fund operations and
21 necessary system investment, even during times of adverse
22 capital market conditions.
23 Moody's has repeatedly warned investors of the risks
24 associated with debt leverage and fixed obligations and
25 advised utilities not to squander the opportunity to
Avera, Di 31
Avista Corporation
1 strengthen the balance sheet as a buffer against future
2 uncertainties. 45 More recently, Moody's concluded:
3 From a credit perspective, we believe a strong
4 balance sheet coupled with abundant sources of
5 liquidity represents one of the best defenses
6 against business and operating risk and potential
7 negative ratings actions. 46
8 Similarly, S&P recently noted that, Uwe generally consider
9 a debt to capital level of 50% or greater to be aggressive
10 or highly leveraged for utilities. ,,47 Fitch affirmed that
11 it expects regulated utilities Uto extend their
12 conservative balance sheet stance in 2010," and employ Ua
13 judicious mix of debt and equity to finance high levels of
14 planned investments. ,,48 This is especially the case for
15 Avista, which faces the dual challenge of financing
16 significant capital expansion plans while at the same time
17 endeavoring to improve its credit standing.
18 Q.Wht other factors do investors consider in their
19 assessment of a comany's capital structure?
20 A.Depending on their specific attributes,
21 contractual agreements or other obligations that require
22 the utility to make specified payments may be treated as
45 Moody's Investors Service, -Storm Clouds Gathering on the Horizon
for the North American Electric Utility Sector," Special Comment (Aug.
2007); -U.S. Electric Utility Sector," Indust~ Outlook (Jan. 2008).46 Moody's Investors Service, -U. S. Electric Utilities Face Challenges
Beyond Near-Term," Indust~ Outlook (Jan. 2010).47 Standard & Poor's Corporation, -Ratings Roundup: U. S. Electric
Utility Sector Maintained Strong Credit Quality In A Gloomy 2009,"
RatingsDirect (Jan. 26, 2010).48 Fitch Ratings Ltd., -U.S. Utilities, Power, and Gas 2010 Outlook,"
Global Power North America Special Report (Dec. 4, 2009).
Avera, Di 32
Avista Corporation
1 debt in evaluating Avista' s financial risk. Power purchase
2 agreements (UPPAs") and leases typically obligate the
3 utility to make specified minimum contractual payments akin
4 to those associated with traditional debt financing and
5 investors consider a portion of these commitments as debt
6 in evaluating total financial risks.Because inves tors
7 consider the debt impact of such fixed obligations in
8 assessing a utility's financial position, they imply
9 greater risk and reduced financial flexibility.In order
10 to offset the debt equivalent associated with off-balance
11 sheet obligations, the utility must rebalance its capital
12 structure by increasing its common equity in order to
13 restore its effective capitalization ratios to previous
14 levels. The capital structure ratios presented earlier do
15 not include imputed debt associated with power purchase
16 agreements or the impact of other off-balance sheet
17 obligations.
18 These commitments have been repeatedly cited by major
19 bond rating agencies in connection with assessments of
20 utility financial risks.49 For example, S&P'reported that
21 it adjusts Avista's capitalization to include approximately
49 See, e.g., Standard & Poor's Corporation, -Standard & Poor's
Methodology For Imputing Debt For U. S. Utili ties' Power Purchase
Agreements, R RatingsDirect (May 7, 2007); Standard & Poor's
Corporation, -Implications Of Operating Leases On Analysis Of U. S.
Electric Utilities," RatingsDirect (Jan. 15, 2008); Standard & Poor'sCorporation, -Top 10 Investor Questions: U. S. Regulated Electric
Utilities, R RatingsDirect (Jan. 22, 2010).
Avera, Di 33
Avista Corporation
1 $195 million in imputed debt from PPAs, leases, and
2 postretirement benefit obligations. 50 Unless Avista takes
3 action to offset this additional financial risk by
4 maintaining a higher equity ratio, the resulting leverage
5 will weaken the Company's creditworthiness, implying a
6 higher required rate of return to compensate investors for
7 the greater risks. 51
8 Q.Wht did you conclude with respect to the
9 Comany's capital structure?
10 A.Based on my evaluation, I concluded that Avista' s
11 requested capital structure represents a reasonable mix of
12 capital sources from which to calculate the Company's
13 overall rate of return.While industry averages provide
14 one benchmark for comparison, each firm must select its
15 capitalization based on the risks and prospects it faces,
16 as well its specific needs to access the capital markets.
17 A public utility with an obligation to serve must maintain
18 ready access to capital under reasonable terms so that it
19 can meet the service requirements of its customers.
20 Avista's capital structure reflects the challenges
21 posed by its resource mix, the burden of significant
50 Standard & Poor's Corporation, -Avista Corp.," RatingsDirect (Aug.
21, 2009).Sl Apart from the immediate impact that the fixed obligation of
purchased power costs has on the utility's financial risk, higher
fixed charges also reduce ongoing financial flexibility, and the
utility may face other uncertainties, such as potential replacement
power costs in the event of supply disruption.
Avera, Di 34
Avista Corporation
1 capital spending requirements, and the Company's ongoing
2 efforts to strengthen its credit standing and support
3 access to capi talon reasonable terms.Moody's observed
4 that its ratings for Avista anticipate uconservative
5 financing strategies. ,,52 The need for access becomes even
6 more important when the company has capital requirements
7 over a period of years, and financing must be continuously
8 available,even during unfavorable capital market
9 conditions.
10
11 Q.
III. CAITAL MA ESTIMATES
What is the purpose of this section?
12 A.This section presents capital market estimates of
13 the cost of equity.The details of my quantitative
14 analyses are contained in Schedule 2 of Exhibit No.3, with
15 the results being sumarized below.
16
17 Q.
A. Overview
Wht role does the rate of return on CODn
18 equity play in a utility's rates?
19 A.The return on common equi ty is the cos t of
20 inducing and retaining investment in the utility's physical
21 plant and assets. This investment is necessary to finance
22 the asset base needed to provide utility service.
23 Investors will commit money to a particular investment only
52 Moody's Investors Service, -Credit Opinion: Avista Corp.," Global
Credit Research (Aug. 13, 2009).
Avera, Di 35
Avista Corporation
1 if they expect it to produce a return commensurate with
2 those from other investments wi th comparable risks.
3 Moreover, the return on common equity is integral in
4 achieving the sound regulatory objectives of rates that are
5 sufficient to: 1) fairly compensate capital investment in
6 the utility, 2) enable the utility to offer a return
7 adequate to attract new capital on reasonable terms, and 3)
8 maintain the utility's financial integrity. Meeting these
9 objectives allows the utility to fulfill its obligation to
10 provide reliable service while meeting the needs of
11 customers through necessary system expansion.
12 Q.Did you rely on a single method to estimate the
13 cost of equity for Avista?
14 A.No.In my opinion, no single method or model
15 should be relied upon to determine a utility's cost of
16 equity because no single approach can be regarded as wholly
17 reliable.For example, a publication of the Society of
18 Utility and Financial Analysts (formerly the National
19 Society of Rate of Return Analysts), concluded that:
20 Each model requires the exercise of judgment as
21 to the reasonableness of the underlying
22 assumptions of the methodology and on the23 reasonableness of the proxies used to validate
24 the theory. Each model has its own way of25 examining inves tor behavior, its own premises,26 and its' own set of simplifications of reality.
27 Each method proceeds from different fundamental28 premises, most of which canot be validated29 empirically. Investors clearly do not subscribe30 to any singular method, nor does the stock price
Avera, Di 36
Avista Corporation
1
2
reflect the a8plication of anyone single method
by inves tors.
3
4
Therefore, I used both the DCF and CAPM methods to estimate
the cost of equity.In addition, I also evaluated a fair
5 ROE return using a comparable earnings approach based on
6 investors' current expectations in the capital markets. In
7 my opinion, comparing estimates produced by one method with
8 those produced by other approaches ensures that the
9 estimates of the cost of equity pass fundamental tests of
10 reasonableness and economic logic.
11 Q.What was your conclusion regarding a fair rate of
12 return on equity for the proxy comanies?
13 A.Based on the results of my quantitative analyses,
14 and my assessment of the relative strengths and weaknesses
15 inherent in each method, I concluded that the cost of
16 equity for the proxy companies is in the 10.9 percent to
17 12.5 percent range, or 11.1 percent to 12.7 percent after
18 including a minimum adjustment for flotation costs.
19 B. Results of ouantitative Anlyses
20 Q. Wht specific proxy group of utilities did yo
21 rely on for your anlysis?
22 A. In estimating the cost of equity, the OCF model
23 is typically applied to publicly traded firms engaged in
24 similar business activities or with comparable investment
53 Parcell, David C., -The Cost of Capital - A Practitioner's Guide,"
Society of Utility and Regulato~ Financial Analysts (1997) at Part 2,
p. 4.
Avera, Di 37
Avista Corporation
1 risks. As described in detail in Schedule 2, I applied the
2 DCF model to a utility proxy group composed of those
3 dividend-paying companies included by Value Line in its
4 Electric Utilities Industry groups with: (1) S&P corporate
5 credit ratings of UBBB-" or UBBB," (2) a Value Line Safety
6 Rank of U2" or U3", and (3) a Value Line Financial Strength
7 Rating of UB+" to "B++". 51 I refer to this group as the
8 UUtility Proxy Group."
9 Q. Wht other proxy group did you consider in
10 evaluating a fair ROE for Avista?
11 A. Under the regulatory standards established by
12 Hope and Bluefield, the salient criteria in establishing a
13 meaningful benchmark to evaluate a fair rate of return is
14 relative risk, not the particular business activity or
15 degree of regulation.As noted in Regulatory Finance:
16 Utilities' Cost of Capital, uIt should be emphasized that
17 the definition of a comparable risk class of companies does
18 not entail similarity of operation, product lines, or
19 environmen tal condi tions ,but rather similarity of
20 experienced business risk and financial risk. "55 Utilities
21 must compete for capital, not just against firms in their
22 own industry, but with other investment opportunities of
54 In addition, I excluded two firms that otherwise would have been in
the proxy group, but are not appropriate for inclusion because Value
Line indicated the potential that common dividends may be cut
(Hawaiian Electric Industries, Inc.), and another (Allegheny Energy,
Inc.) that is in the process of being acquired.55 Morin, Roger A., -Regulatory Finance: utilities' Cost of Capital,"
Public Utilities Reports, Inc. at 58 (1994).
Avera, Di 38
Avista Corporation
1 comparable risk.with regulation taking the place of
2 competitive market forces, required returns for utilities
3 should be in line with those of non-utility firms of
4 comparable risk operating under the constraints of free
5 competi tion.Consistent with this accepted regulatory
6 standard, I also applied the DCF model to a reference group
7 of comparable risk companies in the non-utility sectors of
8 the economy.I refer to this group as the "Non-Utility
9 Proxy Group".
10
11
12
13
Q.
Utility
A.
What criteria did you apply to develop the HOn-
Proxy Group?
My comparable risk proxy group was composed of
those U.S. companies followed by Value Line that:(1) pay
14 common dividends; (2) have a Safety Rank of U1"; (3) have
15 investment grade credit ratings from S&P, and (4) have a
16 Value Line Financial Strength Rating of UB++" or higher.
17 Q.How do the overall risks of your proxy groups
18 comare with Avista?
19 A.As shown below, 'Table WEA-2 compares the non-
20 utility proxy group with the utility proxy group and Avista
21 across four key indicators of investment risk:
Avera, Di 39
Avista Corporation
1
2
TABLE WE-2
COMARISON OJ! RISK INDICATORS
S6iP Value Line
Credit Safety Finacial
Rating BB Stren I&
Non-Utility Group A 1 A+0.79
Utility Proxy Group BBB 3 B+0.73
Avista Corp.BBB-3 B+0.80
3 Considered together, a comparison of these objective
4 measures indicates that Avista' s investment risks exceed
5 those of the two proxy groups.As a result, the cost of
6 equity estimates indicated by my analyses provide a
7 conservative estimate of investors' required rate of return
8 for Avista.
9 Q.Wht cost of eqity is imlied by your DCI'
10 results for the utility proxy group?
11 A.My application of the OCF model, which is
12 discussed in greater detail in Schedule 2, considered four
13 alternative measures of expected earnings growth, as well
14 as the sustainable growth rate based on the relationship
15 between expected retained earnings and earned rates of
16 return (Ubr + sv") and Value Line's proj ected growth in
17 stock price. As shown on Schedule 4 and sumarized below
18 in Table WE-3, after eliminating illogical low- and high-
19 end values, application of the constant growth OCF model
20 resulted in the following cost of equity estimates:
Avera, Di 40
Avista Corporation
1
2
TABLl WB-3
DCI' RBSULS - tr:iL:iTY PROXY GROU
Growth Rate
Value Line
IBES
First Call
Zacksbr+svStock Price
Average Cost of Eqity
11. 5%
11.1%
11. 1%
irf: 6%
10.4%
11.2%
3 Q.Wht were the results of your DCF analysis for
4 the Non-utility Proxy Group?
5 A.As shown on Schedule 6, I applied the DCF model
6 to the non-utility companies in exactly the same manner
As7described earlier for the Utility Proxy Group.
after eliminating8sumarized below in Table WEA-4,
9 illogical low- and high-end values, application of the
10 constant growth OCF model resulted in the following cost of
11 equity estimates:
12 TABLl WB-413 DC RBstTS - NO-tr:iL:iTY GROU
Growth Rate
Value Line
IBES
First Call
Zacksbr+svStock Price
Average Cost of Eqity
11.9%
12.6%
12.8%
12.7%
12.2%
13.7%
14 Q.How did you apply the CAM to estimate the cost
15 of equity?
16 A.Like the DCF model, the CAPM is an ex-ante, or
17 forward-looking model based on expectations of the future.
18 As a result, in order to produce a meaningful estimate of
Avera, Di 41
Avista Corporation
1 investors' required rate of return, the CAPM is best
2 applied using estimates that reflect the expectations of
3 actual investors in the market, not with backward-looking,
4 historical data.Accordingly, I applied the CAPM to the
5 utility proxy group based on a forward-looking estimate for
6 investors' required rate of return from common stocks.
7 Because this forward-looking application of the CAPM looks
8 directly at investors' expectations in the capital markets,
9 it provides a more meaningful guide to the expected rate of
10 return required to implement the CAPM.
11 Q.What cost of equi ty was indicated by the CA
12 approach?
13 A.As shown on Schedule 8, my forward-looking
14 application of the CAPM model indicated an ROE of 9.5
15 percent for the utility proxy group.Applying the CAPM
16 approach to the firms in the non-utility proxy group
17 (Schedule 9) implied a cost of equity of 9. g' percent. As
18 discussed in Schedule 2, however, applying the CAPM is
19 complicated by the impact of the recent capital market
20 turmoil and recession on investors' risk perceptions and
21 required returns, which may cause CAPM cost of common
22 equity estimates to understate investors' required returns
23 for common stocks.
24 This is because relationships between risk-free
25 Treasury bonds and the required returns on common stock
Avera, Di 42
Avista Corporation
1 have been distorted by heightened uncertainties.In
2 addition, beta values, which are estimated based on
3 historical stock prices, have been impacted by the
4 unprecedented market volatility experienced since the third
5 quarter of 2008.These distortions not only impact the
6 absolute level of the CAPM cost of equity estimate, but
7 they affect estimated risk premiums. As the Staff of the
8 Florida Public Service Commission recently concluded:
9 (R) ecognizing the impact the Federal Government's10 unprecedented intervention in the capital markets11 has had on the yields on long-term Treasury12 bonds, staff believes models that relate the13 investor-required return on equity to the yield
14 on government securi ties, such as the CAPM15 approach, produce less reliable estimates of the16 ROE at this time. 56
17 As a result, there is every indication that CAPM approaches
18 fail to fully reflect the risk perceptions of real-world
19 investors in today's capital markets, which would violate
20 the standards underlying a fair rate of return by failing
21 to provide an opportunity to earn a return commensurate
22 wi th other investments of comparable risk.
23 Q.What other anlyses did you conduct to estimate
24 the cost of equity?
25 A.As I noted earlier, I also evaluated the cost of
26 equity using the comparable earnings approach.Reference
56 Staff Recommendation for Docket No. OB0677-El - Petition for
increase in rates by Florida Power & Light
Company, at p. 280 (Dec. 23, 2009).
Avera, Di 43
Avista Corporation
1 to rates of return available from alternative investments
2 of comparable risk can provide an important benchmrk in
3 assessing the return necessary to assure confidence in the
4 financial integrity of a firm and its ability to attract
5 capital.This comparable earnings approach is consistent
6 with the economic underpinnings for a fair rate of return
7 established by the U.S. Supreme Court. Moreover, it avoids
8 the complexities and limitations of capital market methods
9 and instead focuses on the returns earned on book equity,
10 which are readily available to investors.
11 Q.Wht rates of return on equity are indicated for
12 utilities based on the comarable earnings approach?
13 A.Value Line reports that its analysts anticipate
14 an average rate of return on common equity for the electric
15 utility industry of 11.0 percent in 2010 and 11.5 percent
16 over its 2012-2014 forecast horizon.~The capital
17 structure corresponding with this expected return reflects
18 an equity ratio of 49 percent.Meanwhile, for the gas
19 utility industry Value Line expects returns on common
20 equity of 10.5 percent in 2010 and 11.0 percent for the
21 period 2012-2014.58 As shown on Schedule 10, Value Line's
22 proj ections for the utility proxy group suggested an
57 The Value Line Investment Survey at 2231 (Feb. 5, 2010).
58 The Value Line Investment Survey at 444 (Dec. 11, 2009).
Avera, Di 44
Avista Corporation
1 average ROE of 10.7 percent after eliminating potential
2 outliers.
3 Q.What did you conclude with respect to the cost of
4 equity implied by your anlyses for the proxy groups?
5 A.The cost of equity estimates implied by my
6 quantitative analyses are sumarized in Table WEA-5, below:
7 '1ABLE WB-S8 SUY 01' Qt1AmI'1A'1IVB RESUL'1S
DCI'
Value Line
IBES
First Call
Zacks
br+sv
Stock Price
utility
11. 5%
11.1%
11.1%
10.6%
10.4%
11.2%
CA 9.5%
Exected Earnings
2010
2012-14
Utility Proxy Group
Electric
11.0%
11.5%
910
Non-utility
11.9%
l2.6%
12.8%
12.7%
12.2%
13.7%
9.8%
øu
10.5%
11.0%
10.7%
As noted earlier, because the capital market crisis
11 and ensuing recovery have created a numer of problems in
12 applying the CAPM, I largely disregarded the resulting cost
13 of equity estimates.Based on my assessment of the
14 relative strengths and weaknesses inherent in each method,
15 and conservatively giving less emphasis to the upper- and
16 lower-most boundaries of the range of results, I concluded
Avera, Di 45
Avista Corporation
1 that the cost of common equity indicated by my analyses is
2 in the 10.9 percent to 12.5 percent range.
3
4 Q.
C. Flotation Costs
Wht other considerations are relevant in setting
5 the return on equity for a utility?
6 A.The common equity used to finance the investment
7 in utility assets is provided from either the sale of stock
8 in the capital markets or from retained earnings not paid
9 out as dividends. When equity is raised through the sale
10 of common stock, there are costs associated with Ufloating"
11 the new equity securities.These flotation costs include
12 services such as legal, accounting, and printing, as well
13 as the fees and discounts paid to compensate brokers for
14 selling the stock to the public. Also, some argue that the
15 "market pressure" from the additional supply of common
16 stock and other market factors may further reduce the
17 amount of funds a utility nets when it issues common
18 equity.
19 Q.IS there an established mechaism for a utility
20 to recogize equity issuance costs?
21 A.No.While debt flotation costs are recorded on
22 the books of the utility, amortized over the life of the
23 issue, and thus increase the effective cost of debt
24 capital, there is no similar accounting treatment to ensure
25 that equity flotation costs are recorded and ultimately
Avera, Di 46
Avista Corporation
1 recognized.No rate of return is authorized on flotation
2 costs necessarily incurred to obtain a portion of the
3 equity capital used to finance plant.In other words,
4 equity flotation costs are not included in a utility's rate
5 base because nei ther that portion of the gross proceeds
6 from the sale of common stock used to pay flotation costs
7 is available to invest in plant and equipment, nor are
8 flotation costs capitalized as an intangible asset. Unless
9 some provision is made to recognize these issuance costs, a
10 utility's revenue requirements will not fully reflect all
11 of the costs incurred for the use of investors' funds.
12 Because there is no accounting convention to accumulate the
13 flotation costs associated with equity issues, they must be
14 accounted for indirectly, with an upward adjustment to the
15 cost of equity being the most logical mechanism.
16 Q.What is the magnitude of the adjustment to the
17 ubare bones" cost of equity to account for issuance costs?
18 A.There are any numer of ways in which a flotation
19 cost adjustment can be calculated, and the adjustment can
20 range from just a few basis points to more than a full
21 percent.One of the most common methods used to account
22 for flotation costs in regulatory proceedings is to apply
23 an average flotation-cost percentage to a utility's
24 dividend yield.Based on a review of the finance
Avera, Di 47
Avista Corporation
1 literature, Regulatory Finance: Utilities' Cost of Capital
2 concluded:
3
4
5
6
The flotation cost allowance requires an
estimated adjustment to the return on equity of
approximately 5% to 10%, depending on the size
and risk of the issue. 59
7 Alternatively,a study of data from Morgan Stanley
8 regarding issuance costs associated with utility common
9 stock issuances sugges ts an average flotation cost
10 percentage of 3.6%.w
11 Issuance costs are a legitimate consideration in
12 setting the return on equity for a utility, and applying
13 these expense percentages to a representative dividend
14 yield of 4.5 percent implies a flotation cost adjustment on
15 the order of 16 to 45 basis points.
16 Q.Has the IPUC Staff previously considered
1 7 flotation costs in estimating a fair ROE?
18 A.Yes.For example, in Case No. IPC-E-07-8, IPUC
19 Staff witness Terri Carlock noted that she had adjusted her
20 DCF analysis to incorporate an allowance for flotation
21 costs.61
59 Roger A. Morin, Regulatory Finance: Utilities' Cost of Capital, 1994,
at 166.60 Application of Yankee Gas Services Company for a Rate Increase, DPUC
Docket No. 04-06-01, Direct Testimony of George J. Eckenroth (JUl. 2,
2004) at Exhibit GJE-11.1. Updating the results presented by Mr.
Eckenroth through April 2005 also resulted in an average flotation
cost percentage of 3.6%.61 Case No. IPC-E-07-8, Direct Testimony of Terri Carlock at 10 (Dec.
10, 2007).
Avera, Di 48
Avista Corporation
1 Q.Wht then is your conclusion regarding a fair ROE
2 based on yo analyses for the comanies in your proxy
3 groups?
4 A.After incorporating an adjustment for flotation
5 costs of 20 basis points to my ubare bones" cost of equity
6 range, I concluded that my analyses indicate a fair ROE in
7 the 11.1 percent to 12.7 percent range.
8
9
10
11
iv. RE ON EQUITY FOR AVISTA CORP.
Q.
A.
Wht is the purpose of this section?
In addition to presenting the conclusions of my
12 evaluation of a fair rate of return on equity range for
13 Avista, this section also discusses the relationship
14 between ROE and preservation of a utility's financial
15 integrity and the ability to attract capital under
16 reasonable terms on a sustainable basis.
17
18 Q.
A. ImPlications for Financial Integrity
Wh is it important to allow Avista an adequate
19 return on equity?
20 A.Given the importance of the utility industry to
21 the economy and society, it is essential to maintain
22 reliable and economical service to all consumers.'While
23 Avista remains committed to provide reliable utility
24 service, a utility's ability to fulfill its mandate can be
25 compromised if it lacks the necessary financial wherewithal
26 or is unable to earn a return sufficient to attract
Avera, Di 49
Avista Corporation
1 capital.Coupled with the ongoing potential for energy
2 market volatility, Avista's exposure to variations in
3 hydroelectric generation and natural gas price volatility,
4 along with plans for significant infrastructure investment,
5 pose a numer of potential challenges that might require
6 the relatively swift commitment of significant capital
7 resources in order to maintain the high level of service
8 that customers have come to expect.Investors' increased
9 reticence to supply additional capital during times of
10 crisis highlights the necessity of preserving the
11 flexibility necessary during a period of uncertain economic
12 and financial market conditions.These considerations
13 heighten the importance of allowing Avista an adequate
14 return on the fair value of its investment.
15 Q.Wht role does regulation play in ensuring that
16 Avista has access to capital under reasonable term an on
17 a sustainable basis?
18 A.As documented earlier, the major rating agencies
19 have warned of exposure to uncertainties associated with
20 political and regulatory developments. Investors recognize
21 that constructive regulation is a key ingredient in
22 supporting utility credit ratings and financial integrity,
23 particularly during times of adverse conditions.
24 with respect to Avista specifically, the major bond
25 rating agencies have explicitly cited the potential that
Avera, Di 50
Avista Corporation
1 adverse regulatory rul ingscould compromise the Company's
2 credit standing. Of particular concern to investors is the
3 impact of regulatory lag and cost-recovery on Avista' s
4 ability to earn its authorized ROE and maintain its
5 financial metrics, with Moody's concluding that:
6 Failure to obtain adequate and timely support for7 recovery of and return on core utility
8 investments through pending and expected future
9 regulatory proceedings could have negative10 ratings implications.
11 S&P observed that rate relief will remain critical to
12 Avista' s credit outlook,
63 and concluded that, "regulatory
13 lag will continue to be a drag on the company's ability to
14 earn its authorized ROE. "64
15 For Avista, these concerns are magnified by the fact
16 that its credit standing is poised on the precipice between
17 investment and speculative grade ratings.While the
18 Company's efforts to regain an investment grade credit
19 rating have been successful, Avista' s financial metrics
20 remain pressured. As Mr. Thies confirms in his testimony,
21 regulatory support will be a key drîver in securing
22 additional improvement in the Company's financial health.
23 Further strengthening Avista' s financial integrity is
62 Moody's Investors Service i -Credit Opinion: Avista Corp. i" Global
Credit Research (Dec. 3, 2008).63 Standard & Poor's Corporation, -u.s. Electric Utility Credit Quality
Remains Strong Amid Continuing Economic Downturn," RatingsDirect (Dec.
19, 2008).64 Standard & Poor's Corporation, - Avista Corp.' s Corporate Credit
Rating Raised One Notch To 'BBB-'," RatingsDirect (Feb. 7, 2008).
Avera, Di 51
Avista Corporation
1 imperative to ensure that the Company has the capability to
2 maintain an investment grade rating while confronting
3 potential challenges.
4 Q.Do customrs benefit by eDhcing the utility's
5 financial flexibility?
6 A.Yes.While providing an ROE that is sufficient
7 to maintain Avista's ability to attract capital, even in
8 times of financial and market stress, is consistent with
9 the economic requirements embodied in the U. S. Supreme
10 Court's Hope and Bluefield decisions, it is also in
11 customers' best interests. ultimately, it is customers and
12 the service area economy that enjoy the benefits that come
13 from ensuring that the utility has the financial
14 wherewi thal to take whatever actions are required to ensure
15 reliable service. By the same token, customers also bear a
16 significant burden when the ability of the utility to
17 attract necessary capital is impaired and service quality
18 is compromised. As Moody's recently concluded:
19
20
21
22
23
24
25
26
27
Inadequate attention to these challenges could
conceivably push much of this sector into the
non-investment grade category. For now, we think
this unlikely, since most utility companies,
regulators and, politicians would prefer to see
the industry remain financially healthy andinvestment-grade-especially because increasingly
expensive and uncertain financing would have
adverse consequences for customers. The recent
Avera, Di 52
Avista Corporation
1
2
3
4
financial turmoil has underscored the benefits of
strong credit ratings. 65
Q.
B. Return on Equity Recomndtion
What then is your conclusion as to a fair rate of
5 return on equity range for Avista?
6 A.As explained above, based on the capital market
7 oriented analyses for the utility and non-utility proxy
8 groups described in my testimony, I concluded that the
9 Ubare bones" cost of equity range was 10.9 percent to 12.5
10 percent,or 11. 1 percent to 12.7 percent after
11 incorporating an allowance for flotation costs.
12 Considering capital market expectations, the potential
13 exposures faced by Avista, and the economic requirements
14 necessary to maintain financial integrity and support
15 additional capital investment even under adverse
16 circumstances, it is my opinion that this represents a fair
17 and reasonable ROE range for Avista.
18 Q.Based on the results of your evaluation, what is
19 your opinion regarding the reasonableness of the ROE
20 requested by Avista in this case?
21 A.My evaluation indicates that Avista' s requested
22 ROE of 10.9 percent represents a conservative estimate of
23 investors' required rate of return.Gi ven the fact that
24 the Company's requested ROE falls at the lower bound of
65 Moody's Investors Service, -Electric Utilities Face Challenges
Beyond Near-Term," Industry Outlook (Jan. 2010).
Avera, Di 53
Avista Corporation
1 ubare bones" cost of equity range, it should be viewed as
2 an absolute floor in establishing rates for Avista.This
3 conclusion is reinforced by the need to buttress the
4 Company's credit standing, which remains relatively weak,
5 as well as the pressures of funding significant capital
6 expendi tures and meeting increased operating risks,
7 including those associated with Avista's reliance on
8 hydroelectric generation and exposure to volatility in
9 natural gas and wholesale power markets.The
10 reasonableness of a minimum 10.9 percent ROE for Avista is
11 also supported by the Company's relatively greater risks as
12 compared with the proxy groups, the higher uncertainties
13 associated with Avista' s relatively small size, and the
14 need to consider the implications of regulatory lag.
15 Q.Does this conclude your pre-filed direct
16 testimony?
17 A.Yes.
Avera, Di 54
Avista Corporation
DAVID J. MEYER
VICE PRESIDENT AND CHIEF COUNSEL OF
REGULATORY & GOVERNMENTAL AFFAIRS
AVISTA CORPORATION
P.O. BOX 3727
1411 EAST MISSION AVENUE
SPOKANE, WASHINGTON 99220-3727
TELEPHONE: [phone]
FACSIMILE: [phone]
DAVID .MEYER~AVISTACORP . COM
BEFORE THE IDAHO PUBLIC UTILITIES COMMISSION
IN THE MATTER OF THE APPLICATION
OF AVISTA CORPORATION FOR THE
AUTHORITY TO INCREASE ITS RATES
AND CHARGES FOR ELECTRIC AND
NATURAL GAS SERVICE TO ELECTRIC
AND NATURAL GAS CUSTOMERS IN THE
STATE OF IDAHO
CASE NO. AVU-E-10-01
CASE NO. AVU-G-10-01
EXHIBIT NO. 3
WILLIAM E. AVERA
FOR AVISTA CORPORATION
(ELECTRIC AND NATURAL GAS)
EXIBIT 3, SCHEDUL 1
QUALIFICATIONS OF WILLIAM E. AVE
Q. Please describe your qualifications and exprience.
A. I received a B.A. degree with a major in economics from
Emory University. After serving in the U.S. Navy, I entered the
doctoral program in economics at the University of North Carolina
at Chapel Hill. Upon receiving my Ph.D., I joined the faculty at
the University of North Carolina and taught finance in the Graduate
School of Business.I subsequently accepted a position at the
University of Texas at Austin where I taught courses in financial
management and investment analysis.I then went to work for
International Paper Company in New York City as Manager of
Financial Education, a position in which I had responsibility for
all corporate education programs in finance, accounting, and
economics.
In 1977, I joined the staff of the Public Utility Commission
of Texas ("PUCT") as Director of the Economic Research Division.
During my tenure at the PUCT, I managed a division responsible for
financial analysis, cost allocation and rate design, economic and
financial research, and data processing systems, and I testified in
cases on a variety of financial and economic issues. Since leaving
the PUCT, I have been engaged as a consultant. I have participated
in a wide range of assignments involving utility-related matters on
Exhibi t No. 3
Case Nos. AVU-E-10-01 & AVU-G-10-01
W. Avera, Avista
Schedule 1, p. 1 of 10
behalf of utilities, industrial customers, municipalities, and
regulatory commissions.I have previously testified before the
Federal Energy Regulatory Commission ("FERC"), as well as the
Federal Communications Commission, the Surface Transportation Board
(and its predecessor, the Interstate Commerce Commission), the
Canadian Radio-Television and Telecommunications Commission, and
regulatory agencies, courts, and legislative committees in over 40
states, including the Public Service Commission of Maryland ("MPSC"
or "the Commission") .
In 1995, I was appointed by the PUCT to the Synchronous
Interconnection Committee to advise the Texas legislature on the
costs and benefits of connecting Texas to the national electric
transmission grid. In addition, I served as an outside director of
Georgia System Operations Corporation, the system operator for
electric cooperatives in Georgia.
I have served as Lecturer in the Finance Department at the
University of Texas at Austin and taught in the evening graduate
program at St. Edward's University for twenty years. In addition,
I have lectured on economic and regulatory topics in programs
sponsored by universities and industry groups. I have taught in
hundreds of educational programs for financial analysts in programs
sponsored by the Association for Investment Management and
Research, the Financial Analysts Review, and local financial
analysts societies. These programs have been presented in Asia,
Exhibit No. 3
Case Nos. AVU-E-10-0l & AVU-G-10-Ol
W. Avera, Avista
Schedule 1, p. 2 of 10
Europe, and North America, including the Financial Analysts Seminar
at Northwestern University. I hold the Chartered Financial Analyst
(CFA~) designation and have served as Vice President for Membership
of the Financial Management Association. I have also served on the
Board of Directors of the North Carolina Society of Financial
Analysts. I was elected Vice Chairman of the National Association
of Regulatory Commissioners (~NARUC") Subcommittee on Economics and
appointed to NARUC's Technical Subcommittee on the National Energy
Act.I have also served as an officer of various other
professional organizations and societies. A resume containing the
details of my experience and qualifications is attached.
Exhibi t No. 3
Case Nos. AVU-E-10-01 & AVU-G-10-01
W. Avera, Avista
Schedule 1, p. 3 of 10
FlNCAP, INC.
Financial Concepts and Applications
Economic and Financial Counsel
WilLIAM E. AVERA
3907 Red River
Austi, Texas 78751
(512) 458-64
FAX [phone]
ficap~texas.net
Summary of Qualifications
Ph.D. in economics and finance; Charered Financial Analyst (CFA ~ designtion; extensive
expert witness testimony before cours, alternative dispute resolution panels, regulatory agencies
and legislative committees; lectued in exective education progr around the world on ethics,
investment analysis, and regulation; undergraduate and graduate teaching in business and
economics; appointed to leadership positions in governent, industr, academia, and the
miltary.
Employment
Principal,
FlNCAP, Inc.
(Sep. 1979 to present)
Director, Economic Research
Division,
Public Utility Commission of Texas
(Dec. 1977 to Aug. 1979)
Manager, Financial Education,
International Paper Company
New York City
(Feb. 1977 to Nov. 1977)
Financial, economic and policy consulting to business
and governent. Pedorm business and public policy
research, cost/enefit analyses and finacial modeling,
valuation of businesses (almost 200 entities valued),
estimation of daages, statistical and industr studies.
Provide strategy advice and educational serces in public
and private sectors, and serve as expert witness before
regulatory agencies, legislative committees, arbitration
panels, and cours.
Responsible for research and testiony preparation on
rate of retu, rate strctue, and econometrc analysis
dealing with energy, telecommunications, water and
sewer utilities. Testified in major rate cases and appear
before legislative committees and served as Chief
Economist for agency. Administered state and federal
grant fuds. Communicated frequently with political
leaders and representatives from consumer groups,
media, and investment communty.
Directed corporate education program in accounting,
finance, and economics. Developed course materials,
recruited and trained intrctors, liaison within the
company and with academic institutions. Prepared
operatig budget and designed fmancial controls for
corporate professional development program.
Exhibi t No. 3
Case Nos. AVU-E-IO-Ol & AVU-G-IO-Ol
W. Avera, Avista
Schedule 1, p. 4 of 10
Lecturer in Finance,
The University of Texas at Austin
(Sep. 1979 to May 1981)
Assistant Professor of Finance,
(Sep. 1975 to May 1977)
Assistant Professor of Business,
University of Nort Carolina at
Chapel Hil
(Sep. 1972 to JuI. 1975)
Education
Ph.D., Economics and Finance,
University of Nort Carolina at
Chapel Hil
(Jan. 1969 to Aug. 1972)
B.A., Economics,
Emory University, Atlanta, Georgia
(Sep. 1961 to Jun. 1965)
Taught graduate and undergraduate coures in financial
management and investment theory. Conducte reseach
in business and public policy. Named Outstading
Gruate Business Professor and received varous
administrative appointments.
Taught in BBA, MBA, and Ph.D. progrs. Created
project course in finance, Finncial Management for
Women, and paricipated in developing Small Business
Management sequence. Organized the Nort Carolina
Institute for Investment Research, a group of fiancial
institutions that supported academic research. Faculty
advisor to the Media Board, which fuds student
publications and broadcast stations.
Elective courses included financial management, public
finance, moneta theory, and econometrcs. Awarded
the Stonier Fellowship by the American Baners'
Association and University Teachig Fellowship. Taught
statistics, macroeconomics, and microeconomics.
Disserttion: The Geometric Mean Strategy as a
Theory of Multiperiod Portfolio Choice
Active in extrcurcular activities, president of the
Barkley Foru (debate team), Emory Religious
Association, and Delta Tau Delta chapter. Individual
awards and team championships at national collegiate
debate touraments.
Professional Associations
Received Charered Financial Analyst (CFA) designation in 1977; Vice President for
Membership, Financial Management Association; President, Austin Chapter of Plang
Executives Institute; Board of Directors, Nort Carolina Society of Financial Analysts;
Candidate Curculum Committee, Association for Investment Management and Research;
Executive Committee of Southern Finance Association; Vice Chair, Staff Subcommittee on
Economics and National Association of Regulatory Utility Commissioners (NARUC);
Appointed to NARUC Technical Subcommitte on the National Energy Act.
Exhibi t No. 3
Case Nos. AVU-E-10-01 & AVU-G-10-01
W. Avera, Avista
Schedule 1, p. 5 of 10
Teaching in Executive Education Programs
University-Sponsored Programs: Centr Michigan University, Due Univerity, Louisian State
University, National Defense University, National University of Singapore, Texas A&M
University, University of Kasas, University of Nort Carolina, University of Texas.
Business and Government-Sponsored Programs: Advanced Semina on Eargs Reguation,
American Public Welfare Association, Association for Investment Management and Research,
Congressional Fellows Program, Cost of Capital Workshop, Electrcity Consumer Resource
Council, Financial Analysts Association of Indonesia, Financial Analysts Review, Financial
Analysts Seminar at Northwestern University, Governor's Executive Development Progr of
Texas, Louisiana Association of Business and Industr, National Association of Puchasing
Management, National Association of Tire Dealers, Planning Executives Intitute, School of
Bang of the South, State of Wisconsin Investment Board, Stock Exchange of Thailand, Texas
Association of State Sponsored Computer Centers, Texas Baners' Association, Texas Bar
Association, Texas Savings and Loan League, Texas Society of CPAs, Tokyo Association of
Foreign Ban, Union Ban of Switzerland, U.S. Deparent of State, U.S. Navy, U.S. Vetera
Administration, in addition to Texas state agencies and major corporations.
Presented papers for Mils B. Lae Lectue Series at the University of Georgia and Heubner
Lectues at the University of Pennsylvania. Taught gruate courses in finance and economics
for evening program at St. Edward's University in Austin from Januar 1979 though 1998.
Expert Witness Testimony
Testified in over 300 cases before regulatory agencies addressing cost of capital, regulatory
policy, rate design, and other economic and finacial issues.
Federal Agencies: Federal Communications Commission, Federal Energy Regulatory
Commission, Surface Trasporttion Board, Interstate Commerce Commission, and the
Canadian Radio-Television and Telecommunications Commission.
State Regulatory Agencies: Alaska, Arzona, Arkansas, California, Colorado, Connecticut,
Delaware, Florida, Georgia, Hawaii, Idao, llinois, Indiana, Iowa, Kanas, Kentucky,
Marland, Michigan, Missour, Nevad, New Mexico, Montaa, Nebraska Nort Carolina,
Ohio, Oklahoma, Oregon, Pennsylvania, South Carolina, South Dakota, Texas, Uta,
Virgiia, Washington, West Virginia, Wisconsin, and Wyoming.
Testified in 42 cases before federal and state cour, arbitration panels, and alternative dispute
trbunals (89 depositions given) regarding daages, valuation, antitrt liabilty, fiduciar duties,
and other economic and financial issues.
Board Positions and Other Professional Activities
Audit Committee and Outside Director, Georgia System Oprations Corporation (electrc syte
operator for member-owned electrc cooperatives in Georgia); Chairan, Board of Prit Depot,
Inc. and FINCAP, Inc.; Co-chair, Synchronous Interconnection Committe, appointe by Public
Utilty Commission of Texas and approved by governor; Appointed by Hays County
Commission to Citizens Advisory Committee of Habitat Conservation Plan, Operator of AA
Exhibi t No. 3
Case Nos. AVU-E-10-01 & AVU-G-10-01
W. Avera, Avista
Schedule 1, p. 6 of 10
Rach, a certfied organic producer of agrcultual products; Appointed to Organic Livestock
Advisory Committee by Texas Agrcultul Commissioner Susan Combs; Appointed by Texas
Railroad Commissioners to study group for The UP/SP Merger: An Assessment of the Impacts on
the State of Texas; Appointed by Hawaii Public Utilities Commission to team reviewig affliate
relationships of Hawaiian Electrc Industres; Chairan, Energy Task Force, Greate Austi-San
Antonio Corrdor Council; Consultat to Public Utility Commission of Texas on cogeneration
policy and other matters; Consultat to Public Service Commission of New Mexico on
cogeneration policy; Evaluator of Energy Research Grt Proposals for Texas Higher Education
Coordinating Board.
Community Activities
Board of Directors, Sustainable Food Center; Chair, Board of Deaons, Finance Committ, and
Elder, Central Presbyterian Church of Austin; Founding Member, Orage-Chatham County
(N.C.) Legal Aid Screening Committee.
Miltary
Captain, U.S. Naval Reserve (retired after 28 yea service); Commding Offcer, Naval Special
Warfare Engineering (SEAL) Support Unit; Offcer-in-Charge of SWIT patrol boat in Vietn;
Enlisted service as weather analyst (advanced to second class pett officer).
Bibliography
Monographs
Ethics and the Investment Professional (video, workbook, and instrctor's guide) and Ethics
Challenge Today (video), Association for Investment Management and Reseach (1995)
"Definition of Industr Ethics and Development of a Code" and "Applying Ethics in the Real
World," in Good Ethics: The Essential Element of a Firm's Success, Association for
Investment Management and Research (1994)
"On the Use of Securty Analysts' Growt Projections in the DCF Model," with Bruce H.
Fairchild in Earnings Regulation Under Inflation, 1. R. Foster and S. R. Holmberg, eds.
Intitute for Study of Regulation (1982)
An Examination of the Concept of Using Relative Customer Class Risk to Set Target Rates of
Return in Electric Cost-of-Service Studies, with Bruce H. Fairchild, Electrcity Consumers
Resource Council (ELCON) (1981); portons reprited in Public Utilties Fortnightly (Nov.
11, 1982)
"Usefulness of Curent Values to Investors and Creditors," Research Study on Current-Value
Accounting Measurements and Utility, George M. Scott, ed., Touche Ross Foundation (1978)
"The Geometrc Mean Strategy and Common Stock Investment Management," with Henr A.
Lataé in Life Insurance Investment Policies, David Cummins, ed. (1977)
Investment Companies: Analysis of Current Operations and Future Prospects, with J. Finley
Lee and Glenn L. Wood, American College of Life Underwters (1975)
Exhibi t No. 3
Case Nos. AVU-E-10-01 & AVU-G-IO-Ol
W. Avera, Avista
Schedule 1, p. 7 of 10
Aricles
"Should Analysts Own the Stocks they Cover?" The Financial Journalist, (March 2002)
"Liquidity, Exchange Listing, and Common Stock Perormance," with John C. Groth and Ker
Cooper, Journal of Economics and Business (Sprig 1985); reprited by National Association
of Securty Dealers
"The Energy Crisis and the Homeowner: The Gref Process," Texas Business Review (Jan.-Feb.
1980); reprited in The Energy Picture: Problems and Prospects, 1. E. Pluta, ed., Bureau of
Business Research (1980)
"Use ofIFPS at the Public Utilty Commission of Texas," Proceedings of the IFPS Users Group
Annual Meeting (1979)
"Production Capacity Allocation: Conversion, CWI, and One-Ared Economics," Proceedings
of the NARUC Biennial Regulatory Information Conference (1978)
"Some Thoughts on the Rate of Retu to Public Utilty Companies," with Bruce H. Fairchild in
Proceedings of the NARUC Biennial Regulatory Information Conference (1978)
"A New Capital Budgeting Meaure: The Integration of Time, Liquidity, and Uncertty," with
David Cordell in Proceedings of the Southwestern Finance Association (1977)
"Usefulness of Curent Values to Investors and Creditors," in Inflation Accounting/Indexing and
Stock Behavior (1977)
"Consumer Expectations and the Economy," Texas Business Review (Nov. 1976)
"Portolio Performance Evaluation and Long-ru Capital Growth," with Henr A. Lataé in
Proceedings of the Eastern Finance Association (1973)
Book reviews in Journal of Finance and Financial Review. Abstrcts for CF A Digest. Arcles in
Carolina Financial Times.
Selected Papers and Presentations
"Economic Perspective on Water Marketing in Texas," 2009 Water Law Institute, The
University of Texas School of Law, Austin, TX (Dec. 2009).
"Estimating Utility Cost of Equity in Financial Turoil," SNL EXNT i 5th Anual FERC
Briefing, Washingtn, D.C. (Mar. 2009)
"The Who, What, When, How, and Why of Ethics," San Antonio Financial Analysts Society
(Jan. 16, 2002). Similar presentation given to the Austin Society of Financial Analysts (Jan.
17,2002)
"Ethics for Financial Anlysts," Sponsored by Canan Council ofrincial Anlysts: delivered
in Calgar, Edmonton, Regia, and Winpeg, June 1997. Similar presentations given to
Austin Society of Financial Analysts (Mar. 1994), San Antonio Society of Finacial Anlysts
(Nov. 1985), and St. Louis Society of Financial Analysts (Feb. 1986)
"Cost of Capital for Multi-Divisional Corporations," Financial Management Association, New
Orleans, Louisian (Oct. 1996)
"Ethics and the Treasur Function," Governent Treasurers Organization of Texas, Corpus
Chrsti, Texas (Jun. 1996)
Exhibi t No. 3
Case Nos. AVU-E-10-01 & AVU-G-10-01
W. Avera, Avista
Schedule 1, p. 8 of 10
"A Cooperative Futue," Iowa Association of Electrc Cooperatives, Des Moines (December
1995). Similar presentations given to National G & T Conference, Iring, Texas (June 1995),
Kentucky Association of Electrc Cooperatives Anua Meeting, Louisvile (Nov. 1994),
Virginia, Marland, and Delaware Association of Electrc Cooperatives Anual Meetig,
Richmond (July 1994), and Carolina Electrc Cooperatives Anual Meeting, Raleigh (Mar.
1994)
"Information Superhighway Warings: Speed Bumps on Wall Street and Detours from the
Economy," Texas Society of Certfied Public Accountats Natul Gas, Telecommunications
and Electrc Industres Conference, Austin (Apr. 1995)
"EconomicfWall Street Outlook," Carolinas Council of the Institute of Management
Accountats, Myrle Beach, South Carolina (May 1994). Similar presentation given to Bell
Operating Company Accounting Witness Conference, Santa Fe, New Mexico (Apr. 1993)
"Regulatory Developments in Telecommunications," Regional Holding Company Financial and
Accounting Conference, San Antonio (Sep. 1993)
"Estimating the Cost of Capital Durg the 1 990s: Issues and Directions," The Nationa Society
of Rate of Retu Analysts, Washington, D.C. (May 1992)
"Making Utility Regulation Work at the Public Utility Commission of Texas," Center for Legal
and Regulatory Studies, University of Texas, Austin (June 1991)
"Can Regulation Compete for the Hear and Minds of Industral Customers," Emergig Issues
of Competition in the Electrc Utility Industr Conference, Austin (May 1988)
"The Role of Utilties in Fosterig New Energy Technologies," Emerging Energy Technologies
in Texas Conference, Austin (Mar. 1988)
"The Regulators' Perspeçtive," Bellcore Economic Analysis Conference, San Antonio (Nov.
1987)
"Public Utility Commissions and the Nuclear Plant Contrctor," Constrction Litigation
Superconference, Lagua Beach, Califomia (Dec. 1986)
"Development of Cogeneration Policies in Texas," University of Georgia Fift Anual Public
Utilties Conference, Atlanta (Sep. 1985)
"Wheeling for Power Sales," Energy Bureau Cogeneration Conference, Houston (Nov. 1985).
"Asymmetrc Discounting of Inormation and Relative Liquidity: Some Empirical Evidence for
Common Stocks" (with John Groth and Kerr Cooper), Southern Finance Association, New
Orleans (Nov. 1982)
"Used and Useful Planning Models," Planing Executive Institute, 27th Corporate Planing
Conference, Los Angeles (Nov. 1979) .
"Staff Input to Commission Rate of Retu Decisions," The National Society of Rate of Retu
Analysts, New York (Oct. 1979)
'''Discounted Cash Life: A New Measure of the Time Dimension in Capital Budgeting," with
David Cordell, Southern Finance Association, New Orleans (Nov. 1978)
"The Relative Value of Statistics of Ex Post Common Stock Distrbutions to Explain Varance,"
with Charles G. Marin, Southern Finance Association, Atlanta (Nov. 1977)
Exhibi t No. 3
Case Nos. AVU-E-10-01 & AVU-G-10-01
W. Avera, Avista
Schedule 1, p. 9 of 10
"An ANOV A Representation of Common Stock Retus as a Framework for the Allocation of
Portfolio Management Effort," with Charles G. Martin, Financial Management Association,
Montreal (Oct. 1976)
"A Growt-Optimal Portolio Selection Model with Finte Horizon," with Henr A. Latané,
American Finance Association, San Francisco (Dec. 1974)
"An Optimal Approach to the Finance Decision," with Hen A. Lataé, Southern Finance
Association, Atlanta (Nov. 1974)
"A Pragmatic Approach to the Capital Strctue Decision Based on Long-Run Growt," with
Henr A. Lataé, Financial Management Association, San Diego (Oct. 1974)
"Growth Rates, Expected Retu, and Varance in Portfolio Selection and Performance
Evaluation," with Henr A. Lataé, Econometrc Society, Oslo, Norway (Aug. 1973)
Exhibi t No. 3
Case Nos. AVU-E-10-01 & AVU-G-10-01
W. Avera, Avista
Schedule 1, p. 10 of 10
\
EXIBIT 3, SCHEDUL 2
DESCRIPTIONS OF QUANITATIVE ANYSES
1
2
What is the purpose of this schedule?
Schedule 2 presents capital market estimates of
Q.
A.
3 the cost of equity. First, I examine the concept of the
4 cost of equity, along with the risk-return tradeoff
5 principle fundamental to capital markets. Next, I
6 describe DCF, CAPM, and comparable earnings analyses
7 conducted to estimate the cost of equity for reference
8 groups of comparable risk firms.
9
A. Overview
What role does the rate of return on eoinQ.
10 equity play in a utility's rates?
11 The return on common equity is the cost ofA.
12 inducing and retaining investment in the utility's
13 This investment is necessaryphysical plant and assets.
14 to finance the asset base needed to provide utility
15 service. Investors will commit money to a particular
16 investment only if they expect it to produce a return
17 commensurate with those from other investments with
18 comparable risks. Moreover, the return on common equity
19 is integral in achieving the sound regulatory objectives
20 of rates that are sufficient to: 1) fairly compensate
Exhibi t No. 3
Case Nos. AVU-E-I0-0l & AVU-G-IO-01
W. Avera, Avista
Schedule 2, p. 1 of 39
1 capital investment in the utility, 2) enable the utility
2 to offer a return adequate to attract new capital on
3 reasonable terms, and 3) maintain the utility's financial
4 integrity. Meeting these objectives allows the utility to
5 fulfill its obligation to provide reliable service while
6 meeting the needs of customers through necessary system
7 expansion.
8
9
10
Q. What fundamntal economic principle underlies
any evaluåtion of investors' required return on equity?
A. The fundamental economic principle underlying
11 the cost of equity concept is the notion that investors
12 are risk averse. The required rate of return for a
13 particular asset at any point in time is a function of: 1)
14 the yield on risk-free assets, and 2) its relative risk,
15 wi th investors demanding correspondingly larger risk
16 premiums for assets bearing greater risk. Given this
17 risk-return tradeoff, the required rate of return (k) from
18 an asset (i) can be generally expressed as:
19 ki = Rf +RPi
20
21
22
where:Rf Risk-free rate of return, and
RPi = Risk premium required to holdriskier asset i.
23 Thus, the required rate of return for a particular asset
24 at any point in time is a function of: 1) the yield on
Exhibi t No. 3
Case Nos. AVU-E-IO-01 & AVU-G-IO-Ol
W. Avera, Avista
Schedule 2, p. 2 of 39
1 risk-free assets, and 2) its relative risk, with investors
2 demanding correspondingly larger risk premiums for assets
3 bearing greater risk.
4 Q.Is the cost of equity observable in the capital
5 markets?
6 A.No. Unlike debt capital, there is no
7 contractually guaranteed return on common equity capital
8 since shareholders are the residual owners of the utility.
9 Because it is unobservable, the cost of equity for a
10 particular utility must be estimated by analyzing
11 information about capital market conditions generally,
12 assessing the relative risks of the company specifically,
13 and employing various quantitative methods that focus on
14 investors' current required rates of return. These
15 various quantitative methods typically attempt to infer
16 investors' required rates of return from stock prices,
17 interest rates, or other capital market data.
B. COmparable Risk Proxy Groups
18 Q. How did you implemnt these quantitative methods
,19 to estimte the cost of common equity for Avista?
20 A.Application of the DCF model and other
21 quantitative methods to estimate the cost of equity
22 requires observable capital market data, such as stock
Exhibi t No. 3
Case Nos. AVU-E-10-Ol & AVU-G-10-Ol
W. Avera, Avista
Schedule 2, p. 3 of 39
1 prices. Moreover, even for a firm with publicly traded
2 stock, the cost of equity can only be estimated. As a
3 result, applying quantitative models using observable
4 market data only produces an estimate that inherently
5 includes some degree of observation error. Thus, the
6 accepted approach to increase confidence in the results is
7 to apply the DCF model and other quantitative methods to a
8 proxy group of publicly traded companies that investors
9 regard as risk comparable.
10 Q.What specific proxy group did you rely on for
11 your analysis?
12 A.In order to reflect the risks and prospects
13 associated with Avista's jurisdictional utility
14 operations, my DCF analyses focused on a reference group
15 of other utilities composed of those companies included by
16 The Value Line Investment Survey (~Value Line") in its
17 Electric Utilities Industry groups with: (1) S&Pcorporate
18 credit ratings of ~BBB-" or ~BBB," (2) a Value Line Safety
19 Rank of ~2" or ~3", and (3) a Value Line Financial
20 Strength Rating of ~B+" to ~B++". In addition, I excluded
21 two firms that otherwise would have been in the proxy
22 group, but are not appropriate for inclusion because Value
23 Line indicated the potential that common dividends may be
Exhibi t No. 3
Case Nos. AVU-E-10-Ol & AVU-G-10-Ol
W. Avera, Avista
Schedule 2, p. 4 of 39
1 cut (Hawaiian Electric Industries, Inc.), and another
2 (Allegheny Energy, Inc.) that is in the process of being
3 acquired. I refer to this group as the ~Utili ty Proxy
4 Group."
5 Q.What other proxy group did you consider in
6 evaluating a fair ROE for Avista?
7 A.Under the regulatory standards established by
8 Hope and Bluefield, the salient criteria in establishing a
9 meaningful benchmark to evaluate a fair rate of return is
10 relative risk, not the particular business activity or
11 degree of regulation. As noted in Regulatory Finance:
12 Utili ties' Cost of Capi tal, ~It should be emphasized that
13 the definition of a comparable risk class of companies
14 does not entail similarity of operation, product lines, or
15 environmental conditions, but rather similarity of
16 experienced business risk and financial risk. ,,1 Utilities
17 must compete for capital, not just against firms in their
18 own industry, but with other investment opportunities of
19 comparable risk. With regulation taking the place of
20 competitive market forces, required returns for utilities
21 should be in line with those of non-utility firms of
22 comparable risk operating under the constraints of free
1 Morin, Roger A., "Regulatory Finance: Utilities' Cost of Capital,"
Public Utilities Reports, Inc. at 58 (1994).
Exhibi t No. 3
Case Nos. AVU-E-10-01 & AVU-G-10-01
W. Avera, Avista
Schedule 2, p. 5 of 39
1 competi tion. Consistent with this accepted regulatory
2 standard, I also applied the DCF model to a reference
3 group of comparable risk companies in the non-utility
4 sectors of the economy. I refer to this group as the
5 ~Non-Utili ty Proxy Group".
6 Q.What criteria did you apply to develop the Non-
7 utility Proxy Group?
8 A.My comparable risk proxy group was composed of
9 those U.S. companies followed by Value Line that: (1) pay
10 common dividends; (2) have a Safety Rank of ~1"; (3) have
11 investment grade credit ratings from S&P, and (4) have a
12 Value Line Financial Strength Rating of ~B++" or higher.
13 Q.How do the overall risks of your proxy groups
14 compare with Avista?
15 A.As shown below, Table 1 compares the Non-Utility
16 Proxy Group with the Utility Proxy Group and Avista across
17 four key indicators of investment risk:
Exhibi t No. 3
Case Nos. AVU-E-IO-Ol & AVU-G-IO-Ol
W. Avera, Avista
Schedule 2, p. 6 of 39
1
2
TABLE 1
COMARISON OF RISK INDICATORS
S&P Value Line
Credit Safety Financial
Rating Rank Strength Beta
Non-Utili ty Group A 1 A+0.79
Utili ty Proxy BBB 3 B++0.73
Group
Avista Corp.BBB-3 B+0.80
3 Q.Do these criteria provide objective evidence to
4 evaluate investors' risk perceptions?
5 A.Yes. Credit ratings are assigned by independent
6 rating agencies for the purpose of providing investors
7 with a broad assessment of the creditworthiness of a firm.
8 Because the rating agencies' evaluation includes virtually
9 all of the factors normally considered important in
10 assessing a firm's relative credit standing, corporate
11 credit ratings provide a broad, objective measure of
12 overall investment risk that is readily available to
13 investors. Widely cited in the investment community and
14 referenced by investors, credit ratings are also
15 frequently used as a primary risk indicator in
16 establishing proxy groups to estimate the cost of equity.
17 While credit ratings provide the most widely
18 referenced benchmark for investment risks, other quality
Exhibi t No. 3
Case Nos. AVU-E-IO-01 & AVU-G-IO-01
W. Avera, Avista
Schedule 2, p. 7 of 39
1 rankings published by investment advisory services also
2 provide relative assessments of risk that are considered
3 by investors in forming their expectations. Value Line's
4 primary risk indicator is its Safety Rank, which ranges
5 from ~1" (Safest) to ~5" (Riskiest). This overall risk
6 measure is intended to capture the total risk of a stock,
7 and incorporates elements of stock price stability and
8 financial strength. Given that Value Line is perhaps the
9 most widely available source of investment advisory
10 information, its Safety Rank provides a useful guide to
11 the likely risk perceptions of investors.
12 The Financial Strength Rating is designed as a guide
13 to overall financial strength and creditworthiness, with
14 the key inputs including financial leverage, business
15 volatility measures, and company size. Value Line's
16 Financial Strength Ratings range from ~A++" (strongest)
17 down to ~C" (weakest) in nine steps.
18 As discussed in my direct testimony, Avista is rated
19 ~BBB-" by S&P, with the average rating for the firms in
20 the Utility Proxy Group being slightly higher at ~BBB".
21 Avista's Value Line, Safety Rank and Financial Strength
22 Rating are the same as the averages for the Utility Proxy
23 Group, and while I did not reference beta as a selection
Exhibi t No. 3
Case Nos. AVU-E-10-0l & AVU-G-10-Ol
W. Avera, Avista
Schedule 2, p. 8 of 39
1 criteria in identifying the Utility Proxy Group, Avista's
2 beta of 0.80 is also higher than the average of 0.73 for
3 the Utility Proxy Group, suggesting somewhat greater risk.
4 Based on these criteria, which reflect objective,
5 published indicators that incorporate consideration of a
6 broad spectrum of risks, including financial and business
7 position and exposure to company specific factors,
8 investors are likely to regard the risks and prospects of
9 the Utility Proxy Group as being comparable to, albeit
10 somewhat lower than, those of Avista.
11 With respect to the Non-Utility Proxy Group, its
12 average credit ratings, Safety Rank, and Financial
13 Strength Rating suggest less risk than for Avista, with
14 its 0.79 average beta being essentially equal to the 0.80
15 value for the Company. While any differences in
16 investment risk attributable to regulation should already
17 be reflected in these objective measures, my analyses
18 nevertheless conservatively focus on a lower-risk group of
19 non-utility firms.
Exhibi t No. 3
Case Nos. AVU-E-10-Ol & AVU-G-10-Ol'I. Avera, Avista
Schedule 2, p. 9 of 39
1 Q.
C. Discounted Cash Flow Analyses
How are DCF models used to estimte the cost of
2 equity?
3 A.DCF models attempt to replicate the market
4 valuation process that sets the price investors are
5 willing to pay for a share of a company's stock. The
6 model rests on the assumption that investors evaluate the
7 risks and expected rates of return from all securities in
8 the capital markets. Given these expectations, the price
9 of each stock is adjusted by the market until investors
10 are adequately compensated for the risks they bear.
11 Therefore, we can look to the market to determine what
12 investors believe a share of common stock is worth. By
13 estimating the cash flows investors expect to receive from
14 the stock in the way of future dividends and capital
15 gains, we can calculate their required rate of return. In
16 other words, the cash flows that investors expect from a
17 stock are estimated, and given its current market price,
18 we can ~back-into" the discount rate, or cost of equity,
19 that investors implicitly used in bidding the stock to
20 that price.
Exhibi t No. 3
Case Nos. AVU-E-10-01 & AVU-G-10-01
W. Avera, Avista
Schedule 2, p. 10 of 39
1 Q.What market valuation process underlies DCF
2 models?
3 A.DCF models assume that the price of a share of
4 common stock is equal to the present value of the expected
5 cash flows (i.e., future dividends and stock price) that
6 will be received while holding the stock, discounted at
7 investors' required rate of return. That is, the cost of
8 equi ty is the discount rate that equates the current price
9 of a share of stock with the present value of all expected
10 cash flows from the stock.
11 Q.What form of the DCF model is customarily used
12 to estimte the cost of equity in rate cases?
13 A. Rather than developing annual estimates of cash
14 flows into perpetuity, the DCF model can be simplified to
15 a "constant growth" form: 2
2 The constant growth DCF model is dependent on a number of
assumptions, which in practice are never strictly met. These include
a constant growth rate for both dividends and earnings; a stable
dividend payout ratio; the discount rate exceeds the growth rate; a
constant growth rate for book value and price; a constant earned rate
of return on book value; no sales of stock at a price above or below
book value; a constant price-earnings ratio; a constant discount rate(i. e., no changes in risk or interest rate levels and a flat yield
curve); and all of the above extend to infinity.
Exhibi t No. 3
Case Nos. AVU-E-10-Ol & AVU-G-10-Ol
W. Avera, Avista
Schedule 2, p. 11 of 39
1 p. -~0- ke-g
2
3
4
5
6
7
where:Po = Current price per share;
Di = Expected dividend per share in the
coming year;
ke = Cost of equity;
g = Investors' long-term growth
expectations.
8 The cost of equity (Ke) can be isolated by rearranging
9 terms:
10 01k =-+ge p.
o
11 This constant growth form of the DCF model recognizes that
12 the rate of return to stockholders consists of two parts:
13 1) dividend yield (Di/Po), and 2) growth (g). In other
14 words, investors expect to receive a portion of their
15 total return in the form of current dividends and the
16 remainder through price appreciation.
17
18
Q.What steps are required to apply the DCF model?
The first step in implementing the constantA.
19 growth DCF model is to determine the expected dividend
20 yield (Di/Po) for the firm in question. This is usually
21 calculated based on an estimate of dividends to be paid in
22 the coming year divided by the current price of the stock.
23 The second, and more controversial, step is to estimate
24 investors' long-term growth expectations (g) for the firm.
Exhibi t No. 3
Case Nos. AVU-E-10-01 & AVU-G-10-01
W. Avera, Avista
Schedule 2, p. 12 of 39
1 The final step is to sum the firm's dividend yield and
2 estimated growth rate to arrive at an estimate of its cost
3 of equity.
4 Q.How was the dividend yield for the Utility Proxy
5 Group determned?
6 A.Estimates of dividends to be paid by each of
7 these utilities over the next twelve months, obtained from
8 Value Line, served as D1. This annual dividend was then
9 divided by the corresponding stock price for each utility
10 to arrive at the expected dividend yield. The expected
11 dividends, stock prices, and resulting dividend yields for
12 the firms in the Utility Proxy Group are presented on
13 Schedule 4.
14 Q.What is the next step in applying the constant
15 growth DCF model?
16 A.The next step is to evaluate long-term growth
17 expectations, or ~g", for the firm in question. In
18 constant growth DCF theory, earnings, dividends, book
19 value, and market price are all assumed to grow in
20 lockstep, and the growth horizon of the DCFmodel is
21 infinite. But implementation of the DCF model is more
22 than just a theoretical exercise; it is an attempt to
23 replicate the mechanism investors used to arrive at
Exhibi t No. 3
Case Nos. AVU-E-IO-Ol & AVU-G-10-01
W. Avera, Avista
Schedule 2, p. 13 of 39
1 observable stock prices. A wide variety of techniques can
2 be used to derive growth rates, but the only ~g" that
3 matters in applying the DCF model is the value that
4 investors expect.
5 Q.Are historical growth rates likely to be
6 representative o~nvestors' expctations for utilities?
7 A.No. If past trends in earnings, dividends, and
8 book value are to be representative of investors'
9 expectations for the future, then the historical
10 condi tions giving rise to these growth rates should be
11 expected to continue. That is clearly not the case for
12 utilities, where structural and industry changes have led
13 to declining dividends, earnings pressure, and, in many
14 cases, significant write-offs. While these conditions
15 serve to depress historical growth measures, they are not
16 representative of long-term expectations for the utility
17 industry. Moreover, to the extent historical trends for
18 utilities are meaningful, they are also captured in
19 projected growth rates, since securities analysts also
20 routinely examine and assess the impact and continued
21 relevance (if any) of historical trends.
Exhibi t No. 3
Case Nos. AVU-E-10-01 & AVU-G-10-01
W. Avera, Avista
Schedule 2, p. 14 of 39
1 Q.What are investors most likely to consider in
2 developing their long-term growth expctations?
3 A.While the DCF model is technically concerned
4 with growth in dividend cash flows, implementation of this
5 DCF model is solely concerned with replicating the
6 forward-looking evaluation of real-world investors. In
7 the case of electric utilities, dividend growth rates are
8 not likely to provide a meaningful guide to investors'
9 current growth expectations. This is because utilities
10 have significantly altered their dividend policies in
11 response to more accentuated business risks in the
12 industry, with the payout ratio for electric utilities
13 falling from approximately 80 percent historically to on
14 the order of 60 to 70 percent. 3 As a result of this trend
15 towards a more conservative payout ratio, dividend growth
16 in the utility industry has remained largely stagnant as
17 utilities conserve financial resources to provide ~ hedge
18 against heightened uncertainties.
19 As payout ratios for firms in the utility industry
20 trended downward, investors' focus has increasingly
21 shifted from dividends to earnings as a measure of long-
22 term growth. Future trends in earnings, which provide the
3 The Value Line Investment Survey (Sep. 15, 1995 at 161, Dec. 26, 2008
at 687).
Exhibi t No. 3
Case Nos. AVU-E-10-01 & AVU-G-10-01
W. Avera, Avista
Schedule 2, p. 15 of 39
1 source for future dividends and ultimately support share
2 prices, playa pivotal role in determining investors'
3 long-term growth expectations. The importance of earnings
4 in evaluating investors' expectations and requirements is
5 well accepted in the investment community. As noted in
6 Finding Reali ty in Reported Earnings published by the
7 Association for Investment Management and Research:
8 (E) arnings, presumably, are the basis for the
9 investment benefits that we all seek. ~Healthy10 earnings equal heal thy investment benefits"11 seems a logical equation, but earnings are also
12 a scorecard by which we compare companies, a
13 fil ter through which we assess management, and a14 crystal ball in which we try to foretell future
15 performance. 4
16 Value Line's near-term projections and its Timeliness
17 Rank, which is the principal investment rating assigned to
18 each individual stock, are also based primarily on various
19 quantitative analyses of earnings. As Value Line
20 explained:
21 The future earnings rank accounts for 65% in the22 determination of relative price change in the23 future; the other two variables (current24 earnings rank and current price rank) explain25 35%.5
4 Association for Investment Management and Research, ~Finding Reality
in Reported Earnings: An Overview", p. 1 (Dec. 4, 1996).
5 The Value Line Investment Survey, Subscriber's Guide, p. 53.
Exhibi t No. 3
Case Nos. AVU-E-10-01 & AVU-G-10-01
W. Avera, Avista
Schedule 2, p. 16 of 39
1 The fact that investment advisory services, such as Value
2 Line, Thompson, and Reuters, focus on growth in earnings
3 indicates that the investment community regards this as a
4 superior indicator of future long-term growth. Indeed, ~A
5 Study of Financial Analysts: Practice and Theory,"
6 published in the Financial Analysts Journal, reported the
7 resul ts of a survey conducted to determine what analytical
8 techniques investment analysts actually use. 6 Respondents
9 were asked to rank the relative importance of earnings,
10 dividends, cash flow, and book value in analyzing
11 securities. Of the 297 analysts that responded, only 3
12 ranked dividends first while 276 ranked it last. The
13 article concluded:
14 Earnings and cash flow are considered far more15 important than book value and dividends. 7
16 More recently, the Financial Analysts Journal
17 reported the, resul ts of a study of the relationship
18 between valuations based on alternative multiples and
19 actual market prices, which concluded, ~In all cases
6 Block, Stanley B., "A Study of Financial Analysts: Practice and
Theory", Financial Analysts Journal (July/August 1999).7 Id. at 88.
Exhibit No. 3
Case Nos. AVU-E-10-01 & AVU-G-10-01
W. Avera, Avista
Schedule 2, p. 17 of 39
1 studied, earnings dominated operating cash flows and
2 dividends. "8
3 Q.Do the growth rate projections of security
4 analysts consider historical trends?
5 A.Yes. Professional security analysts study
6 historical trends extensively in developing their
7 projections of future earnings. Hence, to the extent
8 there is any useful information in historical patterns,
9 that information is incorporated into analysts' growth
10 forecasts.
11 Q. What are security analysts currently projecting
12 in the way of growth for the firm in the Utility Proxy
13 Group?
14 A.The Value Line earnings growth proj ections for
15 each of the firms in the Utility Proxy Group are displayed
16 on Schedule 4. Also presented are the earnings per share
1 7 (~EPS") growth projections reported by Thomson Reuters
18 IBES (~IBES"), Thomson First Call Estimates (~First
19 Call"), and Zacks Investment Research (~Zacks"). 9
8 Liu, Jing, Nissim, Doron, & Thomas, Jacob, ~Is Cash Flow King in
Valuations?," Financial Analysts Journal, Vol. 63, No.2 (March/April
2007) at 56.
9 Thomson Reuters separately compiles and publishes consensus
securities analyst growth rates under the IBES (formerly Institutional
Brokers Estimate System) and First Call brands.
Exhibi t No. 3
Case Nos. AVU-E-10-01 & AVU-G-10-01
W. Avera, Avista
Schedule 2, p. 18 of 39
1 Q. Same argue that analysts' assessments of qrowth
2 rates are biased. Do you believe these projections are
3 inappropriate for estimtinq investors' required return
4 usinq the DCF model?
5 A. No. In applying the DCF model to estimate the
6 cost of common equity, the only relevant growth rate is
7 the forward-looking expectations of investors that are
8 captured in current stock prices. Investors, just like
9 securi ties analysts and others in the investment
10 community, do not know how the future will actually turn
11 out. They can only make investment decisions based on
12 their best estimate of what the future holds in the way of
13 long-term growth for a particular stock, and securities
14 prices are constantly adjusting to reflect their
15 assessment of available information.
16 Any claims that analysts' estimates are not relied
17 upon by investors are illogical given the reality of a
18 competitive market for investment advice. If financial
19 analysts' forecasts do not add value to investors'
20 decision making, then it is irrational for investors to
21 pay for these estimates. Similarly, those financial
22 analysts who fail to provide reliable forecasts will lose
23 out in competi ti ve markets relative to those analysts
24 whose forecasts investors find more credible. The reality
Exhibi t No. 3
Case Nos. AVU-E-10-Ol & AVU-G-10-01
W. Avera, Avista
Schedule 2, p. 19 of 39
1 that analyst estimates are routinely referenced in the
2 financial media and in investment advisory publications
3 (e. g., Value Line) implies that investors use them as a
4 basis for their expectations.
5 The continued success of investment services such as
6 Thomson Reuters and Value Line, and the fact that
7 projected growth rates from such sources are widely
8 referenced, provides strong evidence that investors give
9 considerable weight to analysts' earnings projections in
10 forming their expectations for future growth. While the
11 projections of securities analysts may be proven
12 optimistic or pessimistic in hindsight, this is irrelevant
13 in assessing the expected growth that investors have
14 incorporated into current stock prices, and any bias in
15 analysts' forecasts - whether pessimistic or optimistic -
16 is irrelevant if investors share analysts' views.
17 Earnings growth projections of security analysts provide
18 the most frequently referenced guide to investors' views
19 and are widely accepted in applying the DCF model. As
20 explained in Regulatory Finance: Utilities' Cost of
21 Capi tal:
22 Because of the dominance of institutional23 investors and their influence on individual24 investors, analysts' forecasts of long-run
Exhibi t No. 3
Case Nos. AVU-E-10-01 & AVU-G-IO-Ol
W. Avera, Avista
Schedule 2, p. 20 of 39
1
2
3
4
5
6
7
growth rates provide a sound basis for
estimating required returns. Financial analysts
also exert a strong influence on the
expectations of many investors who do not
possess the resources to make their own
forecasts, that is, they are a cause of g
(growth) .10
8
9
10
11
Q. How else are investors' expectations of future
long-te~ growth prospects often estimted for use in the
constant growth DCF model?
A.Based on the assumptions underlying constant
12 growth theory, conventional applications of the constant
13 growth DCF model often examine the relationship between
14 retained earnings and earned rates of return as an
15 indication of the sustainable growth investors might
16 expect from the reinvestment of earnings within a firm.
17 The sustainable growth rate is calculated by the formula,
18 g = br+sv, where ~b" is the expected retention ratio, ~r"
19 is the expected earned return on equity, ~s" is the
20 percent of common equity expected to be issued annually as
21 new common stock, and ~v" is the equity accretion rate.
A.
What is the purpose of the ~sv" te~?
Under DCF theory, the ~sv" factor is a component
22
23
Q.
24 of the growth rate designed to capture the impact of
25 issuing new common stock at a price above, or below, book
10 Morin, Roger A., ~Regulatory Finance: Utilities' Cost of Capital,"
Public Utilities Reports, Inc. at 154 (1994).
Exhibi t No. 3
Case Nos. AVU-E-IO-Ol & AVU-G-IO-01
W. Avera, Avista
Schedule 2, p. 21 of 39
1 value. When a company's stock price is greater than its
2 book value per share, the per-share contribution in excess
3 of book value associated with new stock issues will accrue
4 to the current shareholders. This increase to the book
5 value of existing shareholders leads to higher expected
6 earnings and dividends, with the "sv" factor incorporating
7 this additional growth component.
8 Q.What qrowth rate does the earninqs retention
9 method suqqest for the Utility Proxy Group?
10 A.The sustainable, "br+sv" growth rates for each
11 firm in the Utility Proxy Group are summarized on Schedule
12 4, with the underlying details being presented on Schedule
13 5. For each firm, the expected retention ratio (b) was
14 calculated based on Value Line's projected dividends and
15 earnings per share. Likewise, each firm's expected earned
16 rate of return (r) was computed by dividing projected
17 earnings per share by projected net book value. Because
18 Value Line reports end-of-year book values, an adjustment
19 was incorporated to compute an average rate of return over
20 the year, consistent with the theory underlying this
21 approach to estimating investors' growth expectations.
22 Meanwhile, the percent of common equity expected to be
23 issued annually as new common stock (s) was equal to the
Exhibi t No. 3
Case Nos. AVU-E-IO-Ol & AVU-G-IO-Ol
W. Avera, Avista
Schedule 2, p. 22 of 39
1 product of the projected market-to-book ratio and growth
2 in cornon shares outstanding, while the equity accretion
3 rate (v) was computed as 1 minus the inverse of the
4 proj ected market-to-book ratio.
5
6
Q.
A.
What other growth rate did you consider?
As noted earlier, the DCF model assumes that
7 investors expect to receive a portion of their total
8 return in the form of current dividends and the remainder
9 through price appreciation. Consistent with this
10 paradigm, I also examined expected growth in each
11 utility's stock price based on Value Line's 2011-2014
12 projections.
13 Q. What cost of equity estimtes were imlied for
14 the Utility Proxy Group using the DCF model?
15 A.After combining the dividend yields and
16 respective growth projections for each utility, the
17 resul ting cost of equity estimates are shown on
18 Schedule 4.
19 Q. In evaluating the results of the constant growth
20 DCF model, is it appropriate to eliminate estimtes that
21 are extrem low or high outliers?
22 A. Yes. In applying quantitative methods to
23 estimate the cost of equity, it is essential that the
Exhibi t No. 3
Case Nos. AVU-E-IO-Ol & AVU-G-IO-Ol
W. Avera, Avista
Schedule 2, p. 23 of 39
1 resulting values pass fundamental tests of reasonableness
2 and economic logic. Accordingly, DCF estimates that are
3 implausibly low or high should be eliminated when
4 evaluating the results of this method.
5 Q.How did you evaluate DCF estimtes at the low
6 end of the range?
7 A.It is a basic economic principle that investors
8 can be induced to hold more risky assets only if they
9 expect to earn a return to compensate them for their risk
10 bearing. As a result, the rate of return that investors
11 require from a utility's common stock, the most junior and
12 riskiest of its securities, must be considerably higher
13 than the yield offered by senior, long-term debt. As
14 noted earlier, the average corporate credit rating
15 associated with the firms in the Utility Proxy Group is
16 ~BBB+". Companies rated ~BBB-", ~BBB", and ~BBB+" are all
17 considered part of the triple-B rating category, with
18 Moody's monthly yields on triple-B bonds averaging
19 approximately 6.3 percent in January 2010.11 It is
20 inconceivable that investors are not requiring a
21 substantially higher rate of return for holding common
22 stock. Consistent with this principle, the DCF results
11 Moody's Investors Service, www.credittrends.com.
Exhibi t No. 3
Case Nos. AVU-E-10-Ol & AVU-G-10-Ol
W. Avera, Avista
Schedule 2, p. 24 of 39
1 for the Utility Proxy Group must be adjusted to eliminate
2 estimates that are determined to be extreme low outliers
3 when compared against the yields available to investors
4 from less risky utility bonds.
5
6
Q.Have simlar tests been applied by regulators?
Yes. FERC has nqted that adjustments areA.
7 justified where applications of the DCF approach produce
8 illogical results. FERC evaluates DCF results against
9 observable yields on long-term public utility debt and has
10 recognized that it is appropriate to eliminate estimates
11 that do not sufficiently exceed this threshold. In a 2000
12 opinion establishing its current precedent for determining
13 ROEs for electric utilities, for example, FERC noted:
14 An adjustment to this data is appropriate in the15 case of PG&E's low-end return of 8.42 percent,
16 which is comparable to the average Moody' s ~A"17 grade public utility bond yield of 8.06 percent,18 for October 1999. Because investors cannot be19 expected to purchase stock if debt, which has20 less risk than stock, yields ~ssentially the21 same return, this low-end return cannot be22 considered reliable in this case. 12
12 Southern California Edison Company, 92 FERC ~ 61,070 (2000) at p.
22.
Exhibi t No. 3
Case Nos. AVU-E-10-01 & AVU-G-10-01
W. Avera, Avista
Schedule 2, p. 25 of 39
1 More recently, in its March 27, 2009 decision in Pioneer,
2 FERC concluded that it would exclude low-end ROEs ~within
3 about 100 basis points above the cost of debt. "13 ,
4 Q.What else should be considered in evaluating DCF
5 estimates at the low end of the range?
6 A.As indicated earlier, while corporate bond
7 yields have declined substantially as the worst of the
8 financial crisis has abated, it is generally expected that
9 long-term interest rates will rise as the recession ends
10 and the economy returns to a more normal pattern of
11 growth. As shown in Table 2 below, the most recent
12 forecasts of IRS Global Insight and the EIA imply an
13 average triple-B bond yield of 6.72 percent for 2010, or
14 7.12 percent over the 5-year period 2010-2014:
15
13 Pioneer Transmission, LLC, 126 FERC ~ 61,281 at P 94 (2009)
("Pioneer") .
Exhibit No. 3
Case Nos. AVU-E-10-01 & AVU-G-10-01
W. Avera, Avista
Schedule 2, p. 26 of 39
..
1 TABLE 2
2 IMLIED BBB BOND YIELD
Line
No.2010 2010-14
1 Proj ected AA Utility Yield
2 IHS Global Insight (a)5.55%6.30%
3 EIA (b)6.66%6.71%
4 Average 6.11%6.51%
5 BBB - AA Yield Spread ( c)0.61%0.61%
6 Implied BBB Utility Yield 6.72%7.12%
(a) IHS Global Insight, The U.S. Economy: The
3D-Year Focus" (Third-Quarter 2009) at Table
34.
(b) Energy Information Administration, AnnualEnergy Outlook 2010, Early Release (Dec. 5,
2009) at Table 20.
(c) Based on monthly average bond yields forJanuary 2010 reported in Moody's Credi t
Perspecti ves.
3 The increase in debt yields anticipated by IHS Global
4 Insight and EIA is also supported by the widely-referenced
5 Blue Chip Financial Forecasts, which projects that yields
6 on corporate bonds will climb on the order of 70 basis
7 points through the second quarter of 2011.14 Consistent
8 with these forecasts, Fitch recently concluded, ~Interest
14 Blue Chip Financial Forecasts, Vol. 29, No. 2 (Feb. 1, 2010).
Exhibi t No. 3
Case Nos. AVU-E-10-01 & AVU-G-10-01
W. Avera, Avista
Schedule 2, p. 27 of 39
1 rates are expected to rise over the course of the year
2 from very low levels. 1115
3 Q. What does this test of logic imly with respect
4 to the DCF results for the Utility Proxy Group?
5 A.As shown on Schedule 4, sixteen of the cost
6 equity estimates for the firms in the Utility Proxy Group
7 fell below 8.0 percent. 16 In light of the risk-return
8 tradeoff principle and the test applied in Pioneer, it is
9 inconceivable that investors are not requiring a
10 substantially higher rate of return for holding common
11 stock, which is the riskiest of a utility's securities.
12 As a result, consistent with the test of economic logic
13 applied by FERC and the upward trend expected for utility
14 bond yields, these values provide little guidance as to
15 the returns investors require from utility common stocks
16 and should be excluded.
17 Q. What cost of equity is implied by your DCF
18 results for the Utility Proxy Group?
19 A.As shown on Schedule 4 and summarized in Table
20 3, below, after eliminating illogical low- and high-end
15 Fitch Ratings Ltd., "U. S. Utilities, Power, and Gas 2010 Outlook, II
Global Power North America Special Report (Dec. 4, 2009).16 As highlighted on Schedule 4, these DCF estimates ranged from 5.0
percent to 7.9 percent.
Exhibi t No. 3
Case Nos. AVU-E-10-01 & AVU-G-10-01
W. Avera, Avista
Schedule 2, p. 28 of 39
1 values, application of the constant growth DCF model
2 resul ted in the following cost of equity estimates:3 TABLE 3
4 DCF RESULTS - UTILITY PROXY GROUP
Growth Rate
Value Line
IBES
First Call
Zacks
br+sv
Stock Price
Average Cost of Equity
11. 5%
11. 1%
11. 1%
10.6%
10.4%
11.2%
5
6
7
Q. What were the results of your DCF analysis for
the Non-utility Proxy Group?
A.I applied the DCF model to the Non-Utility Proxy
8 Group in exactly the same manner described earlier for the
9 Utili ty Proxy Group. The results of my DCF analysis for
10 the Non-Utility Proxy Group are presented in Schedule 6,
11 with the sustainable, "br+sv" growth rates being developed
12 on Schedule 7.
13 I noted earlier that values that are implausibly low
14 or high should be eliminated when evaluating the results
15 of any quantitative method used to estimate the cost of
16 equity. As highlighted on Schedule 6, in addition to
17 illogical low-end values, various DCF estimates for the
18 firms in the Non-Utility Proxy Group exceeded 17.0
19 percent. I determined that, when compared with the
Exhibi t No. 3
Case Nos. AVU-E-IO-Ol & AVU-G-IO-Ol
W. Avera, Avista
Schedule 2, p. 29 of 39
1 balance of the remaining estimates, these values could be
2 considered implausible and should be excluded. This is
3 also consistent with the precedent adopted by FERC, which
4 has established that estimates found to be ~extreme
5 outliers" should be disregarded in interpreting the
6 results of quantitative methods used to estimate the cost
7 of equity.17
8 As shown on Schedule 6 and summarized in Table 4,
9 below, after eliminating illogical low- and high-end
10 values, application of the constant growth DCF model
11 resulted in cost of common equity estimates generally in
12 the 12 percent to 13 percent range:
13 TAB 4
14 DCF RESULTS - NON-UTILITY PROXY GROUP
Growth Rate
Value Line
IBES
First Call
Zacks
br+sv
Stock Price
Average Cost of Equity
11. 9%
12.6%
12.8%
12.7%
12.2%
13.7%
15 As discussed earlier, reference to the Non-Utility Proxy
16 Group is consistent with established regulatory principles
17 and required returns for utilities should be in line with
17 See, e.g., iso New England, Inc., 109 FERC 'l 61,147 at P 205 (2004).
Exhibi t No. 3
Case Nos. AVU-E-10-01 & AVU-G-10-01
W. Avera, Avista
Schedule 2, p. 30 of 39
1 those of non-utility firms of comparable risk operating
2 under the constraints of free competition.
3
4
Q.
D. Capi tal Asset Pricing Model
Please describe the CA.
The CAPM is a theory of market equilibrium thatA.
5 measures risk using the beta coefficient. Assuming
6 investors are fully diversified, the relevant risk of an
7 individual asset (e.g., common stock) is its volatility
8 relative to the market as a whole, with beta reflecting
9 the tendency of a stock's price to follow changes in the
10 market. The CAPM is mathematically expressed as:
12
13
14
15
16
Rj =Rf +ßj (Rm -Rfl
where:Rj =required rate of return for stock j;
Rf =risk-free rate;
Rm =expected return on the market
portfolio;and,
ßj =beta,or systematic risk,for stock j.
11
17 Like the DCF model, the CAPM is an ex-ante, or forward-
18 looking model based on expectations of the, future. As a
19 result, in order to produce a meaningful estimate of
20 investors' required rate of return, the CAPM must be
21 applied using estimates that reflect the expectations of
22 actual investors in the market, not with backward-iooking,
23 historical data.
Exhibi t No. 3
Case Nos. AVU-E-10-01 & AVU-G-10-01
W. Avera, Avista
Schedule 2, p. 31 of 39
1 Q. How did you apply the CA to estimte the cost
2 of common equity?
3 A.Application of the CAPM to the Utility Proxy
4 Group based on a forward-looking estimate for investors'
5 required rate of return from common stocks is presented on
6 Schedule 8. In order to capture the expectations of
7 today's investors in current capital markets, the expected
8 market rate of return was estimated by conducting a DCF
9 analysis on the dividend paying firms in the S&P 500.
10 The dividend yield for each firm was calculated based
11 on the annual indicated dividend payment obtained from
12 Value Line, increased by one-half of the growth rate
13 discussed subsequently (1 + O. 5g) to convert them to year-
14 ahead dividend yields presumed by the constant growth DCF
15 model. The growth rate was equal to the earnings growth
16 projections for each firm published by IBES, with each
17 firm's dividend yield and growth rate being weighted by
18 its proportionate share of total market value. Based on
19 the weighted average of the proj ections for the 352
20 individual firms, current estimates imply an average
21 growth rate over the next five years of 8.8 percent.
22 Combining this average growth rate with an adjusted
23 dividend yield of 2.5 percent results in a current cost of
Exhibi t No. 3
Case Nos. AVU-E-10-0l & AVU-G-10-Ol
W. Avera, Avista
Schedule 2, p. 32 of 39
1 cornan equity estimate for the market as a whole of
2 approximately 11.3 percent. Subtracting a 4.5 percent
3 risk-free rate based on the average yield on 20-year
4 Treasury bonds produced a market equity risk premium of
5 6.8 percent.
6 Q.What was the source of the beta values you used
7 to apply the CA?
8 A.I relied on the beta values reported by Value
9 Line, which in my experience is the most widely referenced
10 source for beta in regulatory proceedings. As noted in
11 Regulatory Finance: Utilities' Cost of Capital:
12 Value Line betas are computed on a theoretically13 sound basis using a broadly-based market index,14 and they are adjusted for the regression15 tendency of betas to converge to 1.00.16 Value Line is the largest and most widely17 circulated independent investment advisory18 service, and exerts influence on a large number19 of institutional and individual investors and on20 the expectations of these investors. 18
21 As shown on Schedule 8, multiplying the 6.8 percent market
22 risk premium by the average Value Line beta for the firms
23 in the Utility Proxy Group, and then adding the resulting
24 risk premium to the average long-term Treasury bond yield,
25 resul ts in an average ~ndicated cost of cornan equity of
26 9.5 percent.
18 Morin, Roger A., "Regulatory Finance: Utilities' Cost of Capital,"
Public Utilities Reports at 65 (1994).
Exhibi t No. 3
Case Nos. AVU-E-10-01 & AVU-G-10-Ol
W. Avera, Avista
Schedule 2, p. 33 of 39
1 Q. What cost of common equity was indicated for the
2 Non-Utility Proxy Group based on this forward-looking
3 application of the CAPM?
4 A.As shown on Schedule 9, applying the forward-
5 looking CAPM approach to the firms in the Non-Utility
6 Proxy Group results in an average implied cost of common
7 equity of 9.8 percent.
8
9
10
Q. Do you have any observations regarding these
CAPM results?
A.Yes. Applying the CAPM is complicated by the
11 impact of the recent capital market turmoil and recession
12 on investors' risk perceptions and required returns. The
13 CAPM cost of common equity estimate is calibrated from
14 investors' required risk premium between Treasury bonds
15 and common stocks. In response to heightened
16 uncertainties, investors have sought a safe haven in U.S.
17 government bonds and this ~flight to safety" has pushed
18 Treasury yields significantly lower while yield spreads
19 for corporate debt have widened. This distortion not only
20 impacts the absolute level of the CAPM cost of equity
21 estimate, but it affects estimated risk premiums.
22 Economic logic would suggest that investors' required risk
23 premium for common stocks over Treasury bonds has also
24 increased. Thus, recent capital market conditions may
Exhibi t No. 3
Case Nos. AVU-E-10-Ol & AVU-G-10-Ol
W. Avera, Avista
Schedule 2, p. 34 of 39
1 cause CAPM cost of common equity estimates to understate
2 investors' required returns for common stocks,
3 particularly when historical data are used to calculate
4 the market risk premium. As the Staff of the Florida
5 Public Service Commission recently concluded:
6 (R) ecognizing the impact the Federal
7 Government's unprecedented intervention in the
8 capi tal markets has had on the yields on long-
9 term Treasury bonds, staff believes models that10 relate the investor-required return on equity to11 the yield on government securities, such as the
12 CAPM approach, produce less reliable estimates13 of the ROE at this time. 19
14 While my application of the CAPM makes every effort to
15 incorporate investors' forward-looking expectations, the
16 full effect of the ~flight to safety" may not be captured
17 in my market risk premium estimate.
18 Second, the beta in CAPM theory is a measure of the
19 investors' expected relationship of a firm's stock price
20 to the market as a whole. Because investors' expected
21 beta for a firm is not known, reported betas are estimated
22 based on historical relationships. The precipitous drop
23 and subsequent partial recovery in stock prices over the
24 last year or so have caused many firms' historical betas
19 Staff Recommendation for Docket No. OB0677-El - Petition for
increase in rates by Florida Power & Light Company, at p. 280 (Dec.
23, 2009).
Exhibi t No. 3
Case Nos. AVU-E-IO-Ol & AVU-G-IO-01
W. Avera, Avista
Schedule 2, p. 35 of 39
1 to become unstable, so that reported betas mayor may not
2 reflect investors' expected beta. Because of this
3 inherent mismatch between the historical circumstances
4 underlying reported beta values and the current
5 perceptions of investors, the CAPM may not accurately
6 reflect investor's forward-looking rate of return
7 requirements.
8 Meanwhile, forward-looking estimates of the market
9 required rate of return may be distorted by the recent
10 run-up in stock prices. It is not clear whether reported
11 security analysts' dividend and growth projections have
12 kept pace with the economic recovery expectations
13 presumably pushing up stock prices; if not, there is a
14 mismatch that under-estimates the market required rate of
15 return. This incongruity between current measures of the
16 market risk premium and historical beta values is
17 particularly relevant during periods of heightened
18 uncertainty and rapidly changing capital market
19 conditions, such as those experienced recently. As a
20 result, there is every indication that CAPM approaches
21 fail to fully reflect the risk perceptions of real-world
22 investors in today's capital markets, which would violate
23 the standards underlying a fair rate of return by failing
Exhibi t No. 3
Case Nos. AVU-E-10-01 & AVU-G-lO-Ol
W. Avera, Avista
Schedule 2, p. 36 of 39
1 to provide an opportunity to earn a return commensurate
2 wi th other investments of comparable risk.
3 Q.
E. Expected Earnings Approach
What other analyses did you conduct to estimte
4 the cost of equity?
5 A.As I noted earlier, I also evaluated the ROE
6 using the comparable earnings method. Reference to rates
7 of return available from alternative investments of
8 comparable risk can provide an important benchmark in
9 assessing the return necessary to assure confidence in the
10 financial integrity of a firm and its ability to attract.
11 capital. This comparable earnings approach is consistent
12 with the economic underpinnings for a fair rate of return
13 established by the Supreme Court in Hope and Bluefield.
14 Moreover, it avoids the complexities and limitations of
15 capi tal market methods and instead focuses on expected
16 earned returns on book equity, which are more readily
17 available to investors.
18
19
20
Q. Wht rates of return are indicated for utilities
based on this approach?
A.Value Line reports that its analysts anticipate
21 an average rate of return on common equity for the
22 electric utility industry of 11.0 percent in 2010 and 11.5
Exhibi t No. 3
Case Nos. AVU-E-10-01 & AVU-G-IO-Ol
W. Avera, Avista
Schedule 2, p. 37 of 39
1 percent over its 2012-2014 forecast horizon. 20 Meanwhile,
2 for the gas utility industry Value Line expects returns on
3 common equity of 10.5 percent in 2010 and 11.0 percent
4 over the period 2012-2014.21
5 For the flrms in the Utility Proxy Group
6 specifically, the returns on common equity projected by
7 Value Line over its three-to-five year forecast horizon
8 are shown on Schedule 10. Consistent with the rationale
9 underlying the development of the br+sv growth rates,
10 these year-end values were converted to average returns
11 using the same adjustment factor discussed earlier and
12 developed on Schedule 5. As shown on Schedule 10, Value
13 Line's projections for the utility proxy group suggested
14 an average ROE of 10.7 percent.
15 Q.
F. Sumry of Quantitative Results
Please sumrize the results of your
16 quantitative analyses.
17 A.The cost of equity estimates implied by my
18 quantitative analyses are summarized in Table 5 below:
20 The Value Line Investment Survey at 2231 (Feb. 5, 2010).
21 The Value Line Investment Survey at 444 (Dec. 11, 2009).
Exhibi t No. 3
Case Nos. AVU-E-10-01 & AVU-G-10-01
W. Avera, Avista
Schedule 2, p. 38 of 39
i
2
TABLE 5
SUMY OF QUANITATIVE RESULTS
Dcr
Value Line
rBES
First Call
Zacks
br+sv
Stock Price
CA
Expcted Earnings
2010
2012-l4
Utility Proxy Group
Uti1iti
lL. 5%
lL. 1%
lL. l%
lO.6%
LO.4%
lL.2%
9.5%
E1ectric
lL. 0%
lL. 5%
Non-Uti1iti
lL. 9%
l2.6%
l2.8%
l2.7%
l2.2%
l3.7%
9.8%
Gu
LO .5%
lL. 0%
lO.7%
Exhibi t No. 3
Case Nos. AVU-E-IO-Ol & AVU-G-IO-Ol
W. Avera, Avista
Schedule 2, p. 39 of 39
CA
P
I
T
A
L

S
T
R
U
C
T
U
R
E
UT
I
L
I
T
Y

P
R
O
X
Y

G
R
O
U
P
At

F
i
s
c
a
l

Y
e
a
r
-
E
n
d

2
0
0
9

(
a
)
Va
l
u
e

L
i
n
e

P
r
o
j
e
c
t
e
d

(
b
)
Co
m
m
o
n
Co
m
m
o
n
Co
m
p
a
n
y
De
b
t
Pr
e
f
e
r
r
e
d
Eq
u
i
t
y
De
b
t
Ot
h
e
r
Eq
u
i
t
y
1
Am
e
r
e
n

C
o
r
p
.
47
.
6
%
0.
0
%
52
.
4
%
45
.
0
%
1.
0
%
54
.
0
%
2
Am
e
r
i
c
a
n

E
l
e
c

P
w
r
57
.
0
%
0.
2
%
42
.
8
%
52
.
0
%
0.
0
%
48
.
0
%
3
A
v
i
s
t
a

C
o
r
p
.
49
.
3
%
2.
4
%
48
.
3
%
51
.
5
%
0.
0
%
48
.
5
%
4
Bl
a
c
k

H
i
l
s

C
o
r
p
.
49
.
2
%
0.
0
%
50
.
8
%
40
.
5
%
0.
0
%
59
.
5
%
5
Cl
e
c
o

C
o
r
p
.
54
.
4
%
0.
0
%
45
.
6
%
53
.
0
%
0.
0
%
47
.
0
%
6
Co
n
s
t
e
l
l
a
t
i
o
n

E
n
e
r
g
y
35
.
2
%
1.
4
%
63
.
4
%
45
.
5
%
1.
5
%
53
.
0
%
7
DT
E

E
n
e
r
g
y

C
o
.
51
.
1
%
2.
1
%
46
.
7
%
55
.
0
%
0.
0
%
45
.
0
%
8
Ed
i
s
o
n

I
n
t
e
r
n
a
t
i
o
n
a
l
49
.
6
%
4.
2
%
46
.
3
%
50
.
5
%
3.
5
%
46
.
0
%
9
Em
p
i
r
e

D
i
s
t
r
c
t

E
l
e
c
49
.
¡
O
1
O
3.
9
%
46
.
5
%
51
.
0
%
0.
0
%
49
.
0
%
10

G
r
e
a
t

P
l
a
i
n
s

E
n
e
r
g
y
53
.
2
%
0.
6
%
46
.
2
%
51
.
5
%
0.
5
%
48
.
0
%
11

I
D
A
C
O
R
P
,

I
n
c
.
50
.
3
%
0.
0
%
49
.
7
%
49
.
0
%
0.
0
%
51
.
0
%
12

N
o
r
t
e
a
s
t

U
t
i
l
i
t
i
e
s
55
.
2
%
1.
4
%
43
.
4
%
58
.
0
%
1.
0
%
41
.
0
%
13

P
i
n
a
c
l
e

W
e
s
t

C
a
p
i
t
a
l
52
.
2
%
0.
0
%
47
.
8
%
48
.
0
%
0.
0
%
52
.
0
%
14

P
P
L
C
o
r
p
.
55
.
1
%
0.
0
%
44
.
9
%
52
.
5
%
2.
0
%
45
.
5
%
15

P

S

E
n
t
e
r
p
n
s

G
r
o
u
p
44
.
1
%
0.
5
%
55
.
4
%
43
.
0
%
0.
0
%
57
.
0
%
16

U
I
L

H
o
l
d
i
n
g
s
56
.
0
%
0.
0
%
44
.
0
%
52
.
0
%
0.
0
%
48
.
0
%
17

W
e
s
t
a
r

E
n
e
r
g
y
52
.
3
%
0.
5
%
47
.
2
%
47
.
5
%
0.
0
%
52
.
5
%
Av
e
r
a
g
e
50
.
7
%
1.
0
%
48
.
3
%
49
.
7
%
0.
6
%
49
.
7
%
Ex
h
i
b
i
t

N
O
.
3
Ca
s
e

N
o
s
.

A
V
U
-
E
-
1
0
-
1

A
V
U
-
G
-
1
0
-
o
1
(a
)

C
o
m
p
a
n
y

F
o
r
m

1
0
-
K

a
n
d

A
n
u
a
l

R
e
p
o
r
t
s
.
W.

A
v
e
r
a
,

A
v
i
s
t
a
(b
)

T
h
e

V
a
l
u
e

L
i
n
e

I
n
v
e
s
t
m
e
n
t

S
u
r
v
e
y

(
N
o
v
.

2
7

&

D
e
c
.

2
5
,

2
0
0
9
,

F
e
b
.

5
,

2
0
1
0
)
.
Sc
h
e
d
u
l
e

3
,

p
.

1

o
f

1
(a
)

R
e
c
e
t

p
r
i
c
e

a
n
d

e
s
t
i
a
t
e
d

d
i
v
i
d
e
n
d

f
o
r

n
e
x
t

1
2

m
o
s
.

f
r
m

T
h

V
a
l
u
e

L
i
n
e

I
n
v
e
s
b
n
e
n
t

S
u
r
v
e
y
u
m
n
u
r
y

a
n
d

I
n
d
e

(
F
e
b
.

5
,

2
0
1
0
)
.
(b
)

T
h

V
a
l
u
e

L
i

I
n
v
e
s
t
m
e
n
t

S
u
r
e
y

(
N
o
v
.

2
7

&

D
e
c
.

2
5
,

2
0
0
,

F
e
b
.

5
,

2
0
1
0
)
,
(c
)

T
h
s
o
n

R
e
u
t
e
r
s
C
o
p
a
n
y

i
n

C
o
n
t
e
x
t

R
e
r
t

(
F
e
b
.

3
,

2
0
1
0
)
.
(d
)

F
i
r
s
t

C
a
l

E
.
a
r
n
i
n
g
s

V
a
l
u
a
t
i
o
n

R
e
o
r
t

(
F
e
b
.

4
,

2
0
1
0
)
.
(e
)

w
w
.
z
a
c
k
.
c
o
m

(
r
e
r
i
e
v
e

F
e
b
.

4
,

2
0
1
0
)
(f
)

S
e

S
c
e
d
u
l
e

5
.
(g
)

S
u

o
f

d
i
v
i
d
e
n

y
i
e
l
d

a
n
d

r
e
v
e

g
r
o
w
t
h

r
a
t
t
(h
)

E
x
c
l
u
d
e
s

h
i
g
h
l
i
g
h
t
e

f
i
g
u
r
e
Ex
i
b
i
t

N
O
.
3
Ca
s
e

N
o
.

A
V
U
-
E
-
1
G
-
1

A
V
U
-
G
-
1
0
-
Q
1
W.

A
v
e
r
.

A
v
i
s
t
SC
e
d
u
l
e

4
,

p
.

1

o
f

1
SUSTAINABLE GROWT RATE
UTILIT PROXY GROUP
(a)(a)(b)(a)(a)(a)(c)(d)
2012-14 Market Prce 2012-14 Prjections
Company ,Hi Low Avg.EPS DPS ~ll i
1 Ameren Corp.45.00 30.00 $37.50 $3.00 $1.70 $37.25 43.3%8.1%
2 American Elec Pwr 50.00 35.00 $4.50 $3.50 $1.90 $33.25 45.7%10.5%
3 A vista Corp.30.00 19.00 $24.50 $1.75 $1.20 $21.50 31.%8.1%
4 Black Hills Corp.40.00 25.00 $32.50 $2.75 $1.56 $30.75 43.3%8.9%
5 Cleco Corp.40.00 25.00 $32.50 $2.50 $1.60 $21.50 36.0%11.6%
6 Constellation Energy 50.00 30.00 $4.00 $3.50 $1.00 $36.25 71.4%9.7%
7 DTE Energy Co.60.00 40.00 $50.00 $4.25 $2.50 $42.50 41.2%10.00k
8 Edison Internationl 60.00 40.00 $5.00 $4.25 $1.50 $39.50 64.7%10.8%
9 Empire Distrct Elec 30.00 20.00 $2.00 $1.75 $1.35 $17.25 22.9%10.1%
10 Great Plains Energy 25.00 15.00 $20.00 $1.60 $1.0 $22.00 31.3%7.3%
11 IDACORP, Inc.45.00 30.00 $37.50 $2.75 $1.40 $36.00 49.1%7.6%
12 Norteast Utilities 40.00 25.00 $32.50 $2.25 $1.5 $24.50 48.9%9.2%
13 Pinacle West Capital 50.00 30.00 $4.00 $3.25 $2.20 $37.25 32.3%8.7"k
14 PPLCorp.55.00 35.00 $45.00 $3.75 $1.90 $19.50 49.3%19.2%
15 P 5 Enterprise Group 55.00 35.00 $4.00 $3.75 $1.70 $24.00 54.7"k 15.6%
16 UI Holdings 35.00 25.00 $3.00 $2.30 $1.73 $21.75 24.8%10.6%
17 Westar Energy 30.00 20.00 $25.00 $2.10 $1.40 $27.20 33.3%7.7"k
Exhibit No. 3
Case Nos. AVU-E-1o-01 AVU-G-10-o1
W. Avera, Avista
Schedule 5, p. 1 of 3
SUSTAINABLE GROWT RATE
UTILIT PROXY GROUP
(a)(a)(e)(a)(a)(e)(f)(g)(h)
2008 2012-14 Adjusted "r"
No.Common No.Comon Chgin Adj.Adj.
Company BVPS Shares EQ ~~Equity EQ f!i:
1 Ameren Corp.$32.80 212.30 $6,963 $37.25 252.00 $9,387 6.2%1.0299 8.3%
2 American Elec Pw $26.33 406.07 $10,692 $3.25 495.00 $16,459 9.0%1.041 LU)%
3 A vista Corp.$18.30 54.49 $997 $21.50 58.50 $1,25 4.8%1.0232 8.3%
4 Black Hills Corp.$27.19 38.64 $1,051 $3.75 40.00 $1,23 3.2%1.0158 9.1%
5 OecoCorp.$17.65 60.04 $1,060 $21.50 65.00 $1,398 5.7%1.0277 11.9%
6 Constellation Energ $15.98 199.13 $3,182 $36.25 215.00 $7,794 19.6%1.0893 10.5%
7 DTE Energy Co.$36.77 163.02 $5,994 $4.50 178.00 $7,565 4.8%1.0233 10.2%
8 Edison Interntional $29.21 325.81 $9,517 $39.50 325.81 $12,869 6.2%1.0302 11.1%
9 Empire Distrct Elec $15.56 33.98 $529 $17.25 42.00 $72 6.5%1.0315 10.5%
10 Great Plains Energy $21.39 119.26 $2,551 $22.00 158.00 $3,476 6.4%1.0309 7.5%
11 IDACORP, Inc.$27.76 46.92 $1,302 $36.00 52.00 $1,872 7.5%1.0363 7.9%
12 Norteast Utilities $19.38 155.83 $3,020 $24.50 188.00 $4,606 8.8%1.04 9.6%
13 Pinacle West Capital $3.16 100.89 $3,446 $37.25 118.00 $4,396 5.0%1.0243 8.9%
14 PPLCorp.$13.55 374.58 $5,076 $19.50 370.00 $7,215,7.3%1.0352 19.9%
15 P S Enterprise Group $15.36 506.02 $7,772 $24.00 490.00 $11,760 8.6%1.0414 16.3%
16 UIL Holdings $18.85 25.17 $474 $21.75 30.80 $670 7.1%1.034 10.9%
17 Westar Energy $20.18 108.31 $2,186 $27.20 114.00 $3,101 7.2%1.035 8.O"k
Exhibit NO.3
Case Nos. AVU-E-10-01 AVU-G-10-Q1
W. Avera, Avista
SCedule 5, p. 2 of 3
SUSTAINABLE GROWT RATE
UTIT PROXY GROUP
(a)(a)(f)(i)(j)(k)(I)(m)
Common Shares
Outstanding MI "sv" Fador
Company 2008 2012-14 Change Ratio i ~n br+sv
1 Ameren Corp.212.3 252.0 3.49%1.01 0.0351 0.007 0.02%3.6%
2 American Elec Pw 406.1 495.0 4.04%1.28 0.0516 0.2176 1.2%6.1%
3 Avista Corp.54.5 58.5 1.43%1.14 0.0163 0.1224 0.20%2.8%
4 Black Hills Corp.38.6 40.0 0.69%1.06 0.0073 0.0538 0.04%4.0%
5 ClecoCorp.60.0 65.0 1.60%1.51 0.0242 0.3385 0.82%5.1%
6 Constellation Energy 199.1 215.0 1.55%1.10 0.0171 0.0938 0.16%7.7%
7 OTE Energy Co.163.0 178.0 1.77 1.8 0.0209 0.150 0.31%4.5%
8 Edisn International 325.8 325.8 0.00%1.27 0.2100 0.00%7.2%
9 Empire Distnct Elec 34.0 42.0 4.33%1.45 0.0627 0.3100 1.94%4.3%
10 Great Plains Energy 119.3 158.0 5.79%0.91 0.0526 (0.1000)-0.53%1.8%
11 IDACORP, Inc.46.9 52.0 2.08%1.04 0.0216 0.040 0.09%4.0%
12 Norteast Utilities 155.8 188.0 3.82%1.33 0.0507 0.2462 1.25%5.9%
13 Pinnacle West Capital 100.9 118.0 3.18%1.07 0.034 0.068 0.23%3.1%
14 PPLCorp.374.6 370.0 -0.25%2.31 (0.0057)0.5667 -0.32%9.5%
15 P S Enterprise Group 506.0 490.0 -0.64%1.88 (0.0120)0.467 -0.56%8.3%
16 UIL Holdings 25.2 30.8 4.12%1.38 0.0568 0.2750 1.56%4.3%
17 Westa Energy 108.3 114.0 1.03%0.92 0.0095 (0.0880)-0.08%2.6%
(a)The Value Line Investment Survey (Nov. 27 & De. 25, 200, Feb. 5, 2010).
(b) Average of High and Low expected market prices.
(c) Compute at (EPS - OPS) / EPS.
(d) Computed as EPS / BVP.
(e) Product of BVP and No. Shares Outstading.
(f)Five-year rate of chge.
(g) Computed using the formula 2"(1+5-Yr. Change in Equity)/(2+5 Yr. Change in Equity)
(h) Product of year-ed "r" for 2012-14 and Adjustment Factor.
(i)Average of High and Low expected market prices divided by 2012-14 BVPS.
(j)Product of change in common shaes outstading and M/B Ratio
(k) Computed as 1 - BIM Ratio.
(I)Product of "s" and "v".
(m) Product of average "b" and adjusted "r", plus "sv".
Exhibit NO.3
Case Nos. AVU-E-10-01 AVU-G-1Q-1
W. Avera, Avista
Schedule 5, p. 3 of 3
DC
F
M
O
D
E
L
NO
N
-
u
n
U
I

P
R
O
X
Y

G
R
O
u
p
(a
)
(a
)
(b
)
(c
)
(d
)
(e
)
(a
)
(f
)
(f
)
(f
)
(f
)
(f
)
(f
)
Di
v
i
d
e
n
d
Gr
o
w
t
h

R
a
t
t
s
Co
s
t

o
f

E
q
u
i
t
y

E
s
t
i
m
a
t
e
s
Co
m
p
a
n
Xi
YJ
.u
Fi
r
s
t

C
a
l
l
~
br
+
s
v
~
YJ
ii
Fi
r
s
t
C
l
1
1
~
br
+
s
v
Pr
i
c
e
1
3M

Co
m
p
a
n
y

2.
5
4
%
5.
0
%
12
.
1
%
12
.
5
%
11
.
6
%
15
.
8
%
10
.
4
%
i:
14
,
6
%
15
.
0
%
14
.
1
%

1
1
8
.
4
%
1

1
2
.
9
%
2
Ab
b
o
t
t

L
a
b
s
.
2.
9
9
%
10
.
0
%
11
.
5
%
12
.
0
%
10
.
8
%
13
.
6
%
15
.
7
%
13
.
0
%
14
.
5
%
15
.
0
%
13
.
8
%

1
6
.
6
%

I

1
8
.
7
%
1
3
Al
b
e
r
t
o
-
u
l
v
e
r
1.
1
9
%
14
.
5
%
11
.
7
%
12
.
5
%
12
.
5
%
8.
0
%
7.
6
%
15
.
7
"
k
12
.
9
%
13
.
7
%
13
.
7
%
9.
2
%
8.
8
%
4
Al
l
e
r
g
a
n
,

I
n
c
.
0.
3
3
%
14
.
0
%
13
.
0
%
13
.
3
%
15
.
2
%
19
.
2
%
15
.
6
%
14
.
3
%
13
.
3
%
13
.
6
%
15
.
5
%

I
'

1
9
.
5
%
1
16
.
0
%
5
AT
&
T

In
c
.

6.
1
7
%
5.0
%
5.9
%
5.
0
%
5.9
%
5.
9
%
13
.
0
%
11
.
2
%
12
.
1
%
11
.
2
%
12
.
1
%
12
.
0
%
19
.
2
%
6
Au
t
o
m
a
t
i
c

D
a
t
a

P
r
o
c
.
3.
2
%
9.
0
%
11
.
8
%
12
.
0
%
11
.
4
%
9.
8
%
15
.
8
%
12
.
2
%
15
.
0
%
15
.
2
%
14
.
6
%
13
.
1
%
19
.
0
%
7
Ba
r
d

(
C
.
R
.
)
0.
8
1
%
12
.
5
%
13
.
6
%
13
.
9
%
13
.
4
%
13
.
4
%
14
.
4
%
13
.
3
%
14
.
4
%
14
.
7
%
14
.
2
%
14
.
3
%
15
.
2
%
8
Ba
x
t
e
r

I
n
t
l

I
n
c
.
2.
0
0
%
14
.
0
%
11
.
5
%
11
.
5
%
11
.
5
%
15
.
1
%
15
.
4
%
16
.
0
%
13
.
5
%
13
.
5
%
13
.
5
%

I

1
7
.
1

%
1

I

1
7
.
4
%
1
9
Be
c
t
o
n
,

D
i
c
k
i
n
o
n
1.
9
6
%
11
.
5
%
11
.
3
%
11
.
0
%
11
.
4
%
12
.
1
%
12
.
3
%
13
.
5
%
13
.
3
%
13
.
0
%
13
.
4
%
14
.
0
%
14
.
3
%
10
Be
m
i

Co
.

2.
9
5
%
4.
5
%
7.
0
%
7.
0
%
8.
0
%
9.3
%
8.
9
%
i:

1
0
.
0
%

1
0
.
0
%
11
.
0
%
12
.
3
%
11
.
9
%
11
Br
i
s
t
o
l
-
M
y
e
r
s

S
q
i
b
b
4.
8
1
%
9.
0
%
2.
5
%
3,
0
%
7.
1
%
.
5.5
%
11
.
7
%
13
.
8
%

I

7
.
3
%
1
1
7
.
8
%
1
11
.
9
%
10
.
3
%
16
.
5
%
12
Br
o
w
n
-
F
o
r
m
a
n

'
B
'
2.
2
9
%
7.
0
%
13
.
0
%
13
.
0
%
NA
12
.
2
%
9.
2
%
9.
3
%
15
.
3
%
15
.
3
%
NA
14
.
5
%
11
,
4
%
13
Ca
r
d
i
n
a

H
e
a
l
t
h
2.
2
6
%
-2
.
5
%
6.
6
%
10
.
0
%
10
.
1
%
7.
6
%
10
.
8
%
I
-
0
.
2
%
1
8.9
%
12
.
3
%
12
.
4
%
9.
8
%
13
.
1
%
14
Ch
e
v
n

C
o
r
p
.
3.
5
4
%
5.
0
%
NA
NA
9.
0
%
17
.
5
%
12
.
1
%
8.5
%
NA
NA
12
.
5
%

1
2
1
.
0
%
1
15
.
7
%
15
Ch
u
b
b

Co
r
p
.

2.
9
1
%
3.
0
%
8.
0
%
8.5
%
7.
7
%
9.
1
%
12
.
4
%
I
5
.
9
%
1
10
.
9
%
11
.
4
%
10
.
6
%
12
.
0
%
15
.
3
%
16
Co
c
-
C
o
l
a
3.
0
9
%
6.
5
%
9.
0
%
9.0
%
8.
9
%
11
.
1
%
11
.
1
%
9.6
%
12
.
1
%
12
.
1
%
12
.
0
%
14
.
2
%
14
.
2
%
17
Co
l
g
a
t
e
P
a
l
m
o
l
i
v
e
2.
2
%
11
.
5
%
9.
0
%
10
.
0
%
9.
8
%
19
.
5
%
13
.
9
%
13
.
7
%
11
.
2
%
12
.
%
12
.
0
%

1
.
2
1
.
7
%
1
16
.
2
%
18
Co
m
m
e
r
c
e

B
a
n
c
s
h
s
.
2.3
7
%
5.
0
%
6.
5
%
6.
5
%
6.
5
%
8.
2
%
3.5
%
~
8.
9
%
8.9
%
8.
9
%
10
.
5
%

l
5.9
%
1
19
Co
n
A
g
r
a

F
o
o
s
3.6
1
%
11
.
5
%
8.
6
%
9.
0
%
9.
0
%
5.
9
%
12
.
2
%
15
.
1
%
12
.
2
%
12
.
6
%
12
.
6
%
9.5
%
15
.
8
%
20
Co
n
o
c
o
P
h
i
l
l
p
s
3.9
8
%
3.
0
%
-8
.
8
%
-5
.
6
%
3.
1
%
17
.
4
%
21
.
%
I
7
;
0
0
1
1

-
4
.
8
%
1
1
"

-
1
.
%
1

~

I

,
2
1
.
3
%
1
25
.
1
%
21
Co
s
t
c
o

W
h
o
l
e
s
a
l
e
1.
2
%
6.0
%
13
.
2
%
13
.
0
%
13
.
5
%
8.
8
%
6.
1
%
7.
3
%

1
4
.
5
%

1
4
.
3
%

1
4
.
8
%

1
0
.
1
%
7.
4
%
22
CV
S

C
a
r
e
m
a
r
k

C
o
r
p
.
0.
%
%
10
.
5
%
11
.
8
%
14
.
0
%
13
.
1
%
7.
7
"
k
19
.
6
%
11
.
5
%
12
.
8
%
15
.
0
%
14
.
1
%
8.
7
%
20
.
6
%
23
Dis
n
e
y

(
W
a
l
t
)
1.
1
6
%
12
.
0
%
6.
3
%
6.
5
%
9.
0
%
9.6
%
20
.
1
%
13
.
2
%

1

'
7
.
5
%
1
1

'

,
7
.
7
%
1
10
.
2
%
10
.
8
%
21
.
3
%
24
Du
P
o
n
t
5.
1
9
%
0.
0
%
5.
5
%
5.5
%
9.
3
%
4.7
"
k
14
.
6
%
~
1
0
.
7
%

1
0
.
7
%
14
.
5
%
9.
9
%
19
.
8
%
25
Ea
t
o
n

Co
r
p
.

3.
1
2
%
-1
.
5
%
10
.
1
%
11
.
3
%
9.
7
%
7.
6
%
11
.
1
%
.'

1
.
6
%

1
3
.
2
%
'

1
4
.
4
%
12
.
8
%
10
.
7
%
14
.
2
%
26
Ec
l
a
b

I
n
c
.
1.3
9
%
11
.
5
%
13
.
2
%
13
.
0
%
13
.
3
%
22
.
9
%
7.
2
%
12
.
9
%
14
.
6
%
14
.
4
%
14
.
7
%

I

'

2
4
.
%
1
8.
6
%
27
Em
e
r
s
o
n

E
l
e
c
t
r
i
c
3.
2
8
%
4.
5
%
11
.
5
%
10
.
0
%
10
,
8
%
7.
8
%
10
.
6
%
1.
.
7
3
%
1

i
U
%

i
~
%
14
.
1
%
11
.
1
%
13
.
9
%
28
Ev
e
r
e
s
t

R
e

G
r
o
u
p

L
t
d
.
2,
2
6
%
5.0
%
7.
5
%
7.
5
%
10
.
0
%
10
.
7
%
13
.
1
%
7.
3
%

9
.
8
%

9
.
8
%
12
.
3
%
13
.
0
%
15
.
4
%
29
Ex
x
o
n

M
o
b
i
l

C
o
r
p
.
2.
4
9
%
3.5
%
2.
8
%
3.
5
%
6.7
%
14
.
6
%
10
.
3
%
6.
0
%

~

I

"
,

6
.
0
%
1
9.
2
%

I

1
7
.
1
%
1

1
2
.
8
%
30
Ge
1

D
y
i
c
s
2.
3
5
%
11
.
0
%
7.
8
%
8.
0
%
10
.
1
%
12
.
9
%
18
.
2
%
13
.
4
%
10
.
2
%
10
.
4
%
12
.
5
%

1
5
.
2
%

I

2
0
.
%
1
31
Ge
n
1
M
i
l
i
s
2.
8
4
%
9.
0
%
9.
1
%
8.
5
%
7.
7
%
6.
2
%
9.
4
%
11
.
8
%
11
.
9
%
11
.
3
%
10
.
5
%
9.
0
%
12
.
%
32
Gr
a
g
e
r

(
W
.
W
.
)
1.9
8
%
6.
5
%
11
.
0
%
12
.
0
%
11
.
0
%
6.
9
%
9.
2
%
8.5
%
13
.
0
%
14
.
0
%
13
.
0
%
8.
9
%
11
.
2
%
33
He
i

(
H
.
J
.
)
4.
1
0
%
6.
5
%
6.
9
%
8.
0
%
8.
0
%
15
.
9
%
12
.
2
%
10
.
6
%
11
.
0
%
12
.
1
%
12
.
1
%

I

'

2
0
;
%
1
16
.
3
%
34
He
w
l
e
t
-
P
a
c
k
a
r
d
0.
6
3
%
9.
0
%
10
.
0
%
10
.
%
15
.
5
%
10
.
6
%
11
.
2
%
9.
6
%
10
.
6
0
/
0
10
.
6
%
16
.
1
%
11
.
2
%
11
.
8
%
35
Ho
m
e

De
p
o
t

3.
1
3
%
1.5
%
9.6
%
9.
5
%
11
.
2
%
9.
9
%
9.
7
%
li
6
%
1
12
.
7
%
12
.
6
%
14
.
3
%
13
.
0
%
12
.
8
%
36
Ho
n
e
e
l

I
n
t
l
3.
0
6
%
4.0
%
8.
9
%
10
.
0
%
9.
2
%
11
.
6
%
13
.
0
%
.
'
7
.
1
%
12
.
0
%
13
.
1
%
12
.
3
%
14
.
7
%
16
.
0
%
37
Ho
r
m
e
l

F
o
o
d
s
2.
2
4
%
10
.
5
%
10
.
0
%
10
.
%
9.3
%
10
.
1
%
16
.
5
%
12
.
7
%
12
.
2
%
12
.
2
%
11
.
5
%
12
.
4
%

I

1
8
.
8
%
1
38
il
i
n
o
i
s

T
o
o
l

W
o
r
k
s
2.
6
0
%
3.
0
%
3.
3
%
2.
6
%
9.
0
%
9.
9
%
7.
1
%
15
.
6
%
1
1

'

~
;
9
%
1
1

.
,
'

5
.
2
%
1
11
.
6
%
12
.
5
%
9.
7
%
39
In
t
1

B
u
s
i
e
s
s

M
a
c
h
.
1.8
1
%
10
.
5
%
9.
4
%
10
.
0
%
13
.
%
10
.
6
%
13
.
9
%
12
.
3
%
11
.
2
%
11
.
8
%
15
.
4
%
12
.
4
%
15
.
7
%
40
In
t
e
l

Co
r
p
.

3.
3
0
10
.
0
%
11
.
1
%
10
.
0
%
11
.
2
%
15
.
1
%
15
.
8
%
13
.
3
%
14
.
4
%
13
.
3
%
14
.
5
%

I

1
8
.
4
%
1
1

1
9
.
1
%
1
Ex
t
i
b
i
t
N
o
.
3
Ca
s

N
o
s
.

A
V
U
-
E
-
1
(
)
1

A
V
l
-
G
.
1
0
-
o
1
W.

A
v
e
r
a
.

A
v
i
s
t
Sc
e
d
u
l
e

6.

p
.

1

o
f

2
DC
F
M
O
D
E
L
NO
N
-
U
T
I
L
I
T

P
R

G
R
O
U
P
(a
)
(a
)
(b
)
(c
)
(d
)
(e
)
(a
)
(f
)
(f
)
(f
)
(f
)
(f
)
(f
)
Di
v
i
d
e
n
d
Gr
o
w
t

R
a
t
e
s
Co
s
t

o
f

E
q
u
i
t
y

E
s
t
i
t
e
s
Co
m
p
a
n
Xh
~
.o
Fir
s
t

Ca
l
l

~
It
~
~
.o
Fi
r
s
t

C
a
l
l
za
c
k
s
lu
~
41
lT
C
o
r
p
.
1.
6
6
%
7.
5
%
6.8
%
5.
0
%
10
.
0
%
13
.
4
%
12
.
5
%
9.
2
%
8.
5
%
~
11
.
7
%
15
.
1
%
14
.
2
%
42
Jo
h
n
o
n

&

J
o
h
n
3.
1
3
%
7.
5
%
7.
4
%
7.
0
%
7.
4
%
10
.
8
%
12
.
6
%
10
.
6
%
10
.
5
%
10
.
1
%
10
.
5
%
13
.
9
%
15
.
7
%
43
Ke
l
l
o
g
2.
8
8
%
9.
0
%
10
.
4
%
9.
0
%
9.1
%
21
.
3
%
11
.
2
%
11
.
9
%

1
3
.
3
%

1
1
.
9
%

1
2
.
0
%

I

2
4
.
2
%
1
14
.
1
%
44
Ki
b
e
r
l
y
-
e
a
r
k
3.
7
5
%
6.
0
%
11
.
0
%
11
.
0
%
9.5
%
23
.
2
%
11
.
0
%
9.
8
%

1
4
.
8
%

1
4
.
8
%

1
3
.
3
%

2
6
.
9
%
14
.
8
%
45
Kr
a
f
t

Fo
o
d
s

4.
3
2
%
6.
5
%
9.
1
%
9.
1
%
14
.
1
%
4.7
%
13
.
4
%
10
.
8
%

1
3
.
4
%

1
3
.
4
%

I

1
8
.
%
1

9
.
0
%
17
.
7
%
46
Li
l
y

(
E
l
i
)
5.
7
0
%
5.
0
%
1.
3
%
2.
2
%
3.
8
%
17
.
6
%
19
.
6
%
10
.
7
%

I

7
.
0
%
1

~

9
.
5
%

I

2
3
.
3
%
1
25
.
3
%
47
Lo
c
k
e
e

M
a
r
3.
3
4
%
11
.
5
%
9.
1
%
9.
5
%
9.1
%
19
.
8
%
25
.
9
%
14
.
8
%

1
2
.
4
%

1
2
.
8
%

1
2
.
4
%

2
3
.
1
%
29
.
2
%
48
Mc
C
o
r
m
i
c
k

&

C
o
.
2.
9
1
%
8.
5
%
10
.
0
%
20
.
0
%
10
.
0
%
13
.
2
%
11
.
9
%
11
.
4
%

1
2
.
9
%

I

2
2
.
9
%
1

1
2
.
9
%

1
6
.
1
%
14
.
8
%
49
Mc
D
o
n
a
l
d
'
s

C
o
r
p
.
3.
5
5
%
10
.
0
%
9.
4
%
9.
0
%
9.
1
%
6.
2
%
8.
9
%
13
.
6
%
13
.
0
%
12
.
6
%
12
.
7
%
9.
8
%
12
5
%
50
Mc
K
s
s
o
n

C
o
r
p
.
0.
7
5
%
9.
0
%
11
,
3
%
13
.
0
%
12
0
%
12
.
2
%
5.
8
%
9.
8
%
12
.
1
%
13
.
8
%
12
.
8
%
12
.
9
%

~
51
Me
d
t
r
i
c
,

I
n
c
.
1.
9
4
%
10
.
5
%
11
.
0
%
11
.
0
%
11
.
2
%
11
.
7
%
22
.
3
%
12
.
4
%
12
.
9
%
12
.
9
%
13
.
1
%
13
.
7
%

2
4
.
3
%
52
Mi
c
r
s
o
f
t

C
o
r
p
.
1.
9
6
%
10
.
0
%
11
.
0
%
1l
.
)
"
,
(
11
.
2
%
5.
0
%
13
.
1
%
12
.
0
%
13
.
0
%
13
.
0
%
13
.
2
%

I
6.
9
%
1
15
.
1
%
53
NI
K
E
,

I
n
c
.

'
B
'
1.
7
1
%
9.
5
%
12
.
6
%
15
.
0
%
11
.
9
%
11
.
8
%
9.
6
%
11
.
2
%
14
.
3
%
16
.
7
%
13
.
6
%
13
.
6
%
11
.
3
%
54
No
r
t
o
p

G
n
i
3.
2
7
%
9.
5
%
9.
2
%
10
.
0
%
9.
2
%
9.
6
%
21
.
5
%
12
.
8
%
12
.
5
%
13
.
3
%
12
.
5
%
12
.
9
%
24
.
8
%
55
Or
a
c
l
e

C
o
r
p
.
0.
8
7
%
11
.
5
%
12
.
8
%
12
.
5
%
13
.
1
%
8.
8
%
18
.
2
%
12
.
4
%
13
.
7
%
13
.
4
%
14
.
0
%
9.
7
%
19
.
0
%
56
Pe
p
i
C
o
,

I
n
c
.
3.
0
0
%
8.
5
%
10
.
8
%
10
.
8
%
10
.
0
%
14
.
0
%
14
.
3
%
11
.
5
%

1
3
.
8
%

1
3
.
8
%

1
3
.
0
%

I

1
7
.
0
%
1
17
.
3
%
57
Pf
i
r
,

I
n
c
.
3.9
5
%
-4
.
0
%
1.
5
%
1.
9
%
-0
.
7
%
5.
9
%
1.8
%
1'
.
,
.
1
%
1

~

~

~

9
.
8
%
5.
7
%
58
Pr
o
r

&

G
a
m
b
l
e
2.8
6
%
7.0
%
9.
3
%
10
,
0
%
8.
0
%
8.
5
%
13
.
5
%
9.9
%
12
.
2
%
12
.
9
%
10
.
9
%
11
.
4
%
16
.
4
%
59
Ra
y
t
h
e
o
n

C
o
.
2.
5
1
%
13
.
0
%
9.
0
%
9.
0
%
9.
3
%
9.
3
%
17
.
6
%
15
.
5
%
11
.
5
%

1
1
.
5
%

1
1
.
8
%

1
1
.
8
%

I
.

2
0
.
1
%
1
60
Si
g
m
a
-
A
l
d
r
i
c
h
1.
1
3
%
10
.
0
%
9.
0
%
9.
0
%
8.
0
%
18
.
1
%
8.7
%
11
.
%
10
.
1
%

1
0
.
1
%

9
.
1
%

I
.

1
9
~
2
%
1

9
.
8
%
61
St
r
k
e
r

C
o
r
p
.
1.
8
%
12
.
0
%
10
.
7
%
ID
.
%
11
.
7
%
13
.
7
%
20
.
8
%
13
.
2
%
11
.
9
%

1
1
.
6
%

1
2
.
9
%

1
4
.
9
%

1

2
2
0
%
1
62
Sy
s
c
C
o
r
p
.
3.
7
7
%
7.
0
%
15
.
0
%
15
.
0
%
15
.
0
%
9.4
%
9.
9
%
10
.
8
%
18
.
8
%

I

1
8
.
8
%
1
1

1
8
.
8
%
1

1
3
.
1
%

1
3
.
7
%
63
lJ
X

C
o
m
p
a
e
s
1.
3
1
%
13
.
5
%
12
.
4
%
12
.
0
%
12
.
5
%
14
.
3
%
11
.
4
%
14
.
8
%
13
.
7
%
13
.
3
%
13
.
8
%
15
.
6
%
12
.
7
%
64
Un
i
t
e
d

P
a
r
c
e
l

S
e
r
v
.
3.
0
9
%
1.
5
%
7.
9
%
12
.
0
%
11
.
7
%
16
.
2
%
12
.
3
%
1.
.
.
.
4
.
6
%
1
11
.
0
%
15
.
1
%
14
.
8
%

1

1
9
.
3
%
1

1
5
.
4
%
65
Un
i
t
e
d

T
e
c
h
o
l
o
g
i
e
s
2.
2
1
%
8.
0
%
10
.
2
%
10
.
0
%
8.
7
%
14
.
5
%
14
.
8
%
10
.
2
%
12
.
4
%
12
.
2
%
10
.
9
%

1
6
.
7
%

I

1
7
.
0
%
1
66
Ve
r
i
o
n

C
o
m
u
n
c
.
5.
7
9
%
4.
0
%
4.
6
%
4.
0
%
5.
3
%
5.
9
%
13
.
6
%
9.
8
%
ID
.
%
9.
8
%
11
.
1
%

1
1
.
7
%
.

1
9
.
4
%
67
Wa
l
-
M
a
r
t

S
t
o
r
e
2.
1
8
%
9.
5
%
11
.
8
%
11
.
0
0
/
"
11
.
5
%
8.
6
%
14
.
3
%
11
.
7
%
14
.
0
%
13
.
2
%
13
.
7
%
10
.
8
%
16
.
4
%
68
Wa
l
g
r

C
o
.
1.
7
%
10
.
0
%
14
.
2
%
15
.
0
%
14
.
3
%
10
.
9
%
12
.
2
%
11
.
5
%
15
.
7
%
16
.
5
%
15
.
8
%
12
.
3
%
13
.
7
%
69
Wa
s
t
e

M
a
g
e
m
e
n
t
3.
7
3
%
5.
5
%
9.
8
%
10
.
1
%
11
.
0
%
6.
4
%
6.
3
%
9.
2
%
13
.
5
%
13
.
%
14
.
7
%
10
.
1
%
10
.
0
%
Av
e
r
a
g
e

(
g
)
11
.
9
0
"
U.
6
%
12
.
8
%
12
7
%
U,
2
%
13
.
7
'
o
(a
)
ww
.
v
a
l
u
e
l
i
.
c
o
m

(
r
e
t
e
v
e
d

D
e
c

2
4
,

2
0
0
9
)
.
(b
)

T
h
o
m
s

R
e
u
t
e
r
s
,

C
o
m
p
a
n
y

i
n

C
o
n
t
e
x
t

R
e
r
t

(
D
e
c
.

23
,

2
0
0
)
.
(c
)
Fi
r
s
t

C
ø
l

E
A
r
n
i
n
g
s

V
a
l
l
U
t
i
o
n

R
e
r
t

(
D
e
c
.

2
4
,

2
0
0
)
.
(d
)
ww
.
z
a
c
k
.
c
o
m

(
r
e
b
i
e
v
e
d

D
e
c
.

2
4
,

2
0
0
)
.
(e
)
Se

S
c
u
l
e

7
.
(f
)
Su
m

o
f

d
i
v
i
d
e
n
d

y
i
e
l
d

a
n
d

r
e
v
e

g
r
w
t

r
a
t
e
.
(g
)

E
x
c
l
u
d
e
s

h
i
g
h
i
g
t
e

f
i
g
u
r
e
.
Ex
h
i
b
i
t

N
O
.
3
Ca
s
e

N
o
s
.

A
V
U
-
E
-
1
D
-
0
1

A
V
U
-
G
1
O
-
1
W.

A
v
e
r
a
.

A
v
l
s
t
a
Sc
e
d
u
l
e

6
.

p
.

2

o
f

2
SUSTAIABLE GROW1 RATE
NQN-tmlI PRox GR
(a)(a)(b)(a)(a)(a)(c)(d)
2O-U_Pr..20Zoi4 Precons
CoIlY HI 1Æ A!Ul ms ID II i
i 3M Copany $120,00 $100.0 $110.$690 $226 $2.3 67,2"23.5%
2 Abbii Labs $100,00 $8.0 $90.0 $500 $218 $21,95 564%22.8
3 Albeulve $4.00 $3.0 $4.0 $200 SU5 $16.3 77.5%12.3%
4 Allerg Inc.$110,00 $9.0 $100.0 $4.3 $0,25 $24.2 94.3%18.l
5 AT"Tlnc,$5,00 $4.0 $4.0 83.2 $200 $2,05 385%14.7'
6 Autoatc Data Pr $8,00 $1.o $7.5 $3 $1.6 $2.75 51,5%15,9%
7 _(C,R.)$ISS,OO $125.0 $140.0 $7.8 $0,94 $3.2 87,9%19,9%
8 Baxte Int1 Inc $105,00 $9.0 597.5 $6.0 $1.0 $2,00 75.8 30.5%
9 _Di $130,00 $105,00 $117.5 $7.3 $1,90 $3,85 74.%18,9%
10 Beis Co. $4,00 $3,00 837.5 S2 $1,04 $16,90 53,8%13.3'l
11 Brilol-Mye Sqbb $400 $3,00 $3.0 $1.5 SUO $10.2 28,2"19.1
12 Brownforan '8'$7,00 $6.0 $70.0 $4.0 $1.2 $2 69.8 18,6'l
13 Cardinl Health $5,00 $45.0 547.5 $2 $1,00 $2.6 64.3 11,8'l
14 Chro Co,$14000 $110,00 $125,00 $12.50 83,00 SS3,I5 76.23.5
15 OiubbCo,$8,00 $70.0 $77.5 $7,00 $1.0 $5.8 77,1'l 12.1'l
16 CA-C $9,00 $7.0 $8 83.8 $2U $16,40 44,9%23.5'l
17 CogatePaimolive $140,00 $11,00 $127.5 $6.3 $250 $17,70 60.3'l 35,6'l
18 Comer Bacs ssoo $4.0 $4,00 83,40 SUO 831,75 67,6'l 10.7
19 CoAga Foos $4,00 $3,00 835.0 S2 $0,88 $14,95 60,9%15,1%
20 CoPhllllpø $125.0 $100,00 $112.$11,85 $2 $5.0 81,4%20,1'l
21 CoIa Wh $8,00 $6,00 sn 83,75 $0.8 $2.0 78,7'12,9%
22 CV Ca..ark Corp,$7,00 $6.0 $6,00 83.6 $0,48 $3.4 86,7'10,2'l
23 Oís (Walt)$6.0 $5,00 SS7.5 83.8 $060 $2,05 84,4'l 14.2'l
24 DuPont $6,00 $5.0 $5.0 83.0 $1.92 $13.5 36Q'22,1'l
25 Eato Co, $110,00 $9.0 $100.0 $615 $2 SS.5 59.3 11.5'l
26 Ecob In $6,00 $5.0 $6,00 $315 $085 $IUS 73,Q'25.7'
7:Eme Elc $6.0 $5,00 $6 83.5 $1.5 $13.5 ' SS,7'25.6'l
28 Ev..t li Grop Ltd.$165.0 $135.0 $150.0 $15,00 $2 $116.84'l 12,9%
29 Ex Mobl Co,$125,00 $100.0 $112.59.35 $1.5 $3,70 80,2'l 24.2'l
30 Ce1 DyiCl $14500 $120.0 $~32 59.5 $250 $5.2 73,7'18,9%
31 Ce1Milis $105,00 $8.0 $9.0 SS.5 $2.45 $2,60 SS,5'1 24.%
32 Grain¡(W,W,)$140,00 $115.0 $17:.5 $7,40 $2 $42.69,5%17.5'l
33 Hei (H,J,)$7,00 $6.0 $6.0 83,90 $220 $10.5 43.6'l 36,6'l
34 Hele-lackor $800 $6.0 sn 54.5 $0,45 $2.55 9O,Q'15.8'l
35 Home De $4,00 $3.0 $4.0 $2 $1,05 $14.8 SB,Q'16.'l
36 HoneyH 1nt1 $6,00 $5,00 $6,00 83,95 $1.75 $18.5 SS,7'21.8
37 Hol Foos $7.0 $6.0 $67.5 83.8 $1.0 $2.8 68,4'l 15,9%
38 ilinois Too Wor $70,00 $5.0 $6 $3.8 $~.3 $21.3 64.%17.8'l
39 Int1 Busi.. Mach,$2,00 $180,00 S2,oo $13.2 $3.0 $2,90 77,4'l SS,4'1
40 Inte Co,$4,00 $3,00 835.$1.75 $0 59,15 S4 19,1'l
41 mCo,$9,00 $7.0 $8,00 $5 $1,24 S3.B 76,6%15,7'
42 jo" Joh $110,00 $9,00 $100,00 $6.5 $250 S2.8 61.5'l 25,1'l
43 Kelloll $8,00 $7,00 $7.5 $4.6 $I.B $13,70 609%33.6%
44 Kibey-ark $9.0 $8.0 $87.5 SS.85 $2SS $15,15 56,4%38.6'l
45 Krft Foos $5,00 $4.0 $400 $275 $1,40 $2.2 49,1'l 10.5
46 UUy(EU)$7,00 $6.0 $67.5 54.75 $2 $16.5 51.6%29.6'l
47 Loee Marn $215.00 $175.0 $195,00 $13.0 83.5 $2,75 73,1'l 57,1'l
48 McCick" Co,$6,00 $5.0 SS5.o 83,15 $1,28 $17,40 59,4'l 18,1'l
49 Mc:ald's Corp,$100.0 $8.0 $9 S5 $2 $18.2 45,7'28.8
50 McKess Corp,$9,00 $7.0 $8,00 SS,9O $0,48 S4.2 91,9%13.6'l
51 Medtrc,lnc $10000 $8.0 $9 $4.8 $0,98 $20,15 79,6'l 23.8%
52 Micr Corp,$5,00 $4,00 547.5 $265 $0.8 $7,70 69.8 34,4'l
53 NIKE, Inc '8'$100,00 $8.0 S9 SS,IO $1,50 $2,90 70,6'l 21.3'l
54 Nor Grumma $130,00 $110.0 $120,00 $8.6 $225 SS7.3 73.8%15.l
SS OradeCo,$4,00 $4.0 $42.$215 $0,30 $7,90 86 7:.2
56 Peps,ln,$115,00 $9,00 $105.0 SS,I5 $2,10 $19,45 59,2"26.5'l
57 Pfiz,lnc.$2,00 $16.0 $18,00 $1,40 $0,64 $13,45 54,3%10,4'l
58 Pr" Camble $105,00 $8,00 595.0 $4,75 $1,95 $2.0 SB,9%18.'l
59 Rayt Co,$110,00 $9,00 $1~~$6.8 $1,75 $3.6 74.'l 17.2
60 Sigma-Aldrich $8,00 $6.0 $7.0 $4,15 $0,70 $18.5 83,1'l 21,9%
61 Stke Corp,$115,00 $9.0 $105.0 $4.75 $0,72 $2,10 84.8%17.5
62 Sysc:Co,$4,00 $3.0 $4,00 $240 $1,20 $850 5O,Q'28.2
63 Tj Copaes $6,00 $5.0 $6.0 54.0 $0,75 $10,90 81.'l 36,7'
64 Un.. PaI5e,$100,00 $8.0 592.54.2 $2 $11.8 45.2 35,4'l
65 Uni.. Tecog $12000 $9.0 $107.5 $6,75 $2 $2,75 67,4'l 24.3
66 Ver Comunic $6 $5,00 $5.0 83,10 $1,96 $18.8 36.8 16,4%
67 Wal-Mart 5to $900 $7.0 $8.0 SS,45 $1.5 831,90 71.%17,1'l
68 Walgr Co $6.00 $5.0 $6.0 83.35 $0,76 $220 77.3%15.1%
69 Wast Manget $400 $4.0 $4 $2 $1.5 $16.5 46.'l 16,9%
Ex No, 3
Ca No AII-1ll Aw-1Ð-1W, A-e. Avi_7.p,1013
SUSTAIABLE GROWI RATE
NQN-irmPBXY GB
(a)(a)(e)(a)(a)(el (I)(g (h)2l 2l.1l Adua "r'
No.Coem No.CoIl Ch;"Ad~Adl.
Coy 11 5I Il 11 5I Il Il fB i
1 3M Compay 514.2 69.5 $9,876 S1.3 6800 519,95 15.1'l 1,07 252'l
2 Abb Labs,511.8 15240 517,477 $21,95 152Q $3 1~U1646 24.2
3 Albrtlver 511.3 97.8 51,11 516.92 51.s 6.1,03 12.'l
4 Aleran1n $1,19 30.Q $411 52.2 310,00 $7,5 13.3'l 1.0625 19,1'l
5 ATIoTInc 516.3 583.0 $91 $2 59,00 51305 6.2 1.0 152%
6 Autoti Data Pr $9,97 510.3 $50B $2,75 52.00 510,7 16.'l 1,07 17,1%
7 Ba (CR)519.8 99.3 5l,77 53.2 9000 $3,5 12.%l.o 2UI'I
8 Bax 1n111n 510.1 615,99 S6 $2 55,00 511.0 12.1'l 1.05 32.'l
9 Il Dick $2.3 24.0 5493 $3 227.0 SB,819 12.%i.o 2O.I
10 Be Co 513.5 99.7 51,516.0 10B 51,82 6.%1,03 13.7'
11 Brill-Mye Sqibb $620 1974.3 512,241 510.2 197.0 $2193 105 1.05 2O.I
U Bro-Fonnan '8'512,10 150,13 5um $2 145,00 $3197 12.UI565 19.6%
13 Cordlna Hel'"$21,:i 357,10 $7,749 $2.6 35.0 SB 1,6%1,00 l1,9'
14 ChvrCorp,54.2 2004.0 $8,64 $53,15 195.0 5103 3,6'l 1,0179 23.9'l
15 OibbCo,$3,13 352.513,43 $57.8 32,00 518,1 7.1 UI336 12.%
16 Co-Ca 5B.5 2312.00 $2461 516,40 2310,00 $3,8 13.'l 1,0615 24,9'
17 CoatePalmolive 53.7 SOUL 51,740 517.7 48,00 $8496 37.3%1.57 41.2
18 Come Banc,$19.79 79.6 51,51 $31,75 8500 52,11.3'l 1,057 11.3%
19 Cogr Foo 511.02 48 $5.3 514.95 42,00 56,3 3.5 1,0174 15.3%
20 CoUlps $3I1 148.2 $5,167 $59.5 150.00 $8 9,9'\.0473 21.1
21 Co Wholle $21.2 432.1 $9,191 $29.0 410,00 51l,5.3'l 1.Q7 13.3%
22 CV Coreark Co,$2,90 143.8 $338 $345 132.00 $4,97 6.%1.l12 10.5%
23 Di (Wall)517,73 1822.90 $32,32 $27,05 1610,00 54,51 6.'l 1,02 14.7
24 OuPeml $7,63 907 S6 513.85,00 511,518 10.8'l \.0514 23.3'l
25 Eato Co, 53.2 165.0 56,316 $S 1:i,OO 59,104 7.6%1,03 lI,9'
26 Ecab Inc.$665 23.2 51,71 512.24.0 S31 13.B 1,067 '1.4%
'1 Em El 511.8 771.2 $9,116 513.io.o $9,55 0.9'1.l7 25,B'
28 Evet Re Group Ltd,$7.6 65.6 54961 $116.5 60,00 $699 7,1'l UI344 13.3'l
29 Exem Mobil Corp,$2,:i 4976.0 $112,95 $3,:i'4300 $166,410 8.'l 1,03 25,1%
30 Ce1 Dyic $2.0 3871 $10.05 $5.2 36,00 $18,1 12.1.06 2O.I
31 Ce'IMllis $18.2 337.5 56,217 $2 30.0 56,7 1,7'1.00 24.5'l
32 Grainge (W,W,1 $2.2 74.7 S2 $42.65,00 5275 6.2 UI301 18.1
33 He (H.J.)$3,87 315.0 $1,219 $10,65 310.00 $3.3 22 UI993 4Q
34 Hele-Packard $16.3 2415,00 $395 $2 2100,00 $5,95 9.1 1,041 16.%
35 HomDepol $10,48 169.00 $17.774 514.8 168,00 $2,Q 7,1'l 1,03 17.4%
36 Hoelllnt'$9,78 73.5 $7.184 $18.5 715.00 $12,97 12.6'l 1,051 23
õ7 HoreiFoo.$14,92 134.52 S2 $2.8 l300 $3101 9,1%1,04 16.'l
38 D1lnl. Tool Wor $14.1 499.12 $7.192 $21.3 47500 $10.118 7,1'l 1,031 18.%
39 inri Busine Mac,$10.Q 133,10 $13.471 $290 10s00 $2,1 13,2%1,061 58,9'
40 Intel Corp,$7,03 55 53.101 $9.5 60,00 $590 7.1 1,03 19.8%
41 mCo,$16.8 181.8 $3 $3 18500 $6 15,4'l 1,074 16.%
42 Jch 10 jo $15.3 '169.2 $4 $2.8 2S00 $6.142 8,9'1,04 262'l
43 Kello $3,79 381.8 51,44 $13.:i 37,00 $513 28 1.26 õ7.B
44 K1mby.car $9,38 413.6 $3,8 $15,15 415,00 56.2 10,1%1,04 4Q
45 Krit Fo. $15,11 1469.3 $220 $2.2 140,00 $3.6 10.6'l 1.0 l1.1
46 UUy(EII;$5.93 1136,10 $673 $16.1150.00 $18.22'l 1.00 32%
47 Lo Mart $7.2 393,00 $2 $2 3300 $7,5 21.2 1,09 626'l
48 McClck &: Co,$8,11 130,10 51,05 $17,40 13,00 $2,9 17.4'l 1.1799 19.5'l
49 McDalc'. Co.$12.0 1115.3 513,3 $18.101,00 518,24 6,7'1.l 29.7'
SO McJea Corp,$2.8 '11,00 $6192 54.2 25,00 $10.98 12.1'l 1,05 14.%
51 Medtri:lnc.$11,42 1124.90 $12,$2,15 10000 $2ISO 9.4'l 1,04 24,9'
52 Mialt Co,$3,97 9151.0 S3 $7.:i 75.0 $57,75 9.7'1.0 36.1
53 NIKE, In '8'$15,93 491,10 $7,8 $2,90 46,00 510.99 7.1 1.l 221%
54 Norro Grmma $3,45 32.0 $11.92 $57.3 30,00 $17,2 7,6%1,03 1s.'l
55 OrCo,54.7 515000 $21 $7,90 430.0 $33,97 8,1%UI389 28.3
56 PesiC. Inc $7,77 155.0 $12,067 $19.5 150,00 $2,175 19.3 l.01 28.B
S7 Pfze. In $852 6746,00 $5,476 $13.4 670,00 $9.115 9,4%1_10.9'
58 Pr 10 Gamble $246 30:i 56a.14 $2,00 29,00 $7.4 2.1'l 1.002 18.5%
59 Rayt Co,$271 40,10 $9,Q 53.6 35.0 $13,8 B.1,04 17,9'
60 S1gma.Alcrich $11.2 12213 $1,3 $18,95 120,00 $274 10.5'l l.o 23.1
61 Stke Corp,$13.6 39.4 $54a $2,ID 3800 $10,3 13,9'1.0 18,7'
62 SyCo,$5.67 601.2 $340 $8 5600 54760 6,9'U1334 292%
63 TJ Compa $5,17 412.52134 $10,90 34,00 $370 11.7'1,051 38,7'
64 Unte PaKe Se,$61 99,44 56,77 $11.8 99,00 $11.732 11.6%1,05 õ7.4'1
65 Unite Tecol 516.8 !1 51S,9l $27,75 90,00 $24,97 9,4'1,04 2S4'1
66 Ver Comunle $14,68 28.6 $41.io $18.8 2820.00 55.157 5.1 1,(1 16.%
67 W.I.M.rt Sto $16.6 39.0 $6.27 $31,90 34,00 $110,o5 l1.1 1,05 lB.
68 Walgr Co 513,01 98,18 $12,86 $2 95000 $21,l 10,4%1.094 15.8'l
69 Waste Managemt $12.0 490,74 $5.90 516.46,00 $7,6 5,4'l 1,02 17,4'l
e-No,3ca No, Avu1D- AVl1CJ1W.-,A__7,p.2of3
SUSTAINABLE GROWT RATE
NON-imun PR GI
(.)(.)(I)(I)(j (I)Ø)(m)
Con SIaucl MI ....f._Co :i Zl Cw BI It Il Ii
1 3M Copa 69.5 68.00 -0.3 3.75 (0.0147)0,73 -1.0 15.8
2 Abbo Labs. 152240 1500 -0%4.0 (013)0,7561 -0.10%13.6%
3 Albever 97.8 9200 -1.2%2.45 (0.031)0.5 -1,78%8.0%
4 A11e Inc 3l.0 310.00 0.3 4,13 0.0.75 1.21%19,2%
5 ATIETlnc.58!l 59,00 0.%2.04 O.o 0.100 ll 5,9'
6 Autoti Daii Pi 510.3 52.00 Q.3,73 0.0141 0,73 1.03%9.8%
7 Bard (C,R.)99.3 90,00 .1.97 3,57 (0,07)0,7196 -5.0%114%
8 Ba_Inlllnc.615,99 550.0 -2.4%4.8 (0,109)0,799 -8.6%15,1%
9 Be Dick 243.o 22.0 -1.3%3.Q (0.011)0.-2.75 12.1%
10 Beis Co, 99.71 108.00 1.61%2.22 0.0 0.593 1.96%9.3
11 Brist.Mye Sqbb 1974.3 197,00 -0,04%141 (0005)0.70 -011%5.5%
12 Brown-Foran 'B'15o.3 145,00 -0,_3.17 (0,02)0.-1.51%12.%
13 Cardin.i He.lth 357.10 35,00 -0,12%2.(O.O)0.51 -0,12%7.6%
14 Ch Co,200420 195.00 -0%2.(0,0129)0.5748 -074%17.5
15 O1bbCo,352 32,00 .1.6 1.3 (0.Q14)G.-0%9.%
16 Co.c.2312.2310.0 -o,02 5,03 (000)0.82 -0,07%11.%
17 Colgaæ-molive 501.1 48.0 -o.ø7%7.2 (0.06)0.12 -5.3 19.5%
18 Come Banhs 79.6 85.0 1,30 1,42 0.0184 0.2 0,54%8,2%
19 Cogn Foo 4837 42.00 -2.%2.(0,06)0.n9 -346%5,9'
20 CoIUps 148 150,00 0.1,91 O.l1 0.751 0,24%17,4%
21 Co Whle 431 410,00 .1.Q%2.(002)0.6 .1.5 8.8
22 CV Cark Co,143.8 13,00 -1.6%1.83 (0.0)O,4S -1.3%7,7%
23 Disn (Walt)IB229O 1610,00 -2.45%2.13 (0,051)0.29 .2.76%9,%
24 DuPont 907 85,00 .1,19'4,06 (0.04)0.75 .3.6%4,7%
25 Eolo Corp,165,00 170.0 0.6 1,87 0.0112 0.46 0.7,6%
26 Eclob In 23 24.0 0,73%4.90 Il 0,79 2.86%229'
27 Emer Elc 77.2 70,00 .1,92%4.40 (0.)0,7/-6.52%7,ll
28 Eve Re Grop Lt,65,60 60.00 .1,77 1,29 (0,02 0.2 -0.51%10,7%
29 Exon Mobil Co,4976.43.00 .2.2.91 (0.07)0.6 .5.49 14.%
30 ee, Dymics 3871 36.0 .1,15%2.(Q.)0.620 .1.8%12,9'
31 ee'Mlli.337.5 30.0 -23%4.(0.Q)0,7621 .7,46%6,2'
32 Grolnge (W,W,)74,78 65,00 .2.76%3,01 (008)0.6 .5.57%6.9'
33 He (H,J,)3l5 310,00 -0 6.10 (O.Q97 0.8 -1.6%15.9'
34 HewetP.durd 2415.0 210000 -2.6%2.(0.0.6 -4%10.6%
35 Hom De 169.0 168.0 -0,13%2.69 (0,00)0,628 -0.2 9,9'
36 Holl Inll 73.5 71,00 -0.5%331 (00178)0.697 .1.24%11,6%
37 Hon Foo 134.5 130.00 -0,68 2.83 (0,0193)0.67 -1.2 10.1%
38 mins Too Wor 499,12 475,00 -0,99%2.93 (O.Q)0.6 -1,91%9,9'
39 Int'l Busine Moc 1339,10 105,00 -4,75%B.(0,39)0.-34,98%10,6%
40 Inte Co. 5500 60,00 1.5%3.8 0.Q 0.73 4.3%15,1%
41 rtCo,181.8 185.00 035 2.51 0.088 0.6 0.5 13.%
42 John IE Joh 2769.2 25,00 .I.B 3.87 (0,07)0,7415 .5.3%Ill
43 KeIo 381.8 375.00 -0.3%5.(0.02)0.82 .1,69 21.3
44 Klmby-.rk 413.6 41S.o 0.07 5.78 0.Q 0.8 0.%23,2%
45 lCft Foos 146.3 140,00 -0,96%1,72 (0,0165)0.178 -0.69'4,7%
46 Ully(EIi;1136,10 1150,00 0.2%421 0.0102 0.762 0,78%17,6%
47 Lo Mart 39.0 33,00 -3,43%8.5 (0,29)0.8 .26 19,8%
48 McCnnlck IE Co,130,10 13.00 0,74%3.16 0.0 0.6 1,6Q 13.%
49 McD.Id's Co,1115.3 1015.00 .I.B 4,93 (0.091)0,79 .7.3%6.
50 McKen Co,27.0 25.00 -1.2 1.5 (O.Q)0.459 .1.0 12.
51 Medtrlc Inc.112490 100.0 .23%4.7 (0.103)0,771 -8,06%11,7%
52 Mic Co,9151.0 75,00 -3,90 6,17 (0.2 0.8 -20,16%5.0
53 Nlf,In'B'491.0 46,00 .I.3 3.8 (0.0)0.7416 .3,73%11.8
54 Nor Gruan 32.01 30,00 .1.7%2.09 (0,03)0,5221 -1.87%9,6%
55 OrdeCorp.5150.0 43.0 .3.%5.3 (0,190)0.8141 .15.52%8.%
56 PeiCo, Inc.155,00 150,00 -0%5.40 (O.Q4)0.148 -3,04%14,0%
57 Pf. Inc.6746 670,00 -0,14%1.3 (0,0018)0.2 -o.l 5,9'
58 Pi IE G.mble 302.70 29,00 -0.8%3.(0.03)0,72 .2,%B.~
59 Rayt Co 40,10 35.0 -2.%2.(0,067)0,60 -4,03%93%
60 Sim.-Aldri 12213 120,00 -035%3,96 (0,0139)0.7473 -1.04%IB.%
61 Str Corp.3940 3800 -0.74%3,87 (0.Q)0.7419 .2.12'13,7%
62 5ysCo,601.2 56.0 .1.1%4,71 (0.Q)0.75 -5.2%9,4%
63 llX Copaie 412.2 34,00 -3.1%5.(0.2)0.8183 .17,1~143%
64 Unte Parce Se,99.4 9900 -011%7.81 (0,00)0.89 -0.75 16,2'
65 Unite Tecol 94 90,00 -0,91%3.8 (Oll)0,7419 -2.%14.5%
66 Vern Comunic.28.6 28,00 -0,15%2.92 (0.Q2)0,65 -0.2%5,9'
67 W.~Mart 5I 3925 34,00 .2.%2.(0,0679)0.67 -4.24%B.%
68 Walgr Co, 98.18 95,00 -01%2.70 (0.0218)0.6 .137%10,9'
69 Wast Managemt 490,74 46,00 -1.0 2.(002)0.6106 -1.6%6.%
(.)wy,v.lueln..:om (rmev De 24, 20,
(b)Ave of Hig an Lo exp m.rke pr,
(e)Copute .t (EPS. DP I EP,
(d)Copute as EP I BV
(e)Pruct of BV an No. Sh Ouislng,
(I)Flve-ear rote of ch,
(g Copute usin th fo. 2"1+5-Yr, Owge in EqIt)/+5 Yr, Ch In Eqty),
(h)Pr of yed .1" fo 2012-14.nd Adjst F.ct,
(Q Avera of High an Low expe m.rk pr divded by 202.14 BVP ExNo,3
Ol Pruct of chng In como oh.. outstadin an M/ Ratio,C.. No, All11l AV\1O-1
(I)Copute .s 1 . BIM Ratio.
W,A..,_
Ø)Pruct of ..... M\ "v",
SCIe 7. p. 3 al3
(m) Pr of .v..ge". an ad Y. plus "iv',
CAITAL ASSET PRICING MODEL
UTILIT PROXY GROUP
Market Rate of Return
Dividend Yield (a)2.5%
Growth Rate (b)8.8%
Market Return (c)11.3%
Less: Risk-Free Rate (d)
Long-term Treasury Bond Yield 4.5%
Market Rik Premium (e)6.8%
Utility Proxy Group Beta (f 0.73
Utility Proxy Group Risk Premium (g)5.0%
Plus: Rik-free Rate (d)
Long-term Treasury Bond Yield 4.5%
Implied Cost of Equity (h)9.5%
(a) Weighted average dividend yield for the dividend paying firm in the S&P 500 from
ww.valueline.com (retreved Jan. 27, 2010).
(b) Weighted average of IBES earnngs growt rates for the dividend paying firms in the S&P 50
based on data from Thomson Reters Company in Context Report ijan. 27, 2010).
(c) (a) + (b)
(d) Average yield on 20-year Treasury bonds for Januar 2010 from the Federal Reserve Board at
htt://ww.federalreserve.gov/releases/h15/data/Monthy/H15_TCMNOM_Y20.txt.
(e) (c) - (d).
(f) The Value Line Investment Survey (Nov. 27 & Dec. 25, 2009, Feb. 5, 2010).
(g) (e) x (f).
(h) (d) + (g).Exhibit NO.3
Case Nos. AVU-E-1Q-01 AVU-G-10-01
W. Avera, Avista
Schedule 8, p. 1 of 1
CAPITAL ASSET PRICING MODEL
NON-UTILITY PROXY GROUP
Market Rate of Retrn
Dividend Yield (a)2.5%
Growth Rate (b)8.8%
Market Return (e)11.3%
Less: Risk-Free Rate (d)
Long-term Treasury Bond Yield 4.5%
Market Rik Premium (e)6.8%
Non-Utiity Proxy Group Beta (0 0.79
Utility Proxy Group Risk Premium (~)5.3%
Plus: Rik-free Rate (d) ,
Long-term Treasury Bond Yield 4.5%
Implied Cost of Equity (h)9.8%
(a) Weighted average dividend yield for the dividend payig firms in the S&P 50 from
ww.valueline.com (retreved Jan. 27, 2010).
(b) Weighted average ofIBES earnngs growt rates for the dividend payig fi in the S& 50
based on data from Thomson Reuters Company in Context Reprt (Jan. 27, 2010).
(c) (a) + (b)
(d) Average yield on 20-year Treasur bonds for Januar 2010 from the Federal Reserve Board at
htt://ww.federalreserve.gov/releases/h15/data/Monthy/H15_TCMNOM- Y20.txt.
(e) (c) - (d).
(f) ww.valueline.com(retreved Dec. 24, 200).
(g) (e) x (f).
(h) (d) + (g).Exhibit NO.3
Case Nos. AVU-E-10-01 AVU-G-10-01
W. Avera, Avista
Schedule 9, p. 1 of 1
EX
P
E
C
T
E
D

E
A
I
N
G
S

A
P
P
R
O
A
C
H
UT
I
L
I
T
Y

P
R
O
X
Y

G
R
O
U
P
(a
)
(b
)
(c
)
Ex
p
e
c
t
e
d

R
e
t
u
r
n
Ad
j
u
s
t
m
e
n
t
Ad
j
u
s
t
e
d

R
e
t
u
Co
m
p
a
n
y
on

C
o
m
m
o
n

E
q
u
i
t
y
Fa
c
t
o
r
on

C
o
m
m
o
n

E
q
u
i
t
y
1
Am
e
r
e
n

C
o
r
p
.
8.
0
%
1.
0
2
9
9
8.
2
%
2
Am
e
r
i
c
a
n

E
l
e
c

P
w
r
10
.
5
%
1.
0
4
3
1
11
.
0
%
3
Av
i
s
t
a

C
o
r
p
.
8.
5
%
1.
0
2
3
2
8.
7
%
4
Bl
a
c
k

H
i
l
s

C
o
r
p
.
9.
5
%
1.
0
1
5
8
9.
6
%
5
Cl
e
c
o
C
o
r
p
.
11
.
5
%
1.
0
2
7
7
11
.
8
%
6
Co
n
s
t
e
l
l
a
t
i
o
n

E
n
e
r
g
y
9.
5
%
1.
0
8
9
3
10
.
3
%
7
DT
E

E
n
e
r
g
y

C
o
.
10
.
0
%
1.
0
2
3
3
10
.
2
%
8
Ed
i
s
o
n

I
n
t
e
r
n
a
t
i
o
n
a
l
11
.
5
%
1.
0
3
0
2
11
.
8
%
9
Em
p
i
r
e

D
i
s
t
r
i
c
t

E
l
e
c
10
.
5
%
1.
0
3
1
5
10
.
8
%
10

G
r
e
a
t

P
l
a
i
n

E
n
e
r
g
y
7.
0
%
1.
0
3
0
9
7.
2
%
11

I
D
A
C
O
R
P
,

I
n
c
.
7.
5
%
1.
0
3
6
3
7.
8
%
12

N
o
r
t
e
a
s
t

U
t
i
l
i
t
i
e
s
9.
5
%
1.
0
4
2
9.
9
%
13

P
i
n
a
c
l
e

W
e
s
t

C
a
p
i
t
a
l
9.
0
%
1.
0
2
4
3
9.
2
%
14

P
P
L
C
o
r
p
.
19
.
5
%
1.
0
3
5
2
I
20
.
2
%
1
15

P

S

E
n
t
e
r
p
r
i
e

G
r
o
u
p
15
.
5
%
1.
0
4
1
4
16
.
1
%
16

U
I
L

H
o
l
d
i
n
g
s
10
.
5
%
1.
0
3
4
5
10
.
9
%
17

W
e
s
t
a
r

E
n
e
r
g
y
7.
5
%
1.
0
3
5
0
I
7.
8
%
1
Av
e
r
a
g
e

(
d
)
10
.
7
%
(a
)

3
-
5

y
e
a
r

p
r
o
j
e
c
t
o
n
s

f
r
o
m

T
h
e

V
a
l
u
e

L
i
n
e

I
n
v
e
s
t
m
e
n
t

S
u
r
v
e
y

(
N
o
v
.

2
7

&

D
e
c
.

2
5
,

2
0
0
,

F
e
b
.

5
,

2
0
1
0
)
.
(b
)

A
d
j
u
s
t
m
e
n
t

t
o

c
o
n
v
e
r
t

y
e
a
r
-
e
n
d

"
r
"

t
o

a
n

a
v
e
r
a
g
e

r
a
t
e

o
f

r
e
t
u
r
n

f
r
o
m

S
c
h
e
d
u
l
e

5
.
(c
)

(
a
)

x

(
b
)
.
(d
)

E
x
c
l
u
d
e
s

h
i
g
h
l
g
h
t
e
d

f
i
g
u
s
.
Ex
h
i
b
i
t

N
O
.
3
Ca
s
e

N
o
s
.

A
V
U
-
E
-
1
Q
-
0
1

A
V
U
-
G
-
1
0
-
o
1
W.

A
v
e
r
a
,

A
v
i
s
t
a
Sc
h
e
d
u
l
e

1
0
,

p
.

1

o
f

1