20121011Avera DI.pdf

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]

BEFORE THE IDAHO PUBLIC UTILITIES COMMISSION

IN THE MATTER OF THE APPLICATION ) CASE NO. AVU-E-12-08
OF AVISTA CORPORATION FOR THE ) CASE NO. AVU-G-12-07
AUTHORITY TO INCREASE ITS RATES )
AND CHARGES FOR ELECTRIC AND ) DIRECT TESTIMONY
NATURAL GAS SERVICE TO ELECTRIC ) OF
AND NATURAL GAS CUSTOMERS IN THE ) WILLIAM E. AVERA
STATE OF IDAHO )
)

FOR AVISTA CORPORATION

(ELECTRIC AND NATURAL GAS)

DIRECT TESTIMONY OF WILLIAM E. AVERA

TABLE OF CONTENTS

I. INTRODUCTION ............................................. 1
A. Overview ............................................. 1
B. Summary of Conclusions ............................... 4
II. RISKS OF AVISTA .......................................... 8
A. Operating Risks ...................................... 8
B. Impact of Capital Market Conditions ................. 16
C. Support For Avista‟s Credit Standing ................ 21
D. Capital Structure ................................... 25
III. CAPITAL MARKET ESTIMATES .............................. 32
A. Overview ............................................ 32
B. Results of Quantitative Analyses .................... 35
C. Flotation Costs ..................................... 49
IV. RETURN ON EQUITY RECOMMENDATION ......................... 52

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 DCF Model – Non-Utility Proxy
Group
Schedule - 7 – Sustainable Growth Rate – Non-Utility Proxy
Group
Schedule - 8 – Capital Asset Pricing Model
Schedule - 9 – Electric Utility risk Premium
Schedule - 10 – Expected Earnings Approach

Avera, Di 1
Avista Corporation

I. INTRODUCTION 1
Q. Please state your name and business address. 2
A. William E. Avera, 3907 Red River, Austin, Texas, 3
78751. 4
Q. In what capacity are you employed? 5
A. I am the President of FINCAP, Inc., a firm 6
providing financial, economic, and policy consulting 7
services to business and government. 8
Q. Please describe your educational background and 9
professional experience. 10
A. A description of my background and 11
qualifications, including a resume containing the details 12
of my experience, is attached as Schedule 1. 13
A. Overview 14
Q. What is the purpose of your testimony in this 15
case? 16
A. The purpose of my testimony is to present to the 17
Idaho Public Utility Commission (the “Commission” or 18
“IPUC”) my independent evaluation of the fair rate of 19
return on equity (“ROE”) for the jurisdictional electric 20
and gas utility operations of Avista Corp. (“Avista” or 21
“the Company”). In addition, I also examined the 22
Avera, Di 2
Avista Corporation

reasonableness of Avista‟s capital structure, considering 1
both the specific risks faced by the Company and other 2
industry guidelines. 3
Q. Please summarize the information and materials 4
you relied on to support the opinions and conclusions 5
contained in your testimony. 6
A. To prepare my testimony, I used information from 7
a variety of sources that would normally be relied upon by 8
a person in my capacity. I am familiar with the 9
organization, finances, and operations of Avista from my 10
participation in prior proceedings before the IPUC, the 11
Washington Utilities and Transportation Commission, and 12
the Public Utility Commission of Oregon. In connection 13
with the present filing, I considered and relied upon 14
corporate disclosures, publicly available financial 15
reports and filings, and other published information 16
relating to Avista. I also reviewed information relating 17
generally to current capital market conditions and 18
specifically to current investor perceptions, 19
requirements, and expectations for Avista‟s utility 20
operations. These sources, coupled with my experience in 21
the fields of finance and utility regulation, have given 22
Avera, Di 3
Avista Corporation

me a working knowledge of the issues relevant to 1
investors‟ required return for Avista, and they form the 2
basis of my analyses and conclusions. 3
Q. What is the role of the rate of return on common 4
equity in setting a utility's rates? 5
A. The ROE serves to compensate common equity 6
investors for the use of their capital to finance the 7
plant and equipment necessary to provide utility service. 8
Investors commit capital only if they expect to earn a 9
return on their investment commensurate with returns 10
available from alternative investments with comparable 11
risks. To be consistent with sound regulatory economics 12
and the standards set forth by the U.S. Supreme Court in 13
the Bluefield1 and Hope2 cases, a utility‟s allowed ROE 14
should be sufficient to: 1) fairly compensate the 15
utility‟s investors, 2) enable the utility to offer a 16
return adequate to attract new capital on reasonable 17
terms, and 3) maintain the utility‟s financial integrity. 18

1 Bluefield Water Works & Improvement Co. v. Pub. Serv. Comm'n, 262 U.S. 679 (1923). 2 Fed. Power Comm'n v. Hope Natural Gas Co., 320 U.S. 591 (1944).
Avera, Di 4
Avista Corporation

Q. How did you go about developing your conclusions 1
regarding a fair rate of return for Avista? 2
A. I first reviewed the operations and finances of 3
Avista and industry-specific risks and capital market 4
uncertainties perceived by investors. With this as a 5
background, I conducted various well-accepted quantitative 6
analyses to estimate the current cost of equity, including 7
alternative applications of the discounted cash flow 8
(“DCF”) model and the Capital Asset Pricing Model 9
(“CAPM”), an equity risk premium approach based on allowed 10
rates of return, as well as reference to expected earned 11
rates of return for utilities. Based on the cost of 12
equity estimates indicated by my analyses, the Company‟s 13
ROE was evaluated taking into account the specific risks 14
and potential challenges for Avista‟s utility operations 15
in Idaho, as well as other factors (e.g., flotation costs) 16
that are properly considered in setting a fair ROE for the 17
Company. 18
B. Summary of Conclusions 19
Q. What are your findings regarding the 10.9 20
percent ROE requested by Avista? 21
A. Based on the results of my analyses and the 22
economic requirements necessary to support continuous 23
Avera, Di 5
Avista Corporation

access to capital under reasonable terms, I determined 1
that 10.9 percent is a fair and reasonable estimate of 2
investors‟ required ROE for Avista. The bases for my 3
conclusion are summarized below: 4
In order to reflect the risks and prospects 5
associated with Avista‟s jurisdictional utility 6
operations, my analyses focused on a proxy group of 7
other utilities with comparable investment risks. 8
Consistent with the fact that utilities must 9
compete for capital with firms outside their own 10
industry, I also referenced a proxy group of low-11
risk companies in the non-utility sector of the 12
economy; 13
Because investors‟ required return on equity is 14
unobservable and no single method should be viewed 15
in isolation, I applied the DCF, CAPM, and risk 16
premium methods, as well as the expected earnings 17
approach, to estimate a fair ROE for Avista; 18
Based on the results of these analyses, and giving 19
less weight to extremes at the high and low ends of 20
the range, I concluded that the cost of equity for 21
the proxy group of utilities is in the 10.0 percent 22
to 11.4 percent range, or 10.2 percent to 11.6 23
percent after incorporating an adjustment to 24
account for the impact of common equity flotation 25
costs; and, 26
As reflected in the testimony of Company witness 27
Mr. Thies, Avista is requesting a fair ROE of 10.9 28
percent, which is equal to the midpoint of my 29
recommended range. Considering capital market 30
expectations, the exposures faced by Avista, and 31
the economic requirements necessary to maintain 32
financial integrity and support additional capital 33
investment even under adverse circumstances, it is 34
my opinion that 10.9 percent represents a fair and 35
reasonable ROE for Avista. 36
Avera, Di 6
Avista Corporation

Q. What other evidence did you consider in 1
evaluating your ROE recommendation in this case? 2
A. My recommendation is reinforced by the following 3
findings: 4
The reasonableness of a 10.9 percent ROE for Avista 5
is supported by the need to consider the challenges 6
to the Company‟s credit standing: 7
o The pressure of funding significant capital 8
expenditures of $1.2 billion in the next five 9
years, given that the Company‟s current rate 10
base is $2.2 billion, coupled with increased 11
operating risks, heighten the uncertainties 12
associated with Avista; 13
o Because of Avista‟s reliance on hydroelectric 14
generation and increasing dependence on 15
natural gas fueled capacity, the Company is 16
exposed to relatively greater risks of power 17
cost volatility, even with the power cost 18
adjustment (“PCA”); and, 19
o My conclusion that a 10.9 percent ROE for 20
Avista is a reasonable estimate of investors‟ 21
required return is also reinforced by the 22
greater uncertainties associated with Avista‟s 23
relatively small size and the fact that 24
current cost of capital estimates are likely 25
to understate investors‟ requirements at the 26
time the outcome of this proceeding becomes 27
effective and beyond. 28
Sensitivity to financial market and regulatory 29
uncertainties has increased dramatically and 30
investors recognize that constructive regulation is 31
a key ingredient in supporting utility credit 32
standing and financial integrity; and, 33
Providing Avista with the opportunity to earn a 34
return that reflects these realities is an 35
essential ingredient to support the Company‟s 36
financial position, which ultimately benefits 37
Avera, Di 7
Avista Corporation

customers by ensuring reliable service at lower 1
long-run costs. 2
Continued support for Avista‟s financial integrity, 3
including a reasonable ROE, is imperative to ensure 4
that the Company has the capability to maintain an 5
investment grade rating while confronting potential 6
challenges associated with funding infrastructure 7
development necessary to meet the needs of its 8
customers. 9
Q. What is your conclusion as to the reasonableness 10
of the Company’s capital structure? 11
A. Based on my evaluation, I concluded that a 12
common equity ratio of 50.0 percent represents a 13
reasonable basis from which to calculate Avista‟s overall 14
rate of return. This conclusion was based on the 15
following findings: 16
Avista‟s requested capitalization is consistent 17
with the Company‟s need to maintain its credit 18
standing and financial flexibility as it seeks to 19
raise additional capital to fund significant system 20
investments and meet the requirements of its 21
service territory; 22
Avista‟s proposed common equity ratio is entirely 23
consistent with the 49.0 percent and 50.1 percent 24
average common equity ratios for the proxy 25
utilities, based on year-end 2011 data and near-26
term expectations, respectively; and, 27
The requested capitalization reflects the 28
importance of an adequate equity layer to 29
accommodate Avista‟s operating risks and the 30
pressures of funding significant capital 31
investments. This is reinforced by the need to 32
consider the impact of uncertain capital market 33
conditions, as well as off-balance sheet 34
Avera, Di 8
Avista Corporation

commitments such as purchased power agreements, 1
which carry with them some level of imputed debt. 2
II. RISKS OF AVISTA 3
Q. What is the purpose of this section? 4
A. As a predicate to my capital market analyses, 5
this section examines the investment risks that investors 6
consider in evaluating their required rate of return for 7
Avista. 8
A. Operating Risks 9
Q. How does Avista’s generating resource mix affect 10
investors’ risk perceptions? 11
A. Because over 40 percent of Avista‟s total energy 12
requirements are provided by hydroelectric facilities, the 13
Company is exposed to a level of uncertainty not faced by 14
most utilities. While hydropower confers advantages in 15
terms of fuel cost savings and diversity, reduced 16
hydroelectric generation due to below-average water 17
conditions forces Avista to rely more heavily on wholesale 18
power markets or more costly thermal generating capacity 19
to meet its resource needs. As Standard & Poor‟s 20
Corporation (“S&P”) has observed: 21
A reduction in hydro generation typically 22
increases an electric utility‟s costs by 23
requiring it to buy replacement power or run 24
more expensive generation to serve customer 25
Avera, Di 9
Avista Corporation

loads. Low hydro generation can also reduce 1
utilities‟ opportunity to make off-system sales. 2
At the same time, low hydro years increase 3
regional wholesale power prices, creating 4
potentially a double impact – companies have to 5
buy more power than under normal conditions, 6
paying higher prices.3 7
Investors recognize that volatile energy markets, 8
unpredictable stream flows, and Avista‟s reliance on 9
wholesale purchases to meet a significant portion of its 10
resource needs can expose the Company to the risk of 11
reduced cash flows and unrecovered power supply costs. 12
S&P noted that Avista, along with Idaho Power Company, 13
“face the most substantial risks despite their PCAs and 14
cost-update mechanisms,”4 and concluded that Avista‟s 15
“chief risks are the electric utility‟s exposure to 16
replacement power costs (particularly in low water 17
years).”5 Similarly, Moody‟s Investors Service (“Moody‟s”) 18
concluded, “Avista‟s high dependency on hydro resources 19
(approximately 50% of its production comes from hydro 20
fueled electric generation resources) is viewed as a 21
supply concentration risk (which also lends to the 22
potential for metric volatility, especially since hydro 23

3 Standard & Poor’s Corporation, “Pacific Northwest Hydrology And Its Impact On Investor-Owned
Utilities’ Credit Quality,” RatingsDirect (Jan. 28, 2008). 4 Id. 5 Standard & Poor’s Corporation, “Summary: Avista Corp,” RatingsDirect (Jan. 26, 2012).
Avera, Di 10
Avista Corporation

levels, due to weather, is a factor outside of 1
management's control.”6 2
Additionally, Avista has become increasingly reliant 3
on natural gas fired generating capacity to meet base-load 4
needs. Given the significant price fluctuations 5
experienced in energy markets discussed subsequently, 6
increasing reliance on natural gas heightens Avista‟s 7
exposure to fuel cost volatility. 8
Q. Does Avista anticipate the need to access the 9
capital markets going forward? 10
A. Yes. Avista will require capital investment to 11
meet customer growth, provide for necessary maintenance, 12
and fund new investment in electric generation, 13
transmission and distribution facilities. Utility capital 14
additions are expected to total approximately $1.2 billion 15
through 2016. This represents a substantial investment 16
given Avista‟s current rate base of $2.2 billion. 17
Continued support for Avista‟s financial integrity 18
and flexibility will be instrumental in attracting the 19
capital necessary to fund these projects in an effective 20
manner. Avista‟s reliance on purchased power to meet 21

6 Moody’s Investors Service, “Credit Opinion: Avista Corp.,” Global Credit Research (Mar. 17, 2011).
Avera, Di 11
Avista Corporation

shortfalls in hydroelectric generation magnifies the 1
importance of strengthening financial flexibility, which 2
is essential to guarantee access to the cash resources and 3
interim financing required to cover inadequate operating 4
cash flows, as well as fund required investments in the 5
utility system. 6
Q. Is the potential for energy market volatility an 7
ongoing concern for investors? 8
A. Yes. In recent years utilities and their 9
customers have had to contend with dramatic fluctuations 10
in fuel costs due to ongoing price volatility in the spot 11
markets, and investors recognize the potential for further 12
turmoil in energy markets. In times of extreme 13
volatility, utilities can quickly find themselves in a 14
significant under-recovery position with respect to power 15
costs, which can severely stress liquidity. 16
While current expectations for significantly lower 17
wholesale power prices reflect weaker fundamentals 18
affecting current load and fuel prices, investors 19
recognize the potential that such trends could quickly 20
reverse. For example, recurring political crises in the 21
Middle East have led to sharp increases in petroleum 22
Avera, Di 12
Avista Corporation

prices. Moody‟s concluded that utilities remain exposed 1
to fluctuations in energy prices, observing, “This view, 2
that commodity prices remain low, could easily be proved 3
incorrect, due to the evidence of historical volatility.”7 4
Fitch observed that market conditions will likely result 5
in higher natural gas prices, and noted the utility 6
industry‟s potential exposure to future price shocks.8 7
Q. What other financial pressures impact investors’ 8
risk assessment of Avista? 9
A. Investors are aware of the financial and 10
regulatory pressures faced by utilities associated with 11
rising costs and the need to undertake significant capital 12
investments. S&P noted that cost increases and capital 13
projects, along with uncertain load growth, were a 14
significant challenge to the utility industry.9 As Moody‟s 15
observed: 16
[W]e also see the sector‟s overall business risk 17
and operating risks increasing, owing primarily 18
to rising costs associated with upgrading and 19

7 Moody’s Investors Service, “U.S. Electric Utilities: Uncertain Times Ahead; Strengthening Balance
Sheets Now Would Protect Credit,” Special Comment (Oct. 28, 2010). 8 Fitch Ratings Ltd., 2012 Outlook: Utilities, Power, and Gas,” Outlook Report (Dec. 5, 2011). 9 Standard & Poor’s Corporation, “Industry Economic And Ratings Outlook,” RatingsDirect (Feb. 2,
2010).
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Avista Corporation

expanding the nation‟s trillion dollar electric 1
infrastructure.10 2
While enhancing the infrastructure necessary to meet the 3
energy needs of customers is certainly desirable, the 4
magnitude of the associated capital expenditures imposes 5
additional financial responsibilities that are heightened 6
during times of capital market turmoil. As S&P recently 7
noted: 8
To fund future capital spending, companies 9
will need access to external capital markets 10
for incremental funding beyond their 11
internally generated cash – and maintaining 12
solid credit quality will help them do so in 13
a cost-effective and timely manner. … With 14
the anticipated rise in capital spending 15
needs, maintaining access to both the debt 16
and equity markets, at favorable terms, will 17
be crucial for these companies.11 18
As noted earlier, the Company‟s plans include 19
electric utility capital expenditures of approximately 20
$1.2 billion million through 2016, and Moody‟s has noted 21
that Avista‟s primary challenge is related to cost 22
recovery of increasing capital investment.12 Investors are 23
aware of the challenges posed by rising costs and 24

10 Moody’s Investors Service, “Regulation Provides Stability As Risks Mount,” Industry Outlook (Jan.
19, 2011). 11 Standard & Poor’s Corporation, “U.S. Utilities’ Capital Spending Is Rising, And Cost Recovery Is
Vital,” RatingsDirect (May 14, 2012). 12 Moody’s Investors Service, “Credit Opinion: Avista Corp.,” Global Credit Research (Mar. 20, 2012).
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Avista Corporation

burdensome capital expenditure requirements, especially in 1
light of ongoing capital market and economic 2
uncertainties. 3
Q. What other considerations affect investors’ 4
evaluation of Avista? 5
A. Investors also recognize that utilities are 6
confronting increased environmental pressures that could 7
impose significant uncertainties and costs. Moody‟s noted 8
that, “the sector is exposed to increasingly stringent 9
environmental mandates.”13 While the momentum for carbon 10
emissions legislation has slowed, expectations for 11
eventual regulations continue to pose uncertainty. Fitch 12
recently noted that it, “expects the thrust of the EPA‟s 13
agenda will continue to challenge the creditworthiness of 14
issuers in the utility and power sector.”14 15
Q. Would investors consider Avista’s relative size 16
in their assessment of the Company’s risks and prospects? 17
A. Yes. A firm‟s relative size has important 18
implications for investors in their evaluation of 19
alternative investments, and it is well established that 20

13 Moody’s Investors Service, “Regulation Provides Stability As Risks Mount,” Industry Outlook
(Jan. 19, 2011).
14 Fitch Ratings Ltd., New EPA Rules: Ready or Not,” Special Report (Mar. 1, 2012).
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Avista Corporation

smaller firms are more risky than larger firms. With a 1
market capitalization of approximately $1.6 billion, 2
Avista is one of the smallest publicly traded utility 3
companies followed by The Value Line Investment Survey 4
(“Value Line”), which have an average capitalization of 5
approximately $9.3 billion.15 6
The magnitude of the size disparity between Avista 7
and other firms in the utility industry has important 8
practical implications with respect to the risks faced by 9
investors. All else being equal, it is well accepted that 10
smaller firms are more risky than their larger 11
counterparts, due in part to their relative lack of 12
diversification and lower financial resiliency.16 These 13
greater risks imply a higher required rate of return, and 14
there is ample empirical evidence that investors in 15
smaller firms realize higher rates of return than in 16
larger firms.17 Common sense and accepted financial 17
doctrine hold that investors require higher returns from 18

15 www.valueline.com (retrieved Jul. 17, 2012). 16 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 Management (Summer 1978). 17 See for example Rolf W. Banz, “The Relationship Between Return and Market Value of Common
Stocks”, Journal of Financial Economics (September 1981) at 16.
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Avista Corporation

smaller companies, and unless that compensation is 1
provided in the rate of return allowed for a utility, the 2
legal tests embodied in the Hope and Bluefield cases 3
cannot be met. 4
B. Impact of Capital Market Conditions 5
Q. What are the implications of recent capital 6
market conditions? 7
A. As Value Line recently recognized, “It has been 8
a turbulent year for the financial markets, to say the 9
least.”18 Investors have faced a myriad of challenges and 10
uncertainties, including political brinkmanship over 11
raising the federal debt ceiling and S&P‟s subsequent 12
downgrade of its U.S. sovereign debt rating. The 13
sovereign debt crisis in Europe has also dealt a harsh 14
blow to investor confidence, and concerns over potential 15
exposure to a Euro-zone default continue to undermine 16
confidence in the financial and banking sector.19 17
Meanwhile, speculation that the economy remains exposed to 18
a potential “double-dip” recession persists, with 19
unemployment remaining stubbornly high, lackluster 20

18 The Value Line Investment Survey at 541 (Dec. 9, 2011). 19 See, e.g., Standard & Poor’s Corporation, “U.S. Risks To The Forecast: Choppy Seas,” RatingsDirect
(Dec. 21, 2011).
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Avista Corporation

consumer confidence, rising petroleum prices, and 1
continued weakness plaguing the real estate sector. 2
Investors have had to confront ongoing fluctuations 3
in share prices and stress in the credit markets,20 and in 4
response have repeatedly fled to the safety of U.S. 5
Treasury bonds. As Fidelity Investments recently reported 6
to investors: 7
It‟s been quite a year, one of violent mood 8
swings but little overall direction. We seem to 9
be in a time warp where everything happens 10
faster and faster. Everything seems to be 11
correlated. There are very few places to hide, 12
and even those places don‟t feel like good 13
options anymore.21 14
Fidelity Investments concluded that, “2012 will offer more 15
of the same, with significant ups and downs driven by 16
three major factors: Europe, China, and the U.S.”22 17
The dramatic rise in the price of gold also attests 18
to investors‟ heightened concerns over prospective 19
challenges and risks, including the overhanging threat of 20
inflation and renewed economic turmoil. Fidelity 21
Investments noted that, “The sovereign debt crisis in the 22

20 See, e.g., Gongloff, Mark, “Stock Rebound Is a Crisis Flashback – Late Surge Recalls Market’s
Volatility at Peak of Credit Difficulties; Unusual Correlations,” Wall Street Journal at B1 (Feb. 6, 2010);
Lauricella, Tom, “Stocks Nose-Dive Amid Global Fears – Weak Outlook, Government Debt Worries
Drive Dow’s Biggest Point Drop Since ’08,” Wall Street Journal at A1 (Aug. 5, 2011). 21 Fidelity Investments, “2012 markets: Expect ups and downs,” Fidelity Viewpoints (Dec. 21, 2011). 22 Id.
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Avista Corporation

Eurozone remains at the epicenter of the financial 1
markets.”23 With respect to utilities, Moody‟s noted the 2
dangers to credit availability associated with exposure to 3
European banks,24 and concluded: 4
Over the past few months, we have been reminded 5
that global financial markets, which are still 6
receiving extraordinary intervention benefits by 7
sovereign governments, are exposed to turmoil. 8
Access to the capital markets could therefore 9
become intermittent, even for safer, more 10
defensive sectors like the power industry.25 11
Uncertainties surrounding economic and capital market 12
conditions heighten the risks faced by utilities, which, 13
as described earlier, face a variety of operating and 14
financial challenges. 15
Q. How do interest rates on long-term bonds compare 16
with those projected for the next few years? 17
A. Table WEA-1 below compares current interest 18
rates on 30-year Treasury bonds, triple-A rated corporate 19
bonds, and double-A rated utility bonds with near-term 20
projections from the Value Line, IHS Global Insight, Blue 21

23 Id.
24 Moody’s Investors Service, “Electric Utilities Stable But Face Increasing Regulatory Uncertainty,”
Industry Outlook (Jul. 22, 2010). 25 Moody’s Investors Service, “Regulation Provides Stability As Risks Mount,” Industry Outlook (Jan.
19, 2011).
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Avista Corporation

Chip Financial Forecasts (“Blue Chip”), and the Energy 1
Information Administration (“EIA”): 2
TABLE WEA-1 3
INTEREST RATE TRENDS 4
Current (a)2013 2014 2015 2016 2017
30-Yr. Treasury
Value Line (b)2.9%3.7%4.0%4.6%5.0%--
IHS Global Insight (c)2.9%3.7%4.1%4.6%5.4%5.5%
Blue Chip (d)2.9%3.7%4.2%4.9%5.3%5.5%
AAA Corporate
Value Line (b)3.7%4.4%4.7%5.5%6.0%
IHS Global Insight (c)3.7%4.4%4.7%5.5%6.2%6.3%
Blue Chip (d)3.7%4.4%4.9%5.6%6.0%6.2%
S&P (e)3.7%4.0%4.7%5.5%
AA Utility
IHS Global Insight (c)3.9%4.8%5.2%6.0%6.7%6.9%
EIA (f)3.9%5.0%5.8%6.7%7.0%7.1%
(a)
(b)Value Line Investment Survey, Forecast for the U.S. Economy (Aug. 24, 2012)
(c)IHS Global Insight, U.S. Economic Outlook at 19 (May 2012)
(d)Blue Chip Financial Forecasts, Vol. 31, No. 6 (Jun. 1, 2012)
(e)
(f)Energy Information Administration, Annual Energy Outlook 2012 (Jun. 25, 2012)
Based on monthly average bond yields for the six-month period Mar. 2012 - Aug. 2012
reported at www.credittrends.moodys.com and http://www.federalreserve.gov/releases
Standard & Poor's Corporation, "U.S. Economic Forecast: Keeping The Ball In Play,"
RatingsDirect (Aug. 17, 2012)

As evidenced above, there is a clear consensus that the 5
cost of long-term capital will be higher through 2016 than 6
it is currently. As a result, current cost of capital 7
estimates are likely to understate investors‟ requirements 8
at the time the outcome of this proceeding becomes 9
effective and beyond. 10
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Avista Corporation

Q. What do these events imply with respect to the 1
ROE for Avista? 2
A. While conditions in the economy and capital 3
markets appear to have stabilized – at least for the 4
moment – no one knows the future of our complex global 5
economy. Investors continue to react swiftly and 6
negatively to any signs of future trouble in the financial 7
system or economy, and this climate has important 8
implication with respect to the fair ROE for Avista. The 9
fact remains that the electric utility industry requires 10
significant new capital investment. Given the importance 11
of reliable electric utility service, it would be unwise 12
to ignore investors‟ increased sensitivity to risk and 13
future capital market trends in evaluating a fair ROE in 14
this case. 15
Q. Does the prospect for continued turmoil in 16
capital markets also influence the appropriate capital 17
structure for Avista? 18
A. Yes. Financial flexibility plays a crucial role 19
in ensuring the wherewithal to meet funding needs, and 20
utilities with higher financial leverage may be foreclosed 21
from additional borrowing, especially during times of 22
stress. Fitch highlighted this exposure: 23
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Avista Corporation

Capital Markets Freeze: Significant tightening 1
or loss of capital markets and bank access would 2
have a deleterious affect on sector 3
creditworthiness in the face of high capex 4
budgets.26 5
As a result, the Company‟s capital structure must maintain 6
a capital structure at an appropriate level in order to 7
maintain continuous access to capital even during times of 8
unfavorable market conditions. 9
C. Support For Avista’s Credit Standing 10
Q. What credit ratings have been assigned to 11
Avista? 12
A. S&P has assigned Avista a corporate credit 13
rating of “BBB”, while Moody‟s has set Avista‟s Issuer 14
Rating at “Baa2”.27 15
Q. What are the implications for Avista, given the 16
potential for further dislocations in the capital markets? 17
A. Continued support for Avista‟s financial 18
integrity and credit standing is imperative to ensure the 19
Company‟s capability to confront potential challenges. 20
Fitch observed that when credit market conditions are 21
unsettled, “„flight to quality‟ is selective within the 22

26 Fitch Ratings Ltd., “2012 Outlook: Utilities, Power, and Gas,” Outlook Report (Dec. 5, 2011). 27 Moody’s Investor Services, “Rating Action: Moody's Upgrades Avista's Ratings to Baa2,” Global
Credit Research (Mar. 2011).
Avera, Di 22
Avista Corporation

[utility] sector, favoring companies at higher rating 1
levels.”28 As Avista has experienced, the negative impact 2
of declining credit quality on a utility's capital costs 3
and financial flexibility becomes more pronounced as debt 4
ratings move down the scale from investment to non-5
investment grade. As the Chairman of the New York State 6
Public Service Commission noted in his role as spokesman 7
for the National Association of Regulatory Utility 8
Commissioners: 9
While there is a large difference between A and 10
BBB, there is an even brighter line between 11
Investment Grade (BBB-/Baa3 bond ratings by 12
S&P/Moody‟s, and higher) and non-Investment 13
Grade (Junk) (BB+/Ba1 and lower). The cost of 14
issuing non-investment grade debt, assuming the 15
market is receptive to it, has in some cases 16
been hundreds of basis points over the yield on 17
investment grade securities. To me this 18
suggests that you do not want to be rated at the 19
lower end of the BBB range because an unexpected 20
shock could move you outside the investment 21
grade range.29 22
The pressures of significant capital expenditure 23
requirements reinforce the importance of supporting 24
continued improvement in Avista‟s credit standing. 25
Investors understand from past experience in the utility 26

28 Fitch Ratings Ltd., “U.S. Utilities, Power, and Gas 2010 Outlook,” Global Power North America
Special Report (Dec. 4, 2009). 29 Brown, George, “Credit and Capital Issues Affecting the Electric Power Industry,” Federal Energy
Regulatory Commission Technical Conference (Jan. 13, 2009).
Avera, Di 23
Avista Corporation

industry that large capital needs can lead to significant 1
deterioration in financial integrity that can constrain 2
access to capital, especially during times of unfavorable 3
capital market conditions. Considering the uncertain 4
state of financial markets, competition with other 5
investment alternatives, and investors‟ sensitivity to the 6
potential for market volatility, greater credit strength 7
is a key ingredient in maintaining access to capital at 8
reasonable cost. 9
As Mr. Thies confirms in his testimony, continued 10
regulatory support will be a key driver in Avista‟s 11
financial health, which serves as a critical backstop in 12
the event of a recurring capital market crisis or other 13
operating challenges, such as poor hydro conditions or 14
increased capital outlays. 15
Q. What role does regulation play in ensuring that 16
Avista has access to capital under reasonable terms and on 17
a sustainable basis? 18
A. The major rating agencies have warned of 19
exposure to uncertainties associated with political and 20
regulatory developments. Investors recognize that 21
constructive regulation is a key ingredient in supporting 22
utility credit ratings and financial integrity, 23
Avera, Di 24
Avista Corporation

particularly during times of adverse conditions. With 1
respect to Avista specifically, the major bond rating 2
agencies have explicitly cited the potential that adverse 3
regulatory rulings could compromise the Company‟s credit 4
standing, with Moody‟s concluding that, “Avista‟s ratings 5
could be negatively impacted if the level of regulatory 6
support wanes.”30 S&P observed that management of Avista‟s 7
regulatory relationships “is a crucial tenet” underpinning 8
the Company‟s risk profile.31 9
Further strengthening Avista‟s financial integrity is 10
imperative to ensure that the Company has the capability 11
to maintain an investment grade rating while confronting 12
large capital expenditures and other potential challenges. 13
Q. Do customers benefit by enhancing the utility’s 14
financial flexibility? 15
A. Yes. While providing an ROE that is sufficient 16
to maintain Avista‟s ability to attract capital, even in 17
times of financial and market stress, is consistent with 18
the economic requirements embodied in the U.S. Supreme 19
Court‟s Hope and Bluefield decisions, it is also in 20

30 Moody’s Investors Service, “Credit Opinion: Avista Corp.,” Global Credit Research (Mar. 30, 2012). 31 Standard & Poor’s Corporation, “Avista Corp.,” RatingsDirect (Jul. 19, 2012).
Avera, Di 25
Avista Corporation

customers‟ best interests. Customers and the service area 1
economy enjoy the benefits that come from ensuring that 2
the utility has the financial wherewithal to take whatever 3
actions are required to ensure reliable service. 4
D. Capital Structure 5
Q. Is an evaluation of the capital structure 6
maintained by a utility relevant in assessing its return 7
on equity? 8
A. Yes. Other things equal, a higher debt ratio, 9
or lower common equity ratio, translates into increased 10
financial risk for all investors. A greater amount of 11
debt means more investors have a senior claim on available 12
cash flow, thereby reducing the certainty that each will 13
receive his contractual payments. This increases the 14
risks to which lenders are exposed, and they require 15
correspondingly higher rates of interest. From common 16
shareholders‟ standpoint, a higher debt ratio means that 17
there are proportionately more investors ahead of them, 18
thereby increasing the uncertainty as to the amount of 19
cash flow, if any, that will remain. 20
Avera, Di 26
Avista Corporation

Q. What common equity ratio is implicit in Avista’s 1
requested capital structure? 2
A. Avista‟s capital structure is presented in the 3
testimony of Mr. Thies. As summarized in his testimony, 4
the pro-forma common equity ratio used to compute Avista‟s 5
overall rate of return is 50.0 percent in this filing. 6
Q. What was the average capitalization maintained 7
by the Utility Proxy Group? 8
A. As shown on Schedule 3, for the firms in the 9
Utility Proxy Group, common equity ratios at December 31, 10
2011 ranged between 32.5 percent and 60.9 percent and 11
averaged 49.0 percent. 12
Q. What capitalization is representative for the 13
proxy group of utilities going forward? 14
A. As shown on Schedule 3, Value Line expects an 15
average common equity ratio for the proxy group of 16
utilities of 50.1 percent for its three-to-five year 17
forecast horizon, with the individual common equity ratios 18
ranging from 35.0 percent to 60.0 percent. 19
Avera, Di 27
Avista Corporation

Q. How does Avista’s common equity ratio compare 1
with those maintained by the reference group of utilities? 2
A. The 50.0 percent common equity ratio requested 3
by Avista is entirely consistent with the range of equity 4
ratios maintained by the firms in the Utility Proxy Group 5
and is in-line with the 49.0 percent and 50.1 percent 6
average equity ratios at year-end 2011 and based on Value 7
Line‟s near-term expectations, respectively. 8
Q. What implication does the increasing risk of the 9
utility industry have for the capital structures 10
maintained by utilities? 11
A. As discussed earlier, utilities are facing 12
energy market volatility, rising cost structures, the need 13
to finance significant capital investment plans, 14
uncertainties over accommodating economic and financial 15
market uncertainties, and ongoing regulatory risks. Taken 16
together, these considerations warrant a stronger balance 17
sheet to deal with an increasingly uncertain environment. 18
A more conservative financial profile, in the form of a 19
higher common equity ratio, is consistent with increasing 20
uncertainties and the need to maintain the continuous 21
access to capital under reasonable terms that is required 22
Avera, Di 28
Avista Corporation

to fund operations and necessary system investment, 1
including times of adverse capital market conditions. 2
Moody‟s has repeatedly warned investors of the risks 3
associated with debt leverage and fixed obligations and 4
advised utilities not to squander the opportunity to 5
strengthen the balance sheet against future 6
uncertainties.32 More recently, Moody‟s affirmed that it 7
expects regulated utilities to strengthen their balance 8
sheets in order “to prepare for more challenging business 9
conditions.”33 Similarly, S&P noted that, “we generally 10
consider a debt to capital level of 50% or greater to be 11
aggressive or highly leveraged for utilities.”34 Fitch 12
affirmed that equity issuances are needed if regulated 13
utilities are to maintain a balanced capital mix.35 14
Q. What other factors do investors consider in 15
their assessment of a company’s capital structure? 16
A. Depending on their specific attributes, 17
contractual agreements or other obligations that require 18

32 Moody’s Investors Service, “Storm Clouds Gathering on the Horizon for the North American Electric
Utility Sector,” Special Comment (Aug. 2007); “U.S. Electric Utility Sector,” Industry Outlook (Jan.
2008); “U.S. Electric Utilities Face Challenges Beyond Near-Term,” Industry Outlook (Jan. 2010). 33 Moody’s Investors Service, “U.S. Electric Utilities: Uncertain Times Ahead; Strengthening Balance
Sheets Now Would Protect Credit,” Special Comment (Oct. 28, 2010). 34 Standard & Poor’s Corporation, “Ratings Roundup: U.S. Electric Utility Sector Maintained Strong
Credit Quality In A Gloomy 2009,” RatingsDirect (Jan. 26, 2010). 35 Fitch Ratings Ltd., “2012 Outlook: Utilities, Power, and Gas,” Outlook Report (Dec. 5, 2011).
Avera, Di 29
Avista Corporation

the utility to make specified payments may be treated as 1
debt in evaluating Avista‟s financial risk. Power 2
purchase agreements (“PPAs”) and leases typically obligate 3
the utility to make specified minimum contractual payments 4
akin to those associated with traditional debt financing 5
and investors consider a portion of these commitments as 6
debt in evaluating total financial risks. Because 7
investors consider the debt impact of such fixed 8
obligations in assessing a utility‟s financial position, 9
they imply greater risk and reduced financial flexibility. 10
In order to offset the debt equivalent associated with 11
off-balance sheet obligations, the utility must rebalance 12
its capital structure by increasing its common equity in 13
order to restore its effective capitalization ratios to 14
previous levels. The capital structure ratios presented 15
earlier do not include imputed debt associated with power 16
purchase agreements or the impact of other off-balance 17
sheet obligations. 18
These commitments have been repeatedly cited by major 19
bond rating agencies in connection with assessments of 20
Avera, Di 30
Avista Corporation

utility financial risks.36 For example, S&P reported that 1
it adjusts Avista‟s capitalization to include 2
approximately $148.0 million in imputed debt from PPAs, 3
leases, and postretirement benefit obligations.37 Unless 4
Avista takes action to offset this additional financial 5
risk by maintaining a higher equity ratio, the resulting 6
leverage will weaken the Company‟s creditworthiness, 7
implying a higher required rate of return to compensate 8
investors for the greater risks.38 9
Q. What did you conclude with respect to the 10
Company’s capital structure? 11
A. Based on my evaluation, I concluded that 12
Avista‟s requested capital structure represents a 13
reasonable mix of capital sources from which to calculate 14
the Company‟s overall rate of return. While industry 15
averages provide one benchmark for comparison, each firm 16

36 See, e.g., Standard & Poor’s Corporation, “Standard & Poor’s Methodology For Imputing Debt For
U.S. Utilities’ Power Purchase Agreements,” RatingsDirect (May 7, 2007); Standard & Poor’s
Corporation, “Implications Of Operating Leases On Analysis Of U.S. Electric Utilities,” RatingsDirect
(Jan. 15, 2008); Standard & Poor’s Corporation, “Top 10 Investor Questions: U.S. Regulated Electric
Utilities,” RatingsDirect (Jan. 22, 2010). 37 Standard & Poor’s Corporation, “Avista Corp., Balance Sheet 12-31-2011, Global Credit Portal
(August 31, 2012). Similarly, Moody's noted that imputed debt may cause a deterioration in Avista’s
financial performance. Moody’s Investors Service, “Credit Opinion: Avista Corp.,” Global Credit
Research (Mar. 17, 2011). 38 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 31
Avista Corporation

must select its capitalization based on the risks and 1
prospects it faces, as well its specific needs to access 2
the capital markets. A public utility with an obligation 3
to serve must maintain ready access to capital under 4
reasonable terms so that it can meet the service 5
requirements of its customers. Financial flexibility 6
plays a crucial role in ensuring the wherewithal to meet 7
the needs of customers, and utilities with higher leverage 8
may be foreclosed from additional borrowing, especially 9
during times of stress. 10
Avista‟s capital structure is consistent with 11
industry benchmarks and reflects the challenges posed by 12
its resource mix, the burden of significant capital 13
spending requirements, and the Company‟s ongoing efforts 14
to strengthen its credit standing and support access to 15
capital on reasonable terms. Moody‟s observed that its 16
ratings for Avista anticipate “a balanced mix of debt and 17
equity.”39 The need for access becomes even more important 18
when the company has capital requirements over a period of 19
years, and financing must be continuously available, even 20
during unfavorable capital market conditions. 21

39 Moody’s Investors Service, “Credit Opinion: Avista Corp.,” Global Credit Research (Mar. 30, 2012).
Avera, Di 32
Avista Corporation

III. CAPITAL MARKET ESTIMATES 1
Q. What is the purpose of this section? 2
A. This section presents capital market estimates 3
of the cost of equity. The details of my quantitative 4
analyses are contained in Schedule 2, with the results 5
being summarized below. 6
A. Overview 7
Q. What role does the rate of return on common 8
equity play in a utility’s rates? 9
A. The return on common equity is the cost of 10
inducing and retaining investment in the utility‟s 11
physical plant and assets. This investment is necessary 12
to finance the asset base needed to provide utility 13
service. Investors will commit money to a particular 14
investment only if they expect it to produce a return 15
commensurate with those from other investments with 16
comparable risks. Moreover, the return on common equity 17
is integral in achieving the sound regulatory objectives 18
of rates that are sufficient to: 1) fairly compensate 19
capital investment in the utility, 2) enable the utility 20
to offer a return adequate to attract new capital on 21
reasonable terms, and 3) maintain the utility‟s financial 22
integrity. These standards should allow the utility to 23
Avera, Di 33
Avista Corporation

fulfill its obligation to provide reliable service while 1
meeting the needs of customers through necessary system 2
replacement and expansion, but they can only be met if the 3
utility has a reasonable opportunity to actually earn its 4
allowed ROE. 5
Q. Did you rely on a single method to estimate the 6
cost of equity for Avista? 7
A. No. In my opinion, no single method or model 8
should be relied upon to determine a utility‟s cost of 9
equity because no single approach can be regarded as 10
wholly reliable. Therefore, I used the DCF, CAPM, and 11
risk premium methods to estimate the cost of common 12
equity. In addition, I also evaluated a fair ROE using a 13
comparable earnings approach based on investors‟ current 14
expectations in the capital markets. In my opinion, 15
comparing estimates produced by one method with those 16
produced by other approaches ensures that the estimates of 17
the cost of equity pass fundamental tests of 18
reasonableness and economic logic. 19
Avera, Di 34
Avista Corporation

Q. Are you aware that the IPUC has traditionally 1
relied primarily on the DCF and comparable earnings 2
methods? 3
A. Yes, although the Commission has also evidenced 4
a willingness to weigh alternatives in evaluating an 5
allowed ROE. For example, while noting that it had not 6
focused on the CAPM for determining the cost of equity, 7
the IPUC recognized in Order No. 29505 that “methods to 8
evaluate a common equity rate of return are imperfect 9
predictors” and emphasized “that by evaluating all the 10
methods presented in this case and using each as a check 11
on the other,” the Commission had avoided the pitfalls 12
associated with reliance on a single method.40 13
Q. What was your conclusion regarding a fair ROE 14
for the proxy companies? 15
A. Based on the results of my quantitative 16
analyses, and my assessment of the relative strengths and 17
weaknesses inherent in each method, I concluded that the 18
cost of equity for the proxy companies is in the 10.0 19
percent to 11.4 percent range, or 10.2 percent to 11.6 20

40 Order No. 29505 at 38 (emphasis added).
Avera, Di 35
Avista Corporation

percent after including a minimum adjustment for flotation 1
costs. 2
B. Results of Quantitative Analyses 3
Q. What specific proxy group of utilities did you 4
rely on for your analysis? 5
A. In estimating the cost of equity, the DCF model 6
is typically applied to publicly traded firms engaged in 7
similar business activities or with comparable investment 8
risks. As described in detail in Schedule 2, I applied 9
the DCF model to a utility proxy group composed of those 10
dividend-paying companies included by Value Line in its 11
Electric Utilities Industry groups with: (1) S&P corporate 12
credit ratings of “BBB-” to “BBB+,” (2) a Value Line 13
Safety Rank of “2” or “3”, and (3) a Value Line Financial 14
Strength Rating of “B+” or higher.41 I refer to this group 15
of 29 comparable-risk firms as the “Utility Proxy Group.” 16
Q. What other proxy group did you consider in 17
evaluating a fair ROE for Avista? 18
A. Under the regulatory standards established by 19
Hope and Bluefield, the salient criterion in establishing 20

41 In addition, I excluded two utilities that otherwise would have been in the proxy group, but are not
appropriate for inclusion because they are currently involved in a major acquisition.
Avera, Di 36
Avista Corporation

a meaningful benchmark to evaluate a fair ROE is relative 1
risk, not the particular business activity or degree of 2
regulation. With regulation taking the place of 3
competitive market forces, required returns for utilities 4
should be in line with those of non-utility firms of 5
comparable risk operating under the constraints of free 6
competition. Consistent with this accepted regulatory 7
standard, I also applied the DCF model to a reference 8
group of low-risk companies in the non-utility sectors of 9
the economy. I refer to this group as the “Non-Utility 10
Proxy Group”. 11
Q. Do utilities have to compete with non-regulated 12
firms for capital? 13
A. Yes. The cost of capital is an opportunity cost 14
based on the returns that investors could realize by 15
putting their money in other alternatives. Clearly, the 16
total capital invested in utility stocks is only the tip 17
of the iceberg of total common stock investment, and there 18
are a plethora of other enterprises available to investors 19
beyond those in the utility industry. Utilities must 20
compete for capital, not just against firms in their own 21
industry, but with other investment opportunities of 22
comparable risk. Indeed, modern portfolio theory is built 23
Avera, Di 37
Avista Corporation

on the assumption that rational investors will hold a 1
diverse portfolio of stocks, not just companies in a 2
single industry. 3
Q. Is it consistent with the Bluefield and Hope 4
cases to consider required returns for non-utility 5
companies? 6
A. Yes. Returns in the competitive sector of the 7
economy form the very underpinning for utility ROEs 8
because regulation purports to serve as a substitute for 9
the actions of competitive markets. The Supreme Court has 10
recognized that it is the degree of risk, not the nature 11
of the business, which is relevant in evaluating an 12
allowed ROE for a utility. The Bluefield case refers to 13
“business undertakings attended with comparable risks and 14
uncertainties.” It does not restrict consideration to 15
other utilities. Similarly, the Hope case states: 16
By that standard the return to the equity owner 17
should be commensurate with returns on 18
investments in other enterprises having 19
corresponding risks.43 20
As in the Bluefield decision, there is nothing to restrict 21
“other enterprises” solely to the utility industry. 22

42 Bluefield Water Works & Improvement Co. v. Pub. Serv. Comm’n, 262 U.S. 679 (1923). 43 Federal Power Comm’n v. Hope Natural Gas Co. (320 U.S. 391, 1944).
Avera, Di 38
Avista Corporation

Indeed, in teaching regulatory policy I usually 1
observe that in the early applications of the comparable 2
earnings approach, utilities were explicitly eliminated 3
due to a concern about circularity. In other words, soon 4
after the Hope decision regulatory commissions did not 5
want to get involved in circular logic by looking to the 6
returns of utilities that were established by the same or 7
similar regulatory commissions in the same geographic 8
region. To avoid circularity, regulators looked only to 9
the returns of non-utility companies. 10
Q. Does consideration of the results for the Non-11
Utility Proxy Group make the estimation of the cost of 12
equity using the DCF model more reliable? 13
A. Yes. The estimates of growth from the DCF model 14
depend on analysts‟ forecasts. It is possible for utility 15
growth rates to be distorted by short-term trends in the 16
industry or the industry falling into favor or disfavor by 17
analysts. The result of such distortions would be to bias 18
the DCF estimates for utilities. Because the Non-Utility 19
Proxy Group includes low risk companies from many 20
industries, it diversifies away any distortion that may be 21
caused by the ebb and flow of enthusiasm for a particular 22
sector. 23
Avera, Di 39
Avista Corporation

Q. What criteria did you apply to develop the Non-1
Utility Proxy Group? 2
A. My comparable risk proxy group of non-utility 3
firms was composed of those U.S. companies followed by 4
Value Line that: (1) pay common dividends; (2) have a 5
Safety Rank of “1”; (3) have a Financial Strength Rating 6
of “B++” or greater; (4) have a beta of 0.60 or less; and, 7
(5) have investment grade credit ratings from S&P. 8
Q. How do the overall risks of your proxy groups 9
compare with Avista? 10
A. Table WEA-2 compares the Utility Proxy Group 11
with the Non-Utility Proxy Group and Avista across four 12
key indicators of investment risk: 13
TABLE WEA-2 14
COMPARISON OF RISK INDICATORS 15
S&P Value Line
Credit
Rating
Safety
Rank
Financial
Strength

Beta
Utility Group BBB 2 B++ 0.74
Non-Utility Proxy
Group
A 1 A+ 0.58
Avista BBB 2 A 0.70
Avera, Di 40
Avista Corporation

Q. Do these comparisons indicate that investors 1
would view the firms in your proxy groups as risk-2
comparable to the Company? 3
A. Yes. Considered together, a comparison of these 4
objective measures, which consider of a broad spectrum of 5
risks, including financial and business position, and 6
exposure to firm-specific factors, indicates that 7
investors would likely conclude that the overall 8
investment risks for Avista are generally comparable to 9
those of the firms in the Utility Proxy Group. 10
With respect to the Non-Utility Proxy Group, its 11
average credit ratings, Safety Rank, Financial Strength 12
Rating, and beta all suggest less risk than for Avista. 13
The indicators of investment risk considered in my 14
analysis provide a sound, objective, and consistent basis 15
to evaluate relative risks across companies and industry 16
sectors. These measures incorporate a broad spectrum of 17
risks, including financial and business position, the 18
impact of regulation, relative size, and exposure to 19
company specific factors, and they apply equally to 20
regulated and unregulated firms. Indeed, the core idea of 21
modern portfolio theory is that investors will diversify 22
their holdings across multiple firms and industry groups, 23
Avera, Di 41
Avista Corporation

so that the risk of a stock is directly proportional to 1
its beta, not the extent of competition or the freedom to 2
set prices. 3
While the impact of differences in regulation is 4
reflected in objective risk measures, my analyses 5
conservatively focus on a lower-risk group of non-utility 6
firms. The 13 companies that make up the Non-Utility 7
Proxy Group are representative of the pinnacle of 8
corporate America. These firms, which include household 9
names such as Coca-Cola, Colgate-Palmolive, Proctor & 10
Gamble, and Wal-Mart, have long corporate histories, well-11
established track records, and exceedingly conservative 12
risk profiles.44 The companies in my Non-Utility Proxy 13
Group have a stable track record of dividend payments, 14
with the average dividend yield for the group approaching 15
3 percent. Moreover, because of their significance and 16
name recognition, these companies receive intense scrutiny 17
by the investment community, which increases confidence 18
that published growth estimates are representative of the 19
consensus expectations reflected in common stock prices. 20

44 In addition to the risk measures shown in Table WEA-2, the firms in the Non-Utility Proxy Group have
virtually no financial leverage, with an average market value capitalization of approximately 90 percent
common equity.
Avera, Di 42
Avista Corporation

Q. What cost of equity is implied by your DCF 1
results for the Utility Proxy Group? 2
A. My application of the DCF model, which is 3
discussed in greater detail in Schedule 2, considered 4
three alternative measures of expected earnings growth, as 5
well as the sustainable growth rate based on the 6
relationship between expected retained earnings and earned 7
rates of return (“br+sv”). As shown on Schedule 4 and 8
summarized below in Table WEA-3, after eliminating 9
illogical values, application of the constant growth DCF 10
model resulted in the following cost of equity estimates: 11
TABLE WEA-3 12
DCF RESULTS – UTILITY PROXY GROUP 13
Growth Rate Average Midpoint
Value Line 9.7%10.7%
IBES 9.5%11.0%
Zacks 9.4%9.8%
br + sv 8.9%10.2%
Cost of Equity
14
Q. What were the results of your DCF analysis for 15
the Non-Utility Proxy Group? 16
A. As shown on Schedule 6, I applied the DCF model 17
to the non-utility companies in exactly the same manner 18
described earlier for the Utility Proxy Group. As 19
Avera, Di 43
Avista Corporation

summarized below in Table WEA-4, after eliminating 1
illogical values, application of the constant growth DCF 2
model resulted in the following cost of equity estimates: 3
TABLE WEA-4 4
DCF RESULTS – NON-UTILITY GROUP 5
Growth Rate Average Midpoint
Value Line 11.5%10.7%
IBES 10.8%10.4%
Zacks 11.1%10.3%
br + sv 12.8%15.9%
Cost of Equity
6
Q. How can you reconcile these DCF results for the 7
Non-Utility Proxy Group against the significantly lower 8
estimates produced for your comparable-risk group of 9
utilities? 10
A. First, it is important to be clear that the 11
higher DCF results for the Non-Utility Proxy Group cannot 12
be attributed to risk differences. As I documented 13
earlier, the risks that investors associate with the group 14
of non-utility firms - as measured by S&P‟s credit ratings 15
and Value Line‟s Safety Rank, Financial Strength, and Beta 16
– are lower than the risks investors associate with the 17
Utility Group. The objective evidence provided by these 18
observable risk measures rules out a conclusion that the 19
Avera, Di 44
Avista Corporation

higher non-utility DCF estimates are associated with 1
higher investment risk. 2
Rather, the divergence between the DCF results for 3
these two groups of utility and non-utility firms can be 4
attributed to the fact that DCF estimates invariably 5
depart from the returns that investors actually require 6
because their expectations may not be captured by the 7
inputs to the model, particularly the assumed growth rate. 8
Because the actual cost of equity is unobservable, and DCF 9
results inherently incorporate a degree of error, the cost 10
of equity estimates for the Non-Utility Proxy group 11
provide an important benchmark in evaluating a fair ROE 12
for Avista. There is no basis to conclude that DCF 13
results for a group of utilities would be inherently more 14
reliable than those for firms in the competitive sector, 15
and the divergence between the DCF estimates for the 16
Utility and Non-Utility Proxy Groups suggests that both 17
should be considered to ensure a balanced end-result. 18
Q. How did you apply the CAPM to estimate the cost 19
of equity? 20
A. Like the DCF model, the CAPM is an ex-ante, or 21
forward-looking model based on expectations of the future. 22
Avera, Di 45
Avista Corporation

As a result, in order to produce a meaningful estimate of 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 6
for 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 9
markets, it provides a more meaningful guide to the 10
expected rate of return required to implement the CAPM. 11
Empirical research indicates that the CAPM does not 12
fully account for observed differences in rates of return 13
attributable to firm size. The need for an adjustment to 14
account for relative market capitalization arises because 15
differences in investors‟ required rates of return that 16
are related to firm size are not fully captured by beta. 17
Accordingly, my CAPM analyses incorporated an adjustment 18
to recognize the impact of size distinctions, as developed 19
by Morningstar. 20
Avera, Di 46
Avista Corporation

Q. What cost of equity was indicated by the CAPM 1
approach? 2
A. As shown on page 1 of Schedule 8, my forward-3
looking application of the CAPM model indicated an ROE of 4
10.3 percent for the utility proxy group. Adjusting the 5
10.3 percent theoretical CAPM result to incorporate the 6
size adjustment results in an indicated cost of common 7
equity of 11.2 percent. 8
Q. Did you also apply the CAPM using forecasted 9
bond yields? 10
A. Yes. As discussed earlier, there is widespread 11
consensus that interest rates will increase materially as 12
the economy continues to strengthen. Accordingly, in 13
addition to the use of current bond yields, I also applied 14
the CAPM based on the forecasted long-term Treasury bond 15
yields developed based on projections published by Value 16
Line, IHS Global Insight and Blue Chip. As shown on page 17
2 of Schedule 8, incorporating a forecasted Treasury bond 18
yield for 2013-2017 implied a cost of equity of 19
approximately 10.8 percent for the Utility Proxy Group, or 20
11.7 percent after adjusting for the impact of relative 21
size. 22
Avera, Di 47
Avista Corporation

Q. How did you implement the risk premium method? 1
A. I based my estimates of equity risk premiums for 2
electric utilities on surveys of previously authorized 3
rates of return on common equity, which are frequently 4
referenced as the basis for estimating equity risk 5
premiums. My application of the risk premium method also 6
considered the inverse relationship between equity risk 7
premiums and interest rates, which suggests that when 8
interest rate levels are relatively high, equity risk 9
premiums narrow, and when interest rates are relatively 10
low, equity risk premiums widen. 11
Q. What cost of equity was indicated by the risk 12
premium approach? 13
A. As shown on page 1 of Schedule 9, adding an 14
adjusted risk premium of 5.36 percent to the current 15
average yield on triple-B utility bonds of 4.88 percent 16
resulted in an implied cost of equity of approximately 17
10.2 percent. As shown on page 2 of Schedule 9, 18
incorporating a forecasted yield for 2013-2017 and 19
adjusting for changes in interest rates since the study 20
period implied a cost of equity of approximately 11.6 21
percent. 22
Avera, Di 48
Avista Corporation

Q. What other analyses did you conduct to estimate 1
the cost of equity? 2
A. As I noted earlier, I also evaluated the cost of 3
equity using the expected earnings approach. Reference to 4
rates of return available from alternative investments of 5
comparable risk can provide an important benchmark in 6
assessing the return necessary to assure confidence in the 7
financial integrity of a firm and its ability to attract 8
capital. This expected earnings approach is consistent 9
with the economic underpinnings for a fair rate of return 10
established by the U.S. Supreme Court. Moreover, it 11
avoids the complexities and limitations of capital market 12
methods and instead focuses on the returns earned on book 13
equity, which are readily available to investors. 14
Q. What rates of return on equity are indicated for 15
utilities based on the expected earnings approach? 16
A. Value Line reports that its analysts anticipate 17
an average rate of return on common equity for the 18
electric utility industry of 10.5 percent over its 2015-19
2017 forecast horizon.45 As shown on Schedule 10, Value 20

45 The Value Line Investment Survey at 138 (Aug. 24, 2012).
Avera, Di 49
Avista Corporation

Line‟s projections for the utility proxy group suggested 1
an average ROE of 10.1 percent. 2
C. Flotation Costs 3
Q. What other considerations are relevant in 4
setting the return on equity for a utility? 5
A. The common equity used to finance the investment 6
in utility assets is provided from either the sale of 7
stock in the capital markets or from retained earnings not 8
paid out as dividends. When equity is raised through the 9
sale of common stock, there are costs associated with 10
“floating” the new equity securities. These flotation 11
costs include services such as legal, accounting, and 12
printing, as well as the fees and discounts paid to 13
compensate brokers for selling the stock to the public. 14
Q. Is there an established mechanism for a utility 15
to recognize equity issuance costs? 16
A. No. While debt flotation costs are recorded on 17
the books of the utility, amortized over the life of the 18
issue, and thus increase the effective cost of debt 19
capital, there is no similar accounting treatment to 20
ensure that equity flotation costs are recorded and 21
ultimately recognized. No rate of return is authorized on 22
Avera, Di 50
Avista Corporation

flotation costs necessarily incurred to obtain a portion of 1
the equity capital used to finance plant. In other words, 2
equity flotation costs are not included in a utility‟s rate 3
base because neither that portion of the gross proceeds 4
from the sale of common stock used to pay flotation costs 5
is available to invest in plant and equipment, nor are 6
flotation costs capitalized as an intangible asset. Unless 7
some provision is made to recognize these issuance costs, a 8
utility‟s revenue requirements will not fully reflect all 9
of the costs incurred for the use of investors‟ funds. 10
Because there is no accounting convention to accumulate the 11
flotation costs associated with equity issues, they must be 12
accounted for indirectly, with an upward adjustment to the 13
cost of equity being the most logical mechanism. 14
Q. What is the magnitude of the adjustment to the 15
“bare bones” cost of equity to account for issuance costs? 16
A. While there are a number of ways in which a 17
flotation cost adjustment can be calculated, one of the 18
most common methods used to account for flotation costs in 19
regulatory proceedings is to apply an average flotation-20
cost percentage to a utility‟s dividend yield. Based on a 21
Avera, Di 51
Avista Corporation

review of the finance literature, New Regulatory Finance 1
concluded: 2
The flotation cost allowance requires an 3
estimated adjustment to the return on equity of 4
approximately 5% to 10%, depending on the size 5
and risk of the issue.46 6
Alternatively, a study of data from Morgan Stanley 7
regarding issuance costs associated with utility common 8
stock issuances suggests an average flotation cost 9
percentage of 3.6 percent.47 10
Issuance costs are a legitimate consideration in 11
setting the ROE for a utility, and applying these expense 12
percentages to the average dividend yield for the Utility 13
Proxy Group of 4.3 percent implies a flotation cost 14
adjustment on the order of 16 to 43 basis points. 15
Q. Has the IPUC Staff previously considered 16
flotation costs in estimating a fair ROE? 17
A. Yes. For example, in Case No. IPC-E-08-10, IPUC 18
Staff witness Terri Carlock noted that she had adjusted 19

46 Roger A. Morin, “New Regulatory Finance,” Public Utilities Reports, Inc. at 323 (2006). 47 Application of Yankee Gas Services Company for a Rate Increase, DPUC Docket No. 04-06-01, Direct
Testimony of George J. Eckenroth (Jul. 2, 2004) at Exhibit GJE-11.1. Updating the results presented by
Mr. Eckenroth through April 2005 also resulted in an average flotation cost percentage of 3.6 percent.
Avera, Di 52
Avista Corporation

her DCF analysis to incorporate an allowance for flotation 1
costs.48 2
IV. RETURN ON EQUITY RECOMMENDATION 3
Q. What did you conclude with respect to the cost 4
of equity implied by your analyses for the proxy groups? 5
A. The cost of equity estimates implied by my 6
quantitative analyses are summarized in Table WEA-5, 7
below: 8
TABLE WEA-5 9
SUMMARY OF QUANTITATIVE RESULTS 10
Utility Non-Utility
DCF Average Midpoint Average Midpoint
Value Line 9.7%10.7%11.5%10.7%
IBES 9.5%11.0%10.8%10.4%
Zacks 9.4%9.8%11.1%10.3%
br + sv 8.9%10.2%12.8%15.9%
CAPM - Current Bond Yield
Unadjusted 10.3%10.2%
Size Adjusted 11.2%10.9%
CAPM - Projected Bond Yield
Unadjusted 10.8%10.6%
Size Adjusted 11.7%11.3%
Utility Risk Premium
Current Bond Yields
Projected Bond Yields
Expected Earnings 10.1%10.2%
10.2%
11.6%

48 Case No. IPC-E-08-10, Direct Testimony of Terri Carlock at 12-13 (Oct. 24, 2008).
Avera, Di 53
Avista Corporation

Q. Based on the results for the Utility Proxy 1
Group, what is your conclusion regarding a fair ROE range? 2
A. Considering the relative strengths and 3
weaknesses inherent in each method, and conservatively 4
giving less emphasis to the upper- and lower-most 5
boundaries of the range of results for the Utility Proxy 6
Group, I concluded that the cost of common equity is in 7
the 10.0 percent to 11.4 percent range. After 8
incorporating a minimal adjustment for flotation costs of 9
20 basis points to my “bare bones” cost of equity range, I 10
concluded that my analyses indicate a fair ROE in the 10.2 11
percent to 11.6 percent range, with a midpoint of 10.9 12
percent. 13
Q. How were the DCF estimates for the Non-Utility 14
Proxy Group considered in arriving at your recommended ROE 15
range? 16
A. As discussed earlier in my testimony, DCF 17
estimates for the Non-Utility Proxy Group provide a useful 18
benchmark because investors evaluate the required rate of 19
return from utility investments against other 20
opportunities available in the capital markets. The 21
purpose of regulation is to serve as a substitute for the 22
Avera, Di 54
Avista Corporation

actions of competitive markets, and expected returns for 1
non-utility companies form the basis for the regulatory 2
standards underlying a fair ROE. 3
The DCF results for the Non-Utility Proxy Group were 4
considerably higher than those implied for the proxy group 5
of utilities, even though objective evidence demonstrates 6
that the investment risks of the unregulated companies are 7
lower. Moreover, there is no basis to conclude that DCF 8
results for a group of utilities would be inherently more 9
reliable than those for firms in the competitive sector. 10
In fact, considering the prominence of the 13 non-utility 11
companies, the diversification afforded by considering 12
multiple industries, and the scrutiny that analysts‟ 13
afford to these paragons of American industry, the DCF 14
results for the Non-Utility Proxy Group provide compelling 15
evidence that suggests a downward bias in the utility DCF 16
results. I considered this downward bias in evaluating my 17
recommended ROE range from within the results produced for 18
the Utility Proxy Group. 19
Avera, Di 55
Avista Corporation

Q. Based on the results of your evaluation, what is 1
your opinion regarding the reasonableness of the ROE 2
requested by Avista in this case? 3
A. Because the Company‟s requested 10.9 percent ROE 4
falls at the midpoint of my recommended range it 5
represents a reasonable estimate of investors‟ required 6
return that is adequate to compensate investors, while 7
maintaining Avista‟s financial integrity and ability to 8
attract capital on reasonable terms. 9
Apart from the results of the quantitative methods 10
summarized above, it is crucial to recognize the 11
importance of supporting the Company‟s financial position 12
so that Avista remains prepared to respond to unforeseen 13
events that may materialize in the future. Recent 14
challenges in the economic and financial market 15
environment highlight the imperative of maintaining the 16
Company‟s financial strength in attracting the capital 17
needed to secure reliable service at a lower cost for 18
customers. The reasonableness of the Company‟s requested 19
ROE is reinforced by the operating risks associated with 20
Avista‟s reliance on hydroelectric generation, the higher 21
uncertainties associated with Avista‟s relatively small 22
size, and the fact that current cost of capital estimates 23
Avera, Di 56
Avista Corporation

are likely to understate investors‟ requirements at the 1
time the outcome of this proceeding becomes effective and 2
beyond. 3
Q. Does this conclude your pre-filed direct 4
testimony? 5
A. Yes. 6
DAVID J. MEYER
VICE PRESIDENT AND CHIEF COUNSEL FOR
REGULATORY & GOVERNMENTAL AFFAIRS
AVISTA CORPORATION
P.O. BOX 3727
1411 EAST MISSION AVENUE
SPOKANE, WASHINGTON 99220-3727
TELEPHONE: [phone]
FACSIMILE: [phone]
[e-mail]

BEFORE THE IDAHO PUBLIC UTILITIES COMMISSION

IN THE MATTER OF THE APPLICATION ) CASE NO. AVU-E-12-08
OF AVISTA CORPORATION FOR THE ) CASE NO. AVU-G-12-07
AUTHORITY TO INCREASE ITS RATES )
AND CHARGES FOR ELECTRIC AND )
NATURAL GAS SERVICE TO ELECTRIC ) EXHIBIT NO. 3
AND NATURAL GAS CUSTOMERS IN THE )
STATE OF IDAHO ) WILLIAM E. AVERA
)

FOR AVISTA CORPORATION

(ELECTRIC AND NATURAL GAS)

Exhibit No. 3
Case Nos. AVU-E-12-08 & AVU-G-12-07
W. Avera, Avista
Schedule 1, p. 1 of 11

EXHIBIT 3, SCHEDULE 1

QUALIFICATIONS OF WILLIAM E. AVERA

Q. What is the purpose of this exhibit?
A. This exhibit describes my background and experience
and contains the details of my qualifications.
Q. Please describe your qualifications and experience.
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
Exhibit No. 3
Case Nos. AVU-E-12-08 & AVU-G-12-07
W. Avera, Avista
Schedule 1, p. 2 of 11

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 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.
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
Exhibit No. 3
Case Nos. AVU-E-12-08 & AVU-G-12-07
W. Avera, Avista
Schedule 1, p. 3 of 11

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, 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
Exhibit No. 3
Case Nos. AVU-E-12-08 & AVU-G-12-07
W. Avera, Avista
Schedule 1, p. 4 of 11

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.
Exhibit No. 3
Case Nos. AVU-E-12-08 & AVU-G-12-07
W. Avera, Avista
Schedule 1, p. 5 of 11

WILLIAM E. AVERA

FINCAP, INC. 3907 Red River
Financial Concepts and Applications Austin, Texas 78751
Economic and Financial Counsel (512) 458–4644
FAX [phone]
[e-mail]

Summary of Qualifications Ph.D. in economics and finance; Chartered Financial Analyst (CFA ®) designation; extensive expert
witness testimony before courts, alternative dispute resolution panels, regulatory agencies and
legislative committees; lectured in executive education programs around the world on ethics,
investment analysis, and regulation; undergraduate and graduate teaching in business and economics;
appointed to leadership positions in government, industry, academia, and the military.

Employment
Principal,
FINCAP, Inc.
(Sep. 1979 to present)

Financial, economic and policy consulting to business
and government. Perform business and public policy
research, cost/benefit analyses and financial modeling,
valuation of businesses (almost 200 entities valued),
estimation of damages, statistical and industry studies.
Provide strategy advice and educational services in
public and private sectors, and serve as expert witness
before regulatory agencies, legislative committees,
arbitration panels, and courts. Director, Economic Research
Division,
Public Utility Commission of Texas
(Dec. 1977 to Aug. 1979)

Responsible for research and testimony preparation on
rate of return, rate structure, and econometric analysis
dealing with energy, telecommunications, water and
sewer utilities. Testified in major rate cases and
appeared before legislative committees and served as
Chief Economist for agency. Administered state and
federal grant funds. Communicated frequently with
political leaders and representatives from consumer
groups, media, and investment community. Manager, Financial Education,
International Paper Company
New York City
(Feb. 1977 to Nov. 1977)
Directed corporate education programs in accounting,
finance, and economics. Developed course materials,
recruited and trained instructors, liaison within the
company and with academic institutions. Prepared
operating budget and designed financial controls for
corporate professional development program.
Exhibit No. 3
Case Nos. AVU-E-12-08 & AVU-G-12-07
W. Avera, Avista
Schedule 1, p. 6 of 11

Lecturer in Finance

Assistant Professor of Business
Education
Ph.D., Economics and Finance
The Geometric Mean Strategy as a
Theory of Multiperiod Portfolio Choice
B.A., Economics

Professional Associations Received Chartered Financial Analyst (CFA) designation in 1977; Vice President for Membership,
Financial Management Association; President, Austin Chapter of Planning Executives Institute; Board
of Directors, North Carolina Society of Financial Analysts; Candidate Curriculum Committee,
Association for Investment Management and Research; Executive Committee of Southern Finance
Association; Vice Chair, Staff Subcommittee on Economics and National Association of Regulatory
Utility Commissioners (NARUC); Appointed to NARUC Technical Subcommittee on the National
Energy Act.
Exhibit No. 3
Case Nos. AVU-E-12-08 & AVU-G-12-07
W. Avera, Avista
Schedule 1, p. 7 of 11

Teaching in Executive Education Programs University-Sponsored Programs: Central Michigan University, Duke University, Louisiana State
University, National Defense University, National University of Singapore, Texas A&M University,
University of Kansas, University of North Carolina, University of Texas.
Business and Government-Sponsored Programs: Advanced Seminar on Earnings Regulation,
American Public Welfare Association, Association for Investment Management and Research,
Congressional Fellows Program, Cost of Capital Workshop, Electricity Consumers Resource Council,
Financial Analysts Association of Indonesia, Financial Analysts Review, Financial Analysts Seminar
at Northwestern University, Governor's Executive Development Program of Texas, Louisiana
Association of Business and Industry, National Association of Purchasing Management, National
Association of Tire Dealers, Planning Executives Institute, School of Banking of the South, State of
Wisconsin Investment Board, Stock Exchange of Thailand, Texas Association of State Sponsored
Computer Centers, Texas Bankers' Association, Texas Bar Association, Texas Savings and Loan
League, Texas Society of CPAs, Tokyo Association of Foreign Banks, Union Bank of Switzerland,
U.S. Department of State, U.S. Navy, U.S. Veterans Administration, in addition to Texas state
agencies and major corporations. Presented papers for Mills B. Lane Lecture Series at the University of Georgia and Heubner Lectures
at the University of Pennsylvania. Taught graduate courses in finance and economics for evening
program at St. Edward's University in Austin from January 1979 through 1998.

Expert Witness Testimony Testified in over 300 cases before regulatory agencies addressing cost of capital, regulatory policy, rate
design, and other economic and financial issues. Federal Agencies: Federal Communications Commission, Federal Energy Regulatory Commission,
Surface Transportation Board, Interstate Commerce Commission, and the Canadian Radio-Television
and Telecommunications Commission. State Regulatory Agencies: Alaska, Arizona, Arkansas, California, Colorado, Connecticut, Delaware,
Florida, Georgia, Hawaii, Idaho, Illinois, Indiana, Iowa, Kansas, Kentucky, Maryland, Michigan,
Missouri, Nevada, New Mexico, Montana, Nebraska, North Carolina, Ohio, Oklahoma, Oregon,
Pennsylvania, South Carolina, South Dakota, Texas, Utah, Virginia, Washington, West Virginia,
Wisconsin, and Wyoming. Testified in 42 cases before federal and state courts, arbitration panels, and alternative dispute tribunals
(89 depositions given) regarding damages, valuation, antitrust liability, fiduciary duties, and other
economic and financial issues.

Board Positions and Other Professional Activities Audit Committee and Outside Director, Georgia System Operations Corporation (electric system
operator for member-owned electric cooperatives in Georgia); Chairman, Board of Print Depot, Inc.
and FINCAP, Inc.; Co-chair, Synchronous Interconnection Committee, appointed by Public Utility
Commission of Texas and approved by governor; Appointed by Hays County Commission to Citizens
Advisory Committee of Habitat Conservation Plan, Operator of AAA Ranch, a certified organic
producer of agricultural products; Appointed to Organic Livestock Advisory Committee by Texas
Exhibit No. 3
Case Nos. AVU-E-12-08 & AVU-G-12-07
W. Avera, Avista
Schedule 1, p. 8 of 11

Agricultural Commissioner Susan Combs; Appointed by Texas Railroad Commissioners to study
group for The UP/SP Merger: An Assessment of the Impacts on the State of Texas; Appointed by
Hawaii Public Utilities Commission to team reviewing affiliate relationships of Hawaiian Electric
Industries; Chairman, Energy Task Force, Greater Austin-San Antonio Corridor Council; Consultant to
Public Utility Commission of Texas on cogeneration policy and other matters; Consultant to Public
Service Commission of New Mexico on cogeneration policy; Evaluator of Energy Research Grant
Proposals for Texas Higher Education Coordinating Board.

Community Activities
Board of Directors, Sustainable Food Center; Chair, Board of Deacons, Finance Committee, and Elder,
Central Presbyterian Church of Austin; Founding Member, Orange-Chatham County (N.C.) Legal Aid
Screening Committee.

Military
Captain, U.S. Naval Reserve (retired after 28 years service); Commanding Officer, Naval Special
Warfare Engineering (SEAL) Support Unit; Officer-in-Charge of SWIFT patrol boat in Vietnam;
Enlisted service as weather analyst (advanced to second class petty officer).

Bibliography
Monographs Ethics and the Investment Professional (video, workbook, and instructor’s guide) and Ethics Challenge
Today (video), Association for Investment Management and Research (1995)
“Definition of Industry Ethics and Development of a Code” and “Applying Ethics in the Real World,”
in Good Ethics: The Essential Element of a Firm’s Success, Association for Investment
Management and Research (1994)
“On the Use of Security Analysts’ Growth Projections in the DCF Model,” with Bruce H. Fairchild in
Earnings Regulation Under Inflation, J. R. Foster and S. R. Holmberg, eds. Institute for Study of
Regulation (1982)
An Examination of the Concept of Using Relative Customer Class Risk to Set Target Rates of Return in
Electric Cost-of-Service Studies, with Bruce H. Fairchild, Electricity Consumers Resource Council
(ELCON) (1981); portions reprinted in Public Utilities Fortnightly (Nov. 11, 1982)
“Usefulness of Current Values to Investors and Creditors,” Research Study on Current-Value
Accounting Measurements and Utility, George M. Scott, ed., Touche Ross Foundation (1978)
“The Geometric Mean Strategy and Common Stock Investment Management,” with Henry A. Latané
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 Underwriters (1975) Articles “Should Analysts Own the Stocks they Cover?” The Financial Journalist, (March 2002)
Exhibit No. 3
Case Nos. AVU-E-12-08 & AVU-G-12-07
W. Avera, Avista
Schedule 1, p. 9 of 11

“Liquidity, Exchange Listing, and Common Stock Performance,” with John C. Groth and Kerry
Cooper, Journal of Economics and Business (Spring 1985); reprinted by National Association of
Security Dealers
“The Energy Crisis and the Homeowner: The Grief Process,” Texas Business Review (Jan.–Feb.
1980); reprinted in The Energy Picture: Problems and Prospects, J. E. Pluta, ed., Bureau of
Business Research (1980)
“Use of IFPS at the Public Utility Commission of Texas,” Proceedings of the IFPS Users Group
Annual Meeting (1979)
"Production Capacity Allocation: Conversion, CWIP, and One-Armed Economics,” Proceedings of the
NARUC Biennial Regulatory Information Conference (1978)
"Some Thoughts on the Rate of Return to Public Utility Companies,” with Bruce H. Fairchild in
Proceedings of the NARUC Biennial Regulatory Information Conference (1978)
"A New Capital Budgeting Measure: The Integration of Time, Liquidity, and Uncertainty,” with David
Cordell in Proceedings of the Southwestern Finance Association (1977)
"Usefulness of Current Values to Investors and Creditors,” in Inflation Accounting/Indexing and Stock
Behavior (1977)
"Consumer Expectations and the Economy,” Texas Business Review (Nov. 1976)
"Portfolio Performance Evaluation and Long-run Capital Growth,” with Henry A. Latané in
Proceedings of the Eastern Finance Association (1973)
Book reviews in Journal of Finance and Financial Review. Abstracts for CFA Digest. Articles in
Carolina Financial Times. Selected Papers and Presentations “Economic Perspective on Water Marketing in Texas,” 2009 Water Law Institute, The University of
Texas School of Law, Austin, TX (Dec. 2009).
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Washington, D.C. (Mar. 2009)
"The Who, What, When, How, and Why of Ethics," San Antonio Financial Analysts Society (Jan. 16,
2002). Similar presentation given to the Austin Society of Financial Analysts (Jan. 17, 2002)
“Ethics for Financial Analysts,” Sponsored by Canadian Council of Financial Analysts: delivered in
Calgary, Edmonton, Regina, and Winnipeg, June 1997. Similar presentations given to Austin
Society of Financial Analysts (Mar. 1994), San Antonio Society of Financial Analysts (Nov. 1985),
and St. Louis Society of Financial Analysts (Feb. 1986)
“Cost of Capital for Multi-Divisional Corporations,” Financial Management Association, New
Orleans, Louisiana (Oct. 1996)
"Ethics and the Treasury Function,” Government Treasurers Organization of Texas, Corpus Christi,
Texas (Jun. 1996)
"A Cooperative Future,” Iowa Association of Electric Cooperatives, Des Moines (December 1995).
Similar presentations given to National G & T Conference, Irving, Texas (June 1995), Kentucky
Association of Electric Cooperatives Annual Meeting, Louisville (Nov. 1994), Virginia, Maryland,
and Delaware Association of Electric Cooperatives Annual Meeting, Richmond (July 1994), and
Carolina Electric Cooperatives Annual Meeting, Raleigh (Mar. 1994)
Exhibit No. 3
Case Nos. AVU-E-12-08 & AVU-G-12-07
W. Avera, Avista
Schedule 1, p. 10 of 11

"Information Superhighway Warnings: Speed Bumps on Wall Street and Detours from the Economy,”
Texas Society of Certified Public Accountants Natural Gas, Telecommunications and Electric
Industries Conference, Austin (Apr. 1995)
"Economic/Wall Street Outlook,” Carolinas Council of the Institute of Management Accountants,
Myrtle Beach, South Carolina (May 1994). Similar presentation given to Bell Operating Company
Accounting Witness Conference, Santa Fe, New Mexico (Apr. 1993)
"Regulatory Developments in Telecommunications,” Regional Holding Company Financial and
Accounting Conference, San Antonio (Sep. 1993)
“Estimating the Cost of Capital During the 1990s: Issues and Directions,” The National Society of
Rate of Return Analysts, Washington, D.C. (May 1992)
“Making Utility Regulation Work at the Public Utility Commission of Texas,” Center for Legal and
Regulatory Studies, University of Texas, Austin (June 1991)
"Can Regulation Compete for the Hearts and Minds of Industrial Customers,” Emerging Issues of
Competition in the Electric Utility Industry Conference, Austin (May 1988)
"The Role of Utilities in Fostering New Energy Technologies,” Emerging Energy Technologies in
Texas Conference, Austin (Mar. 1988)
"The Regulators’ Perspective,” Bellcore Economic Analysis Conference, San Antonio (Nov. 1987)
"Public Utility Commissions and the Nuclear Plant Contractor,” Construction Litigation
Superconference, Laguna Beach, California (Dec. 1986)
"Development of Cogeneration Policies in Texas,” University of Georgia Fifth Annual Public Utilities
Conference, Atlanta (Sep. 1985)
"Wheeling for Power Sales,” Energy Bureau Cogeneration Conference, Houston (Nov. 1985).
"Asymmetric Discounting of Information and Relative Liquidity: Some Empirical Evidence for
Common Stocks" (with John Groth and Kerry Cooper), Southern Finance Association, New Orleans
(Nov. 1982)
“Used and Useful Planning Models,” Planning Executive Institute, 27th Corporate Planning
Conference, Los Angeles (Nov. 1979)
"Staff Input to Commission Rate of Return Decisions,” The National Society of Rate of Return
Analysts, New York (Oct. 1979)
""Discounted Cash Life: A New Measure 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 Distributions to Explain Variance,” with
Charles G. Martin, Southern Finance Association, Atlanta (Nov. 1977)
“An ANOVA Representation of Common Stock Returns as a Framework for the Allocation of
Portfolio Management Effort,” with Charles G. Martin, Financial Management Association,
Montreal (Oct. 1976)
“A Growth-Optimal Portfolio Selection Model with Finite Horizon,” with Henry A. Latané, American
Finance Association, San Francisco (Dec. 1974)
“An Optimal Approach to the Finance Decision,” with Henry A. Latané, Southern Finance
Association, Atlanta (Nov. 1974)
Exhibit No. 3
Case Nos. AVU-E-12-08 & AVU-G-12-07
W. Avera, Avista
Schedule 1, p. 11 of 11

“A Pragmatic Approach to the Capital Structure Decision Based on Long-Run Growth,” with Henry
A. Latané, Financial Management Association, San Diego (Oct. 1974)
“Growth Rates, Expected Returns, and Variance in Portfolio Selection and Performance Evaluation,”
with Henry A. Latané, Econometric Society, Oslo, Norway (Aug. 1973)

Exhibit No. 3
Case Nos. AVU-E-12-08 & AVU-G-12-07
W. Avera, Avista
Schedule 2, p. 1 of 48
EXHIBIT 3, SCHEDULE 2

DESCRIPTION OF QUANTITATIVE ANALYSES

Q. What is the purpose of this schedule? 1
A. Exhibit 3, Schedule 2 presents capital market
estimates of the cost of equity. First, I examine the
concept of the cost of equity, along with the risk-return
tradeoff principle fundamental to capital markets. Next,
I describe DCF, CAPM, risk premium, and expected earnings
analyses conducted to estimate the cost of equity for
reference groups of comparable risk firms.
A. Overview
Q. What role does the rate of return on common 9
equity play in a utility’s rates? 10
A. The return on common equity is the cost of
inducing and retaining investment in the utility’s 12
physical plant and assets. This investment is necessary
to finance the asset base needed to provide utility
service. Competition for investor funds is intense and
investors are free to invest their funds wherever they
choose. They will commit money to a particular investment
only if they expect it to produce a return commensurate
with those from other investments with comparable risks.

Exhibit No. 3
Case Nos. AVU-E-12-08 & AVU-G-12-07
W. Avera, Avista
Schedule 2, p. 2 of 48
Q. What fundamental economic principle underlies 1
any evaluation of investors’ required return on equity? 2
A. The fundamental economic principle underlying
the cost of equity concept is the notion that investors
are risk averse. In capital markets where relatively
risk-free assets are available (e.g., U.S. Treasury
securities), investors can be induced to hold riskier
assets only if they are offered a premium, or additional
return, above the rate of return on a risk-free asset.
Since all assets compete with each other for investor
funds, riskier assets must yield a higher expected rate of
return than safer assets to induce investors to hold them.
Given this risk-return tradeoff, the required rate of
return (k) from an asset (i) can be generally expressed
as:
ki = Rf +RPi 16
where: Rf = Risk-free rate of return, and
RPi = Risk premium required to hold riskier
asset i.
Thus, the required rate of return for a particular asset
at any point in time is a function of: 1) the yield on
risk-free assets, and 2) its relative risk, with investors
demanding correspondingly larger risk premiums for assets
bearing greater risk.

Exhibit No. 3
Case Nos. AVU-E-12-08 & AVU-G-12-07
W. Avera, Avista
Schedule 2, p. 3 of 48
Q. Is the cost of equity observable in the capital 1
markets? 2
A. No. Unlike debt capital, there is no
contractually guaranteed return on common equity capital
since shareholders are the residual owners of the utility.
Because it is unobservable, the cost of equity for a
particular utility must be estimated by analyzing
information about capital market conditions generally,
assessing the relative risks of the company specifically,
and employing various quantitative methods that focus on
investors’ current required rates of return. These 11
various quantitative methods typically attempt to infer
investors’ required rates of return from stock prices,
interest rates, or other capital market data.
B. Comparable Risk Proxy Groups
Q. How did you implement these quantitative methods 15
to estimate the cost of common equity for Avista? 16
A. Application of the DCF model and other
quantitative methods to estimate the cost of equity
requires observable capital market data, such as stock
prices. Moreover, even for a firm with publicly traded
stock, the cost of equity can only be estimated. As a
result, applying quantitative models using observable
market data only produces an estimate that inherently

Exhibit No. 3
Case Nos. AVU-E-12-08 & AVU-G-12-07
W. Avera, Avista
Schedule 2, p. 4 of 48
includes some degree of observation error. Thus, the
accepted approach to increase confidence in the results is
to apply the DCF model and other quantitative methods to a
proxy group of publicly traded companies that investors
regard as risk comparable.
Q. What specific proxy group did you rely on for 6
your analysis? 7
A. In order to reflect the risks and prospects
associated with Avista’s jurisdictional utility 9
operations, my DCF analyses focused on a reference group
of other utilities composed of those companies included by
The Value Line Investment Survey (“Value Line”) in its 12
Electric Utilities Industry groups with: (1) S&P corporate
credit ratings of “BBB-” to “BBB+,” (2) a Value Line 14
Safety Rank of “2” or “3”, and (3) a Value Line Financial 15
Strength Rating of “B+” or higher.1 I refer to this group
as the “Utility Proxy Group.”
Q. What other proxy group did you consider in 18
evaluating a fair ROE for Avista? 19
A. Under the regulatory standards established by
Hope and Bluefield, the salient criterion in establishing
a meaningful benchmark to evaluate a fair ROE is relative
1 In addition, I excluded two utilities that otherwise would have been in the proxy group, but are not
appropriate for inclusion because they are currently involved in a major acquisition.

Exhibit No. 3
Case Nos. AVU-E-12-08 & AVU-G-12-07
W. Avera, Avista
Schedule 2, p. 5 of 48
risk, not the particular business activity or degree of
regulation. With regulation taking the place of
competitive market forces, required returns for utilities
should be in line with those of non-utility firms of
comparable risk operating under the constraints of free
competition. Consistent with this accepted regulatory
standard, I also applied the DCF model to a reference
group of low-risk companies in the non-utility sectors of
the economy. I refer to this group as the “Non-Utility
Proxy Group”.
Q. What criteria did you apply to develop the Non-11
Utility Proxy Group? 12
A. My comparable risk proxy group of non-utility
firms was composed of those U.S. companies followed by
Value Line that: (1) pay common dividends; (2) have a
Safety Rank of “1”; (3) have a Financial Strength Rating 16
of “B++” or greater; (4) have a beta of 0.60 or less; and, 17
(5) have investment grade credit ratings from S&P.
Q. Do these criteria provide objective evidence to 19
evaluate investors’ risk perceptions? 20
A. Yes. Credit ratings are assigned by independent
rating agencies for the purpose of providing investors
with a broad assessment of the creditworthiness of a firm.

Exhibit No. 3
Case Nos. AVU-E-12-08 & AVU-G-12-07
W. Avera, Avista
Schedule 2, p. 6 of 48
Ratings generally extend from triple-A (the highest) to D
(in default). Other symbols (e.g., "A+") are used to show
relative standing within a category. Because the rating
agencies’ evaluation includes virtually all of the factors 4
normally considered important in assessing a firm’s 5
relative credit standing, corporate credit ratings provide
a broad, objective measure of overall investment risk that
is readily available to investors. Although the credit
rating agencies are not immune to criticism, their
rankings and analyses are widely cited in the investment
community and referenced by investors. Investment
restrictions tied to credit ratings continue to influence
capital flows, and credit ratings are also frequently used
as a primary risk indicator in establishing proxy groups
to estimate the cost of common equity.
While credit ratings provide the most widely
referenced benchmark for investment risks, other quality
rankings published by investment advisory services also
provide relative assessments of risks that are considered
by investors in forming their expectations for common
stocks. Value Line’s primary risk indicator is its Safety 21
Rank, which ranges from “1” (Safest) to “5” (Riskiest). 22
This overall risk measure is intended to capture the total

Exhibit No. 3
Case Nos. AVU-E-12-08 & AVU-G-12-07
W. Avera, Avista
Schedule 2, p. 7 of 48
risk of a stock, and incorporates elements of stock price
stability and financial strength. Given that Value Line
is perhaps the most widely available source of investment
advisory information, its Safety Rank provides useful
guidance regarding the risk perceptions of investors.
The Financial Strength Rating is designed as a guide
to overall financial strength and creditworthiness, with
the key inputs including financial leverage, business
volatility measures, and company size. Value Line’s
Financial Strength Ratings range from “A++” (strongest) 10
down to “C” (weakest) in nine steps. Finally, Value 11
Line’s beta measures the volatility of a security's price 12
relative to the market as a whole. A stock that tends to
respond less to market movements has a beta less than
1.00, while stocks that tend to move more than the market
have betas greater than 1.00.
Q. How do the overall risks of your proxy groups 17
compare with Avista? 18
A. Table WEA-2 compares the Utility Proxy Group
with the Non-Utility Proxy Group and Avista across four
key indicators of investment risk:

Exhibit No. 3
Case Nos. AVU-E-12-08 & AVU-G-12-07
W. Avera, Avista
Schedule 2, p. 8 of 48
TABLE WEA-2 1
COMPARISON OF RISK INDICATORS 2
S&P Value Line
Credit
Rating
Safety
Rank
Financial
Strength

Beta
Q. What does this comparison indicate regarding 3
investors’ assessment of the relative risks of your proxy 4
groups? 5
A. Considered together, a comparison of these
objective measures, which consider of a broad spectrum of
risks, including financial and business position, and
exposure to firm-specific factors, indicates that
investors would likely conclude that the overall
investment risks for Avista are generally comparable to
those of the firms in the Utility Proxy Group.
With respect to the Non-Utility Proxy Group, its
average credit ratings, Safety Rank, Financial Strength
Rating, and beta suggest less risk than for Avista. While
the impact of differences in regulation is reflected in
objective risk measures, my analyses conservatively focus
on a lower-risk group of non-utility firms.

Exhibit No. 3
Case Nos. AVU-E-12-08 & AVU-G-12-07
W. Avera, Avista
Schedule 2, p. 9 of 48
C. Discounted Cash Flow Analyses
Q. How are DCF models used to estimate the cost of 1
equity? 2
A. DCF models attempt to replicate the market
valuation process that sets the price investors are
willing to pay for a share of a company’s stock. The 5
model rests on the assumption that investors evaluate the
risks and expected rates of return from all securities in
the capital markets. Given these expectations, the price
of each stock is adjusted by the market until investors
are adequately compensated for the risks they bear.
Therefore, we can look to the market to determine what
investors believe a share of common stock is worth. By
estimating the cash flows investors expect to receive from
the stock in the way of future dividends and capital
gains, we can calculate their required rate of return. In
other words, the cash flows that investors expect from a
stock are estimated, and given its current market price,
we can “back-into” the discount rate, or cost of equity,
that investors implicitly used in bidding the stock to
that price.

Exhibit No. 3
Case Nos. AVU-E-12-08 & AVU-G-12-07
W. Avera, Avista
Schedule 2, p. 10 of 48
Q. What market valuation process underlies DCF 1
models? 2
A. DCF models assume that the price of a share of
common stock is equal to the present value of the expected
cash flows (i.e., future dividends and stock price) that
will be received while holding the stock, discounted at
investors’ required rate of return. That is, the cost of 7
equity is the discount rate that equates the current price
of a share of stock with the present value of all expected
cash flows from the stock.
Q. What form of the DCF model is customarily used 11
to estimate the cost of equity in rate cases? 12
A. Rather than developing annual estimates of cash
flows into perpetuity, the DCF model can be simplified to
a “constant growth” form:
gk
DP
e
1
0
where: P0 = Current price per share;
D1 = Expected dividend per share in the
coming year;
ke = Cost of equity;
g = Investors’ long-term growth
expectations.

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.

Exhibit No. 3
Case Nos. AVU-E-12-08 & AVU-G-12-07
W. Avera, Avista
Schedule 2, p. 11 of 48
The cost of equity (Ke) can be isolated by rearranging
terms:
gP
Dk
0
1
e
This constant growth form of the DCF model recognizes that
the rate of return to stockholders consists of two parts:
1) dividend yield (D1/P0), and 2) growth (g). In other
words, investors expect to receive a portion of their
total return in the form of current dividends and the
remainder through price appreciation.
Q. What steps are required to apply the DCF model? 10
A. The first step in implementing the constant
growth DCF model is to determine the expected dividend
yield (D1/P0) for the firm in question. This is usually
calculated based on an estimate of dividends to be paid in
the coming year divided by the current price of the stock.
The second, and more controversial, step is to estimate
investors' long-term growth expectations (g) for the firm.
The final step is to sum the firm's dividend yield and
estimated growth rate to arrive at an estimate of its cost
of equity.

Exhibit No. 3
Case Nos. AVU-E-12-08 & AVU-G-12-07
W. Avera, Avista
Schedule 2, p. 12 of 48
Q. How was the dividend yield for the Utility Proxy 1
Group determined? 2
A. Estimates of dividends to be paid by each of
these utilities over the next twelve months, obtained from
Value Line, served as D1. This annual dividend was then
divided by the corresponding stock price for each utility
to arrive at the expected dividend yield. The expected
dividends, stock prices, and resulting dividend yields for
the firms in the Utility Proxy Group are presented on page
1 of Exhibit 3, Schedule 4.
Q. What is the next step in applying the constant 11
growth DCF model? 12
A. The next step is to evaluate long-term growth
expectations, or “g”, for the firm in question. In 14
constant growth DCF theory, earnings, dividends, book
value, and market price are all assumed to grow in
lockstep, and the growth horizon of the DCF model is
infinite. But implementation of the DCF model is more
than just a theoretical exercise; it is an attempt to
replicate the mechanism investors used to arrive at
observable stock prices. A wide variety of techniques can
be used to derive growth rates, but the only “g” that 22

Exhibit No. 3
Case Nos. AVU-E-12-08 & AVU-G-12-07
W. Avera, Avista
Schedule 2, p. 13 of 48
matters in applying the DCF model is the value that
investors expect.
Q. Are historical growth rates likely to be 3
representative of investors’ expectations for utilities? 4
A. No. If past trends in earnings, dividends, and
book value are to be representative of investors’ 6
expectations for the future, then the historical
conditions giving rise to these growth rates should be
expected to continue. That is clearly not the case for
utilities, where structural and industry changes have led
to declining growth in dividends, earnings pressure, and,
in many cases, significant write-offs. While these
conditions serve to depress historical growth measures,
they are not representative of long-term expectations for
the utility industry or the expectations that investors
have incorporated into current market prices. As a
result, historical growth measures for utilities do not
currently meet the requirements of the DCF model.
Q. Do the growth rate projections of security 19
analysts nonetheless consider historical trends? 20
A. Yes. Professional security analysts study
historical trends extensively in developing their
projections of future earnings. Hence, to the extent

Exhibit No. 3
Case Nos. AVU-E-12-08 & AVU-G-12-07
W. Avera, Avista
Schedule 2, p. 14 of 48
there is any useful information in historical patterns,
that information is incorporated into analysts’ growth 2
forecasts.
Q. What are investors most likely to consider in 4
developing their long-term growth expectations? 5
A. While the DCF model is technically concerned
with growth in dividend cash flows, implementation of this
DCF model is solely concerned with replicating the
forward-looking evaluation of real-world investors. In
the case of utilities, dividend growth rates are not
likely to provide a meaningful guide to investors’ current 11
growth expectations. This is because utilities have
significantly altered their dividend policies in response
to more accentuated business risks in the industry.3 As a
result of this trend towards a more conservative payout
ratio, dividend growth in the utility industry has
remained largely stagnant as utilities conserve financial
resources to provide a hedge against heightened
uncertainties.
As payout ratios for firms in the utility industry
trended downward, investors’ focus has increasingly 21
3 For example, the payout ratio for electric utilities fell from approximately 80% historically to on the
order of 60%. The Value Line Investment Survey (Sep. 15, 1995 at 161, Aug. 24, 2012 at 138).

Exhibit No. 3
Case Nos. AVU-E-12-08 & AVU-G-12-07
W. Avera, Avista
Schedule 2, p. 15 of 48
shifted from dividends to earnings as a measure of long-
term growth. Future trends in earnings per share (“EPS”),
which provide the source for future dividends and
ultimately support share prices, play a pivotal role in
determining investors’ long-term growth expectations. The
importance of earnings in evaluating investors’ 6
expectations and requirements is well accepted in the
investment community, and surveys of analytical techniques
relied on by professional analysts indicate that growth in
earnings is far more influential that trends in dividends
per share (“DPS”). Apart from Value Line, investment 11
advisory services do not generally publish comprehensive
DPS growth projections, and this scarcity of dividend
growth rates relative to the abundance of earnings
forecasts attests to their relative influence. The fact
that securities analysts focus on EPS growth, and that
dividend growth rates are not routinely published,
indicates that projected EPS growth rates are likely to
provide a superior indicator of the future long-term
growth expected by investors.

Exhibit No. 3
Case Nos. AVU-E-12-08 & AVU-G-12-07
W. Avera, Avista
Schedule 2, p. 16 of 48
Q. What are security analysts currently projecting 1
in the way of growth for the firms in the Utility Proxy 2
Group? 3
A. The projected EPS growth rates for each of the
firms in the Utility Proxy Group reported by Value Line,
Thomson Reuters (“IBES”), and Zacks Investment Research
(“Zacks”)are displayed on page 2 of Exhibit 3, Schedule4.4
Q. Some argue that analysts’ assessments of growth 8
rates are biased. Do you believe these projections are 9
inappropriate for estimating investors’ required return 10
using the DCF model? 11
A. No. In applying the DCF model to estimate the
cost of common equity, the only relevant growth rate is
the forward-looking expectations of investors that are
captured in current stock prices. Investors, just like
securities analysts and others in the investment
community, do not know how the future will actually turn
out. They can only make investment decisions based on
their best estimate of what the future holds in the way of
long-term growth for a particular stock, and securities
prices are constantly adjusting to reflect their
assessment of available information.
4 Formerly I/B/E/S International, Inc., IBES growth rates are now compiled and published by Thomson
Reuters.

Exhibit No. 3
Case Nos. AVU-E-12-08 & AVU-G-12-07
W. Avera, Avista
Schedule 2, p. 17 of 48
Any claims that analysts’ estimates are not relied 1
upon by investors are illogical given the reality of a
competitive market for investment advice. The market for
investment advice is intensely competitive, and securities
analysts are personally and professionally motivated to
provide the most accurate assessment possible of future
growth trends. If financial analysts’ forecasts do not 7
add value to investors’ decision making, then it is 8
irrational for investors to pay for these estimates.
Those financial analysts who fail to provide reliable
forecasts will lose out in competitive markets relative to
those analysts whose forecasts investors find more
credible. The reality that analyst estimates are
routinely referenced in the financial media and in
investment advisory publications (e.g., Value Line)
implies that investors use them as a basis for their
expectations.
The continued success of investment services such as
Thomson Reuters and Value Line, and the fact that
projected growth rates from such sources are widely
referenced, provides strong evidence that investors give
considerable weight to analysts’ earnings projections in 22
forming their expectations for future growth. While the

Exhibit No. 3
Case Nos. AVU-E-12-08 & AVU-G-12-07
W. Avera, Avista
Schedule 2, p. 18 of 48
projections of securities analysts may be proven
optimistic or pessimistic in hindsight, this is irrelevant
in assessing the expected growth that investors have
incorporated into current stock prices, and any bias in
analysts’ forecasts – whether pessimistic or optimistic –
is irrelevant if investors share analysts’ views. 6
Earnings growth projections of security analysts provide
the most frequently referenced guide to investors’ views 8
and are widely accepted in applying the DCF model. As
explained in New Regulatory Finance:
Because of the dominance of institutional
investors and their influence on individual
investors, analysts’ forecasts of long-run
growth rates provide a sound basis for
estimating required returns. Financial analysts
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]. The accuracy of these
forecasts in the sense of whether they turn out
to be correct is not an issue here, as long as
they reflect widely held expectations.5
Q. How else are investors’ expectations of future 23
long-term growth prospects often estimated for use in the 24
constant growth DCF model? 25
A. In constant growth theory, growth in book equity
will be equal to the product of the earnings retention
5 Morin, Roger A., “New Regulatory Finance,” Public Utilities Reports, Inc. at 298 (2006) (emphasis
added).

Exhibit No. 3
Case Nos. AVU-E-12-08 & AVU-G-12-07
W. Avera, Avista
Schedule 2, p. 19 of 48
ratio (one minus the dividend payout ratio) and the earned
rate of return on book equity. Furthermore, if the earned
rate of return and the payout ratio are constant over
time, growth in earnings and dividends will be equal to
growth in book value. Despite the fact that these
conditions are seldom, if ever, met in practice, this
“sustainable growth” approach may provide a rough guide 7
for evaluating a firm’s growth prospects and is frequently 8
proposed in regulatory proceedings.
Accordingly, while I believe that analysts’ EPS
growth forecasts provide a superior and more direct guide
to investors’ expectations, I have included the 12
“sustainable growth” approach for completeness. The 13
sustainable growth rate is calculated by the formula,
g = br+sv, where “b” is the expected retention ratio, “r” 15
is the expected earned return on equity, “s” is the 16
percent of common equity expected to be issued annually as
new common stock, and “v” is the equity accretion rate.
Q. What is the purpose of the “sv” term? 19
A. Under DCF theory, the “sv” factor is a component
of the growth rate designed to capture the impact of
issuing new common stock at a price above, or below, book
value. When a company’s stock price is greater than its 23

Exhibit No. 3
Case Nos. AVU-E-12-08 & AVU-G-12-07
W. Avera, Avista
Schedule 2, p. 20 of 48
book value per share, the per-share contribution in excess
of book value associated with new stock issues will accrue
to the current shareholders. This increase to the book
value of existing shareholders leads to higher expected
earnings and dividends, with the “sv” factor incorporating 5
this additional growth component.
Q. What growth rate does the earnings retention 7
method suggest for the Utility Proxy Group? 8
A. The sustainable, “br+sv” growth rates for each 9
firm in the Utility Proxy Group are summarized on page 2
of Exhibit 3, Schedule 4, with the underlying details
being presented on Exhibit 3, Schedule 5. For each firm,
the expected retention ratio (b) was calculated based on
Value Line’s projected dividends and earnings per share. 14
Likewise, each firm’s expected earned rate of return (r) 15
was computed by dividing projected earnings per share by
projected net book value. Because Value Line reports end-
of-year book values, an adjustment was incorporated to
compute an average rate of return over the year,
consistent with the theory underlying this approach to
estimating investors’ growth expectations. Meanwhile, the 21
percent of common equity expected to be issued annually as
new common stock (s) was equal to the product of the

Exhibit No. 3
Case Nos. AVU-E-12-08 & AVU-G-12-07
W. Avera, Avista
Schedule 2, p. 21 of 48
projected market-to-book ratio and growth in common shares
outstanding, while the equity accretion rate (v) was
computed as 1 minus the inverse of the projected market-
to-book ratio.
Q. What cost of equity estimates were implied for 5
the Utility Proxy Group using the DCF model? 6
A. After combining the dividend yields and
respective growth projections for each utility, the
resulting cost of equity estimates are shown on page 3 of
Exhibit 3, Schedule 4.
Q. In evaluating the results of the constant growth 11
DCF model, is it appropriate to eliminate estimates that 12
are extreme outliers? 13
A. Yes. In applying quantitative methods to
estimate the cost of equity, it is essential that the
resulting values pass fundamental tests of reasonableness
and economic logic. Accordingly, DCF estimates that are
implausibly low or high should be eliminated when
evaluating the results of this method.
Q. How did you evaluate DCF estimates at the low 20
end of the range? 21
A. It is a basic economic principle that investors
can be induced to hold more risky assets only if they
expect to earn a return to compensate them for their risk

Exhibit No. 3
Case Nos. AVU-E-12-08 & AVU-G-12-07
W. Avera, Avista
Schedule 2, p. 22 of 48
bearing. As a result, the rate of return that investors
require from a utility’s common stock, the most junior and 2
riskiest of its securities, must be considerably higher
than the yield offered by senior, long-term debt.
Consistent with this principle, the DCF results must be
adjusted to eliminate estimates that are determined to be
extreme low outliers when compared against the yields
available to investors from less risky utility bonds.
Q. Have similar tests been applied by regulators? 9
A. Yes. FERC has noted that adjustments are
justified where applications of the DCF approach produce
illogical results. FERC evaluates DCF results against
observable yields on long-term public utility debt and has
recognized that it is appropriate to eliminate estimates
that do not sufficiently exceed this threshold. In a 2002
opinion establishing its current precedent for determining
ROEs for electric utilities, for example, FERC noted:
An adjustment to this data is appropriate in the
case of PG&E’s low-end return of 8.42 percent,
which is comparable to the average Moody’s “A” 20
grade public utility bond yield of 8.06 percent,
for October 1999. Because investors cannot be
expected to purchase stock if debt, which has
less risk than stock, yields essentially the

Exhibit No. 3
Case Nos. AVU-E-12-08 & AVU-G-12-07
W. Avera, Avista
Schedule 2, p. 23 of 48
same return, this low-end return cannot be
considered reliable in this case.6
Similarly, in its August 2006 decision in Kern River Gas 3
Transmission Company, FERC noted that:
[T]he 7.31 and 7.32 percent costs of equity for
El Paso and Williams found by the ALJ are only
110 and 122 basis points above that average
yield for public utility debt.
The Commission upheld the opinion of Staff and the
Administrative Law Judge that cost of equity estimates for
these two proxy group companies “were too low to be 11
credible.”
The practice of eliminating low-end outliers has been
affirmed in numerous FERC proceedings,9 and in its April
15, 2010 decision in SoCal Edison, FERC affirmed that, “it
is reasonable to exclude any company whose low-end ROE
fails to exceed the average bond yield by about 100 basis
points or more.”10
Q. What benchmarks did you consider in evaluating 19
the DCF results for the Utility Proxy Group? 20
A. As noted earlier, the average S&P corporate
credit rating for the Utility proxy Group is “BBB”, the 22
6 Southern California Edison Company, 92 FERC ¶ 61,070 at p. 22 (2000). 7 Kern River Gas Transmission Company, Opinion No. 486, 117 FERC ¶ 61,077 at P 140 & n. 227
(2006). 8 Id. 9 See, e.g., Virginia Electric Power Co., 123 FERC ¶ 61,098 at P 64 (2008). 10 Southern California Edison Co., 131 FERC ¶ 61,020 at P 55 (2010) (“SoCal Edison”).

Exhibit No. 3
Case Nos. AVU-E-12-08 & AVU-G-12-07
W. Avera, Avista
Schedule 2, p. 24 of 48
same as for Avista. Companies rated “BBB-”, “BBB”, and 1
“BBB+” are all considered part of the triple-B rating
category, with Moody’s monthly yields on triple-B bonds
averaging approximately 4.9 percent in August 2012.11 It
is inconceivable that investors are not requiring a
substantially higher rate of return for holding common
stock.
Q. What else should be considered in evaluating DCF 8
estimates at the low end of the range? 9
A. While corporate bond yields have declined
substantially as the worst of the financial crisis has
abated, it is generally expected that long-term interest
rates will rise as the economy returns to a more normal
pattern of growth. As shown in Table 2 below, forecasts
of IHS Global Insight and the EIA imply an average triple-
B bond yield of approximately 7.2 percent over the period
2013-2017:

11 Moody’s Investors Service, www.credittrends.com.

Exhibit No. 3
Case Nos. AVU-E-12-08 & AVU-G-12-07
W. Avera, Avista
Schedule 2, p. 25 of 48
TABLE 2 1
IMPLIED BBB BOND YIELD 2
2013-17
Projected AA Utility Yield
IHS Global Insight (a)5.92%
EIA (b)6.33%
Average 6.13%
Current BBB - AA Yield Spread (c)1.11%
Implied Triple-B Utility Yield 7.24%
(a)
(b)
(c)
Energy Information Administration, Annual Energy Outlook
2012 (Jun. 25, 2012)
IHS Global Insight, U.S. Economic Outlook at 19 (May 2012)
Based on monthly average bond yields from Moody's
Investors Service for the six-month period Mar. 2012 - Aug.
2012
The increase in debt yields anticipated by IHS Global
Insight and EIA is also supported by the widely-referenced
Blue Chip Financial Forecasts, which projects that yields
on corporate bonds will climb approximately 180 basis
points through the period 2012 through 2014-18.12
Q. What does this test of logic imply with respect 9
to the DCF estimates for the Utility Proxy Group? 10
A. As highlighted on page 3 of Exhibit 3, Schedule
4, twenty of the individual DCF estimates ranged from –4.0
percent to 6.7 percent. In light of the risk-return

12 Blue Chip Financial Forecasts, Vol. 31, No. 6 (Jun. 1, 2012).

Exhibit No. 3
Case Nos. AVU-E-12-08 & AVU-G-12-07
W. Avera, Avista
Schedule 2, p. 26 of 48
tradeoff principle and the test applied in SoCal Edison,
it is inconceivable that investors are not requiring a
substantially higher rate of return for holding common
stock, which is the riskiest of a utility’s securities. 4
As a result, consistent with the test of economic logic
applied by FERC and the upward trend expected for utility
bond yields, these values provide little guidance as to
the returns investors require from utility common stocks
and should be excluded.
Q. Do you also recommend excluding estimates at the 10
high end of the range of DCF results? 11
A. Yes. The upper end of the cost of common equity
range produced by the DCF analysis presented on page 3 of
Exhibit 3, Schedule 4 was set by a cost of equity
estimates of 29.1 percent. When compared with the balance
of the remaining estimates, this value is clearly
implausible and should be excluded in evaluating the
results of the DCF model for the Utility Proxy Group.
This is also consistent with the precedent adopted by
FERC, which has established that estimates found to be

Exhibit No. 3
Case Nos. AVU-E-12-08 & AVU-G-12-07
W. Avera, Avista
Schedule 2, p. 27 of 48
“extreme outliers” should be disregarded in interpreting 1
the results of the DCF model.13
Q. What cost of equity is implied by your DCF 3
results for the Utility Proxy Group? 4
A. As shown on page 3 of Exhibit 3, Schedule 4 and
summarized in Table 3, below, after eliminating illogical
low- and high-end values, application of the constant
growth DCF model resulted in the following cost of common
equity estimates:
TABLE 3 10
DCF RESULTS – UTILITY PROXY GROUP 11
Growth Rate Average Midpoint
Value Line 9.7%10.7%
IBES 9.5%11.0%
Zacks 9.4%9.8%
br + sv 8.9%10.2%
Cost of Equity
12
Q. What were the results of your DCF analysis for 13
the Non-Utility Proxy Group? 14
A. I applied the DCF model to the Non-Utility Proxy
Group in exactly the same manner described earlier for the
Utility Proxy Group. The results of my DCF analysis for
the Non-Utility Proxy Group are presented in Exhibit 3,
Schedule 6, with the sustainable, “br+sv” growth rates 19

13 See, e.g., ISO New England, Inc., 109 FERC ¶ 61,147 at P 205 (2004).

Exhibit No. 3
Case Nos. AVU-E-12-08 & AVU-G-12-07
W. Avera, Avista
Schedule 2, p. 28 of 48
being developed on Exhibit 3, Schedule 7. As shown on
page 3 of Exhibit 3, Schedule 6 and summarized in Table 4,
below, after eliminating illogical low- and high-end
values, application of the constant growth DCF model
resulted in the following cost of common equity estimates:
TABLE 4 6
DCF RESULTS – NON-UTILITY PROXY GROUP 7
Growth Rate Average Midpoint
Value Line 11.5%10.7%
IBES 10.8%10.4%
Zacks 11.1%10.3%
br + sv 12.8%15.9%
Cost of Equity
8
As discussed earlier, reference to the Non-Utility Proxy
Group is consistent with established regulatory
principles. Required returns for utilities should be in
line with those of non-utility firms of comparable risk
operating under the constraints of free competition.
Q. How can you reconcile these DCF results for the 14
Non-Utility Proxy Group against the significantly lower 15
estimates produced for your comparable-risk group of 16
utilities? 17
A. First, it is important to be clear that the
higher DCF results for the Non-Utility Proxy Group cannot

Exhibit No. 3
Case Nos. AVU-E-12-08 & AVU-G-12-07
W. Avera, Avista
Schedule 2, p. 29 of 48
be attributed to risk differences. As I documented
earlier, the risks that investors associate with the group
of non-utility firms - as measured by S&P’s credit ratings 3
and Value Line’s Safety Rank, Financial Strength, and Beta
– are lower than the risks investors associate with the
Utility Proxy Group. The objective evidence provided by
these observable risk measures rules out a conclusion that
the higher non-utility DCF estimates are associated with
higher investment risk.
Rather, the divergence between the DCF results for
these groups of utility and non-utility firms can be
attributed to the fact that DCF estimates invariably
depart from the returns that investors actually require
because their expectations may not be captured by the
inputs to the model, particularly the assumed growth rate.
Because the actual cost of equity is unobservable, and DCF
results inherently incorporate a degree of error, the cost
of equity estimates for the Non-Utility Group provide an
important benchmark in evaluating a fair ROE for Avista.
There is no basis to conclude that DCF results for a group
of utilities would be inherently more reliable than those
for firms in the competitive sector, and the divergence
between the DCF estimates for the Utility and Non-Utility

Exhibit No. 3
Case Nos. AVU-E-12-08 & AVU-G-12-07
W. Avera, Avista
Schedule 2, p. 30 of 48
Proxy Groups suggests that both should be considered to
ensure a balanced end-result.
D. Capital Asset Pricing Model
Q. Please describe the CAPM. 3
A. The CAPM is a theory of market equilibrium that
measures risk using the beta coefficient. Assuming
investors are fully diversified, the relevant risk of an
individual asset (e.g., common stock) is its volatility
relative to the market as a whole, with beta reflecting
the tendency of a stock’s price to follow changes in the 9
market. The CAPM is mathematically expressed as:
Rj = Rf +βj(Rm - Rf)
where: Rj = required rate of return for stock j;
Rf = risk-free rate;
Rm = expected return on the market
portfolio; and,
βj = beta, or systematic risk, for stock j.
Like the DCF model, the CAPM is an ex-ante, or forward-
looking model based on expectations of the future. As a
result, in order to produce a meaningful estimate of
investors’ required rate of return, the CAPM must be 20
applied using estimates that reflect the expectations of
actual investors in the market, not with backward-looking,
historical data.

Exhibit No. 3
Case Nos. AVU-E-12-08 & AVU-G-12-07
W. Avera, Avista
Schedule 2, p. 31 of 48
Q. How did you apply the CAPM to estimate the cost 1
of common equity? 2
A. Application of the CAPM to the Utility Proxy
Group based on a forward-looking estimate for investors’ 4
required rate of return from common stocks is presented on
Exhibit 3, Schedule 8. In order to capture the
expectations of today’s investors in current capital 7
markets, the expected market rate of return was estimated
by conducting a DCF analysis on the dividend paying firms
in the S&P 500.
The dividend yield for each firm was obtained from
Value Line, and the growth rate was equal to the consensus
earnings growth projection for each firm published by
IBES, with each firm’s dividend yield and growth rate 14
being weighted by its proportionate share of total market
value. Based on the weighted average of the projections
for the 384 individual firms, current estimates imply an
average growth rate over the next five years of 10.3
percent. Combining this average growth rate with a year-
ahead dividend yield of 2.6 percent results in a current
cost of common equity estimate for the market as a whole
(Rm) of approximately 12.9 percent. Subtracting a 2.9
percent risk-free rate based on the average yield on

Exhibit No. 3
Case Nos. AVU-E-12-08 & AVU-G-12-07
W. Avera, Avista
Schedule 2, p. 32 of 48
30-year Treasury bonds produced a market equity risk
premium of 10.0 percent.
Q. What was the source of the beta values you used 3
to apply the CAPM? 4
A. I relied on the beta values reported by Value
Line, which in my experience is the most widely referenced
source for beta in regulatory proceedings. As noted in
New Regulatory Finance:
Value Line is the largest and most widely
circulated independent investment advisory
service, and influences the expectations of a
large number of institutional and individual
investors. … Value Line betas are computed on a
theoretically sound basis using a broadly based
market index, and they are adjusted for the
regression tendency of betas to converge to
1.00.14
Q. What else should be considered in applying the 18
CAPM? 19
A. As explained by Morningstar:
One of the most remarkable discoveries of modern
finance is that of a relationship between firm
size and return. The relationship cuts across
the entire size spectrum but is most evident
among smaller companies, which have higher
returns on average than larger ones.15
Because empirical research indicates that the CAPM does
not fully account for observed differences in rates of
14 Morin, Roger A., “New Regulatory Finance,” Public Utilities Reports at 71 (2006). 15 Morningstar, “Ibbotson SBBI 2010 Valuation Yearbook,” at p. 85 (footnote omitted).

Exhibit No. 3
Case Nos. AVU-E-12-08 & AVU-G-12-07
W. Avera, Avista
Schedule 2, p. 33 of 48
return attributable to firm size, a modification is
required to account for this size effect.
According to the CAPM, the expected return on a
security should consist of the riskless rate, plus a
premium to compensate for the systematic risk of the
particular security. The degree of systematic risk is
represented by the beta coefficient. The need for the
size adjustment arises because differences in investors’ 8
required rates of return that are related to firm size are
not fully captured by beta. To account for this,
Morningstar has developed size premiums that need to be
added to the theoretical CAPM cost of equity estimates to
account for the level of a firm’s market capitalization in 13
determining the CAPM cost of equity.16 These premiums
correspond to the size deciles of publicly traded common
stocks, and range from a premium of 6.1% for a company in
the first decile (market capitalization less than $207
million), to a reduction of 38 basis points for firms in
the tenth decile (market capitalization between $15.5
billion and $354.4 billion). Accordingly, my CAPM
analyses incorporated an adjustment to recognize the
impact of size distinctions by market capitalization that

16 Id. at Table C-1.

Exhibit No. 3
Case Nos. AVU-E-12-08 & AVU-G-12-07
W. Avera, Avista
Schedule 2, p. 34 of 48
the beta value does not otherwise capture, but which is
acknowledged by empirical research.
Q. What cost of equity estimate was indicated for 3
the Utility Proxy Group based on this forward-looking 4
application of the CAPM? 5
A. As shown on page 1 of Exhibit 3, Schedule 8,
application of the forward-looking CAPM approach resulted
in an average unadjusted ROE estimate of 10.3 percent,
with a midpoint cost of equity estimate of 10.2 percent.
After adjusting for the impact of firm size, the CAPM
approach implied an average cost of equity of 11.2
percent, with a midpoint cost of equity estimate of 10.9
percent.
Q. Is it appropriate to consider anticipated 14
capital market changes in applying the CAPM? 15
A. Yes. As discussed earlier, there is widespread
consensus that interest rates will increase materially as
the economy continues to strengthen. As a result, current
bond yields are likely to understate capital market
requirements at the time the outcome of this proceeding
becomes effective. Accordingly, in addition to the use of
current bond yields, I also applied the CAPM using a
forecasted long-term Treasury bond yield developed based

Exhibit No. 3
Case Nos. AVU-E-12-08 & AVU-G-12-07
W. Avera, Avista
Schedule 2, p. 35 of 48
on projections published by Value Line, IHS Global Insight
and Blue Chip.
Q. What cost of equity was produced by the CAPM 3
after incorporating forecasted bond yields? 4
A. As shown on page 2 of Exhibit 3, Schedule 8,
incorporating a forecasted Treasury bond yield for 2013-
2017 implied a cost of equity of approximately 10.8
percent for the Utility Proxy Group, or 11.7 percent after
adjusting for the impact of relative size. The midpoints
of the respective ranges were 10.6 percent and 11.3
percent.
Q. Should the CAPM approach be applied using 12
historical rates of return? 13
A. No. While investors undoubtedly consider
historical information as one facet in their evaluation of
future expectations, the cost of capital is a forward-
looking concept. Because the CAPM is focused solely on
the perceptions of today’s capital market investors, it 18
should not be applied using historical rates of return.
The CAPM cost of common equity estimate is calibrated from
investors’ required risk premium between Treasury bonds 21
and common stocks. In response to heightened
uncertainties, investors have repeatedly sought a safe

Exhibit No. 3
Case Nos. AVU-E-12-08 & AVU-G-12-07
W. Avera, Avista
Schedule 2, p. 36 of 48
haven in U.S. government bonds and this “flight to safety” 1
has pushed Treasury yields significantly lower while yield
spreads for corporate debt have widened. This distortion
not only impacts the absolute level of the CAPM cost of
equity estimate, but it affects estimated risk premiums.
Economic logic would suggest that investors’ required risk 6
premium for common stocks over Treasury bonds has also
increased.
Meanwhile, backward-looking approaches incorrectly
assume that investors’ assessment of the required risk
premium between Treasury bonds and common stocks is
constant, and equal to some historical average. At no
time in recent history has the fallacy of this assumption
been demonstrated more concretely. As the Staff of the
Florida Public Service Commission concluded:
[R]ecognizing the impact the Federal
Government’s unprecedented intervention in the 17
capital markets has had on the yields on long-
term Treasury bonds, staff believes models that
relate the investor-required return on equity to
the yield on government securities, such as the
CAPM approach, produce less reliable estimates
of the ROE at this time.17
17 Staff Recommendation for Docket No. 080677-E1 - Petition for increase in rates by Florida Power &
Light Company, at p. 280 (Dec. 23, 2009).

Exhibit No. 3
Case Nos. AVU-E-12-08 & AVU-G-12-07
W. Avera, Avista
Schedule 2, p. 37 of 48
Q. Has the Federal Reserve continued to pursue a 1
policy of actively managing long-term government bond 2
yields? 3
A. Yes. In September 2011, the Federal Reserve
announced “Operation Twist”, involving the exchange of 5
short-term Treasury instruments for longer-term government
bonds, in an effort to put downward pressure on long-term
interest rates. In addition, the Federal Reserve has
repeatedly implemented “quantitative easing,” which 9
involves the central bank’s purchase of long-term
financial assets on the secondary market, in order to
affect a reduction in long-term borrowing costs.
Q. Are these conditions continuing to impact risk 13
premiums? 14
A. Yes. The incongruity between investors’ current 15
expectations and historical risk premiums is particularly
relevant during periods of heightened uncertainty and
rapidly changing capital market conditions, such as those
experienced recently. The ongoing potential for renewed
turmoil in the capital markets has been seen repeatedly,
with common stock prices exhibiting the dramatic
volatility that is indicative of heightened sensitivity to
risk. The Federal Reserve’s policies, coupled with the 23
global “flight to safety” in the face of rising political, 24

Exhibit No. 3
Case Nos. AVU-E-12-08 & AVU-G-12-07
W. Avera, Avista
Schedule 2, p. 38 of 48
economic, and capital market uncertainties, has led to a
dramatic increase in risk premiums, as illustrated by the
spreads between triple-B utility bond yields and 30-year
Treasuries shown in Figure WEA-1, below:
FIGURE WEA-1 5
YIELD SPREAD (BP) BBB UTILITY – 30-YR. TREASURY 6
120
140
160
180
200
220
240
2/17
/
2
0
1
1
4/17
/
2
0
1
1
6/17
/
2
0
1
1
8/17
/
2
0
1
1
10/1
7
/
2
0
1
1
12/1
7
/
2
0
1
1
2/17
/
2
0
1
2
4/17
/
2
0
1
2
6/17
/
2
0
1
2
This increase in the yield spread indicates that the
additional compensation investors demand to take on higher
risks has increased. As S&P observed:
During periods of stress, correlations
frequently increase among risky asset classes
such as the relationship between the return on

Exhibit No. 3
Case Nos. AVU-E-12-08 & AVU-G-12-07
W. Avera, Avista
Schedule 2, p. 39 of 48
speculative-grade bonds and the return from
equities.18
Equity risk premiums cannot be observed directly, but
because common stock investors are the last in line with
respect to their claim on a utility’s cash flows, higher 5
yield spreads imply an even steeper increase in the
additional return required from an investment in common
equity. In short, heightened capital market and economic
uncertainties, and the increase in risk premiums demanded
by investors, further undermine any reliance on historical
studies to apply the CAPM.
E. Risk Premium Approach
Q. Briefly describe the risk premium method. 12
A. The risk premium method of estimating investors’ 13
required rate of return extends to common stocks the risk-
return tradeoff observed with bonds. The cost of equity
is estimated by first determining the additional return
investors require to forgo the relative safety of bonds
and to bear the greater risks associated with common
stock, and by then adding this equity risk premium to the
current yield on bonds. Like the DCF model, the risk
premium method is capital market oriented. However,
18 Standard & Poor’s Corporation, “Recent Expansion In Credit Spreads Shows Bond Market Stress, But
Less Severe Than During The Financial Crisis,” RatingsDirect (Oct. 11, 2011).

Exhibit No. 3
Case Nos. AVU-E-12-08 & AVU-G-12-07
W. Avera, Avista
Schedule 2, p. 40 of 48
unlike DCF models, which indirectly impute the cost of
equity, risk premium methods directly estimate investors’ 2
required rate of return by adding an equity risk premium
to observable bond yields.
Q. How did you implement the risk premium method? 5
A. I based my estimates of equity risk premiums for
electric utilities on surveys of previously authorized
rates of return on common equity. Authorized returns
presumably reflect regulatory commissions’ best estimates 9
of the cost of equity, however determined, at the time
they issued their final order. Such returns should
represent a balanced and impartial outcome that considers
the need to maintain a utility’s financial integrity and 13
ability to attract capital. Moreover, allowed returns are
an important consideration for investors and have the
potential to influence other observable investment
parameters, including credit ratings and borrowing costs.
Thus, this data provides a logical and frequently
referenced basis for estimating equity risk premiums for
regulated utilities.

Exhibit No. 3
Case Nos. AVU-E-12-08 & AVU-G-12-07
W. Avera, Avista
Schedule 2, p. 41 of 48
Q. How did you implement the risk premium approach 1
using surveys of allowed rates of return? 2
A. Surveys of previously authorized rates of return
on common equity are frequently referenced as the basis
for estimating equity risk premiums. The rates of return
on common equity authorized utilities by regulatory
commissions across the U.S. are compiled by Regulatory
Research Associates and published in its Regulatory Focus 8
report. In Exhibit 3, Schedule 9, the average yield on
public utility bonds is subtracted from the average
allowed rate of return on common equity for electric
utilities to calculate equity risk premiums for each year
between 1974 and 2011. Over this 38-year period, these
equity risk premiums for electric utilities averaged 3.41
percent, and the yield on public utility bonds averaged
8.91 percent.
Q. Is there any capital market relationship that 17
must be considered when implementing the risk premium 18
method? 19
A. Yes. There is considerable evidence that the
magnitude of equity risk premiums is not constant and that
equity risk premiums tend to move inversely with interest
rates. In other words, when interest rate levels are
relatively high, equity risk premiums narrow, and when

Exhibit No. 3
Case Nos. AVU-E-12-08 & AVU-G-12-07
W. Avera, Avista
Schedule 2, p. 42 of 48
interest rates are relatively low, equity risk premiums
widen. The implication of this inverse relationship is
that the cost of equity does not move as much as, or in
lockstep with, interest rates. Accordingly, for a 1
percent increase or decrease in interest rates, the cost
of equity may only rise or fall, say, 50 basis points.
Therefore, when implementing the risk premium method,
adjustments may be required to incorporate this inverse
relationship if current interest rate levels have changed
since the equity risk premiums were estimated.
Finally, it is important to recognize that the
historical focus of the risk premium studies almost
certainly ensures that they fail to fully capture the
significantly greater risks that investors now associate
with providing electric utility service. As a result,
they are likely to understate the cost of equity for a
firm operating in today’s electric power industry.
Q. What cost of equity is implied by surveys of 18
allowed rates of return on equity? 19
A. Based on the regression output between the
interest rates and equity risk premiums displayed on page
4 of Exhibit 3, Schedule 9, the equity risk premium for
electric utilities increased approximately 41 basis points

Exhibit No. 3
Case Nos. AVU-E-12-08 & AVU-G-12-07
W. Avera, Avista
Schedule 2, p. 43 of 48
for each percentage point drop in the yield on average
public utility bonds. As illustrated on page 1 of Exhibit
3, Schedule 9, with the yield on average public utility
bonds in August 2012 being 4.18 percent, this implied a
current equity risk premium of 5.36 percent for electric
utilities. Adding this equity risk premium to the yield
on triple-B utility bonds of 4.88 percent produces a
current cost of equity of approximately 10.2 percent.
Q. What cost of equity was produced by the risk 9
premium approach after incorporating forecasted bond 10
yields? 11
A. As shown on page 2 of Exhibit 3, Schedule 9,
incorporating a forecasted yield for 2013-2017 and
adjusting for changes in interest rates since the study
period implied an equity risk premium of 4.36 percent for
electric utilities. Adding this equity risk premium to
the average implied yield on triple-B public utility bonds
for 2013-2017 of 7.24 percent resulted in an implied cost
of equity of approximately 11.6 percent.
F. Expected Earnings Approach
Q. What other analyses did you conduct to estimate 20
the cost of equity? 21
A. As I noted earlier, I also evaluated the ROE
using the comparable earnings method. Reference to rates

Exhibit No. 3
Case Nos. AVU-E-12-08 & AVU-G-12-07
W. Avera, Avista
Schedule 2, p. 44 of 48
of return available from alternative investments of
comparable risk can provide an important benchmark in
assessing the return necessary to assure confidence in the
financial integrity of a firm and its ability to attract
capital. This comparable earnings approach is consistent
with the economic underpinnings for a fair rate of return
established by the Supreme Court in Hope and Bluefield.
Moreover, it avoids the complexities and limitations of
capital market methods and instead focuses on expected
earned returns on book equity, which are more readily
available to investors.
Q. What economic premise underlies the expected 12
earnings approach? 13
A. The simple, but powerful concept underlying the
expected earnings approach is that investors compare each
investment alternative with the next best opportunity. If
the utility is unable to offer a return similar to that
available from other opportunities of comparable risk,
investors will become unwilling to supply the capital on
reasonable terms. For existing investors, denying the
utility an opportunity to earn what is available from
other similar risk alternatives prevents them from earning
their opportunity cost of capital. In this situation the

Exhibit No. 3
Case Nos. AVU-E-12-08 & AVU-G-12-07
W. Avera, Avista
Schedule 2, p. 45 of 48
government is effectively taking the value of investors’ 1
capital without adequate compensation. The expected
earnings approach is consistent with the economic
rationale underpinning established regulatory standards,
which specifies a methodology to determine an ROE
benchmark based on earned rates of return for a peer group
of other regional utilities.
Q. How is the comparison of opportunity costs 8
typically implemented? 9
A. The traditional comparable earnings test
identifies a group of companies that are believed to be
comparable in risk to the utility. The actual earnings of
those companies on the book value of their investment are
then compared to the allowed return of the utility. While
the traditional comparable earnings test is implemented
using historical data taken from the accounting records,
it is also common to use projections of returns on book
investment, such as those published by recognized
investment advisory publications (e.g., Value Line).
Because these returns on book value equity are analogous
to the allowed return on a utility’s rate base, this 21
measure of opportunity costs results in a direct, “apples 22
to apples” comparison.

Exhibit No. 3
Case Nos. AVU-E-12-08 & AVU-G-12-07
W. Avera, Avista
Schedule 2, p. 46 of 48
Moreover, regulators do not set the returns that
investors earn in the capital markets – they can only
establish the allowed return on the value of a utility’s 3
investment, as reflected on its accounting records. As a
result, the expected earnings approach provides a direct
guide to ensure that the allowed ROE is similar to what
other utilities of comparable risk will earn on invested
capital. This opportunity cost test does not require
theoretical models to indirectly infer investors’ 9
perceptions from stock prices or other market data. As
long as the proxy companies are similar in risk, their
expected earned returns on invested capital provide a
direct benchmark for investors’ opportunity costs that is 13
independent of fluctuating stock prices, market-to-book
ratios, debates over DCF growth rates, or the limitations
inherent in any theoretical model of investor behavior.
Q. What rates of return on equity are indicated for 17
electric utilities based on the expected earnings 18
approach? 19
A. Value Line reports that its analysts anticipate
an average rate of return on common equity for the

Exhibit No. 3
Case Nos. AVU-E-12-08 & AVU-G-12-07
W. Avera, Avista
Schedule 2, p. 47 of 48
electric utility industry of 10.5 percent over its
forecast horizon.19
For the firms in the Utility Proxy Group
specifically, the returns on common equity projected by
Value Line over its forecast horizon are shown on Exhibit
3, Schedule 10. Consistent with the rationale underlying
the development of the br+sv growth rates, these year-end
values were converted to average returns using the same
adjustment factor discussed earlier and developed on
Exhibit 3, Schedule 5. As shown on Exhibit 3, Schedule
10, Value Line’s projections for the utility proxy group 11
suggested an average ROE of 10.1 percent.
G. Summary of Quantitative Results
Q. Please summarize the results of your 13
quantitative analyses. 14
A. The cost of equity estimates implied by my
quantitative analyses are summarized in Table 5 below:

19 The Value Line Investment Survey at 138 (Aug. 24, 2012).

Exhibit No. 3
Case Nos. AVU-E-12-08 & AVU-G-12-07
W. Avera, Avista
Schedule 2, p. 48 of 48
TABLE 5 1
SUMMARY OF QUANTITATIVE RESULTS 2
Utility Non-Utility
DCF Average Midpoint Average Midpoint
Value Line 9.7%10.7%11.5%10.7%
IBES 9.5%11.0%10.8%10.4%
Zacks 9.4%9.8%11.1%10.3%
br + sv 8.9%10.2%12.8%15.9%
CAPM - Current Bond Yield
Unadjusted 10.3%10.2%
Size Adjusted 11.2%10.9%
CAPM - Projected Bond Yield
Unadjusted 10.8%10.6%
Size Adjusted 11.7%11.3%
Utility Risk Premium
Current Bond Yields
Projected Bond Yields
Expected Earnings 10.1%10.2%
10.2%
11.6%

CAPITAL STRUCTURE Schedule 3
Page 1 of 1
UTILITY PROXY GROUP
Common Common
Company Debt Preferred Equity Debt Other Equity
1 ALLETE 44.4% 0.0% 55.6% 40.0% 0.0% 60.0%
2 Alliant Energy 45.7% 3.5% 50.9% 47.0% 2.5% 50.5%
3 Ameren Corp. 45.9% 0.0% 54.1% 45.0% 1.0% 54.0%
4 American Elec Pwr 49.7% 0.0% 50.3% 48.5% 0.0% 51.5%
5 Avista Corp. 48.7% 2.1% 49.1% 52.0% 0.0% 48.0%
6 Black Hills Corp. 39.1% 0.0% 60.9% 50.5% 0.0% 49.5%
7 CenterPoint Energy 67.5% 0.0% 32.5% 65.0% 0.0% 35.0%
8 DTE Energy Co. 50.6% 0.0% 49.4% 50.0% 0.0% 50.0%
9 Edison International 55.4% 4.1% 40.5% 56.0% 4.0% 40.0%
10 El Paso Electric 52.8% 0.0% 47.2% 56.5% 0.0% 43.5%
11 Empire District Elec 50.0% 0.0% 50.0% 49.5% 0.0% 50.5%
12 Exelon Corp. 46.6% 0.3% 53.1% 47.0% 0.5% 52.5%
13 FirstEnergy Corp. 56.6% 0.0% 43.4% 55.0% 0.0% 45.0%
14 Great Plains Energy 54.2% 0.6% 45.2% 47.5% 0.5% 52.0%
15 Hawaiian Elec. 46.1% 1.2% 52.7% 45.0% 1.0% 54.0%
16 IDACORP, Inc. 47.3% 0.0% 52.7% 46.5% 0.0% 53.5%
17 NorthWestern Corp. 51.4% 0.0% 48.6% 49.0% 0.0% 51.0%
18 OGE Energy Corp. 49.3% 0.0% 50.7% 50.0% 0.0% 50.0%
19 Otter Tail Corp. 44.7% 1.5% 53.8% 41.5% 1.0% 57.5%
20 PG&E Corp. 48.9% 1.0% 50.1% 48.5% 0.5% 51.0%
21 Pinnacle West Capital 46.3% 0.0% 53.7% 42.5% 0.0% 57.5%
22 Portland General Elec. 51.0% 0.0% 49.0% 45.5% 0.0% 54.5%
23 PPL Corp. 61.9% 0.0% 38.1% 49.0% 0.0% 51.0%
24 Pub Sv Enterprise Grp 40.9% 0.0% 59.1% 44.0% 0.0% 56.0%
25 SCANA Corp. 54.5% 0.0% 45.5% 53.0% 0.0% 47.0%
26 Sempra Energy 50.4% 0.1% 49.5% 51.5% 0.5% 48.0%
27 TECO Energy 57.3% 0.0% 42.7% 55.5% 0.0% 44.5%
28 UIL Holdings 58.8% 0.0% 41.2% 54.0% 0.0% 46.0%
29 Westar Energy 49.7% 0.4% 49.9% 50.0% 0.0% 50.0%
Average 50.5% 0.5% 49.0% 49.5% 0.4% 50.1%
(a) Company Form 10‐K and Annual Reports.
(b) The Value Line Investment Survey (Jun. 22, Aug. 3, & Aug. 24, 2012).
Value Line Projected (b)At Fiscal Year‐End 2011  (a)
Exhibit No. 3
Case Nos. AVU-E-12-08 AVU-G-12-07
W. Avera, Avista
Schedule 3, p. 1 of 1
DCF MODEL ‐ UTILITY PROXY GROUP Schedule 4
Page 1 of 3
DIVIDEND YIELD
(a)(b)
Company Price Dividends Yield
1  ALLETE 41.42$  1.86$  4.5%
2  Alliant Energ 46.35$  1.85$  4.0%
3  Ameren Corp. 33.96$  1.63$  4.8%
4  American Elec Pwr 42.44$  1.92$  4.5%
5  Avista Corp. 26.89$  1.19$  4.4%
6  Black Hills Corp 31.66$  1.49$  4.7%
7  CenterPoint Energ 20.78$  0.82$  3.9%
8  DTE Energy Co. 53.91$  2.48$  4.6%
9  Edison Internationa 45.18$  1.32$  2.9%
10  El Paso Electri 33.53$  1.02$  3.0%
11  Empire District Ele 21.46$  1.00$  4.7%
12  Exelon Corp 38.31$  2.10$  5.5%
13  FirstEnergy Corp 47.93$  2.20$  4.6%
14  Great Plains Energ 22.02$  0.87$  4.0%
15  Hawaiian Elec. 28.10$  1.24$  4.4%
16  IDACORP, Inc. 42.45$  1.32$  3.1%
17  NorthWestern Corp 36.59$  1.50$  4.1%
18  OGE Energy Corp. 53.89$  1.62$  3.0%
19  Otter Tail Corp 23.30$  1.19$  5.1%
20  PG&E Corp. 44.94$  1.82$  4.0%
21  Pinnacle West Capita 53.18$  2.16$  4.1%
22  Portland General Elec. 27.29$  1.09$  4.0%
23  PPL Corp. 29.10$  1.46$  5.0%
24  Pub Sv Enterprise Grp 32.68$  1.44$  4.4%
25  SCANA Corp. 48.63$  2.01$  4.1%
26  Sempra Energy 69.22$  2.45$  3.5%
27  TECO Energy 17.94$  0.90$  5.0%
28  UIL Holdings 36.62$  1.73$  4.7%
29  Westar Energ 30.20$  1.33$  4.4%
     Average 4.2%
(a)Average of closing prices for 30 trading days ended Aug. 24, 2012
(b)The Value Line Investment Survey, Summary & Index (Aug. 24, 2012)
Exhibit No. 3
Case Nos. AVU-E-12-08 AVU-G-12-07
W. Avera, Avista
Schedule 4, p. 1 of 3
DCF MODEL ‐ UTILITY PROXY GROUP Schedule 4
Page 2 of 3
GROWTH RATES
(a)(b)(c) (d)
br+sv
Company V Line IBES Zacks Growth
1  ALLETE 6.5% 5.0% 5.0% 4.1%
2  Alliant Energ 6.0% 6.3% 6.2% 4.5%
3  Ameren Corp.‐1.0%‐4.1% 0.0% 2.2%
4  American Elec Pwr 4.5% 3.4% 3.6% 4.6%
5  Avista Corp. 5.5% 4.0% 4.7% 3.9%
6  Black Hills Corp 7.0% 6.0% 6.0% 3.0%
7  CenterPoint Energ 4.0% 5.1% 5.7% 4.4%
8  DTE Energy Co. 4.0% 4.6% 4.9% 3.9%
9  Edison Internationa 1.0%‐0.9% 3.7% 5.1%
10  El Paso Electri 3.5% 3.7% 1.1% 4.6%
11  Empire District Ele 6.0% 10.2% NA 3.1%
12  Exelon Corp ‐2.0%‐9.5% 4.9% 7.9%
13  FirstEnergy Corp 5.0% 2.5% 1.0% 3.7%
14  Great Plains Energ 5.5% 5.3% 7.8% 2.5%
15  Hawaiian Elec. 9.0% 8.6% 6.7% 4.9%
16  IDACORP, Inc. 2.0% 4.0% 5.0% 3.9%
17  NorthWestern Corp 5.0% 7.5% 5.0% 4.5%
18  OGE Energy Corp. 6.0% 5.4% 5.7% 6.9%
19  Otter Tail Corp 24.0% 5.0% 5.0% 4.3%
20  PG&E Corp. 4.5% 0.0% 2.6% 5.2%
21  Pinnacle West Capita 5.0% 5.9% 5.9% 3.7%
22  Portland General Elec. 5.5% 3.6% 4.1% 3.9%
23  PPL Corp. 6.5%‐8.2% NA 7.1%
24  Pub Sv Enterprise Grp ‐0.5% 2.0% 2.0% 5.7%
25  SCANA Corp. 4.0% 4.8% 4.4% 4.9%
26  Sempra Energy 4.5% 7.0% 4.3% 6.1%
27  TECO Energy 6.5% 2.7% 3.3% 5.4%
28  UIL Holdings 4.0% 4.1% 4.5% 2.9%
29  Westar Energ 6.5% 4.8% 6.1% 3.5%
(a)The Value Line Investment Survey (Jun. 22, Aug. 3, & Aug. 24, 2012)
(b)
(c)
(d)See Schedule 5.
Earnings Growth
www.finance.yahoo.com (Retrieved Sep. 11, 2012)
www.zacks.com (retrieved Sep. 11, 2012)
Exhibit No. 3
Case Nos. AVU-E-12-08 AVU-G-12-07
W. Avera, Avista
Schedule 4, p. 2 of 3
DCF MODEL ‐ UTILITY PROXY GROUP Schedule 4
Page 3 of 3
DCF COST OF EQUITY ESTIMATES
(a) (a) (a) (a)
br+sv
Company V Line IBES Zacks Growth
1  ALLETE 11.0% 9.5% 9.5% 8.6%
2  Alliant Energ 10.0% 10.3% 10.2% 8.4%
3  Ameren Corp. 3.8% 0.8% 4.8% 7.0%
4  American Elec Pwr 9.0% 7.9% 8.1% 9.1%
5  Avista Corp. 9.9% 8.4% 9.1% 8.3%
6  Black Hills Corp 11.7% 10.7% 10.7% 7.7%
7  CenterPoint Energ 7.9% 9.0% 9.6% 8.4%
8  DTE Energy Co. 8.6% 9.2% 9.5% 8.5%
9  Edison Internationa 3.9% 2.0% 6.6% 8.1%
10  El Paso Electri 6.5% 6.7% 4.1% 7.6%
11  Empire District Ele 10.7% 14.9%   NA 7.8%
12  Exelon Corp 3.5%‐4.0% 10.4% 13.4%
13  FirstEnergy Corp 9.6% 7.1% 5.6% 8.3%
14  Great Plains Energ 9.5% 9.2% 11.8% 6.5%
15  Hawaiian Elec. 13.4% 13.0% 11.1% 9.3%
16  IDACORP, Inc. 5.1% 7.1% 8.1% 7.0%
17  NorthWestern Corp 9.1% 11.6% 9.1% 8.6%
18  OGE Energy Corp. 9.0% 8.4% 8.7% 9.9%
19  Otter Tail Corp 29.1% 10.1% 10.1% 9.5%
20  PG&E Corp. 8.5% 4.1% 6.6% 9.3%
21  Pinnacle West Capita 9.1% 9.9% 10.0% 7.8%
22  Portland General Elec. 9.5% 7.6% 8.1% 7.9%
23  PPL Corp. 11.5%‐3.2%   NA 12.1%
24  Pub Sv Enterprise Grp 3.9% 6.4% 6.4% 10.1%
25  SCANA Corp. 8.1% 8.9% 8.5% 9.0%
26  Sempra Energy 8.0% 10.5% 7.8% 9.6%
27  TECO Energy 11.5% 7.7% 8.3% 10.5%
28  UIL Holdings 8.7% 8.8% 9.2% 7.7%
Average  (b)9.7% 9.5% 9.4% 8.9%
Midpoint (c)10.7% 11.0% 9.8% 10.2%
(a)Sum of dividend yield (Schedule 4, p. 1) and respective growth rate (Schedule 4, p. 2
(b)Excludes highlighted figures.
(c)Average of low and high values.
Earnings Growth
Exhibit No. 3
Case Nos. AVU-E-12-08 AVU-G-12-07
W. Avera, Avista
Schedule 4, p. 3 of 3
DCF MODEL ‐ UTILITY PROXY GROUP Schedule 5
Page 1 of 2
BR+SV GROWTH RATE
(a) (a) (a) (b) (c) (d) (e)
Adjustment ‐‐‐‐‐‐‐‐‐  ʺsvʺ Factor  ‐‐‐‐‐‐‐
Company                    EPS DPS BVPS   b     r   Facto Adjusted r   br     s     v     sv   br + sv
1  ALLETE $3.25 $2.00 $34.50 38.5% 9.4% 1.0257 9.7% 3.7% 0.0191 0.1882 0.36%4.1%
2  Alliant Energy $3.50 $2.20 $32.35 37.1% 10.8% 1.0222 11.1% 4.1% 0.0123 0.2811 0.34%4.5%
3  Ameren Corp. $2.50 $1.80 $34.00 28.0% 7.4% 1.0094 7.4% 2.1% 0.0111 0.0933 0.10%2.2%
4  American Elec Pwr $3.75 $2.15 $37.50 42.7% 10.0% 1.0243 10.2% 4.4% 0.0086 0.2105 0.18%4.6%
5  Avista Corp. $2.25 $1.40 $24.00 37.8% 9.4% 1.0227 9.6% 3.6% 0.0150 0.2000 0.30%3.9%
6  Black Hills Corp. $2.50 $1.60 $31.00 36.0% 8.1% 1.0145 8.2% 2.9% 0.0051 0.0462 0.02%3.0%
7  CenterPoint Energy $1.40 $0.90 $12.00 35.7% 11.7% 1.0219 11.9% 4.3% 0.0039 0.4000 0.15%4.4%
8  DTE Energy Co. $4.50 $2.75 $49.25 38.9% 9.1% 1.0244 9.4% 3.6% 0.0158 0.1435 0.23%3.9%
9  Edison International $3.50 $1.55 $38.75 55.7% 9.0% 1.0228 9.2% 5.1%‐       0.1389 0.00%5.1%
10  El Paso Electric $2.50 $1.30 $23.75 48.0% 10.5% 1.0172 10.7% 5.1% (0.0158)0.3667  ‐0.58%4.6%
11  Empire District Elec $1.75 $1.20 $18.50 31.4% 9.5% 1.0151 9.6% 3.0% 0.0071 0.1591 0.11%3.1%
12  Exelon Corp. $3.50 $2.10 $28.75 40.0% 12.2% 1.0497 12.8% 5.1% 0.0717 0.3947 2.83%7.9%
13  FirstEnergy Corp. $3.75 $2.40 $37.00 36.0% 10.1% 1.0153 10.3% 3.7%‐       0.2952 0.00%3.7%
14  Great Plains Energy $1.75 $1.10 $23.75 37.1% 7.4% 1.0209 7.5% 2.8% 0.0221 (0.1310)‐0.29%2.5%
15  Hawaiian Elec. $2.00 $1.40 $20.25 30.0% 9.9% 1.0478 10.3% 3.1% 0.0666 0.2636 1.75%4.9%
16  IDACORP, Inc. $3.40 $1.90 $40.90 44.1% 8.3% 1.0281 8.5% 3.8% 0.0131 0.0911 0.12%3.9%
17  NorthWestern Corp. $3.00 $1.80 $29.75 40.0% 10.1% 1.0278 10.4% 4.1% 0.0151 0.2067 0.31%4.5%
18  OGE Energy Corp. $4.25 $1.90 $37.00 55.3% 11.5% 1.0376 11.9% 6.6% 0.0087 0.3273 0.28%6.9%
19  Otter Tail Corp. $1.85 $1.30 $19.05 29.7% 9.7% 1.0335 10.0% 3.0% 0.0444 0.3073 1.36%4.3%
20  PG&E Corp. $3.75 $2.00 $36.25 46.7% 10.3% 1.0267 10.6% 5.0% 0.0134 0.1944 0.26%5.2%
21  Pinnacle West Capital $3.75 $2.45 $41.00 34.7% 9.1% 1.0239 9.4% 3.2% 0.0210 0.2190 0.46%3.7%
22  Portland General Elec. $2.25 $1.25 $26.25 44.4% 8.6% 1.0200 8.7% 3.9% 0.0032 0.0455 0.01%3.9%
23  PPL Corp. $3.00 $1.70 $25.50 43.3% 11.8% 1.0492 12.3% 5.3% 0.0550 0.3200 1.76%7.1%
24  Pub Sv Enterprise Grp $3.00 $1.55 $26.25 48.3% 11.4% 1.0253 11.7% 5.7% 0.0000 0.3438 0.00%5.7%
25  SCANA Corp. $3.75 $2.15 $39.75 42.7% 9.4% 1.0457 9.9% 4.2% 0.0428 0.1632 0.70%4.9%
26  Sempra Energ $5.75 $2.80 $51.50 51.3% 11.2% 1.0248 11.4% 5.9% 0.0073 0.3133 0.23%6.1%
27  TECO Energy $1.65 $1.00 $13.00 39.4% 12.7% 1.0247 13.0% 5.1% 0.0079 0.3953 0.31%5.4%
28  UIL Holdings $2.45 $1.73 $25.50 29.4% 9.6% 1.0163 9.8% 2.9% 0.0022 0.3625 0.08%2.9%
29  Westar Energy $2.40 $1.48 $28.15 38.3% 8.5% 1.0320 8.8% 3.4% 0.0153 0.0617 0.09%3.5%
  ‐‐‐‐‐‐‐‐‐‐‐‐‐‐  2016  ‐‐‐‐‐‐‐‐‐‐‐‐
Exhibit No. 3
Case Nos. AVU-E-12-08 AVU-G-12-07
W. Avera, Avista
Schedule 5, p. 1 of 2
DCF MODEL ‐ UTILITY PROXY GROUP Schedule 5
Page 2 of 2
BR+SV GROWTH RATE
(a) (a) (f) (a) (a) (f) (g) (a) (a) (h) (a) (a) (g)
 ‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐  2011  ‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐ 2016  ‐‐‐‐‐‐‐‐‐‐‐‐Chg ‐‐‐‐  Common Shares  ‐‐‐‐
Company                    Eq Ratio Tot Cap Com Eq Eq Ratio Tot Cap Com Eq Equity High Low Avg.M/B 2011 2016 Growth
1  ALLETE 55.7% $1,937 $1,079 60.0% $2,325 $1,395 5.3% $50.00 $35.00 $42.50 1.232 37.50 40.50 1.55%
2  Alliant Energy 50.9% $5,921 $3,014 50.5% $7,455 $3,765 4.5% $50.00 $40.00 $45.00 1.391 111.02 116.00 0.88%
3  Ameren Corp. 53.7% $14,738 $7,914 54.0% $16,100 $8,694 1.9% $45.00 $30.00 $37.50 1.103 242.60 255.00 1.00%
4  American Elec Pwr 49.3% $29,747 $14,665 51.5% $36,300 $18,695 5.0% $55.00 $40.00 $47.50 1.267 483.42 500.00 0.68%
5  Avista Corp. 48.6% $2,440 $1,186 48.0% $3,100 $1,488 4.6% $35.00 $25.00 $30.00 1.250 58.42 62.00 1.20%
6  Black Hills Corp. 48.6% $2,490 $1,210 49.5% $2,825 $1,398 2.9% $40.00 $25.00 $32.50 1.048 43.92 45.00 0.49%
7  CenterPoint Energy 32.8% $12,863 $4,219 35.0% $15,000 $5,250 4.5% $25.00 $15.00 $20.00 1.667 426.03 431.00 0.23%
8  DTE Energy Co. 49.4% $14,196 $7,013 50.0% $17,900 $8,950 5.0% $70.00 $45.00 $57.50 1.168 169.25 181.00 1.35%
9  Edison International 40.6% $24,773 $10,058 40.0% $31,600 $12,640 4.7% $55.00 $35.00 $45.00 1.161 325.81 325.81 0.00%
10  El Paso Electric 48.2% $1,577 $760 43.5% $2,075 $903 3.5% $45.00 $30.00 $37.50 1.579 39.96 38.00 ‐1.00%
11  Empire District Elec 50.1% $1,386 $694 50.5% $1,600 $808 3.1% $25.00 $19.00 $22.00 1.189 41.98 43.25 0.60%
12  Exelon Corp. 54.0% $26,661 $14,397 52.5% $45,100 $23,678 10.5% $55.00 $40.00 $47.50 1.652 663.00 820.00 4.34%
13  FirstEnergy Corp. 45.8% $28,996 $13,280 45.0% $34,400 $15,480 3.1% $60.00 $45.00 $52.50 1.419 418.22 418.22 0.00%
14  Great Plains Energy 51.6% $5,741 $2,962 52.0% $7,025 $3,653 4.3% $25.00 $17.00 $21.00 0.884 136.14 154.00 2.50%
15  Hawaiian Elec. 53.9% $2,841 $1,531 54.0% $4,575 $2,471 10.0% $35.00 $20.00 $27.50 1.358 96.04 122.00 4.90%
16  IDACORP, Inc. 54.4% $3,045 $1,657 53.5% $4,100 $2,194 5.8% $55.00 $35.00 $45.00 1.100 49.95 53.00 1.19%
17  NorthWestern Corp. 47.8% $1,797 $859 51.0% $2,225 $1,135 5.7% $45.00 $30.00 $37.50 1.261 36.28 38.50 1.19%
18  OGE Energy Corp. 48.4% $5,300 $2,565 50.0% $7,475 $3,738 7.8% $65.00 $45.00 $55.00 1.486 98.10 101.00 0.58%
19  Otter Tail Corp. 54.0% $1,059 $572 57.5% $1,390 $799 6.9% $35.00 $20.00 $27.50 1.444 36.10 42.00 3.07%
20  PG&E Corp. 50.2% $24,119 $12,108 51.0% $31,000 $15,810 5.5% $55.00 $35.00 $45.00 1.241 412.26 435.00 1.08%
21  Pinnacle West Capital 55.9% $6,841 $3,824 57.5% $8,450 $4,859 4.9% $60.00 $45.00 $52.50 1.280 109.25 118.50 1.64%
22  Portland General Elec. 50.4% $3,298 $1,662 54.5% $3,725 $2,030 4.1% $30.00 $25.00 $27.50 1.048 75.36 76.50 0.30%
23  PPL Corp. 37.2% $29,071 $10,814 51.0% $34,700 $17,697 10.4% $45.00 $30.00 $37.50 1.471 578.41 695.00 3.74%
24  Pub Sv Enterprise Grp 57.9% $17,731 $10,266 56.0% $23,600 $13,216 5.2% $45.00 $35.00 $40.00 1.524 505.95 506.00 0.00%
25  SCANA Corp. 45.7% $8,511 $3,890 47.0% $13,075 $6,145 9.6% $55.00 $40.00 $47.50 1.195 130.00 155.00 3.58%
26  Sempra Energ 49.2% $20,015 $9,847 48.0% $26,300 $12,624 5.1% $85.00 $65.00 $75.00 1.456 239.93 246.00 0.50%
27  TECO Energy 45.8% $4,954 $2,269 44.5% $6,525 $2,904 5.1% $25.00 $18.00 $21.50 1.654 215.80 221.00 0.48%
28  UIL Holdings 41.4% $2,643 $1,094 46.0% $2,800 $1,288 3.3% $45.00 $35.00 $40.00 1.569 50.65 51.00 0.14%
29  Westar Energy 50.0% $5,531 $2,766 50.0% $7,620 $3,810 6.6% $35.00 $25.00 $30.00 1.066 125.70 135.00 1.44%
(a) The Value Line Investment Survey (Jun. 22, Aug. 3, & Aug. 24, 2012).
(b) Computed using the formula 2*(1+5‐Yr. Change in Equity)/(2+5 Yr. Change in Equity).
(c) Product of average year‐end ʺrʺ for 2016 and Adjustment Factor.
(d) Product of change in common shares outstanding and M/B Ratio.
(e) Computed as 1 ‐ B/M Ratio.
(f) Product of total capital and equity ratio.
(g) Five‐year rate of change.
(h) Average of High and Low expected market prices divided by 2016 BVPS.
 ‐‐‐‐‐‐‐‐ 2016 Price ‐‐‐‐‐‐‐
Exhibit No. 3
Case Nos. AVU-E-12-08 AVU-G-12-07
W. Avera, Avista
Schedule 5, p. 2 of 2
DCF MODEL ‐ NON‐UTILITY GROUP Schedule 6
Page 1 of 3
DIVIDEND YIELD
(a)(b)
Company Price Dividends Yield
1  Abbott Labs. 63.32$    2.04$  3.2%
2  Bard (C.R.) 103.68$  0.80$  0.8%
3  Church & Dwight 55.01$    0.96$  1.7%
4  Coca‐Cola Co. 76.26$    2.04$  2.7%
5  Colgate‐Palmolive 101.85$  2.63$  2.6%
6  Genʹl Mills 38.44$    1.32$  3.4%
7  Kellogg 48.92$    1.75$  3.6%
8  Kimberly‐Clark 82.70$    2.96$  3.6%
9  McCormick & Co. 58.66$    1.28$  2.2%
10  McDonaldʹs Corp. 89.13$    2.80$  3.1%
11  PepsiCo, Inc. 69.32$    2.16$  3.1%
12  Procter & Gamble 61.86$    2.25$  3.6%
13  Wal‐Mart Stores 69.21$    1.59$  2.3%
     Average 2.8%
(a)Average of closing prices for 30 trading days ended Jul. 17, 2012.
(b)The Value Line Investment Survey, Summary & Index(Jul. 20, 2012).
Exhibit No. 3
Case Nos. AVU-E-12-08 AVU-G-12-07
W. Avera, Avista
Schedule 6, p. 1 of 3
DCF MODEL ‐ NON‐UTILITY GROUP Schedule 6
Page 2 of 3
GROWTH RATES
(a)(b)(c) (d)
br+sv
Company V Line IBES Zacks Growth
1  Abbott Labs. 10.0% 8.6% 7.3% 18.2%
2  Bard (C.R.) 7.5% 8.3% 9.8% 19.6%
3  Church & Dwight 11.0% 11.4% 11.5% 10.4%
4  Coca‐Cola Co. 8.5% 7.8% 7.8% 5.2%
5  Colgate‐Palmolive 9.5% 8.5% 8.7% 7.2%
6  Genʹl Mills 8.0% 6.8% 7.7% 10.4%
7  Kellogg 7.5% 7.2% 8.1% 20.4%
8  Kimberly‐Clark 8.5% 8.3% 7.0% 13.1%
9  McCormick & Co. 9.0% 8.4% 8.9% 15.1%
10  McDonaldʹs Corp. 8.5% 9.8% 9.9% 9.9%
11  PepsiCo, Inc. 9.5% 4.5% 4.2% 9.2%
12  Procter & Gamble 8.0% 6.6% 7.4% 6.3%
13  Wal‐Mart Stores 7.5% 8.3% 9.7% 9.5%
(a)The Value Line Investment Survey (retrieved Jul. 17, 2012).
(b)www.finance.yahoo.com (retrieved Jul. 17, 2012).
(c)www.zacks.com (retrieved Jul. 17, 2012).
(d)See Schedule 7.
Earnings Growth
Exhibit No. 3
Case Nos. AVU-E-12-08 AVU-G-12-07
W. Avera, Avista
Schedule 6, p. 2 of 3
DCF MODEL ‐ NON‐UTILITY GROUP Schedule 6
Page 3 of 3
DCF COST OF EQUITY ESTIMATES
(a) (a) (a) (a)
br+sv
Company V Line IBES Zacks Growth
1  Abbott Labs. 13.2% 11.8% 10.5% 21.4%
2  Bard (C.R.) 8.3% 9.1% 10.6% 20.4%
3  Church & Dwight 12.7% 13.1% 13.2% 12.1%
4  Coca‐Cola Co. 11.2% 10.5% 10.5% 7.8%
5  Colgate‐Palmolive 12.1% 11.1% 11.3% 9.7%
6  Genʹl Mills 11.4% 10.2% 11.1% 13.8%
7  Kellogg 11.1% 10.8% 11.7% 23.9%
8  Kimberly‐Clark 12.1% 11.9% 10.6% 16.7%
9  McCormick & Co. 11.2% 10.5% 11.1% 17.3%
10  McDonaldʹs Corp. 11.6% 12.9% 13.0% 13.0%
11  PepsiCo, Inc. 12.6% 7.6% 7.3% 12.4%
12  Procter & Gamble 11.6% 10.2% 11.0% 10.0%
13  Wal‐Mart Stores 9.8% 10.6% 12.0% 11.8%
Average  (b)11.5% 10.8% 11.1% 12.8%
Midpoint (c)10.7% 10.4% 10.3% 15.9%
(a)Sum of dividend yield (Schedule 6, p. 1) and respective growth rate (Schedule 6, p. 2).
(b)Excludes highlighted figures.
(c) Average of low and high values.
Earnings Growth
Exhibit No. 3
Case Nos. AVU-E-12-08 AVU-G-12-07
W. Avera, Avista
Schedule 6, p. 3 of 3
DCF MODEL ‐ NON‐UTILITY GROUP Schedule 7
Page 1 of 2
BR+SV GROWTH RATE
(a) (a) (a) (b) (c) (d) (e)
Adjust. ‐‐‐‐‐‐‐‐‐  ʺsvʺ Factor  ‐‐‐‐‐‐‐‐
Company                    EPS DPS BVPS   b     r   Factor Adj. r    br     s     v     sv   br + sv
1  Abbott Labs. $6.50 $2.40 $22.25 63.1% 29.2% 1.0345 30.2% 19.1% (0.0114) 0.7718  ‐0.88%18.2%
2  Bard (C.R.) $8.75 $0.94 $34.75 89.3% 25.2% 1.0444 26.3% 23.5% (0.0498) 0.7794  ‐3.88%19.6%
3  Church & Dwight $3.75 $1.00 $25.20 73.3% 14.9% 1.0525 15.7% 11.5% (0.0187) 0.5968  ‐1.12%10.4%
4  Coca‐Cola Co. $5.65 $2.76 $21.20 51.2% 26.7% 1.0317 27.5% 14.1% (0.1085) 0.8196  ‐8.89%5.2%
5  Colgate‐Palmolive $7.80 $3.50 $11.20 55.1% 69.6% 1.0682 74.4% 41.0% (0.3648) 0.9277  ‐33.85%7.2%
6  Genʹl Mills $3.55 $1.60 $15.25 54.9% 23.3% 1.0381 24.2% 13.3% (0.0398) 0.7227  ‐2.88%10.4%
7  Kellogg $5.00 $2.15 $9.05 57.0% 55.2% 1.0528 58.2% 33.2% (0.1438) 0.8903  ‐12.80%20.4%
8  Kimberly‐Clark $7.00 $3.50 $19.30 50.0% 36.3% 1.0319 37.4% 18.7% (0.0691) 0.8070  ‐5.58%13.1%
9  McCormick & Co. $4.35 $1.80 $21.70 58.6% 20.0% 1.0621 21.3% 12.5% 0.0354  0.7520 2.66%15.1%
10  McDonaldʹs Corp. $7.50 $3.75 $18.40 50.0% 40.8% 1.0167 41.4% 20.7% (0.1280) 0.8467  ‐10.84%9.9%
11  PepsiCo, Inc. $5.40 $2.46 $24.25 54.4% 22.3% 1.0543 23.5% 12.8% (0.0457) 0.7744  ‐3.54%9.2%
12  Procter & Gamble $5.95 $3.00 $34.40 49.6% 17.3% 1.0275 17.8% 8.8% (0.0379) 0.6560  ‐2.49%6.3%
13  Wal‐Mart Stores $6.30 $2.00 $31.50 68.3% 20.0% 1.0281 20.6% 14.0% (0.0715) 0.6400  ‐4.58%9.5%
  ‐‐‐‐‐‐‐‐‐‐‐  2016  ‐‐‐‐‐‐‐‐‐‐
Exhibit No. 3
Case Nos. AVU-E-12-08 AVU-G-12-07
W. Avera, Avista
Schedule 7, p. 1 of 2
DCF MODEL ‐ NON‐UTILITY GROUP Schedule 7
Page 2 of 2
BR+SV GROWTH RATE
(a) (a) (f) (a) (a) (g) (a) (a) (f)
‐‐‐‐‐  Common Shares  ‐‐‐‐‐
Company                    2011 2016 Chg.High Low Avg.M/B 2011 2016 Growth
1  Abbott Labs. $24,440 $34,500 7.1% $105.00 $90.00 $97.50 4.382 1,570.40 1,550.00 ‐0.26%
2  Bard (C.R.) $1,782 $2,780 9.3% $175.00 $140.00 $157.50 4.532 84.54 80.00 ‐1.10%
3  Church & Dwight $2,041 $3,450 11.1% $70.00 $55.00 $62.50 2.480 142.29 137.00 ‐0.75%
4  Coca‐Cola Co. $31,635 $43,450 6.6% $130.00 $105.00 $117.50 5.542 2,263.00 2,050.00 ‐1.96%
5  Colgate‐Palmolive $2,375 $4,700 14.6% $170.00 $140.00 $155.00 13.839 480.02 420.00 ‐2.64%
6  Genʹl Mills $6,366 $9,315 7.9% $60.00 $50.00 $55.00 3.607 644.80 610.00 ‐1.10%
7  Kellogg $1,760 $2,985 11.1% $90.00 $75.00 $82.50 9.116 357.30 330.00 ‐1.58%
8  Kimberly‐Clark $5,249 $7,225 6.6% $110.00 $90.00 $100.00 5.181 395.70 370.00 ‐1.33%
9  McCormick & Co. $1,619 $3,015 13.2% $95.00 $80.00 $87.50 4.032 133.05 139.00 0.88%
10  McDonaldʹs Corp. $14,390 $17,000 3.4% $130.00 $110.00 $120.00 6.522 1,021.40 925.00 ‐1.96%
11  PepsiCo, Inc. $20,899 $35,985 11.5% $120.00 $95.00 $107.50 4.433 1,564.00 1,485.00 ‐1.03%
12  Procter & Gamble $68,001 $89,500 5.6% $110.00 $90.00 $100.00 2.907 2,765.70 2,590.00 ‐1.30%
13  Wal‐Mart Stores $71,315 $94,500 5.8% $95.00 $80.00 $87.50 2.778 3,418.00 3,000.00 ‐2.58%
(a) The Value Line Investment Survey (retrieved Jul. 17, 2012).
(b) Computed using the formula 2*(1+5‐Yr. Change in Equity)/(2+5 Yr. Change in Equity).
(c) Product of year‐end ʺrʺ for 2016 and Adjustment Factor.
(d) Product of change in common shares outstanding and M/B Ratio.
(e) Computed as 1 ‐ B/M Ratio.
(f) Five‐year rate of change.
(g) Average of High and Low expected market prices divided by 2016 BVPS.
 ‐‐‐‐‐‐‐‐‐‐ 2016 Price ‐‐‐‐‐‐‐‐‐ ‐‐‐‐ Common Equity ‐‐‐‐
Exhibit No. 3
Case Nos. AVU-E-12-08 AVU-G-12-07
W. Avera, Avista
Schedule 7, p. 2 of 2
CAPM ‐ UTILITY PROXY GROUP Schedule 8
Page 1 of 2
CURRENT BOND YIELDS
(a) (b) (c) (d (e) (f) () (h) (i)
Div Proj. Cost of Risk‐Free Risk Unadjusted Size Implied
Company Yield Growth Equity Rate Premium Beta Ke Adjustment Cost of Equity
1  ALLETE 2.6% 10.3% 12.9% 2.9% 10.0% 0.70 9.9% 1.75% 11.7%
2  Alliant Energy 2.6% 10.3% 12.9% 2.9% 10.0% 0.75 10.4% 0.94% 11.3%
3  Ameren Corp. 2.6% 10.3% 12.9% 2.9% 10.0% 0.80 10.9% 0.78% 11.7%
4  American Elec Pwr 2.6% 10.3% 12.9% 2.9% 10.0% 0.70 9.9%‐0.38% 9.5%
5  Avista Corp. 2.6% 10.3% 12.9% 2.9% 10.0% 0.70 9.9% 1.75% 11.7%
6  Black Hills Corp. 2.6% 10.3% 12.9% 2.9% 10.0% 0.85 11.4% 1.75% 13.2%
7  CenterPoint Energy 2.6% 10.3% 12.9% 2.9% 10.0% 0.80 10.9% 0.78% 11.7%
8  DTE Energy Co. 2.6% 10.3% 12.9% 2.9% 10.0% 0.75 10.4% 0.78% 11.2%
9  Edison International 2.6% 10.3% 12.9% 2.9% 10.0% 0.80 10.9% 0.78% 11.7%
10  El Paso Electric 2.6% 10.3% 12.9% 2.9% 10.0% 0.75 10.4% 1.75% 12.2%
11  Empire District Elec 2.6% 10.3% 12.9% 2.9% 10.0% 0.70 9.9% 1.77% 11.7%
12  Exelon Corp. 2.6% 10.3% 12.9% 2.9% 10.0% 0.80 10.9%‐0.38% 10.5%
13  FirstEnergy Corp. 2.6% 10.3% 12.9% 2.9% 10.0% 0.80 10.9%‐0.38% 10.5%
14  Great Plains Energy 2.6% 10.3% 12.9% 2.9% 10.0% 0.75 10.4% 1.17% 11.6%
15  Hawaiian Elec. 2.6% 10.3% 12.9% 2.9% 10.0% 0.70 9.9% 1.17% 11.1%
16  IDACORP, Inc. 2.6% 10.3% 12.9% 2.9% 10.0% 0.70 9.9% 1.74% 11.6%
17  NorthWestern Corp. 2.6% 10.3% 12.9% 2.9% 10.0% 0.70 9.9% 1.75% 11.7%
18  OGE Energy Corp. 2.6% 10.3% 12.9% 2.9% 10.0% 0.80 10.9% 0.94% 11.8%
19  Otter Tail Corp. 2.6% 10.3% 12.9% 2.9% 10.0% 0.90 11.9% 1.77% 13.7%
20  PG&E Corp. 2.6% 10.3% 12.9% 2.9% 10.0% 0.55 8.4%‐0.38% 8.0%
21  Pinnacle West Capital 2.6% 10.3% 12.9% 2.9% 10.0% 0.70 9.9% 0.94% 10.8%
22  Portland General Elec. 2.6% 10.3% 12.9% 2.9% 10.0% 0.75 10.4% 1.74% 12.1%
23  PPL Corp. 2.6% 10.3% 12.9% 2.9% 10.0% 0.65 9.4%‐0.38% 9.0%
24  Pub Sv Enterprise Grp 2.6% 10.3% 12.9% 2.9% 10.0% 0.75 10.4%‐0.38% 10.0%
25  SCANA Corp. 2.6% 10.3% 12.9% 2.9% 10.0% 0.65 9.4% 0.94% 10.3%
26  Sempra Energy 2.6% 10.3% 12.9% 2.9% 10.0% 0.80 10.9%‐0.38% 10.5%
27  TECO Energy 2.6% 10.3% 12.9% 2.9% 10.0% 0.85 11.4% 0.94% 12.3%
28  UIL Holdings 2.6% 10.3% 12.9% 2.9% 10.0% 0.70 9.9% 1.74% 11.6%
29  Westar Energy 2.6% 10.3% 12.9% 2.9% 10.0% 0.75 10.4% 0.94% 11.3%
Average 10.3% 11.2%
Range 8.4%‐‐11.9% 8.0%‐‐13.7%
Midpoint 10.2% 10.9%
(a)Wei hted avera e dividend yield for the dividend pa in  firms in the S&P 500 from www.valueline.com (Retreived Jul. 26, 2012
(b)Weighted average of IBES earnings growth rates for the dividend paying firms in the S&P 500 from http://finance.yahoo.com (retrieved Jul. 26, 2012).
(c) (a) + (b).
(d
(e)(c) ‐ (d)
(f) The Value Line Investment Surve  (Jun. 22, Au . 3, & Au . 24, 2012
() (d) + (e) x (f)
(h)Morningstar , ʺ2012 Ibbotson SBBI Valuation Yearbook,ʺ at A endix C, Table C‐1 (2012). 
(i) () + (h)
Market Return (Rm)
Six‐month average yield on 30‐year Treasury bonds for Mar. 2012 ‐ Aug. 2012 from the Federal Reserve Board at http://www.federalreserve.gov/releases/h15/data/htm.
Exhibit No. 3
Case Nos. AVU-E-12-08 AVU-G-12-07
W. Avera, Avista
Schedule 8, p. 1 of 2
CAPM ‐ UTILITY PROXY GROUP Schedule 8
Page 2 of 2
PROJECTED BOND YIELDS
(a) (b) (c) (d (e) (f) () (h) (i)
2013‐17
Div Proj. Cost of Risk‐Free Risk Unadjusted Size Implied
Company Yield Growth Equity Rate Premium Beta Ke Adjustment Cost of Equity
1  ALLETE 2.6% 10.3% 12.9% 4.6% 8.3% 0.70 10.4% 1.75% 12.2%
2  Alliant Energy 2.6% 10.3% 12.9% 4.6% 8.3% 0.75 10.8% 0.94% 11.8%
3  Ameren Corp. 2.6% 10.3% 12.9% 4.6% 8.3% 0.80 11.2% 0.78% 12.0%
4  American Elec Pwr 2.6% 10.3% 12.9% 4.6% 8.3% 0.70 10.4%‐0.38% 10.0%
5  Avista Corp. 2.6% 10.3% 12.9% 4.6% 8.3% 0.70 10.4% 1.75% 12.2%
6  Black Hills Corp. 2.6% 10.3% 12.9% 4.6% 8.3% 0.85 11.7% 1.75% 13.4%
7  CenterPoint Energy 2.6% 10.3% 12.9% 4.6% 8.3% 0.80 11.2% 0.78% 12.0%
8  DTE Energy Co. 2.6% 10.3% 12.9% 4.6% 8.3% 0.75 10.8% 0.78% 11.6%
9  Edison International 2.6% 10.3% 12.9% 4.6% 8.3% 0.80 11.2% 0.78% 12.0%
10  El Paso Electric 2.6% 10.3% 12.9% 4.6% 8.3% 0.75 10.8% 1.75% 12.6%
11  Empire District Elec 2.6% 10.3% 12.9% 4.6% 8.3% 0.70 10.4% 1.77% 12.2%
12  Exelon Corp. 2.6% 10.3% 12.9% 4.6% 8.3% 0.80 11.2%‐0.38% 10.9%
13  FirstEnergy Corp. 2.6% 10.3% 12.9% 4.6% 8.3% 0.80 11.2%‐0.38% 10.9%
14  Great Plains Energy 2.6% 10.3% 12.9% 4.6% 8.3% 0.75 10.8% 1.17% 12.0%
15  Hawaiian Elec. 2.6% 10.3% 12.9% 4.6% 8.3% 0.70 10.4% 1.17% 11.6%
16  IDACORP, Inc. 2.6% 10.3% 12.9% 4.6% 8.3% 0.70 10.4% 1.74% 12.2%
17  NorthWestern Corp. 2.6% 10.3% 12.9% 4.6% 8.3% 0.70 10.4% 1.75% 12.2%
18  OGE Energy Corp. 2.6% 10.3% 12.9% 4.6% 8.3% 0.80 11.2% 0.94% 12.2%
19  Otter Tail Corp. 2.6% 10.3% 12.9% 4.6% 8.3% 0.90 12.1% 1.77% 13.8%
20  PG&E Corp. 2.6% 10.3% 12.9% 4.6% 8.3% 0.55 9.2%‐0.38% 8.8%
21  Pinnacle West Capital 2.6% 10.3% 12.9% 4.6% 8.3% 0.70 10.4% 0.94% 11.4%
22  Portland General Elec. 2.6% 10.3% 12.9% 4.6% 8.3% 0.75 10.8% 1.74% 12.6%
23  PPL Corp. 2.6% 10.3% 12.9% 4.6% 8.3% 0.65 10.0%‐0.38% 9.6%
24  Pub Sv Enterprise Grp 2.6% 10.3% 12.9% 4.6% 8.3% 0.75 10.8%‐0.38% 10.4%
25  SCANA Corp. 2.6% 10.3% 12.9% 4.6% 8.3% 0.65 10.0% 0.94% 10.9%
26  Sempra Energy 2.6% 10.3% 12.9% 4.6% 8.3% 0.80 11.2%‐0.38% 10.9%
27  TECO Energy 2.6% 10.3% 12.9% 4.6% 8.3% 0.85 11.7% 0.94% 12.6%
28  UIL Holdings 2.6% 10.3% 12.9% 4.6% 8.3% 0.70 10.4% 1.74% 12.2%
29  Westar Energy 2.6% 10.3% 12.9% 4.6% 8.3% 0.75 10.8% 0.94% 11.8%
Average 10.8% 11.7%
Range 9.2%‐‐12.1% 8.8%‐‐13.8%
Midpoint 10.6% 11.3%
(a)Wei hted avera e dividend yield for the dividend pa in  firms in the S&P 500 from www.valueline.com (Retreived Jul. 26, 2012
(b)Weighted average of IBES earnings growth rates for the dividend paying firms in the S&P 500 from http://finance.yahoo.com (retrieved Jul. 26, 2012).
(c) (a) + (b).
(d
(e)(c) ‐ (d)
(f) The Value Line Investment Surve  (Jun. 22, Au . 3, & Au . 24, 2012
() (d) + (e) x (f)
(h)Morningstar , ʺ2012 Ibbotson SBBI Valuation Yearbook,ʺ at A endix C, Table C‐1 (2012). 
(i) () + (h)
Market Return (Rm)
Average projected 30‐year Treasury bond yield for 2013‐2017 based on data from the Value Line Investment Survey, Forecast for the U.S. Economy (Aug. 24, 2012); IHS 
Global Insight, U.S. Economic Outlook at 19 (May 2012); & Blue Chip Financial Forecasts, Vol. 31, No. 6 (Jun. 1, 2012).
Exhibit No. 3
Case Nos. AVU-E-12-08 AVU-G-12-07
W. Avera, Avista
Schedule 8, p. 2 of 2
ELECTRIC UTILITY RISK PREMIUM Schedule 9
Page 1 of 4
CURRENT BOND YIELDS
Current Equity Risk Premium
(a)Avg. Yield over Study Period 8.91%
(b)Aug. 2012 Average Utility Bond Yield 4.18%
Change in Bond Yield ‐4.73%
(c)Risk Premium/Interest Rate Relationship ‐0.4114
Adjustment to Average Risk Premium 1.95%
(a)Average Risk Premium over Study Period 3.41%
Adjusted Risk Premium 5.36%
Implied Cost of Equity
(b)Aug. 2012 BBB Utility Bond Yield 4.88%
Adjusted Equity Risk Premium 5.36%
Risk Premium Cost of Equity 10.24%
(a) Schedule 9, page 3.
(b) Moodyʹs Investors Service, www.creditrends.com.
(c) Schedule 9, page 4.
Exhibit No. 3
Case Nos. AVU-E-12-08 AVU-G-12-07
W. Avera, Avista
Schedule 9, p. 1 of 4
ELECTRIC UTILITY RISK PREMIUM Schedule 9
Page 2 of 4
PROJECTED BOND YIELDS
Current Equity Risk Premium
(a)Avg. Yield over Study Period 8.91%
(b)Projected Average Utility Bond Yield 6.60%
Change in Bond Yield ‐2.31%
(c)Risk Premium/Interest Rate Relationship ‐0.4114
Adjustment to Average Risk Premium 0.95%
(a)Average Risk Premium over Study Period 3.41%
Adjusted Risk Premium 4.36%
Implied Cost of Equity
(b)Projected BBB Utility Bond Yield 7.24%
Adjusted Equity Risk Premium 4.36%
Risk Premium Cost of Equity 11.60%
(a) Schedule 9, page 3.
(b)
(c) Schedule 9, page 4.
Based on data from IHS Global Insight, U.S. Economic Outlook at 19 (May 2012); Energy 
Information Administration, Annual Energy Outlook 2012 (Jun. 25, 2012); & Moodyʹs Investors 
Service at www.credittrends.com.
Exhibit No. 3
Case Nos. AVU-E-12-08 AVU-G-12-07
W. Avera, Avista
Schedule 9, p. 2 of 4
ELECTRIC UTILITY RISK PREMIU Schedule 9
Page 3 of 4
AUTHORIZED RETURNS
(a) (b)
Allowe Average Utilit Ris
Year ROE Bond Yiel Premiu
1974 13.10% 9.27% 3.83%
1975 13.20% 9.88% 3.32%
1976 13.10% 9.17% 3.93%
1977 13.30% 8.58% 4.72%
1978 13.20% 9.22% 3.98%
1979 13.50% 10.39% 3.11%
1980 14.23% 13.15% 1.08%
1981 15.22% 15.62%‐0.40%
1982 15.78% 15.33% 0.45%
1983 15.36% 13.31% 2.05%
1984 15.32% 14.03% 1.29%
1985 15.20% 12.29% 2.91%
1986 13.93% 9.46% 4.47%
1987 12.99% 9.98% 3.01%
1988 12.79% 10.45% 2.34%
1989 12.97% 9.66% 3.31%
1990 12.70% 9.76% 2.94%
1991 12.55% 9.21% 3.34%
1992 12.09% 8.57% 3.52%
1993 11.41% 7.56% 3.85%
1994 11.34% 8.30% 3.04%
1995 11.55% 7.91% 3.64%
1996 11.39% 7.74% 3.65%
1997 11.40% 7.63% 3.77%
1998 11.66% 7.00% 4.66%
1999 10.77% 7.55% 3.22%
2000 11.43% 8.09% 3.34%
2001 11.09% 7.72% 3.37%
2002 11.16% 7.53% 3.63%
2003 10.97% 6.61% 4.36%
2004 10.75% 6.20% 4.55%
2005 10.54% 5.67% 4.87%
2006 10.36% 6.08% 4.28%
2007 10.36% 6.11% 4.25%
2008 10.46% 6.65% 3.81%
2009 10.48% 6.28% 4.20%
2010 10.34% 5.56% 4.78%
2011 10.22%5.13%5.09%
Average 12.32% 8.91% 3.41%
(a)
(b) Moodyʹs Investors Service
Major Rate Case Decisions, Regulatory Focus, Regulatory Research Associates; Utilit Sco e 
Regulatory Service , Argus.
Exhibit No. 3
Case Nos. AVU-E-12-08 AVU-G-12-07
W. Avera, Avista
Schedule 9, p. 3 of 4
ELECTRIC UTILITY RISK PREMIU Schedule 9
Page 4 of 4
REGRESSION RESULTS
SUMMARY OUTPU
Re ression Statistics
Multiple R 0.9062018
R Squar 0.8212016
Adjusted R Square 0.816235
Standard Erro 0.005182
Observations 38
ANOV
d SS MS F i ni icance F
Regression 1 0.004439957 0.00444 165.3441 5.054E‐15
Residual 36 0.000966702 2.69E‐05
Tota 37 0.005406659
Coe icients Standard Error t Stat P‐value Lower 95% U er 95% Lower 95.0% U er 95.0%
Intercep 0.0707625 0.00297293 23.80226 1.28E‐23 0.06473308 0.07679183 0.064733085 0.07679183
X Variable 1 ‐0.4114494 0.031997942 ‐12.8586 5.05E‐15 ‐0.47634415 ‐0.34655465 ‐0.476344147 ‐0.346554648
Exhibit No. 3
Case Nos. AVU-E-12-08 AVU-G-12-07
W. Avera, Avista
Schedule 9, p. 4 of 4
EXPECTED EARNINGS APPROACH Schedule 10
Page 1 of 1
UTILITY PROXY GROUP
(a) (b) (c)
Expected Return Adjustment Adjusted Return
Company on Common Equity Factor on Common Equity
1  ALLETE 9.5% 1.025678 9.7%
2  Alliant Energy 10.5% 1.022242 10.7%
3  Ameren Corp. 7.0% 1.009396 7.1%
4  American Elec Pwr 10.0% 1.02427 10.2%
5  Avista Corp. 9.0% 1.022698 9.2%
6  Black Hills Corp. 8.0% 1.014469 8.1%
7  CenterPoint Energy 11.5% 1.021858 11.8%
8  DTE Energy Co. 9.5% 1.024386 9.7%
9  Edison International 9.0% 1.022847 9.2%
10  El Paso Electric 11.0% 1.017201 11.2%
11  Empire District Elec 9.0% 1.015138 9.1%
12  Exelon Corp. 12.5% 1.04971 13.1%
13  FirstEnergy Corp. 10.0% 1.015327 10.2%
14  Great Plains Energy 7.5% 1.02095 7.7%
15  Hawaiian Elec. 10.0% 1.047783 10.5%
16  IDACORP, Inc. 8.5% 1.028066 8.7%
17  NorthWestern Corp. 10.0% 1.027831 10.3%
18  OGE Energy Corp. 11.5% 1.037613 11.9%
19  Otter Tail Corp. 10.0% 1.033484 10.3%
20  PG&E Corp. 10.5% 1.026673 10.8%
21  Pinnacle West Capital 9.0% 1.023942 9.2%
22  Portland General Elec. 8.5% 1.019993 8.7%
23  PPL Corp. 11.5% 1.049212 12.1%
24  Pub Sv Enterprise Grp 11.0% 1.025251 11.3%
25  SCANA Corp. 9.5% 1.045707 9.9%
26  Sempra Energy 11.0% 1.024834 11.3%
27  TECO Energy 13.0% 1.024662 13.3%
28  UIL Holdings 9.5% 1.016316 9.7%
29  Westar Energy 8.5% 1.03203 8.8%
Average  (d)10.1%
Midpoint (e)10.2%
(a)The Value Line Investment Survey (Jun. 22, Aug. 3, & Aug. 24, 2012).
(b) Adjustment to convert year‐end return to an average rate of return from Schedule 5.
(c) (a) x (b).
(d) Excludes highlighted figures.
(e) Average of low and high values.
Exhibit No. 3
Case Nos. AVU-E-12-08 AVU-G-12-07
W. Avera, Avista
Schedule 10, p. 1 of 1