ML18230A821
| ML18230A821 | |
| Person / Time | |
|---|---|
| Site: | Harris  |
| Issue date: | 06/30/1976 |
| From: | Wilder R Carolina Power & Light Co |
| To: | Office of Nuclear Reactor Regulation, State of SC, Public Service Commission |
| References | |
| 18361, 18387 | |
| Download: ML18230A821 (51) | |
Text
Before .the
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PUBLIC SERYICE COVifPISSION of the STATE OF SOUTH CAROLINA
'in re CAROLINA POWER AND LIGHT COhPANY Docl et Numbers 18361 and 18387 Docke~z Sn- canoe -'VO P
" Contro18 77i600 I Q(
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PlI Qpgg Rg Testimony of Ronald P. Wilder In regard to Fair Rate of Return June, 1976
- g. Please state your name and address.
A. My nam is Ronald P. llilder and I live at 707 Trafalgar Drive, Columbia, South Carolina.
What is your present occupation and place of employment?
A. I am an economics. professor and am an Associate Professor of Economics in the College of Business Administration at the University of South Carolina, Columbia, South Carolina. My appearance before the Commis-sion is as an individual and not as a representative of the University.
lfhat is your educational background?
A. I studied economics at Rice University, Houston, Texas, where I re-ceived the B.A. in economics in 1963 and the M.A. in economics in 1964.
I entered the doctoral program in economics at Vanderbilt University, Nashville, Tennessee in 1964 and was awarded the Ph.D. in economics in 1969. llhile at Vanderbilt I specialized in Industrial organization, which is the study of market structures, including regulated indus-tries. I als'o served as a teaching assistant in economics and statis-ties. In the summer of 1965 I was awarded a summer internship at the U. S. Department of State, where I worked in the Bureau of Economic Affairs. In the summer of 1966 I served as a consultant to Southern Bell= Telephone Company.
- g. Please summarize your experience since leaving graduate school.
A. Having received a reserve commission in the U. S.,Army in 1963, I entered active duty as a First Lieutenant in October, 1968. After attending the Ordnance Officer Basic Course at Aberdeen, Maryland, I served at Headquarters, U. S. Army Materiel Command, llashington, D. C. during the period December, 1968 to March, 1970. My duties at the Army Materiel Command related to cost analysis of weapons systems,
a including the performance of life cycle cost studies. I was promoted to Captain in October 1969. During the period April, 1970 to August, 1970, I served with the First Logistics Command, Vietnam'and with Head-quarters, U. S. Army, Yietnam. Hy duties during this period were as a maintenance staff officer. I was released from active duty in August, 1970 and subsequen'tly received an honorable discharge.
In September, 1970, I joined the faculty of the University of South Carolina as an Assistant Professor of Economics. Since joining the faculty, I have taught courses in principles of economics, managerial economics, engineering economics, government regulation of business, industrial organization, and the economics of regulation. I was pro-moted to Associate Professor in Yiay, 1975.
I)hat has been your experience relating to public utility.regulation?
A. Ny teaching experience has included courses dealing with the managerial topics of cost of capital and capital budgeting as well as economic aspects of utility regulation.
fP research experience has been heavily oriented toward aspects of public utility regulation. I have written several articles on public utility regulation, which have been published in journals such as Land Economics, The Bell Journal of Economics-and Ylang ement Science, Business and Economic Review and Southern Economic Journal.
I Gas an invited participant in two seminars on public utility regula-tion sponsored by AT & T; in 1974 at the Gra'Quate School of ltanagement at UCLA and in 1975 at the Graduate School of Business at the University of Chicago.
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During the past year I served a's a consultant to the Special Committee
to study Electric Rates and the structure of the Public Service Commission, which is composed of State legislators and private citi-zens.
.What is the subject of your research and testimony in these proceed-ingsV A. I have been asked to perform a study of the fair rate of return for the Carolina Power and Light Company.
iihy is the determination of a fair rate of return central to .most utility hearings relating to requests for rate increases.
1'ublic A. This question can best be answered by contrasting the operations of a firm in the unregulated, market sector of the economy (e.g. General Motors) with the operations of a regulated public utility such as CP 5 L. To simplify matters, let us assume that market sector firms such as GM are totally unregulated, although this is, of course, an oversimplification since market sector firms are subject to variety
~ -.of government controls such as antitrust, wage-price guidelines, en-vironmental controls, etc. Still, the important difference between CP 8 L and GM is that CP 8 L is subject to systema'tic rate and rate of return regulation, while GM is not.
Consider first how GM sets prices for its various products. The management at GM presumab y bases its actions on a set o object-ies of which a primary concern is to maximize profits or maximize stock-holders wealth. In pursuit of this objective, GM management sets prices and rates of output at levels which will best achieve the ob-jective, taking into account cost structures, the extent of competi-tion, and demand conditions. Neither GM s. prices nor its profits are regulated by government; rather, the forces of'ompetition are left
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to perform this function. The adequacy of competition in this reoard
.if, of cource, highly controversial.
liow CP R L is also operated by a management group. which is interested primarily in maximizing profits or stockholders wealth. The differ-.
ence between CP IE L and 8< is that CP 8 L is a regulated public utility.
This regulated status is a result of a public policy decision by the state that electric utilities, because of economies of size and other reasons are more efficient operating as region'al monopolies, than if two or more utilities served a particular locality. Because this pro-tected monopoly status removes virtually all direct competition, rate and rate of return regulation have been instituted in lieu of compe-titive forces to attempt to insure that. electric service will be pro-vided at the lowest price commensurate with the long-run survival of the utility firm as a viable economic unit. Consequently, the pur-suit of profit maximization by the regulated utility is subject to the constraint that its rate of return not exceed the lowest level
-which will allow it to continue to attract capital on a competitive basis, which is the legal concept of fair rate of return as set forth I
in the Hope decision:
The return to the equity owner should be commen-
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surate with returns on investment in other enter-prises having corresponding risks. That return, moreover, should be sufficient to assure confidence in the financial integrity of the enterprise, so as to maintain its credit and to attract capital.
I.FPC v. Hope Natural Gas, 320 U. S. 591. (1944) at 603.3 lihat economic principles are relevant to your study of the fair rate of return for CP8L?
A. There aree two fundamental
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principles involved.: C
.'4 The first of these p
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principles, relating to the expansion of the firm and its demand for capital resources, is .that the firm should increase its capacity by purchasing new plant and equipment to the point at which the rate of return on the last dollar of investment is equal to its cost of capi-tal, i.e. the cost of obtaining funds. If this condition is not met, expansion will reduce, rather than increase or hold constant, the pro-fitability of the firm.
The second principle applies to the .supplier of capital funds. It states that the supplier of capital, the individual who purchases the E
stock or bonds of the firm, should purchase a given financial instru-ment only if its return is at least as great as that available on other investments of comparable risk. If this condition is not met, the supplier of capital is not maximizing his wealth.
It should be pointed out that these two economic principles are con-sistent with the legal principles as set forth in the Hope case, men-
- .tioned, above.
Further, a rate of return which satisfies these two economic princi- .
ples will be fair to the utility in the sense that it be able to con-tinue to raise capital; it will be fair'to stock-and-bond-holders in the sense that they earn their opportunity cost. (a return as good as Chat available on similar investments having comparable risk), and it will be fair to rate-payers in the sense that average rates asso-ciated with this rate will be the lowest possible rates which cover all the utility's costs including the cost of capital and hence allow the firm to continue operation. The concept of fairness to consumers assumes that the rate of return is the minimum rate of return which
satisfies the two above economic principles and also assumes that the utility operates efficiently, that is, that it minimizes the cost of producing a'iven level of output. The assurance of cost-minimiza-tion is a regulatory function.
How sensitive are utility rates to the allowed rate of return?
A. Return on capital is one of the major items in the utility's cost structure, since electric utilities are relatively capital intensive.
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For a rough idea of,the importance of the rate of return to the uti-lity's rate-payers, let us consider the revenue and cost structure of CPEL during 1975. Of total operating revenues of $ 606.3 million, the total return on capital (the sum of interest paid plus preferred dividends, plus return on equity capital) was $ 191.6 million or 31.6 percent of total operating revenue.
Focusing on return on equity, which is the major item of controversy in rate of return determination, we find that the return on cordon equity for 1975 for CP&L was $ 75.9 million, or 12.5 percent of total operating revenues, which equates to a return on common equity of 10.5 percent.
To illustrate the sensitivity of average rates to rate of return, suppose that CP&L had earned a rate of return of, common equity which was one percentage point higher than that actually observed, i.e.
that rate of return on common equity in 1975 was 11.5 percent rather than 10.5 percent. If all other costs had remained the same, by how
. much would revenues have had to increase to achieve this higher rate of return, assuming that demand conditions permitted the same kilo-watt hour sales at the higher rates? Required revenues would be $ 7.2
million greater, an increase of 1.2 percent. Average rates for all classes of customers would be increased from 2.49 to about 2.52 cents, per kilowatt-hour and the average annual residential bill would be increased from $ 347.54 to about $ 352 per year.
From these estimates, it can be seen that a 10 percent increase in the rate of return on equity for CP8L would be associated with about a 1.3 percent increase in required revenue, assuming no change in output,'osts, or taxes.
This discussion of sensitivity of electric rates to rate of return illustrates why consumers tend to be interested in the outcome of rate cases, particularly during periods of inflation when other costs such as fuel and interest expenses are also increasing at rapid rates.
What role does the determination of the fair rate of return have in regulatory p'roceedings relating to utility's application for a rate increase?
The general practice in. utility regulation is to set a utility's prices so that it covers all costs, including taxes and depreciation, plus the allowed return on investment. The return on investment is computed by multiplying. the rate base by an allowed rate of return, where the rate base is the book value (original cost less deprecia-tion) of the utility's capital investment in plant and equipmen..
Given the allowed rate of return, the total revenue required to achieve that rate of return can be computed as follows:
Revenue required = Total operating costs + (Allowed rate of return X Rate base) and the average rate per kilowatt hour would then be:
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Average rate = Revenue reguired Expected Total kilowatt hour sales Of course, utility rate structures are much more complex than simply determining the average rate. This testimony is not considering the question of rate structures.
'From the above relationships, it can be seen that the analysis by a regulatory body of a. utility's request for a rate increase involves determination of the following items: r'he
- 1) Expected kilowatt hour sales
- 2) Expected operating costs to produce the level of output in 1)
- 3) Rate base
- 4) Allowed rate of return.
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Since items 1), 2), and 3) are usually estimated. based on accounting records of.a historical test period,. ihe main item of contention in most rate cases is item 4), the allowed or. fair rate of return.
It is to the level of the fair rate of return for CP&L that my testi-mony is addressed.
- g. llhat are the major elements involved in estimating the fair rate of return?
A.'aking the utility's capital structure as given, the overall rate of return on rate base is computed as the weighted average of required returns on each element of the capital structure. Suppose, for example, a firm has 60 percent debt requiring a return of 7 percent and 40 per-cent equity requiring a return of 10 percent. Then the overall required 0
rate of return is:
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(.4) = 8.25 7$ (.6) + 105 The cost of debt capital for the test year is a known quantity, based on the average interest rate of the embedded (outstanding) debt instru-ments. The cost of preferred stock is also known. Hence, the major unknown in the determination of the fair rate of return is the cost of equity capital.
Briefly outline your procedures for determining a fair rate of return on rate base for CPSL.
A. Ny determination of fair rate of return focuses on the cost of equity capital. The cost of equity capital is estimated using the discounted cash flow approach. This cost of equity is then checked for reason-ableness by comparing it with historic and current rates of return on equity for other regulated and non-regulated firms and the project the likely .rate of return for CP8L in the immediate future. The final step is to compute the overall rate of return on rate base as the weighted average of cost of debt, cost of preferred stock, and cost of equity.
- g. Mhat is the conceptual basis for the use of he discounted cash flow approach in estimating the cost of equity capital?
A. The starting point is the previously mentioned principle that the rational, wealth maximizing investor will purchase a given common stock only if its return is at least as great as that of other in-vestments with comparable risk. The crucial problem here is that in-vestors are interested in the future, expected returns on investments.
It is the investor's concern for the future rather than .the past which makes the estimation of the cost of equity capital difficult and which requires the use of subjective judgement in the estimation of the cost
of equity capital. This focus on the future is the basis for using the discounted cash flow'pproach to estimating the cost of equity capital.
Describe the use of the discounted cash flow model in estimating the cost of equity capital.
A. The price an investor is willing to pay for a share of common stock
, will be equal to his estimation of its present value. The present value of a share of stock is the sum of the discounted proceeds which the investor expects to receive as a consequence of buying the stock. The discount rate reflects the opportunity cost of the inves-tor, that is, the return which the investor could earn on the next best alternative investment of comparable risk. The discounting pro-.
cedure reflects the time-value of money, which means that a sum re-ceived today is worth more than the same amount received in the fu-ture because of the earnings available if the present sum is invested during the interim period.
Pages 1-2 in the e'xhibits show an example of the algebraic derivation of the discounted present value approach to stock prices 'and the cost of equity capital.
The investor is assumed to select stocks for purchase on the basis of expected rate of return, k, which depends on current price, current
'I dividends, and the expected annual rate of growth of dividends, g, as shown in equation 5) of Page 2 of the exhibits.
Unless the expected rate of return for CPSL stock is as large as that available on other investments of comparable risk, the investor cannot be induced to buy the stock. Hence, the approach in using the dis-
counted cash flow approach to estimating the cost of equity capital, k is based on current market prices for the common stock, current divi-dend levels, and estimates of the future rate of growth of dividends which investors can reasonably expect.
The reasoning used in the discounted cash flow approach, therefore, is that current stock prices reflect investors'xpectations of the future earnings and dividends of the company. If expectations become more optimistic, present value (equation 4) increases and the stock price increases. If expectations becom more pessimistic, the stock price decreases. At any point in time, we can infer the cost of equity capital by estimating the expected growth of dividends of the firm and adding that rate of growth to the current dividend yield to obtain the est~mated cost of capital.
To what extent does the discounted cash flow approach require the use of judgement .on the part of the analyst?
A. Since current. stock prices and dividend yields are observable, the main clem nt for which judgement is required is the estimation of the future growth rate in dividends expected'by investors.
it clear Investors'xpectations are dependent in part on historical trends, but from observed fluctuations in stock prices that expectati ons can change dra...atically in the face of sudden changes in the general eco-nomic environm nt, such as an energy crisis, a recession, or an acceleration of rates of inflation. Because 'the period 1973-1975 was characterized by such rapid and significant changes in the econo-mic environment, changes in growth rates of dividends in the recent past are probably misleading as indica'tors of future growth rates.
Therefore, considerable judgement is called for 8 in order to weigh the
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relative importance of historical verus recent growth rate as indica-tors of future growth .rates.
How did you use this discounted cash flow approach as a basis for estimating the cost of equity capital for Carolina Power and Light-Company?
A. The basic rate of return on equity, k, was estimated by applying the equation k =
Dl + g (From Exhibit-Page 2), both to Carolina Power p
and Light Company and to a sample of comparable electric utilities.
Expected growth rates of dividends, g, were estimated in alternative ways based on varying assumptions. about the future econom'ic environ-ment. This basic rate of return on equity was then checked for rea-sonableness by comparing it with current and historical rates of'eturn on equity. A further comparison was'made with the current bond yields, taking into account historial and current risk premia of stock*versus bond yields and taking into account current and ex-pected future rates of inflation.
Describe how you estimated the expected dividend growth rate for Carolina Power and Light Company.
A. Since long range trends in dividend payments are directly tied to the earnings of the firm, I have looked at historical rates of growth of both dividends per share and earnings per share. Historical data for these items for CPEL during the period 1960-1975 are shown in Exhibit-Page 3. This period is long enough to include three recessions (1961, 1970, and 1974) with subsequent recovery years'. In addition to the earnings and dividends data, it is also useful to examine the annual average stock prices (Page 4) and rates of return on common equity
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and dividend yields on market value of the common stock. (Exhibit-Page 5.)
The major conclusion derived from the examination of these data is the following: Although the rate of return on common equity has been generally stable (in the range of 11-12 percent) throughout the period, with the exception of the recessionary years 1970 and 1974, stock prices have 'fallen substantially since the middle to leyte 1960's with a corresponding increase in dividend yields.
The implication of these changes is'hat stockholders have lowered their expectations of the future rate of growth of dividends. As this occurred, stock prices fell, and dividend yields increased. At the bottom of Exhibit-Page 3 are shown annual compounded rates of growth of earnings and dividends per share between selected years during this period. The high stock price and relatively low dividend
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yield of the mid-1960's are associated with the very rapid growth rates (12 percent for dividends per'share and 10 percent for earnings per share) during the period 1960-65. A".- growth rates decreased, stock prices fell. Although the overall average growth rates between the years 1960 and 1975 are 5.9 percent for dividends per share and 6.1
, percent for earnings per share, stockholders are behaving as though they believe that the much lower growth rates of the past few years are the best indication of the firm s Qlo'('Ith n the n xt f w years.
What is your estimate of the expected growth in dividends per share for CP8L?
'A. I believe that the period 1973-1975 is a starting point for establish-ing investors! expectations, with the qualification that investors ex-pect growth to be slightly higher than in this period because 1974 was a recessionary year and
1975 was a year in which recovery from the 1974 recession did not begin until tPe end of the first quarter.
The annual gr'owth rate in earnings per share during 1973-75 was 2.3 percent. The last previous "normal" historical period (without re-cession, price controls, or the effects of the energy crisis) was
. 1965-69 during which earnings per share grew at an annual rate of 3.1 percent. Therefore, I believe a reasonable estimate of stock-holders'xpectations of the growth rate in dividends per share is 3.1 percent. This estimate is based on my judgement that the exper-ience of late l960's provide the best precedent for what investors can expect in the next few years.- It also reflects the argument that growth in earnings per share- is a better indication of growth than the pattern of dividends actually paid in the past.
1lhat rate of return on equity for CPSL is consistent with this growth rate?
A. The dividend yield on the average stock price for 1975 was 9.7 percent (Exhibit-Page 5). Applying the capitalization equation k = D + g,
'o I'obtain: k = 9.7N + 3.1~> = 12;8X. Therefore, my basic estimate of the cost of equity capital for CPSL is 12.8 percent. This estimate is a starting point only, and will be modified by the subsequent analysis of alternative investments and by consideration of the cost of issuing new common stock.
Did you also estimate the basic rate of return on equity for a group of e'lectric utilities comparable to CP8L'?
A.'es, I did. I selected the Hoody's utility sample as a comparison group, since it contains CPEL, as well as other large electric uti-
lities. Utilities in this group represent alternative common stocks which investors could purchase rather than purchasing CPSL common stock. As will be shown, these stocks have a risk status which is similar to that of CP8L and therefore form the basis for a reasonable estimate of rate of return on alternative investments of comparable risk.
What utilities are included in the Hoody's Sample?
A. There are 24 electric and combined gas.-electric utilities in the Hoody's sample. A list of the companies is shown on Page 6 of the Exhibits.
- g. What has been the recent experience of this sample of utilities with respect to dividends,.earnings, and stock prices?
A. The dividends per share and earnings per share trends are shown in Page 7 of the Exhibits, with stock prices and dividend yields shown on Page 8. The performance of this group has been similar to that of CPEL. Earnings per share grew at a rapid pace in the early 1960's and at a slower rate in the late 1960's and early 1970's. Stock prices reached their peak in 1965, slumped during the 1970 recession, and slumped drastically with the 1974 recession. Recovery appeared to be underway in 1975..
What rate of return on equity is suggested by the experience of the Hoody's utility average?
A, The 1975 dividend yield on average market value for the Hoody's group is 9.8 percent (Exhibit-Page 8). This provides the first element in the rate of return equation. The second element is the growth rate
.in dividends per share expected by investors. Again, my judgement is that the 1965-69 growth experience of earnings per share provides'he
most reliable evidence for the future growth of dividends per share for the b/oody's group. From Exhibit-Page 8 we find that the 1965-69 rate of growth of earnings per share of the Yioody's .group was 4.0 percent. Applying the capitalization equation k = Dl + g p
where D = 9.8~ and g
= 4.0X we obtain an estimated rate of return on p
equity of 13.8 percent for the Yioody's group.
Q How does this rate of return for the Yioody's group compare with that previously calculated for CP8L?
A. The 13.8 percent basic rate of return for the Hoody's group is one percentage point higher than the 12.8 percent estimate for CPEL.
This difference could be due to a number of reasons, but the major difference is likely to be differences in perceived risk.
What concepts of risk are applicable to investor'ssessments of common stocks?
A. There are two major conceptual categories of risk: business risk and
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financial risk. The concept of business risk .is concerned with the variability of operating income of, the firm. It assumes that inves-tors have a preference for earnings that grow in a stable fashion, rather than erratically. Financial risk,,on the other hand, reflects the capital structure of the firm. The higher the proportion of debt in the firm's capital'structure; the greater the proportion of fixed charges (interest costs) to total operating income.
'Did you compare CPEL and the Hoody's utility sample with respect to business risk and financial risk?
A.. Yes, I did. Let s consider financial risk first. Electric utilities
are highly capital intensive enterprises and therefore have very large and continuous requirement for additional capital investment as total demand grows. Additionally, the demand for electricity is somewhat more stable over the business cycle than is the demand for many manufactured goods, especially durable goods. Because of these structural features of electric utilities, they tend to have higher proportions of debt in the capital mix than do industrial firms.
This extensive use 'of debt is true for CPEL as well as the Hoody's sample. To illustrate this point, I show in Exhibit-Pages 9 and 10 the capital structure of CP8L and the Hoody's sample for several recent years.
(}. How does the financial risk for the Hoody's group compare with that for CPRL?
A. Financial risk refers to the risk to wh.ich common stockholders are exposed due 'to the priority of debt service and preferred stock dividends over common stock dividends. Because common stockholders are the last in line to.be paid out of the operating income of the firm, their receipts are subject to more uncertainty. As a firm in-creases its debt ratio, other things remaining the same, the propor-tion of its fixed charges relative to operating income increases, and the uncertainty to which common stockholders are exposed also increases.
Because of these considerations, the-relative financial risk of corrmon stockholders of CPEL and of the Hoody's group can be assessed by a comparison of their recent capital structures. This comparison is made in Pages 9 and 10 of the Exhibit. As can be seen, the propor.-
tions of common equity in total capitalization are very similar for
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4 CPEL and the Hoody's group. For 1974, the last year for which com-plete data were available, CPEL had a common equity ratio of 29.3 percent compared to 33.9 percent for the Hoody's group. The respec-tive averages for the 1970-1974 period were 32.2 percent (CPKL) ver-sus 34.6 percent (Hoody's):
I conclude from this comparison that CP8L and the Hoody.'s group have
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capital structures which are quite similar and that their common stockholders are subject to a comparable degree of financial risk.
does CPKL compare with the Hoody's sample with respect to busi-r'ow ness risk?
A. Given that the respective capital structures are similar, the fluc-tuations in earnings per share are due primarily to'changing business conditions (e.g. demand, rates and costs). One commonly used method of measuring business risk is the coefficient of variation, defined as the. ratio of the standard deviation to the arithmetic mean of a
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sample. As an example of how this measure could be used, consider two fin;,s, both having the same mean'earnings per share of $5 over a five year period. Suppose that Firm A had a series of annual earnings per share as follows: $ 4, $ 5, $ 5, $ 5, $ 6, while Firm B experienced the series $ 2, $ 5, $ 5, $ 5, $ 8. Then the arithmetic means, (X), standard deviations (a) and coefficients of variation (V) are as follows:
Firm A Firm B ArithttM.tic Hean (X)
Standard Deviation (a) .73 2.12 Coefficient of Variation (V) .14 .42 w
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In this example, Firm B would be considered more risky than Firm A because the variability of earnings per share is greater.
I applied this measure of business risk to CP&L and to the Moody's group, with the results shown on Page ll of the Exhibit. Although CP&L earnings per share were somewhat more variable than the Moody's group for the entire 1960-75 period, for the period 1965-69 on which I based my estimates of dividend growth, the coefficients of variation were virtually identical (.06 for Moody's group versus .05 for CP&L).
I conclude, therefore, that the Moody's group and CP&L have similar business risk and that the estimated rates of return on equity should be comparable.
If rates of return are comparable, why is the estimated rate of retur'n on equity for CP&L (12.8 percent) one percentage point lower than that for the Moody's sample (13.8 percent)?
A. Primarily because .earnings per share grew slightly faster for the Moody's group during the 1965-69 test period (4. 1 percent for Moody's versus 3 percent for CP&L). The current dividend yields are almost identical (9.7 percent for CP&L versus 9.8 percent for the Moody's group).
Did you use any other approaches to verify the reasonableness of the basic rate of return on equity for CP&L'?
A. I used one additional approach which takes into account the effect of inflation rates on interest rates and investors'equired rates of return. Conceptually, we can think of the nominal interest rate or rate of return as consisting of three components: a real interest rate, a risk premium, and a compensation for inflation. This concept takes into account the fact that nominal returns are influenced by
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both perceived risk and by expectations regarding future inflation.
The risk premium of concern here is the difference in required return between bond yields and rates of return to common equity. This dif-'erence in return is a reflection of how much more .compensation in-vestors require to induce them to purchase common stock, with a less certain future payment stream, rath'er than bonds, with a more certain stream of future payments.
The data underlying 'this approach to estimating the rate of return on equity is shown in Pages 12 and 13 in the Exhibit for CPEL and the average, respectively. 'oody's Price adjusted bond yields and rates of return on common equity are shown in columns 4 and 5 of these exhibits. The price adjustment is made by subtracting the annual rate of change of the consumer price index from the nominal returns on bonds and stocks.
The risk premium between return on common equity and bond yields is then calculated by subtracting the price. adjusted bond yield from the price adjusted rate of return on common equity, with the results shown in column 6 of Exhibit-Pages 12 and 13. This risk premium was rela-tively large during the early and mid-1960's, with a decline during the 1970's as inflation rates increased. The years 1974 and 1975 were unusual years in that risk premium'became very small or -even negative. This negative value of the risk premium was a result of the combination of recession and inflation, particularly in 1974. It suggests'hat bond holders did not expect the abnormally high infla-tion rates to persist.
Examining the average (arithmetic mean) values for the price-adjusted
risk premia, I find the following results for'CPEL and tloody's:
Period CPRL tlood 's Avera e 1960-1975 4.44 3.87
,1965-1969 6.41 5.03 As before, I chose the 1965-69 period as the period best representa-
. tive of likely future conditions. The average annual rate of change in the consumer price index during this period was 3.8 percent, which is reasonably close to the 4 percent-5 percent'range which many econo-mic forecasters expect for the year 1976. (The annual rate of change in the Consumer Price Index for the first quarter of 1976 was 2.9 percent.)
The next step in this real rate nf return analysis is to .estimate a nominal rate'of return on equity as the sum of the expected inflation rate, the average price-adjusted return on bonds', and the average risk premium of cordon stock relative to bonds. This computation for both CPSL and the ltoody's average is shown in Exhibit-Page 14, using alter-native rates of'nflation of 4 percent and 5 percent.
It is my judgement, based on reading economic forecasts for 1976 and examining current conditions, that 5 percent is the most reasonable estimate for the annual rate of inflation over the next few years.
Given this expected inflation rate, the range of nominal rates af re-turn on equity as estimated in this fashion is between 12.41 percent (Hoody's) and 13.88 percent (CP8L).
Mhat is your estimate of the basic rate of return on equity for CPEL?
A. Based on the two approaches used to estimate rate of return on equity
for Hoody's and CPEL and given the demonstration that CPSL and the Hoody's average represent investments of comparable risk, the basic
.rate of return has been found to lie in the range between 12.41 per-cent and 13;88 percent. A basic rate of return on equity of 13 per-cent is a representative value within this range. I conclude that the basic rate of return on equity for CPSL should be 13.0 percent.
- g. Are there other considerations in arriving at the fair rate of return on equity for CPEL?
A. The remaining consideration is by how much the fair rate of return to CPRL should exceed the required rate of return of its investors.
The difference between these two returns is due to the cost of issuing new common stock. Because of this 'cost, the net proceeds to the com-pany when a new issue of common is made are less than the price paid by the purchasers of the stock. .The size of this difference between gross and net proceeds 'from stock sales are illustrated by the data in Exhibit-Page 16.
The data in. this exhibit show the'average relationship between gross price per share (the price at which the stock was offered) to the net price per share (the average proceeds per share received by the com-pany after the costs of'issuance were paid). Over the 1960-75 period, the average ratio of gross price to net price was 1.03. Over the more recent 1973-75 period the ratio was'.05, suggesting that issu-ance costs were somewhat higher in the early 1970's than in the 1960's.
I believe that the latter ratio (1.05) is the best .indication of current issuance costs.
Is there also an effect of new issues of common stock on stock prices~
A. New issues .of moderate size may tend to depress stock prices slightly,
~ '
' ~ 4 but this effect tends to be overshadowed by general stock market
. movements due, to changing market conditions. In an effort to measure the effect of new issues of common stock on stock prices, I have tabu-lated in Exhibit-Page 16 the average CPEL stock prices in the calendar quarter in which the new issue took place, compared to the average prices in the first quarter prior to and the first quarter subsequent to the quarter of issue. The effect of the new issue o'n the stock price is estimated by the ratio of the average stock price in the first quarter after issue to the average stock price, in the first preceding quarter. The average over the 1960-1975 period of'his ratio is 1.05, which suggests that there is no general tendency for stock prices to fall as a result of new issues.'n other words, the potentially de-pressing effect of new issues is, on the average, outv(eighted by changes in general market conditions.
hhat is your conclusion regarding a fair rate of return on equity for CPKL?
A. Taking into account the basic rate of return previously estimated of 13.0 percent, and the cost of issuance of new common stock of 1.05 times the net price received by the company, we may compute the fair rate of'return on. equity as follows,:
On the basis of the discounted cash flow model, the cost of equity capital (k) is k = Dl + g = 13.05, where Dl is the current annual p
dividend per share, P is the current market price per share and g is the expected annual rate of growth in earnings and dividends. As shown previously, the 1975 values for CPSL for Dl and P were:
D = $ 1.60; P = $ 16.46 and = $ 1.60 = 9..75.
D1 P $ 16.46 1
~
a.
I
This current dividend yield is now to be adjusted to reflect the difference between price paid by purchasers of new shares (P ) and the net price received by the company (P ) where.P .= 1.05 or P = P .
'n 1.05 Making this substitution, we obtain.D1.=. D1
=..$ 1.60 = 10.25.
n o/1;05 $ 16.46/1.05 Therefore, the effect of taking into account the cost o'f issuance of
~
new cordon stock is to increase the cost of'equity by .5/l (the differ-ence between 10.2~ and 9.7%).
? conclude that the fair rate of return on equity for CP8L is 13.5 percent. This rate of return earned by the company would allow pur-chasers of new issues of cordon stock to earn the 13.0 percent return which my analysis suggests they would require in order to purchase the stock under conditions in effect during'975.
- g. )<hat rate of return on rate base is consistent with the rate of return on equity of 13.5 percent?
A. The rate of return on rate base is computed as the weighted average of the respective rates of return to debt, to 'preferred stock, and to common equity. The computation of the weighted average cost of'api-tal requires knowledge of the capital structure, as well as the em-bedded costs of debt and preferred stock and the rate of return to equity capital.
The embedded cost of debt is shown on Page 18 of the Exhibit. Because of historically increasing rates of interest in 'the period since 1960, the embedded (average) cost of debt capital has steadily increased.
At the end of 1975, the embedded cost of debt was 7.75 percent on total debt of $ 1. 15 billion.
The embedded cost of preferred stock is shown in Exhibit-Page 18.
Its average cost as of. the end of 1975 was 8.06 percent.
Combining these costs with the previously estimated cost of equity capital, and with the capital structure of CPSL, the weighted average cost of capital is derived in Exhibit-Page 19. The weighted average cost of capital, using capital structure as of December 31, 1975, is 9.6f percent.
I conclude that the fair rate of return on rate base for CPEL is 9.6g percent. This rate of return on rate base is consistent with a rate of return on common equity of 13.5- percent, which'y analysis suggests is an ample rate of return for the. purpose of attracting new equity capital.
- g. How does this rate of return on equity for CPEL compare with recent rates of return in other jurisdictions?
A. This rate of return is somewhat higher than that allowed in two recent FPC wholesale rate cases. In April 'l976, the FPC allowed wisconsin Power a 12 percent return on equity and allowed Connecticut Light and Power Company a 12.25 percent on equity. In other state juris-dictions, some recently allowed rates of return on equity have been considerably higher than that found here; for example, a 16 percent return on equity allowed for Utah Power and Light Company, and a 14.5 percent return on equity allowed for Houston Lighting and Power Company, both 'in the spring of 1976. A rate of return on equity of 13.5 percent appears to lie within the range of recent commission decisions.
- g. Mhat are the implications of the rate of return which you find in your study for the future operations of CP8L7
A. The consideration of the implications of this rate of return should include its effects on the three major constituencies of the firm:
its creditors (bondholders), its owners (common stockholders), and its customers.
>lith respect to its creditors, the. primary question is whether the rate of return found in re study would maintain the financial inte-grity of the firm. The financial integrity. of CPSL has been under some pressure, particularly as a result of the unexpectedly high
,rates of inflation in. 1973 and 1974. A summary m asure of the ability of the firm to meet its fixed interest obligations is the coverage ratio, which is the ratio. of net income (be ':re income taxes) plus fixed interest charges to the fixed chary:;s. Historical'ata regarding the trend of this coverage ratio for C 8L are shown on Page 20 of the Exhibit.
The significance of the 1974 coverage ratio of 1.92 is that 'it appears to have been a major factor in the down-rating of CPEL's bond rating from A to Baa by Moody's Investors Services in February, 1975. This down-rating means that Moody's analysts believe that the investment grade of CPSL securities is somewhat below the "good" rating implicit in an A or better rating. (This Baa rating was still in effect as of Hay, 1976.) The effect of the Baa rating is that interest costs on new bond issues are somewhat higher than they would be if an A rating by Hoody's were regained.
What effect would an allowed rate of return on common equity of 13.5 percent have on CP8L's bond rating? If CP8L had earned 13.5 percent on common equity in 1975, its interest coverage ratio would have
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been approximately 3.0, had capital 'structure. remained the same.
(The estimate of this'ratio is shown on Page 21 of the Exhibit.)
8ased on ftoody's ratings of recent utility bond issues as shown on Page 22 of the Exhibit, it appears that a coverage. ratio of 3.0 would have been more than adequate to restore an A rating, although I
Hoody's stresses that it does not use a purely statistical approach in arriving at its bond ratings.
I conclude that the. rate of return arrived at here meets the cri-of financial integri.ty. t'erion Hith regard to the common stockholders, if the firm were allowed to earn 13.5 percent on common equity, and if investors expected earn-ings at that rate to continue indefinitely, then the common stock would tend to sell at or slightly above book value. A constant rate of earnings would imply no reinvestment of earnings and hence all
~ ~
earnings paid out as dividends. (This constant rate of earnings assumption is used here to simplify the discussion.)
To illustrate that an allowed rate of return equal to the cost of equity capital tends to result in share prices approaching book value, consider the 1975 results for CPEL. Earnings on comon equity were 2.70 per share or 10.5 percent on book value. If CPEL had earned 13.5 percent, earnings would have had to increase by the ratio '13;5l = 1.29.
T0.99 If all earnings were paid as dividends, with no growth expected, the share prices would tend to be P = = ~Earnin s = 2.70 x 1.29 = $ 29,80, 01 k ...135 which is slightly above the actual book value.per share at the end of ne I
~
4 0 1975.
I conclude from this analysis that a rate of return on equity of 13.5 percent would be sufficient to allow the coomon stock to sell at or slightly above book value.
With regard to CPKL customers, the rate of return arrived at here is sufficient to allow the company to continue to meet'growth in demand and to provide service of adequate quality. The customers'oncern is two-fold: he is interested in both adequate quality of service and in obtaining service at the lowest possible price. The set of prices which would allow CP8L to earn a rate of return in the vicinity of the rate suggested here meets the concerns of the custo-mers, provided that CP&L minimizes its costs of operations. Although efficiency of operation is beyond the scope of my testimony, it is a subject which the regulatory commission must always be concerned with in rate cases.
EXHIBIT - Page 1 Derivation of. the Discounted Cash Flow Formula for the Cost of Equity Capital Definitions of symbols:
P : Current price per share of common stock D.:
J Expected annual dividend per sliare, where j=l for first year, 2 for second year, etc; k: Investor's discount rate, which is firm's cost of equity capital since it reflects rate of return available to investor on the next best investment of comparable risk Pn: per share investor expects to receive stock at the end of n years.
f'rice if .he sells The present value of a share of stock purchased at the beginning of year 1, with dividends D. received at the end of each year, and stock sold at the end of year n is:
Dl Dn' b 1+k D2 g+kk2 " g+kkk Yl+FP Pn
.If the invostor holds the stock indefinitely, the present value is
- 2) P=o 1+k
+
gZ (1+k
+
.... +
. gn (1+k)n where n is indefinitely large.
,If we assume'hat dividends grow ',ndefin;tel~~ at an. annual rate of growth after the first year, of g .the present value a share of stock is:
'=' gl gl(1+g) gl(l+g) (l~g)n 1
- 3) P + + ~ ~ ~ ~ +
(1+k) (leak) (1+k) (14k)"
age It can be shown that equation 3) can be simplied to:
- 4) P o
=
...Dl k-g provided k>g.
If equation 4) is solved for k, we obtain the equation for estimating the cost of equity capital:
- 5) k= +g Po
EXHIBIT-Page 3
~ ~ ~ $ ~
I,EVELS AND RATES OF GROWTH OF DI YIDENDS PER SHARE AND EARNINGS PER SHARE CAROLINA POWER AND LIGHT COl1PANY (1) (2) Ratio Year Dividends Per- Share Earnings Per Share (1)-:(2) 1960 $ .68 $ 1.12 .61 1961, .76 1.22 .62 1962 .845 1 . 33 .64 1963 .94 1.41 .67
'964 1.04 1.62 .64 1965 1.19 1.80 .66 1966 1.295 1.88 .69 1967 '.35 1. 91 .71 1968 1. 39 1.99 .70 1969 1.43 2. 04 .70 1970 1.46 1.56 .94 1971 1.46 1.95 1972 1.49 2.85 .52 1973 1.56 2.59 .60 1974 1.60 2.21 .72 1975 1.60 2.71 .59 Annual Compounded Rates of Growth 1960-1965 125 10$
1965-1969 4.7X 3.1$
1969-1972 1.3X 125
. 1973-1975 1.3% 2. 3X 1960-1975 5. 9% 6.1X SOURCE: Computed from Carolina Power E Light response to South Carolina Public Service Commission data request.
4
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EXHIBIT-Page 4 CAROL IHA POWER R L I GMT Annual Average Stock Price Year Average Price Per Share 1960 ~
$ 20.06 1961 27.39 .
1962 28.36 1963 33. 52 1964 39.1) 1965 45. 33 1966 45. 03 1967 40.58 1968 38.38 1969 34. 80 1970 26.13 19TI 25.13 1972 26.98 1973 24. 51 1974 16.00 1975 '6.46 0
SOURCE: Computed from quarterly Average Prices, CPEL response to South Carolina Public Service Commission data request.
'EXHIBIT-Page 5
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CAROLINA POHER AND LIGHT Return on Common Equity and Dividend Yield Dividend .Yield Year Return. on Cordon Equity (Average Market Value) 1960 ll 40~ 3.4C 1961 11. 84 '.8 1962 11.85 3.0 1963 '11.89 2.8 1964 12.76 2.7 1965 13.31 2.6 1966 12.89 2.9 1967 12.45 3.3 1968 12.40 3.6 1969 12.10 4.1 1970 8.64 5.6 1971 10.54 5.8 1972 13.85 5.5 1973 11.45 6.4 1974 9.60 10. 0 1975 12.04 9.7 SOURCE: CPEL response to South Carolina Public Service Commission data request and Exhibit-Pages 3-4.
EXHIBIT-Page 6 COt~iPANIES INCLUDED IN THE t'IOODY'S'TILITIES AVERAGES Baltimore Gas & Electric Co.
Boston Edison Co.
Carolina Power & Light Co.
Central Hudson Gas & .Elec. Corp.
Central Haine Power Co.
Cincinnati Gas & Electric Co.
.Cleveland Electric Illuminating Co.
Comnonwealth Edison Co.
Consolidated Edison Co. (N. Y.) Inc.
Dayton Power & Light Co.
Delmarva Power & Light Co.
Detroit Edison Co.
Florida Power Corp.
Houston Lighting & Power Co.
Idaho Power Co.
Indianapolis Power & Light Co.
Northeast Utilities Co.
Pacific Gas & Electric Co.
Pennsylvania Power & Light Co.
Philadelphia Electric Service Co. of Colorado Co.'ublic Southern California Edison Co.
Tampa Electric Co.
Utah Power & Light Co.
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'XHIBIT-Page 7 HOODY'S UTILITES AVERAGE: DIVIDENDS PER SHARE, EARNINGS PER SHARE AND GROIN'TH RATES, 1960-1975 Year Dividends Per Share Earnings Per Share 1960 $ 2.68 $ 4.12 1961 2. 81 4.33 1962 2.97 4.73 1963 3.21 4.99
'1 964 3.43 5.41 1965 3. 86 5.92 1966 4.11 6.30 1967 4.34 '6.67 1968 4. 50 6.67 1969 4.61 6.92 1970 4.70 6.89 1971 4.77 7.14 1972 4.87 7. 73 1973 5.01 7. 55 1974 4.83 7.63 1975 4.91 7.77 Annual Compounded Rates of Growth 1960-1965 7.6X 7.6N 1965-1969 4.5% 4.0$
1969-1972 2.05 3.9g 1973-1975 -1.0X 1.5%
1960-.1975. 4.1$ 4.3X SOURCE: Hoody's Utility Itanual 1975 (1960-1974), Moody's Public Utility News Reports (1975).
Estima ted.
~ ~ g ~ EXHIBIT-Page 8 MOODY'S UTILITIES AVERAGE: ANNUAL AVERAGE COMMON STOCK PRICES, 1960-1975 Dividend Yield on Year Average Price Per Share Average Market Price 1960 $ 69.82 3. 8%
1961 90. 55 3.1
] 962 94.50 3.1 1963 102. 79 3.1 1964 108. 76 3.2.
1965 117. 08 3.3 1966 102.90 4.0 1967 101. 87 4.3 1968 98. 37 4.6 1969 94. 55 4.9 1970 79.06 5.9 1971 84.16 5.7 1972 80. 20 6.0 1973 71. 21 7.0 1974 48.26 10.0 1975 50.35 9.8 SOURCE: Moody Public Utility Manual (1960-1974), Moody Publ.ic
. Utility News Reports (1975).
Estimated.
EXHIBIT-Page 9 CAROLINA POWER 5 LIGHT CAPITAL STRUCTURE.,
~ 1960-1975 Total Capital Debt Preferred Stock Common Equity Year (SNillions) Percentage Percentage Percentage 1960 288. 7 50.05 11.9% 38.1%
1961 324. 7 52.1 10. 6 37. 4 1962 334.0 51. 6 10.3 38.1 1963 339.1 50.6 10.'1 -39.3 1964 384.5 52.3 8.9 38.8 1965 291. 2 51. 2 8.8 40.0 1966 438. 1 52.3 7.9 39.9 1967 510. 2 52. 7 11.6 35.6 1968 558.3 55.4 10. 6 34.0 1969 595.2 51. 9 10. 0 38. 1 1970 744. 5 53. 6 12.0 34.4 1971 954. 2 56.0 13. 0 31.0 1972 1,301. 4 52.6. 13.4 34.1 1973 1,633. 7 54;0 13.7 32. 3 1974 1,870. 7 55. 3 15.4 29. 3 1975 2,213.6 52.2 15..2 32.6 SOURCE: Carolina Po>ver 5 Light response to South Carolina Public Service Commission data request.
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1 EXHIBIT-Page.10 TOTAL CAPITALIZATION AND CAPITAL STRUCTURE, MOODY'S UTILITIES GROUP, 1970-1974 Total Capitalization Debt Preferred Stock Common Equity Year ~
($ Mil>>ons) Percentage Percentage Percentage 1970 28,149 54.4$ 10.9$ 34.7X 1971 32 227 53. 5 1 l. 8 . 34.6 1972 35,792 52. 3 12.8 34. 9 1973 39,756 52.0 12.9 35.1 1974 44,168 52.7 13.3 33. 9 SOURCE: Computed from Moody's Public Utility Manual (1975).
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EXtfIBIT-Page ll Heasures of Business Risk for CPEL and the Hoody's Utility Sample
- 1. Definitions:
Xi'. individual items in a sample, i=1,n n: number of items in a sample n
E X i=1 X: Arithmetic mean where X =
n a .'tandard deviation, a measure of variation or "scatter" around the mean where E(Xi X)2 n-1 Y: Coefficient of variation, a measure of variation relative to the mean value, where V = a/X
- 2. Comparisons of relative dispersion of earnings per share Time Periods CPSL ~Yiood 's 1960-75 1.89" 6. 30
.52 1.20
.28 .19 1965-69 1.92 6.50
.10 .39 Y .05 .06
EXHTBTT-Page 12 RATES OF TKFLATlOK, BOYD 'YlELOS AhD RATES OF RETURK CAROLl% Pfr'EP. $ L)GHT. 1960-1975 (1)
.Bond Yields (2) (3) (6) ~ (5)-(4)
(Average of Rate of . Rate of Change (5)'(2)-(3) Price-Adjusted Year Kew issues) Return in Consvrcr (4) (T)-(3) Price-Adjusted Risk Premla, rated Baa on Conron Price index Price-Adjusted Return on Comen Stock and Higher Equity (annual rates) Bond Yield Cocoon Equity Versus Bonds 1960 4.91K 11.406 1.56 3.41'S 9.9OX 6.49S 1961 4.54 '11.84 .7 3.84 11.14 7.30 1962 11.85 1.2 10.65 ',
1963 11.89 1.6 10.29 4.50 12.76 1.2 3.30 11 '6 8.26 1965 13.31 1.9 11.41 1966 5.18 12.89 3.4 1.78 9.49 7.71 1967 6.45 12.45 3.0 3.45 9.45 6.00 1968 6.87 12.40 4.7 2.17 . 7.70 5.53 1969 12.10 6.1 6.00 1970 8.83 8.64 5.5 3.33 3.14 -0.19 1971 7.60 10.54 3.4 4.20. 7.14 2.94 1972 7.81 13.85 3.4 4.41 10.45 6.04 1973 7.94 11.45 8.8 -0.86 2.65 2.51 1974 10.63 9.60 12.2 -1.57 - 2.60 -1.03 1975 11.27 12.04 7.0 4.27 0.77 Average 1960-1975 4.1 2.64 4.44 Average 1965-1969 3.8 2 47 6.41 SOORCEY Colurns 1, 2 - Carollra Power 6 Light response to South Carolina Public Service CocnLlssion data request; Colum 3 - Survey of Current Business, April 1976, and previous issues.
Ho new bond issues.
I I I '
II
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II
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I ~
I
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EXHIBIT-Page 14 REAL RATE OF RETURN CONCEPT OF RATE OF RETURN ON EQUITY, CPE L AND HOODY AVERAGE (1) (2) * (3) * (4)=(l)+(2)+(3)
Expected Average* Average Estimated Nominal Inflation Price Adjusted Risk Premia Rate of Return on Rate Bond Yield Common Stock vs. Bonds Common Equity CPSL 2.47K ~
6.41Ã 12. 88'5 2.47K 6.41% 13.88K l/oo'dy's Average
- 2. 38$ 5.03K 11.41%
2.385 5.035 12.41K SOURCE: Computed from Exhibit-Pages 12 and 13.
Based on average for 1965-69.
0
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~
EXHIBIT-Page 15
~
CAROLINA PolJER AND LIGHT ColQON STOCK PRICES, AVERAGES FOR CALENDAR QUARTER OF NEW ISSUE, QUARTER BEFORE AND QUARTER AFTER NEM ISSUE, 1960-1975 (1) (2) (3) (4)
'3)
Quarter of New Quarter Before Quarter After Ratio
'Issue New Issue New Issue
- (2) 4-61 $ 27.55 3-6'I $ 30.18 i-62 $ 29.77 .986 2>>"64 $ 37. 27 $ 36.91 3-64 $ 41.12 1.114 2-66 $ 46.43 $ 45.67 3-66 $ 43.71 .957 3-69 $ 36.37 2-69 $ 3Z.81 4-69 $ 31.75 .968 4-70 $ 23.89 3-70 $ 2z.70 1-71 $ 27.60 1. 216 2-71 $ 24.64 1-71 $ z7.6o ,3-71 $ 24.29 .880 1-72 $ 26.18 4-71 $ 24.00 2-72 $ 25.81 1.075 4-72 $ 29.64 $ 26.27 . 1-73 $ 27.14 1.033 4-73 $ 21.66 3-73 $ 23.54 1-74 $ 21.69 .921 1-75 $ 14.94 4-74 $ 1Z.73 2-75 .$ 15.63 1. 228 4-75 $ 18.35 3-75 $ 16.92 ~ 1-76 $ 20.00 1.182 Aver age 1960-1975 1.053 SOURCE: Computed from Carolina Power and Light response to South Carolina Public Service Commission data request.
Es tima ted.
EXHIBIT-Page 16 CAROLINA POWER AND LIGHT RELATIONSHIP BETWEEN GROSS PRICE AND NET PRICE PER SHARE, COtliMOH STOCK ISSUES, 1960-1975 (1) . (2) (3) -: (4)=(3)--.(2)
Number of Gross Price . Net Price ., Ratio:
Date Shares Sold Per Share Per Share Gross 'Price/Net Price 11-15-61 150,000 $ 62.25 $ 61.10 1.02 06-24-64 250,000 $ 37.125 .. $ 36.225 1.02 04-06-66 250,000 . $ 43.00 $ 41.70 1.03 09-17-69 1,000,000 $ 29.50 $ 28.54 1.03 10-14-70 1,250,000 $ 23. 00 , $ 22.12 1.04 06-23-71 1,500,000 $ 22.25 $ 21. 50 1.03 01-19-72 2,000,000 $ 27.375 $ 26.625... 1.03 11-01-72 2,500,000 $ 28.75 $ 28.05 1.06 11-08-73 3,000,000 $ 21. 25 $ 20.31 1.06 01-16-75 4,000,000 $ 14.75 $ 14.00 1.05 11-05-75 5,000,000 $ 17.875 $ 17.215 1.04 Average 1961-1975 1.03 Average 1973-1975 1.05 SOURCE: Moody's Public Utility Manual and Carolina Power and Light Response to South Carolina Public Service Commission data request.
~ ~, EXHI BIT-Page 17 CAROLINA POWER AND LIGHT EMBEDDED COST OF LONG TERM DEBT, END OF YEAR, 1960, 1965, AND 1970-75 .
Cumulative Net Cumulative Weighted End of Year Proceeds Annual Cost Average Cost First Mort a e Bonds 1960 $ 144,238, 285 5 1,221,327 3. 62K 1965 . 199,099,607 7,703,507 3.87 1970 397,764,934 22,428,992 5.64 1971 532,115,739 32,653,676 6.14 1972 631,432',705 40,409,636 6.40 1973 831,188,759 56,286,863 6. 77 1974 982,139,502 71,561,263 7.17 1975 1,102,910,320 85,148,118 7.72 Term Note
~issued 1972-due 1978) 1975 50,000,000 $ 4,165,000* 8.33Ã
Total End of Year 1975 $ 1,152,910,320 $ 89,313,118 7.75K SOURCE: Carolina Power and Light response to South Carolina Public Service Commission data request.
'*Floating interest rate. Rate shown based on rate in effect 12-31-75.
EXHIBIT-Page 18 CAROLINA POWER AND LIGHT Et'iBEDDED COST OF PREFERRED STOCK Cumulative Cumul ati ve Annual Weighted End of Year Net Proceeds Cost Average Cost 1960 0 34,030,205 5 1,606,295 4.72K 1965 34,030,205 1,606,295 4. 72 1970 88,246,204 5,696,295 6.46 1971 122,751,754 8,478,795 6.91 1972 172,115,287 12,338,795 7.17 1973 222,013,493 16,063,795 7.24 1974 286,244,312 21,515,795 7.54 1975 333,988,354 26,925,795 8.06 SOURCE: Carolina Power and Light response to South Carolina Pubic Service Commission data request.
EXHIBIT-Page 19 CAROLINA POWER AND LIGHT CALCULATION OF WEIGHTED AYERAGE COST OF CAPITAL AS OF END OF YEAR, 1975 Millions Percentage .
Type of Capital of Cost of Total Weighted Dollars Rate. Ca pi tal i zati on Rate Debt $ 1,152. 9 7.75K 52. 2~ 4.05$
Preferred Stock 334. 0 8. 06 15.+ 1.22 Co+con Equity 722.3 13.50 32,6 4.40 TOTAL $ 2,209.2 100.0 9.67 Weighted Average Cost 9.674 4
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EXHIBIT-Page 20 CAROLINA POWER AND LIGHT FIXED CHARGE COVERAGE RATIO Year Fixed Charge Coverage Ratio 1960 5. 70 1965 5.77 1970 2. 25 1971 2.50 1972 2.90 1973 '2;34 1974 1.92 1975 2.27 SOURCE: Carolina Power and Light response to South Carolina Public Service Commission data request.
EXHIBIT-Page 21 ESTIMATE OF FIXED CHARGE COVERAGE, RATIO AT 13.5% RETURN ON EQUITY, 1975 (Thousands of Dollars)
Total Fixed Charges 99,886 Net Income (1.21 x actual 1975 earnings) 122,962 Add: Federal 5 State. Income Taxes 30,975 (1.21 x actual 1975 taxes)
Deferred Taxes 25,748 Investment Tax Credit '0,192 Add: Above Fixed Charges '99,886 Earnings. for Coverage Ratio Computation: 299,763 Coverage Ratio: 3.00 SOURCE: Estimated from Carolina Power and Light 1975 Annual Report.
EXHIBIT-Page 22 RECENT BOND ISSUES, AMOUNTS, MOODY'S RATINGS
'AND COVERAGE RATIOS Amount Hoody's Bond Coverage Date Company ($ Nillion) Rating Ratio 3-76 Nississippi Power 25 A 2.92 3-76 Jersey Central Power 60 Baa 2. 34 3-76 Utah Power 5 Light 35 A 2.79 3-76 Southern California Edison 125 Aa 2.85 3-76 Phil adel phia Electric 100 A 2.36 3-76 S. M. Public Service 40 Aa 3. 62 3-76 Yietropolitan Edison 50 .A 3.41 3-76 Portland General Elec. 50 Baa 2.14 3-76 Alabama Power 50 A 2.47 3-76 Iowa-Illinois Gas & Elec. 20 Aa 3.80 3-76 Public Service Elec. 8 Gas 60 Aa 2.57 4-76 Utah Power and Light 32 A 3.14 5-76 lhsconsin Power 5 Light 35 Aa 4.18 4-76 Appalachian Power 60 . Baa l. 95 5-76 Union Elec. Co. 70 A 2. 51 5-76 Iowa Public Service 25 A 3. 89 5-76 Central Illinois Light 40 A 2.28 5-76 Ohio Power 80 Baa 2.11 4-76 Kansas Power 8 Light .45 Aa 4.00 4-76 Central Maint, Power 35 Baa . 2.53 4-76 S. M. Electric Power 45 Aa 5-76 Long Island Lighting 60 . A 2.58 5-76, Indianapolis Power 25 Aa 2.89 5-76 Kansas City Power 40- Aa 3.00 5-76 Kentucky Utilities Co. 30 Aa 3.80
. Interest Covera e Ratios b Ratin :
Average Aa =ratings: 3.4 Average A ratings: 2.9
. Average Baa ratings:. 2;2