ML19345G869
| ML19345G869 | |
| Person / Time | |
|---|---|
| Site: | Fermi  |
| Issue date: | 10/31/1980 |
| From: | Stojic G MICHIGAN, STATE OF |
| To: | |
| Shared Package | |
| ML19345G856 | List: |
| References | |
| NUDOCS 8104220566 | |
| Download: ML19345G869 (114) | |
Text
{{#Wiki_filter:. . . l 1 l . t . . . l 5 TATE OF MICHIGAN , OEFORE THE MICHIGAN PUBLIC SERVICE COMMISSION l I I . In the matter of the application ) of THE DETR0lT EDISON COMPANY ) for authority to file, establish ) and make effective increased ) Case No. U-6488
- rates throughout all of its ser- )
, vice area and for other related ) l authorizations. )
)
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DIRECT TESTIMONY and EXHIBITS of GEORGE R. ST0JIC October, 1980 ' t 0 I '810 4 2 s og(,y
The Detroit Edison Company U-6488 1 Q. Please state your name, position, and business address. l 2 A. My name is George R. StoJIc. I serve as a staff economist in the Financial 3, Analysis Section of the Michigan Public Service Comunission. My business 4 address is 6545 Mercantile way, Lansing, Michigan 63909 5 Q. What is the purpose of your testimony in this proceeding? 6 A. The purpose ofi my testimony is to recommend a fair rate of return for The 7 Detroit Edison Company. 8 Q. Would you please state your education and professional experlince which l 9 qualifies you to make such a recommendation? 10 A. I received a Bachelor of Science degree from Ferris State Co,llege in 1974, l 11,l majoring in pu611c administration with a concentration of study in economics. 12 , I also studied as an undergraduate at Michigan State University for two g3 l terms, majoring in economics. I received my Master of Arts degree in 1977 I 14 t i from Michigan State University, majoring in economics, and have since attended 15 graduate classes in finance and economics at Michigan State un'iversity. 16 j in 1977,1 Joined the Michigan Public Service Comnission as a staff 17 economist. My experience with the Consnission has included the submission 184 {I{ of testimony on fair rate of return in .several rate cases, the estimation i 19
!! of future capital costs for case U-6150, and various special studies. In l .I 20 l addition to my work at the Public Service Conunission, I teach economics at 21
! Lansing community College.
I 22 { Q. How do you plan to proceed with your determination of a fair rate of return l l 23 for The Detroit Edison Company?
- h. A.
My determination follows the cost of capital approach, a method wnich identi-24!! O 25.!! " '" rc 'ca't' =" t ="a> 't c# a "v'= r t * - l 1
2-O- 1 lj calculates the relative proportions of those various capital items to the 2,l company's total capital structure, and computes the cost of each type of 3 capital item to determine an overall required rate of return. 4 Q. Beginning with the task of identifying the company's sources of capital, 5' please describe the capital structure that you have used in this case. A. I have developed an estimated capital structure for Detroit Edison as I 6lI 7 ', project it to look at Decanoer 31, 1981. T' a projected December 31, 1981 8g capital structure ratios that I have developed appear on exhibit page 1. 9 q. I show you a document marked for identificnion as Exhibit S- . Is this 10 'I doc"'ent, captioned " Detroit Edison Company, Capital Structure Capital 11 Costs, Related Financial Data, and Rate of Return", the exhibit you have i ar iou iv - r ~c =' O 12 13 l A.
- l Yes, it is.
I 14 l. Q. Was the information in this exhibit propired by you or under your direction? 15 , A. Yes,it was, 16[;
- q. Please explain page 1 of your exhibit to the Cenu:Ission.
17 A. Page 1 depicts the rate of return that I am recommending Detroit Edison se l gg } al lowed to earn on i ts capital . As I mentioned previously, this calculation 19i l Is based upon an estimated Deceeber 31, 1981 capital structure. Column (A) 20 .: shows the calculated percentage of each capital item to the total capital a structure. Column (8) exhibits the cost rate of the various capital compo-21 {ll . 22 y nents, as estimated for 1981, and Column (C) gives the weighted cost rate of 23 . each capital component. The overall cost rate, ranging from 8.93% to 9.05%. 24 is snown on line 9 of Column (C). 02s.ii a ai a a crih ta rivation of vour estimat e i9ai c ait i structure.
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l i I l l 1 i A. I began by estimating the December 31, 1960 capital structure and then used k 2i the estimated 1980 capital structure and the Company's filing in its current ! I I securities case, U-4557, as the basis for estimating the December 31, 1981
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3l 4.- capital structure. . I. 50 Page 2 of my exhibit p;" trays the capital structure that I have esti-I . 6 j' mated for December 31, 1980. Beginning with the actual August 31, 1980 cap-7 Ital structure balances, shown in Column (A) of page 2, I have made adjust- i i 8 ll ments, shown in Column (5), to take into account certain Company planned 9i securities offerings, other Company supplied estimates and estimates that i 10 lj have made myself regarding securities issuances and interim rate relief. . 11 ' The adjustments shown in Coliann (B), to the August 31, 1980 capital structure l 12 , balances result in the, estimated December 31,1980 capital structure balances e 13 ,I shown in Column (C) of exhibit page 2. Column (0) of that page depicts the i 14 percentage that each capital item represents of the estimated December 31, 15 p 1960 capital structure. il 16i ; - The derivation of my estimated December 31, 1981 capital structure is 17 ", shown on page 3 of the exhibit. Follcaving the process described above, I la ;; began with the estimated December 31, 1980 capital structure and made adjust-66 19 ments to take into consideration certain Company planned securities offerings 20 j! to be made at various times during 1981 (most of which are stated in Detroit 21 f,! Edison's application in security case U-6557), other Company supplied esti-el 22 mates that I have found to be reasonably acceptable and estimates that i 23 [ have made myself regarding security issuances and issuance expenses, trock i. 2: y conversion and rate relief. Column (A) of exhibit page 3 depicts the capital 25 structure amounts estimated to be outstanding at Decameer 31, 1980; w ile
O . l l i 1 the amounts in Column (8) represent the adjustments previously mentioned. 1 2 combining columns (A) and (a) yields column (c), the estimated amounts of 3 each capital item outstanding at December 31, 1981. column (D) of page 3 l 1 4 depicts the percentage of total capital that each item of capital represents 5 and serves as the estimated December 31, 1981 capital structure that appears 6 on exhibit page 1. Giancing down column (D), one may observe that the 7 estimated capital structure will consist of 39 37% long-term debt, 56% 8 short-term debt, 9.44% preferred stock, 2.322 preference stock, 29 98% 9 , ccamon equity, 9 99% accumulated ' deferred taxes and 8.34% Belle River finan-10 , cing. 11 Q. Please explain your inclusion of the Bella River financing as zero cost cap-itai i,; your estimated Decem.e, 3i. i38i c.pitai structure. 012 13 A. Due to the nature of the Belle River financial arrangement, it is possible 14 to identify the specific financial source for this construction project. 15 Besides identifying the source of capital for the project, the arrangement 16'l calls for the capitalization of interest, thereby allowing the company to 17 utilize the capital at no current cost. In effect, it is a source of zero 18 cos t capi ta l . By including the financing in my capital structure at zero 19 cost, its economic cost, staff has offset the effect that the Belle River project would have on the company's revenue deficiency by being included in 20 l 21 the rate base. 22 q. What does your exhibit page 4 show? 23 A. Exhibit page 4 depicts the actual, average capital structure. for the 13 24 . l months ended December 31, 1979 of interest on this page are the capitali-02s- ti rti ici -(') *="ci aari=i==="v6 r==="-
O 1 capital structure that I have estimated for 1981. I believe this close re-2 lationship supports the reasonableness of the capital structure I as advo-3 cating in this case. 4 q. Have you examined Detroit Edison's historical capital structures? 5 A. Yes, I have. Page 5 of my exhibit depicts Detroit Edison's year and capital 6 structures for the five years ended December 31, 1979 Examining the lower 7 portion of page S allows one to observe the change in the capital structure 8 ratios from year to year. It can be seen that the ratios have not changed 9 appreciably over the last couple- years, and have changed only modestly over , 10 the last five years. In my opinion. It is not unreasonable to expect the 11 1981 capital structure to bear a close relationship to the recent historical 12 percentages. 13 Q. Please explain page 6 of your exhibit. 14 A. Pages 6a and 6b of my exhibit show the derivation of Detroit Edison's aver-15 age long-term debt cost for 1979 To the far left of the page, one will 16 note a description of Edison's individual long-term debt items. Columns (A) 17 and (B) record the issuance and maturity dates of these individual items, 18 and Colunn (C) shows the amount of sach issue. Column (D) states the costs 19 of the.various issues to the public, while Column (E) represents the expenses 20 of finansing the various issues as a percent of the bond value. In Column (F), 21 not proceeds to the Company of each issue are recorded and Column (G) displays ) l 22 the cost of each issue based on net proceeds. The annual Interest (the amount i 23 outscanding in Column (H) multIplled by the cest Column (G)) results in the 24 amounts shown in Column (1) . The cost of long-term debt is computed by divi-25 ding total annual cost by the total amount outstanding and can be seen to l l
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I result in a cost rate of 8.41% at December 31, 1979, for Detroit Edison 2 company, as shown on line 49, column (G) of page 6b. 3 Q. What do you estimets Detroit Edison's long-term debt cost rate to be for 1980 4 and 19817 5 A. As shown on exhibit pages 7a and b and 8a and b, I am estimating Detrol.t 6 Edison's long' term debt cost rate to be 8.86% for 1980 and 8.76% for 1981. 7 it is the latter cost rate for long-term debt, 8.76%, that I am using in my 8 rate of return recommendation found on page 1 of my exhibit. 9 q. What have you calculated Detroit Edison's short-term debt cost rate to be 10 at December 31, 19797 11 A. As shown on exhibit page 9, the average cost rate of Edison's short-term debt stood at ii.70% at oecember 3i, 1979 At the same time, the prime rate O 12 13 reached 15.25%, indicating Detroit Edison's ability to raise short-term cap-14 Ital at rates below the prevailing prime rate. Page 10, of my exhibit, 15 details the relationship between the prime rate and the various Detroit 16 Edison short-term debt instruments for the 12 months ended December 31, 17 1979 Excluded from the page 10 calculations are the Renaissance Energy 18 Company notes payable. I have excluded these notes from the computation ' 19 because of the uncertainty that exists with respect to how much longer this 20 line of short-term credit will be available to Detroit Edison. Txamination ; 21 of page 10 does, indeed, reveal that Detroit Edison has been able to raise 1 its short-term debt capital at sub-prime rates. 22 23 Q. What have you based an estimate of Detroit ~ Edison's 1981 short-term debt cost rate upon? 24 O25 a- '
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O 1 i on a prime rate of 12% and on the observations made from exhibit page 10 i 2 which Indicates that Detroit Edison can raise short-term debt at sub-prime \ . 3 rates. l 4 in order to compute a short-term debt cost rate figure for December 31, 5 *981, I have weighted each short-term debt instrument by the amount of that 6 Item outstandirig at December 31, 1979 Additionally, noting the uncertainty 7 involved, I have excluded the Renaissance Energy Company notes payable from 8 the calculation. Page 11 of my exhibit shows the calculation for my esti-9 mate of the short-term debt cost rate to be used in my estirnated 1981 l 10 capital structure. Perusal cf page 11 Indicates that I am recommending a e 11 cost rate of 10.97% for short-term debt in this case. - 12 Before continuing with my discussion of Detroit Edison's capital costs, 13 it may prove helpful to point out how volatile short-term debt rates can be. 14 From a high of 20% this spring, the prime rate has declined to 12% at the 15 time this testimony was being prepared. Clearly, short-term debt rates are 16 highly sensitive to economic conditions and the actions of the Federal 17 Reserve Board. Considering the uncertainty that exists with respect to 18 inflation, national output, and the actions of the Federal Reserve, it is 19 dif ficult to predict the course of short-term debt rates fer the near i 20 future. Because of this situation and the volatility of short-term debt i 21 rates, the commission may want to use a more recent prime rate figure if the 22 rate changes significantly between the preparation time of this testimony 23 and the time the case is decided. 24 Q. Please continue with the explanation of your exhibit. 25 A. Turning to page 12, = find the calculations for Detroit Edison's preferrec
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I stock cost at December 31, 1979 As indicated on line 9 of Column (H), 2 the calculations result in a preferred stock cost of 8.17%. 3 q. Does 8.172 also became the preferred stock cost rate 'or 1980 and 19817 4 A. No. Detroit Edison has Indicated that It intends to is sue either preferred 5 or preference stock in the fourth quarter of 1980 and in 1*Bl. I have assumed 6 that the company will issue preferred stock in each year. Because of the 7 issuances, the cost of preferred stock will increase in 1980 and 1981. This 8 increase can be seen on exhibit pages 13 and 14 to result in a 1980 preferred 9 stock cost of 9 20% and a 1981 preferred stock cost of 9.842. It is the 10 9.84% preferred stock cost rate estimate for 1981 that is used in the esti-11 mated 1981 capital structure dich appears on exhibit page 1. 12 Q. What have you calculated as Detroit Edison's preference stock cest? 13 A. Page 15 of the exhibit shows that the calculation for Detroit Edison's pre-14 farence stock results in a cost rate of 10.88% for 1979 Since I have 15 assumed that the company will issue preferred stock in 1980 and 1981, the 16 only changes that will occur to the preference stock balances will be the 17 result of sinking fund provisions for the $2.75 series and S2.753 series of 18 preference stock. The sinking fund provisions will result in a slight decti.ne 19 in the preference stock cost rates for 1980 and 1981. These changes can be i j 20 seen on pages 16 and 17 to result in preference stock cost rates of 10.862 i 21 for 1980 and 10.84% for 1981. The 1981 figure of 10.844 represents the 1 22 cost of preference stock that appears in the estimated 1981 capital struc- ' 23 ture found on exhibit page 1. i 24 Q. Please continue with your discussion of the scurces and cost of Detroit 25 Ed i son 's capi ta l . l 1 - i
1 0 1 A. on line 6 of page I we note that deferred income taxes and investment tax l l 2 credits represent 7.81% of Edison's total capitalization. These items are t . l 3 provided by the ratepayers and represent a source of cost-free capital for 4 Edison; therefore, I have given them a zero cost rate. Consistent with the 5 Comeission's policy regarding accumulated deferred Job Development invest-6 ment Tax Credits, I have included the estimated 1981 balance of these credits 7 in my estimated 1981 capital structure at the overall rate of return. The 8 Job Development investment Tax Credits can be seen on line 7 of exhibit page 9 1, to amount to 2.18% of Detroit Edison's total capital for the test year. 10 As seen on line 8 of page 1, Selle River financing is estimated to 11 represent 8.34% of the Company's total capital at December 31, 1981, and as 12 noted previously, I have given this item a zero cost rate. 13 Q. What standards have you taken into consideration in determining a proper 14 rate of return to reconnend on Detroit Edison's common equity? 15 A. I have taken into consideration standards that have been established by the 16 U.S. Supreme Court. The Supreme Court, in the Federal Pcm.er Commission vs. 17 Hope Natural Gas Company case (51 PUR NS 193, 1944). established standards 18 that regulatory consission have used in determining a proper return to grant 19 on common equity. In that case the Court stated: 20 "From the investor or company point of view, it is impor-tant that there be enough revenue, not only for the - t 21 operating expenses, but also for the capital costs of the business. These include service on the debt and 22 divid*adt on th* co"'on stock. sy that standard, the return to the equity owner should be commensurate with l 23 the return on Investments in other enterprises having corresponding risks. . . . . That return, moreover, should 24 be sufficient to assure confidence in the financial irite- , grity of the enterprise, so as to maintain its credit ! and attract capital." Q 25 G
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I' l The Court, however, failed to identify those factors which constitute 2 ,ii corresponding risk, or the magnitude of a return necessary to assure confi- , j dance la the financial Integrity of the company and to allow it to attract 3 4 capital. Instead, tha Court left the identification and evaluation of 5 these factors to the Judgment of regulatory commissions. These ca. emissions 6 base their decisions on the testimony of witnesses who are knowledgeable 7 of the subject matter and who support their recommendations with studies 8 involving empirical evidence. i 9 j'! Q. Have you performed any such studies to determine a fair rate of return on h 10:' common equity for Detroit Edison? 11 'I, A. yes, I have. In evaluating a fair rate of return on ' common equity for b n U 12 h Detroit Edison, I have examined earnings of comparable companies, utilized 1,l a discounted cash flow study (DCF) and employed a capital asset pricing 14 Jl model (CAPM). 4 Q. Please describe the procedura you have used in salecting comparable companies. 15 l'li 16 jj A. Keeping in mind that no two companies are the same, I believe that the pro-et i 17ji cadure I followed resulted in companies that are comparable to Detroit 1 sl 18 (( Edison. I began by selecting Value Line investment Survey's electric util-l Ities with 1979 total capital in excess of 2.5 billion dollars. From this 19 l. initial group, I chose those companies with beta coefficients of between .50 20 d,. 21
! and .70. My final group of comparable companies and their beta coefficients i
22 j are listed on exhibit page 18. I 23 Q. How do you intend to use your comparable companies to determine a fair 1 24 equity return rate in this case? A. The Supreme Court, in the Bluefield Vaterworks and improvement Comoany vs. O 25 ll 1
Q' 1 Pubile Service Conunission of West Virginia case (262 U.S. 679) stated that: 2 "A public utility is entitled to such rates as will permit it to earn a return on the value of the property which it employs 3 for the convenience of the public equal to that generally being made at the same time and in the same general part of 4 the country on investments in other bus tress 6.5rtakings which are attended by corresponding risks and uncertainties; l 5 but it has no constitutional right to profits such as are realized or anticipated in highly profitable enterprises or 6 speculative ventures." 7 It would be wise, then, to examine the returns earned by these other businesses 8 having corresponding risks and uncertainties. 9 Q. What were the results of your examination of the earnings of comparable 10 companies? 11 A. As shown on line 16 of exhibit page 19, the average return rate earned by 12 the thirteen comparable companies for the most recent year,1979, is 10.8%. O 13 The return rates earned by the companies over the past five years, as shown 14 on line 16 of the far right-hand column, can be seen to average 11.05%. 15 Detroit Edison's average return rate on common equity over the same five-16 year period of time was substantially lower as witnessed by the 9 28% return 17 rate reported on llae 17 of the far right-hand column of page 19 18 Q. Did you take any other factors into consideration before arriving at a rate 19 of return recommendation based upon the earnings of comparable companies? 20 A. Yes, I did. In order to evaluate the sufficiency of the earnings of the 21 comparable companies, I examined the market-to-book ratios of those comparable 22 firms over the period 1975-19/9 i 23 Q. Why did you examine market-to-book ratios? l 24 A. They may give an Indication of the adequacy of historical earnings. Economic ' I 1 25 l theory asserts that if a firm earns, or is expe ed to earn, a return on its 1 l l
i O equity that is equivalent to the yleid at which a share of that firm's common 1 2 stock is selling in the market, the market price of that firm's stock should 3 approach ^he stock's book value. If the firm's earnings deviate from the 4 market yield on the firm's stock, the market price to book value ratio w!Il 5 deviate from unity, other things remaining constant. Thus, a market-to-book 6 ratio consistently below unity would tend to indicate that a firm's earnings
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7 have been less enan the Investor's requ' ired" return for thit firs. 8 4 What was the res. ult of you examination of the market-to-book ratios of the 9 comparable companies? 10 A. On page 20 of the exhibit, the five year market-to-book ratios, as shown on line 16, can be seen to average .82%, while Detroit Edison's market-to-book 11 l a. 12 ra t ic. :as averaged .76%. d 13 Q. Do you arrive at any determination from your examination of the earnings and 14 market-to-book ratios of your comparable companies? 15 A. yes, I do. From my examination of the data, I conclude that 11% represents 16 the sainimum return rate consistent with established standards for determina-17 tion of a proper rate of return in rete case proceedings, and seems to be 18 less than the return required by investors in these comparable companies an: 19 Detroit Edison, as attested to be the continuous low market-to-book ratio. i
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! 20 4 Do you have any other ccaments to maks regarding your return rate recommenda-l 21 tion based on your study of comparable companies? 22 A. Evaluation of return recommendations based upon comparable companies should l 23 be made with the knowledge that performance in the past may not be an accurate
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24 Indicator of cv;* rent needs. For example, a period of poor performance may O 25 " ' '"'" "' '"a ' ~ ' *"'" ~"' " '" 3" "" *aa :- '
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O - i 1 d at is needed. In addition, studies of comparable companies are subject to ) 2 the defect of circular reasoning dich leaves them vulnerable theoretically. l 3 Finally, the earned return on equity may not be the actual cost of equity. l 4 It is desirable to grant a utility a return squal to its cost of capital, 5 because by so doing, the consumer pays no more than his fair share for utIIIty i 6 service and the company receives the revenue it needs to meintain its financial 7 Integrity, attract capital and earn rates of return comparable to those being l 8 earned in the market by comparable firms. , 9 q. How does one measure a firn/s cost of equity capital? h l j 10 A. A firm's cost of equity capital can be estimated by use of a DCF or CAPM. 1 l , i j 11 I Q. How does a DCF allow one to.deterni.no a company's required return rate?
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12 A. The conventional theory behind this technique argues that the value of a 13 share of stock, like the value of any other asset, can be represented by the 14 present value of the cash flows the stock, or asset, is expected to provide I 15 for its owner, secause the benefit of holding a conunon stock is its dividene. 16 the problem of determining the cost of equity becomes the problem of deter-17 mining what discount rate the market is using to establish the present value 18 (price) of the dividends on a share of common s tock. The DCF estimates tnis ! l 19 discount rate with use of the formula: k=h+G 20 k = investor required return 21 0 = anticipated annual dividend P = market price of the share 22 G = expected growth rate 23 In measuring the required return, or cost of equity, on a share of s tock, tne dividend yield is easily determined by dividing the anticipated dividend by the share's price. The long run dividend growth expectation is much more l l
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O - I difficuit to ascertain. 2 If a corporation is expected to earn a rate of return of "r" on its 3 common equity and if it retains a portion, "b", of those earnings, then 4 earnings, per share can be expected to increase by "br" in the subsequent 5 yea r. Thus "br" measures the rate at which earnings can be expected to grow 6 and, if the firm has a normal dividend payout ratio, it is a good measure of 7 future dividend growth. 8 Q. What values for "b" and "r" have you used to determine expected growth in 9 dividends? 10 A. Since investors evaluate the past performance of a company in deriving future - 11 expectations, I have used historical values of "b" and "r" in estimating Detroit i O 12 idison s g,owth , ate. in computieg growth rates from histo,icai figu,es, 13 however, one must make assumptions regarding how much weight Investors place 14 on particular historicai growth rates. 15 q. Piease explain your growth rare estimation procedure. 16 A. I bagan with th ee possible scenarios on how investors may weight historicai 17 g rowth ra tes . The first s'cenario assures that investors place most weight on 18 current earnings and that the significance of past earnings declines continually 19 wi th time. The second scenario assumes that investors place less significance 20 on current earnings and more on earnings which occured in the recent past ano 21 : hen iess significance, again, on earnings that occurred further in the past. 22 Restated, this scenario suggests that the significance of past earnings first 23 ; increases and then declines with time. The third scenario assuus that in-l 24 vestors weight historical earnings equally. O 25 To test which scenario most accurateiv descriees investor se avier. i _3 ,-, ------*e---y *---r-- -+ - - - - - - - - - - - ----,we v--- -- +---------------------------------+,---*-------c--- - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - -
0 1 utilized the DCF formula which I previously discussed, ano regression analysis. ! 2 in using the DCF formula, I rearranged terms somewhat to derive the expression: 3 h=k g 4 The formula implies that there is a negative or inverse relationship between 5 firms' dividend yleids and growth races. The inverse relationship implies 6 that firms with higher anticipated growth rates should have lower dividend 7 yields than firms with lower growth rates if the companies are of comparable 8 risk. 9 Consis tent with the three scenarios describing investor behavior, I have 10 generated three sets of weighted, historical growth rates. The growth rates 11 were connuted by using historical figures for "r" and "b" for Detroit Edison 12 and each of the comparable conpanies that appear on exhibit page 18. Each 13 set consists of three, five, seven and ten years of historical growth rates 14 for Detroit Edison and the fifteen comparable companies. The first set, i 15 l wich conforms to the first scenario 'of continually declining significance i 16 ) with time, was weighted by use of the concept of sum of the years digits. By 17 using the sum of the years digits methodology to generate growth rate weights 18 and then applying these weights for three, five, seven and ten years of histor-19 Ical data, I gave progressively less weight to growth rates which occurred 20 : further in the past. I 21' The second set of growth rates, dich conforms to the second scenario of 22 first increasing and then decreasing historical significance, was generated by 23 weights that were conputed with the use of a second degree, lagged polynomical 24 p t equa tion. The weights were generated by econometric estimation of the equation pJ 25 l parameters and then applied to the historical growth rates. O
0 1 The third set of growth rates, dich treat the significance of past years 2 equally, represent the averages of the past three, five, seven and ten years 3 of gr-th rates. l 4 q. Please continue with your explanation of growth rate estimation. 5 A. My next step was to determine, statistically, which of the growth rates, 6 from the three sets, best represented investors behaviors. In order to maka 7 such a determination I used regression analysis on the equation: -. 8 E=k P g 9 i Regression analysis is a statistical technique that allows one to 10 evaluate whether or not a . statistically significant relationsnip exists 11 between one variable, called a dependent variable, and one or more other O 12 vari.bies, caned an inapee-et variabiets) . i t . iso an-s -e to *termine l 13 what effect the independent variable (s) has and how strongly It is related to 14 the dependent variable. As an example, we might think of a person's weight as 15 being dependent, in part, on a person's height. In such a case a person's 16 [. weight would be the dependent variabis and a person's height would be the 1 17 l Independent variable. statistically, through a r'egression analysis, we could ! I l 18 ' evaluate the data and determine if weight and height are Indeed related ano 19 the effect that a person's height might have on his or her weight. 20 in evaluating the formula y = k g, I used the three, five, seven and 21 ten year growth rates, from the three sets previously discussed, individually 22 as proxies for the "g" portion of the expression. The "k" portion of the 23 equation, which consists of an inflation and risk cowonent, should be 24 ! Invariant over the sample since the companies are of cogarable risk and 25 the data is cross-sectional. Nevertheless, it is impossible to select companies
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O i 1 1I that are of precisely the same risk. Therefore, I have included each firm's 2 beta coefficient in the regression model as a proxy to account for any 3 differences in risk that may exist among the companies. 4 My procedure involved successively regressing the coganies' beta 5 coefficients 4and weighted growth rates on the companies dividend yields 6 untt i sach weighted growth rate had been regressed on the dividend yields. 7 For exagle, First the beta coefficients and the sum of years digits weighted ' 8 growth rates for the past three years were regressed on the companies' 9 dividend yields. Next, the beta coefficients and sum of years digits weighted 10 growth rates for the previous five years were regressed on the dividend yields. l 11 The procedure was followed untII the three, five, seven and ten year growth 1 12 rates for all three sets of data were regressed on the dividend yields. 13 The growth rates that i used were for the three, five, seven and ten 14 years ending in 1979. The beta coefficients used for each company are the 15 same as those shoe on page 18 of the, exhibit. Finally, the dividend yields 16 l were computed by using the average of the high and low March 1980 market 17 price for each company. 18 The final step in er growth rate estimation procedure was to determine 19 which of the weighted grcneth rates fit the dividend yield data best. I used 20 the coefficient of determination in order to evaluate the best fit. After 21 examining the results of the regressions, I have found that growth rates for the
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22 three previous years weighted by the son of years digit method fit the data best. 23 Therefore, I have used this procedure l'a order to determine Detroit Edison's 24 expected growth rate. The best fit equation appears on exhibit page 25 O 25 q. Using the procedure that you have just described, what greneth race have you l
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O- ' I calculated for Detroit Edison? 2 A. The procedure that I have adopted results in aa expected growth rate of 159% 3 for the Detroit Edison Company. 4 q. Hoe did you calculate the D/P portion of the formula in this case? 5 A. The "D" portion of this expression is simply the anticipated dividend for 6 the next 12 months. The price used in the formula is simply the average of ~ 7 the high and low market price for Detroit Edison for the quarter ending g July 31, 1980, as reported in the June, July and August,1980, Standard & 9 Poor's Stock Guide publications. The result of dividing the dividend, 51.60, 10 by the average market price, $13.31 results in a dividend yield of 12.02%. 11
- q. What is the next step in the determination of the investor's required return 12 rate?
g3 A. The next step is the addition of the growth rate to the dividend yield to 14 determine the investor's required return for Detroi t Edison. The 1.59% growth 15 rate added t dividend yield of 12.02% results in a required return of 13.61%. 16 Q. Does the 13.61% represent the cost of all common equity for Detroit Edison? 17 A. No. New connon equity generally has a higher cost attached to it than existing 18 common equity because of the expenses incurred in issuing new stock.
- I have 19 estimated a reasonable allowance for these issuance expenses of 3 73% for 20 Detroit Edison. If the Comelssion desires to grant Detroit Edison an allow-21 l
ance for these issuance expenses, the 13.61%' figure should be increased by 22 ' 3 73%. The calculation to make this adjustment can be found on exhibit page 23, 21, and on line 13 of that page can be seen to result is a cost rate for co .en 24 equity of 14.02%. In granting an allowance for Issuance expenses, however, the O 2s co i ion v i h to e *e into con ider cion the f ce eh = oeiv == ii \ -
l l 1 .p ortion of the Company's common equity is subject to the issuance expenses. 2 A major portion of the company's casocon equity is not subject to such expenses 3 and therefore such an alicavance may overstate somewhat the true cost of equity 4 to the firm. 5 Q. How have you , derived an allowance for issuance expenses of 3.73%7 6 A. I arrived at anl allowance of 3 73% by examining the expenses associated with 7 three of Detroit Edison's comon stock offerings. As s w a on line 6 of 8 exhibie page 22, these expenses can be seen to amount to 3.73%. 9 Q. Are you recessnanding that the Comission grant Detroit Edison an allowance for 10 market pressure in this case? i 11 A. No. I believe that a market pressure allowance would be inappropriate in this O 12 c case. 13 Q. Please describe how the CAPM can be used to estimate the cost of conunon equity? 14 A. The first step in understanding how the CAPM can be used to estimate conunon 15 equity cost rates is to observe the risk of a stock in relation to a portfolio. 16 in general, the standard deviation of market returns (riskiness) of a portfolio 17 of assets is less than the average of the standard deviations of the Individual 18 assets. The inplication of this observation is that some, but not all, cf 19 the risk from holding an asset, such as a share of stock, can be diversiffeo 20 away by holding a portfolio of securities. That portion of a stock's total 21 risk that can be reduced through diversification is termed unsystematic r!sk, I l 22 while 9at portion which cannot be diversified away is called systematic risk. 23 , it is the systematic risk of a stock that is relevant to capital market theory, , i 24 ! since some of the total risk,cthe unsystematic por' tion, can be diversified )
, 25 away. Systematic risk arises from the tendency of a stock or portfolio to be
\
O-1 effected by general stock market movements. 2 q. How dow Joe measure a firm's systematic risk? 3 A. As noted previously, the systematic risk of a stock is the tendency of its 4 own market return to move with changes in the entire stock market's return 5 (henceforth referred to as the market return). This tendency can be captured by regressing the returns of an Indiveaual stock on the market return. The l 6 7 coefficient on the market return from such a regression is called the beta 8 coefficient and it measures the change in an Individual stock's return as the 9 market return changes. I f, for exarrple, a stock has a beta = 1.0, then we 10 would expect that stock's return to change in direct proportion to changes in 11 the market's return. A beta = .80 would Indicate that if the market return O 12 increased by 1.ot, we.could expect that firm's return to increase by .802. To 13 retterate, the systematic risk of a stock represents a risk that cannot be 14 diversified away and is measured by the firm's beta coefficient. 15 Q. Please continue with your explanation of how the CAPM can be used to estimate 16 the os t a f common equi ty. t 17 A. Economic theory asserts that as the risk of an asset increases, tM return 18 required by investors for holding that asset also increases, and conversely 19 as the risk of an asset decreases so does the return required by investors. Even if an asset had zero risk, however, investors would still require a return 20 l 21 for investing in that asset. 22 l Investors would require a return for investing in a risk-free 23 asset to compensate themselves for giving up the use of their cor.ey for a 24- period of time. As an illustration, if an asset had no risk asse-lated with O 25 .I It and there was no threat of inflation, an investor would require a return
s I 0 1 for investing in that asset as compensation for not being able to use that 2 money himself. This return is known as bare rent or the pure Interest rate. 3 in addition if Investors expect inflation to occur while they are holding an 4 asset, ( they will require a return as compensation for the loss of purchasing 5 power their money experiences while it is invested. This is true even if it 6 is invested in an asset that has no risk of default. Taken together, the y bare rent and cospensation for inflation that investors require from an asset a that has no risk are known as the riskiess or risk-free rate of return. In 9 addition to the risklass rate of return, if an asset possesses risk, then an 10 additional return 9r premium must be awarded to investors to compensate them 11 for the risk assmed in holding that asset. As noted previously, the greater 12 the risk, the greater the premium or additional return above the risk-free 13 rate that investors will recuire from that asset. 14 The required return on a stock consists of the risk-free rate of return 15 plus a premium to compensate Investors for the additional risk assumed in 16 purchasing the stock. This relationship can be expressed in the form: 17 kg = Rg + pg Ig where kg = Investors' required return on the firm's stock 19 Af = the riskless rate of return 20 Pg = the risk premium on the firm's stock 21 The risk premium required for the market as a whole is equal to (k, - Af ), 22 dere k, is equal to the market's required return rate and R f is the riseloss i l 23 rate of return. With knowledge of the market's risk premium, one can ests: . ate 24 the required return for any firm's stock by utilizing the equation: O 25 k , . R, . b , <k, - R,3
- ~ - > g - - - - - - - . , . , _ ~ , . , , _ _ , , , _ _ _ _ _ . _ __
) + i., !
l l l 1 O I where kg, km and Rf = defined as before 2 bg = firm's beta coefficient 3 in narrative form, the equation expresses a firm's required return as the sum 4 of the risk-free rate of return and the firm's risk premium, which can be 5 expressed as the market's premium multiplied by the firm's beta coefficient. . 6 if a firm has a beta coefficient of less than unity, it will consnand a 7 smaller than average risk premium, and if its beta exceeds unity, its risk 8 premium will be greater than average. A beta equal to unity implies a risk 9 premium, for that firm, equal to the market's risk premium. 10 Q. How did you derive an estimate for the market's requirad rate of re. turn? 11 A. In order to estimate the market risk premium, I computed the historical ! O 22 s read between the market rate of return earned bv the stock market and the l 13 market rate of return earned on long-term government bonds. The spread gives 14 us the return earned by the market in excess of that earned by a risk-free 15 asset, or a stock market risk premium estimate. 16 1, order to estimate the stock market and government long-term debt 17 market returns, I used monthly observations of the Standard & Poor's 500 18 market index and Federal Reserve Board figures respectively. Af ter computing 19 the monthly market returns for the period running from January of 1953 to 20 December of 1978, I subtracted the government bond rsturns from the stock 21 market returns and aggregated the monthly differences on an annual basis 22 consistent with calendar years. The average. annual rate, 8.17%, serves as an 23 estimate of the market risk premium.
- 24. Q. Sared upon your market risk premium estimate, what have you estimated the
. 25 market required rate of return to be? .,-,......---_..-w.-.,_. -._..my._,,.--.-.,....,c .--...,-..m_. . . , , , . - . . , . , . . - . _ . - , . _ , , - , - . - - . _ - - - - . - - .
1 A. The market's current required rate of return can be estimated by adding the 2 market's historical risk premium over debt to the current long-term government 3 debt yields. Using the average premium that I generated of 8.172 and the 4 ' i l average long-term government debt yleid for the four weeks ending September.3, 5 1980, of 11.08%, one derives an estimate of the markets rate cf return of 6 19.25%. This calculation is shown on page 23 of the exhibit. 7 q. Did you take any other factors into consideration in estimating the markets 8 required rate of return? 9 A. Yes, I did. While the market risk premium may be insensitive to many macro-10 econcele disturbances, it is theoretically sensitive to the rate of Inflation. 11 The risk premium sensitivi.ty to inflation derives from the relative changes in O 12 th. expected v.,i.eces of the ,e.i v.iu. of the retu,ns f,om . qui tv .nd dest 13 with changing expectations of inflation. Consistent with the theory, we could 14 expect the premium to decline during periods of time characterized by increas-15 ing expectations of inflation. 15 If this sensitivity is not taken into consideration, the use of an 17 estimated market rate of return of 19 2% could seriously overstate a firm's 18 cos t af equi ty capi tai . 19 Q. How have you taken the risk premium sensitivity to inflation into account in 20 estimating Detroit Edison's equity cost rate? I l 21 A. I have taken this inflation sensitivity into account by estimating the effect 1 22 that inflation expectations have on the risk premium and then adjusting the 23 risk premium accordingly. In order to estimate the inflation sensitivity, i 24 have regressed inflation rates, which I used as a proxy for inflation expecta-25, tions, for the years 1953 through 1978 on the annual risk premiums that i 1
O . I computed for each of those years. The data used in the regression and the 2 estimated equation appear on exhibit page 23. Evaluation of the equation 3 Indicates that the regression coefficient is negative, Indicating an inverse 4 relationship between inflation and the merket risk premium. This relation-5 ship is consistent with the theory enunciated previously. Additionally, the 6 t-value of -2.05 indicates that the regression coefficient is Indeed 7 different from zero at the 95% level of confidenca. 8 in order to take inflation expectations into account, one could " plug" 9 a number for inflation expectations into the equation and compute an inflation-10 adjusted risk premium. While it is difficult to estimate expectations of . l 11 inflation, in a recent case I have estimated a market expected rate of l 12 inflation of 7% for the next 30-35 years. Using this number as a proxy for , 13 expectations, one can compute a risk premium of .86%, tnis calculation appears I 14 on line 11 of exhibit page 23. 15 As indicated, the 7% figure is a proxy for actual expectations. To the 1 16 ' degree that it differs from actual expectations, the estimated risk adjusted 17 premium will be inaccurate. Nevertheless, it is important to take inflation 18 expectations into account in estimating the market risk preimium, in order 19 to take the effect of inflation expectations into account in estimating tne 20 market risk premium, I have averaged the inflation adjusted figure and the 21' historical figure to derive an inflation-adjusted market risk premium of l - 22 4.52%i8.17%+.86%) ,. Using the 4.523 premium and a government long-term
. 2 .
23 debt rate of 11.08%,1 compute a market required rate of return of 15.60% l 24 I (11.08% ' 4.52%). It is this figure that I have used in my CAPM. 25- q. w?'t does knowledge of the market rate of return serve? _,.._.,._,,__-.,_,,,_-_r__-m,,_..-r- , , , . - - - . , , ,-,.c,cw,.-, - - - - . - , . - . - -- --y- .-- - - - -
. +
O' 1 A. It may prove helpful to remember that the market return rate consists of a 2 risk-free rate of return and a premium above the risk-free rate to compensate 3 the investor for the risk of the market. Any given firm's common equity may 4 be more or less risky than the stock market as a whole depending upon hoe 5 ' that firm's return moves as the market return c'hanges.'"Tliis' rlWas deiicribed ~- 6 previously, can be mersured by the firm's beta coefficient. If a firm's beta 7 coefficient is less than the market average beta, which is unity, that firm is 8 less risky than the market and therefore requires a smaller risk premium over 9 the risk-free return rate than the market requires. Just the opposite is true 10 if the firm has a beta coefficient greater than the market average. A firm's 11 risk premium over the riskless rate of return is dependent on the market pre-12 mium and the firm's beta coefficient. By multiplying the firm's beta by the 13 market return rata, one can compute the firm's risk premium over the risk-free 14 rate of return, an( when this premium is added to the risk-free rate, it results 15 in the firm's required rate of return. 16 q. What have you estimated as the risk-free return rate to be used In your CAPM7 17 A. The best estimate available for the risk-free rate of return is the yield on ' 18 U. S. Government securities. During periods of time in which short-term yields 19 d;ffer from long-tera yields, however, there is some question as to which yield 20 to use. Some analysts prefer to use the long-term rate because it reflects 21 expectations of inflation for the long run and is not subject to radical 22 fluctuations that may be caused by temporary conditions in the money markets 23 or price levels. Other analysts argue that the short run rates are the best 24 Indication of the risk-free rate at any point in time; fully reflecting the 1 h 25 investor's expectations of inflation. On page 23 of my exhibit, I have computec
. m l l
I O rities hort-term rates on govsrnment secu I both tae long-term rates and the1980. s It can be seen on0 7?% line 5 o r 1f for the four weeks ending September 3, has averaged 1 ment securities 2f the three month rate on governe averaged 11.084 page that 3 month, while long-tors rates hav 4 for the Edison using have you estimate 4 for Detroit 5
',g, y r e nu n eq Ity 4- Wh*t C*** f 6
the CAPM7 24, I derive a cost rate estimate o 7 , f 4.522 and A. As shown on line 2 of exhibit page n a market rate risk premium 8 13 79% for Detrolt Edison band upo g of return af 11.084 ost of equity capital declines to a risk-free rate ' 10 O My astimate for Detrolt Edison s cf 4.52% and a ris 11 f 13 44% If a merket risk premium o
,, I i your use 12 f of 10 734. h earnings of comparable compan es 13 h company be allowse Q,
Based upon your examination of t ete are you recommend 14 of the DCF and CAPM, what cost ra rates 15 his proceeding? I have derived a range of return 4 to earn on its equity in t using enol 16 A. Through a combination of techniques,A concentrationl running f rom 11.05 to 14.024. d 14.02%. The results of my studies l! 17 I 18 ity,is fai 2( OCF and CAPM falls between 13 44% anf return f 19 21 me to conclude that a range o
- 20 f dation res 22 and reasonable in this case. l capitalization does this recommen 21' ,)
23 Q. What overall cost rate on tota 14 22 24 '"' hta rate of return of from 13
' range from 8.932 e O "' " A.
On page 1 of my exhibit, we find t aan overall return 24 on the common equity cogutes to 25 D
CASE NO. U-6488 EXNISIT NO. SCHEDULE No. WITNESS: G. 5tojic DATE: ! Page 1 O of 1 pages DETRolT EDISON COMPANY RATE OF RETURN December 31, 1981 1 Percent of Weighted Line Total No. Cost Cost Description Capital Rate Rate (A) (8) (C)
- 1. Long-Term Debt 39 37 % 8.76 % 3.45 %
- 2. Short-Term Debt 56 10 97 .06 3 Preferred Stock 9.44 9.8% 93
- 4. Preference Stock 2 32 10.84 .25 5 Connon Equity 29 98 13.5-14.0 4.05-4.20
- 6. Accumulated Deferred Income Taxes and I.T.C. 7.81 7 Accumulated Deferred J.D.I.T.C. 2.18 8.93-9.09 .19 .20
- 8. Belle River Financial Arrangement utilized 8.34 9 Total 100.00 % 8.93-9.09%
Source: Column (A): Exhibit page 3 Column 0 Column (8): Exhibit pages J O . l
wws av. v-woo EXHISIT No. SCHEDUL2 No. WITNESS: G. stojic OATE: Page 2 of 1 Pages O DETRolT EDISON COMPANY ESTIMATED CAPITAL STRUCTURE December 31, 1980 (Dollars in Thousands) l Line Es timated Percent Balance at Balance at of Total No. Descript ion 8-31-80 Adjustments 12-31-80 Caoltal (A) (8) (C) (D)
- 1. Long-Term Debt $2,296,928 $ 7,200 $2,304,128
- 2. Unamortized Long-Term Debt Expense 20,226
- 3. Total Long-Term Debt (480) 19,746 2,276,702 7,580 2,284,382 44.46%
- 4. Short-Term Debt 31,431 (12,0i2) 19,369 38
- 5. Preferrad Stock 439,947 41,400
- 6. 481,347 Preferred Stock Expense 7,135 456 7,591
- 7. Total Preferred Stock 432,812 40,944 473,756 9.22
- 8. Preferenee $tock 146.055 146,055 9 Preference Stock Expense 6,784 6,784
- 10. Total Preference Stock 139,271 139,271 2 71
- 11. Common stock 1,143,310 61,065 1,204,375
- 12. Comon Stock Expense 30,156 2,088 32,244
- 13. Retained Earnings 345,706 22,918 368,624
- 14. Total Comon Equity 1,458,860 81,895 1,540,755 29 98
- 15. Accumulated Deferred income Taxes and ITC 366,661 10,563 377,224
- 16. Accumulated Deferred JOITC 98,711 7.34 5,079 103,790 2.02
- 17. Belle River Financial Arrangement UtiiIzed 138,256 61,744 200,000 3.89
- 18. Total Capital $4,942,704 5195,843 55,138,547 100.00%
O source: Certain estimates su..iise bv cem anv and.ot*er estimates s .iree bv witness. -www- =s- wr-~,,s,--w-e -,v,-
CASE NO. U-6488 EXHIBIT NO. SCHEDULE NO. WITNESS: G. Stolic DATE: Page 3 of 25 Pages DETRolf EDISON COMPANY ESTIMATED CAPITAL STRUCTURE December 31, 1981 (Dollars in Thousands) ; Es timated Es timated Percent Line Balance at No. Descriotion Balance at of Total 12-31-80 Adiustments 12-31-81 Capital (A) (B) (C) (D)
- 1. Long-Term Debt $2.304,128 $ $2,304,233 105
- 2. Unamortized Long-Term Debt Expense 19,746 24 19,770 3 Total Long-Term Debt 2,284,382 81 2,284,463 39 37%
- 4. Short-Term Debt 19,369 T3,050 32,419 56 5 Preferred Stock 481,347 75,091 556,438
- 6. Preferred Stock. Expense 7,591 1,105 8,696 Q 7. Total Preferred Stock 473,756 73,986 547,742 9.44
- 8. Preference Stock 146,055 ( 5,000) 141,055 9 Preference Stock Expense 6,784 ( 245) 6,539
- 10. Total Preference Stock 139,271. ( 4,755) 134,516 2.32 i
- 11. Cormon Stock 1,204,375 198,517 1,402,892 l
- 12. Common Stock Expense 32,244 5,336 37,580 13 Retained Earnings 368,624 5,823 374,447
- 14. ;
Total Common Stock 1,540,755 199,004 1,739,759 29.98
- 15. Accumulated Deferred snecme '
Taxes and ITC 377,224 76,015 453,239 7.81
- 16. Accumulated Deferred JOITC 103,790 22,537 126,327 2.16 17 Belle River Financial Arrangement Utilized 200,000 284,000 484,000 8.34
- 18. Total Capital 55,138,547 5 663,918 $5,802,465 100.00%
s Source: Certain estimates suppliac by Company , Amplicant's Case U-6557 and other estimates supplied by witness.
,,.-._.,--.--,,,m. .;,...,m . , . , . _ - _ . . - , _ _ _ , , , _ . , _ . _ _ . , _ _ .
CASE NO. U-6488 EXHISIT No. SCHEDULE NO. WITNESS:_ G. Stojic O-- Page k of L Pages DATE: DETR0lT EDISON CCMPANY CAPITAL STRUCTURE THIRTEEN MONTH AVEAAGE ENDED DECEM8EA 31, 1979 Line Description Dollar Percent of No. Amount Total (000) CaoftaIizatien (A) (3) 1 Long-Term Debt
$2,039,774 46.66 %
- 2. Short-Tenn Debc 78.352 1.79
- 3. Preferred Stock 352,5c8 8.06 4
Preference Stock 143,C23 3 27
- 5. Connon Equity 1,322,366 30.25" 6.
Accumulated Deferred Income Taxes and investment Tax Cred i ts 328.457 7.51
- 7. Job Development investment Tax Credits 107.573 2.46
- 8. TCTAL 5k,372,053 1c0.00 %
Source: Company Reports to the Michigan Public Service Comission. O e
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.. .. . . . .-. CASE NO . U-6fs88 EXHl817 NO.
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I eflooli (Sl50sl C00eAsev Page 2 of 2 10stG Hest DEST Coil
- i BECIMER 31. 1980
, (Continued)
Date Date Amouset Price Cost i Line of of of La financing Iset eased on Amount Annual l Itu u D_e1glgtlos~ jsswe N turi t_y 0fferIng Pubtic (m ences Pyoceed5 kt Proceeds outilandIstg Cest (Al' 'le) ~~TI')- "[b)- p(ET"' TC ~lcT ' ~ (41 ', ~(l l" r.eneral 6 sefundj~ng i
' Wi ase9 toisis: t can' ta)
- 31. Series 19tP. 6-7/88 2-15-77 7-15 97 l
32.
$ 4.400.004 100.005 3.511 96.49*. 7.295 g 4.400.000 g 320.760 l Series ler to. 2. 7.255 9-08-79 2-15-97 I.030.000 100.00 2.A6 97.14 7.55 1.030.000 77.765 l 3). Series leer. Ilos. I-7
' 4.01 - 6.6255 F-01-77 7-01-97 32.850.000 100.00 2.63 97.37 6.79 32.854.eee
- 34. Series leer, llos. S-21 2.200.950 5.855 - 11 7-01-79 7 01-91 15.l00.000 100.00 2.77 97.23 7.11
- 35. 15.140.000 1.873.688 Series 00P. loos. 3-17 1 4.41 - 6.255 10-01-77 30-08-07 16.700.000 800.00 2.58 97.42 6.26 16.700.000
- 36. 1.045.470
! Series 00P. Ite. le. 7.251 9-01-79 10-01-07 2.100.000 100.00 2.78 97.29 7.44 2.500.000 163.064 1 37. Series PP. 9.8755 6-15-78 6-15-08 18. 70.000.000 98.82 1.27 97.55 10.14 70.000.000 7.090.000 [ 5eries QslP. Isos.1-9 5.6% - 6.45 6-01-78 6-01-91 9.300.000 100.00 2.80 97.20 6.56 9.300.000
- 39. Series RR. 9.e5 650.000 10-15-78 10-15-08 70.000.000 100.00 3.22 98.78 9.93 70.000.000
- 40. Series 55. 10.3755 6.951.000 3-15-79 3-15-99 150.000.000 100.00 .66 99.34 10.45 150.000.000 15.675.000
- 41. Series IIP. less. I-IS.
5.855 - 7.1255 7-01-79 F-01-09 3,000.000 100.00 4.13 95.87 7.40 3.000.000 283.200
- 42. Series IAl. 10.5755 9-15-79 9-15-09
} 100.000.000 99.20 1.07 98.13 11.09 100.000.000 11.990.000 1-
- 43. lantecured framistor LI l Aet Wrldle' Interest hates 10-14 77 7-08-84 155.P90.000 100.00 .I6 99.84 13.24 155.000,000 20.522.000 lastellment Sales Contrac
- 44. ierles T ~ ' ~ ~ '~ ~ts: 6-01-73 6-01-03 46.000.000 100.00 1.56 98.44 5.76 43.000.008 2.476.eno
- 45. Series B 5 01-74 5-01-04 100.00 22.550.ous 2.44 97.60 7.71 21.550.000 1.661.505
- 46. %erles C 7-15-74 7-15-M 3.59 13.000.000 100.00 96.41 A.33 4.400.000 366.570 Istued in 1980:
- 47. (InschTrial fr'isiilssory leotes 1980 1900 50 ".bo.000 100.00 .09 99.91 11.95
- 48. 50.000.000 5.525.000 5estes 1980A. 12.75s 1900 1987 50.000.000 100.00 1.13 98.87 13.00 50.000.0n0 6.500.000
- 49. Seeles 1980s. 12.751 1980 2000 300.000.000 100.00 .54 99.46 12.33 160.000.000 12.810.000 5d. Series QQP. F.755 - 9.55 1980 1994 4.350.000 ICO.00 3.05 96.95 9.28 2.354.soon 218.00s
- 51. Series CP. 7.751 - les 1980 2007 25.000.000 100.00 3.01 96.99 52.
10.02 al.coe.co0* 2.104.seo
; Series Dr. 7.755 - let 1980 2010 10.750.000 800.00 3.46 96.54 10.76 8.750.000* 892.50s
- 53. 10lAt
- 54. $2.187.645.ees laen.44s.349 Lont leen Debt Cost Rate S.865 Source: temgaany seports eo ahe sticlilgen PuleIIc 5eavIce Cas IesIen and W8enesa a tstimate yJ$
as n$ --
- 8"g
-i .
3 '" It s 5P
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v. rv
#1 8
O O O . Miaoli tol50s 'DMPAsif a page I of I LONG Ifan Wei rASI . MCEMEe P 'l este Date Price C. t i. Amou,nt
., ., . t. . ,lm set ..s st -.
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<l., -1 Gesseral 6 eefiendl.
937 wgj.9 rgis 1 9 . g , p s u g ee.s 9t, .sgf
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- l. Series 1. 2. H1 9-01-47 9-08-87 $ 60.000.00P 801.135 1.075 800.06 2.Ms
- 2. Series J. 2.M5 3-84-50 3-01-85 35.000.000 142.27 8 59.9M.ene $ 1.649.333
.Se 101.29 2.69 35.000.000 941.500
- 3. Series N. 2.875E 3-15-54 3-15-M 40.000.000 99.25
- 4. Series P. 4.0755 1.08~ M.17 2.97 39.995.000 1.187.452 S-15-57 e-15-87 70.000.000 --
.45 99.55 4.90 66.325,000
- 5. Series Q. 4.6255 6-01-59 6-08-89 3.249.925
- 6. 40.000.000 --
2.42 97.54 4.78 37.695.00s 1.001.e21 Series S. 6E 12-01-66 12-01-96 100.000.000 300.00 1.00 99.00
- 7. Series 5. 6.45 . 6.87 500.006.438 6.470.000 10-01-68 10-01-94 150.000.000 99.75 1.37 M.63 6.50
- 8. Series T. 91 12-01-69 12-01-99 150.000.000 9.750.000
- 9. 75.000.000 99.75 1.45 M.55 9.14 75.000.000 6.e55.00s Series W. 9.151 7-01-70 7-01 00 75.000.000 500.00 1.18 98.02 9.27
- 10. Series V. 8.155 17-15-70 12-15-00 75.000.000 6.952.500 100.000.000 300.00 1.12 98,88 4.25 100.000.000 II. Series E. 8.1255 6-15-71 6-15-01 a.250.000
- 12. 100.000.000 99.56 1.65 M.35 8. !'7 100.000.000 8.270.00s Series T. 7.3755 11-15-71 11-15-01 40.000.000 100.00 8.25 98.75 7.48
- 13. Series 2. 7.58 1 15-73 60.0Ga.00s 4.4as 000 1-15-03 100.000.000 100.36 .57 99.43 7.50
- 14. Series AA. 9.8755 5-01-74 300.000.000 7.550.000 5-08-04 100.000.000 99.25 1.9) 98.07 30.00
- 75. Series CC. 12.751 1-15-M l-15-02 100.000.000 le.000.One
- 16. 50.000.000 500.00 1.e4 M.16 13.16 50.800.000 6.500.0n0 Series 00P. less.1-9 M - 9.251 11-01-75 31-01-95 14.305.000 100.00 4.02 95.M 17 Series EE. 11.0755 9.2e 12.705.000 1.173.024 12-15-75 32-15-00 50.000.000 100.00 1.M 98.16 le. Series Ff e. 81os. 3 13, 12.11 37.500.000 4.541.250 5.55 - 8.5E 32-15-75 32-I5-00 35.000.000 300.00 3.55 M.45 i 19. Series ffR. Ilo. 14, 7.1251 8.63 34.000.000 2.9H.20e 6-01-77 2-01-01 10.600.000 100.00 1.79 98.21 7.29
- 20. Series GGP 1805. I-7 10.600.000 772.740 5.55 - 8.1255 6-15-76 6 15-M 28.500.000 100.00 3.22 M.78
! 21. Series G6P. Nos. 8-22, 8.22 27.700.000 2.2N 940 4.45 - 6.105 10-01-77 6-15-96 13.000.000 100.00 3.07 M.13 6. M
- 22. Series 108. 10.6255 13.800.a00 863.800 7-15 76 7-15-06 50.000.000 100.00 1.83 98.17 10.83 50.000.000
- 23. Series llP. Isos. I-7 5.415.000 55 - 75 3-08-77 3-01-05 100.00 24'. 2.750.000 4.75 95.29 7.27 2.750.000 199.925 Series IIP. Iles. 3-22 5.855 - 75 3-01 79 3-01-05 1.000.000 99.e2 9.13
- 25. 90.69 7.87 1.000 me 78.700 Series JJP. stol. I-7 51 - M 3-01-77 3-01-05 5.850.000 300.00 3.99 W.el M. 7.28 5.054.000 421.7M Series JJP No. 8. 7.255 9-11-79 3-01-05 1.000.000 300.00 3.21 M.79 7.54
- 27. Series KKP. mes. I-7 1.088.000 H .4C4 51 - 71 3-01-77 3-01-05 13.350.000 100.00 3.40 M.6e 7.15
- 28. 13.35e.000 M4.525 Series EEP Ile. S. 7.25E 9-01-79 3-01-05 1.540.000 100.00 3.01 M.99 7.52 1.540.000 115.000
- 29. Certes llP. sees. I-7 58 - 6.6255 3-01-77 3-01-98 5.600.000 100.00 3.74 M.M 6.Se
- 30. Series LLP. Iems e-!5 5.600.000 300.a00 65 - 6. 1 9 01-79 3-01-91 3.250.000 100.00 2.66 97.34 6.82
. 3.250.000 221.658 1MWE5m 85
." I;; -i .g g
P E .5 c
.A .- g.
a.~ 8.; ___ *m _ _8. a l
eClaoli tel500 Coge>AeV Page 2 of 2 iDeG IfGM DEti C051
- stCIfete 31. 1981 (Continued)
Date Date Amonant Price ilne or Cost et of ta financing liet eased on Annant Annual ] Gessera). ~& M[9aee' L iI can't.) ($) (Y) 6 ) F [f.Y h i 3
- 31. Series Ite'. 6-7/0E M. 2-15-77 7-15-97 $ 4.400.000 100.001 3.515 i
Series lee *. es. 2. 7.255 9-01-79 2-15-97 M. 49 *. 7.29I g 4.400.000 g 320.760 M. 1.eM.000 100.00 2.06 97.14 7.55 3.e M.000 I Series leer. Ibss. I-7 77.765 4.05 - 6.6258 7-88-77 7-41-97 32.050.000 100.00 - i 34. Series Iser, loos. 3-28. 2.63 97.37 - 6.70 32.050.000 2.200.950 5.051 - 75 7-01 79 7-01-97 100.00 1 !. M. 15.100.000 2.77 97.23 7.18 Series 00P. Ilus.1-17 15.140.000 1.073.614 4.45 - 6.255 10-01-77 10-01-07 16.700.000 300.00 36 2.5e 97.42 6.26 16.700.000 Series 00P. es. le. 7.255 9-08-79 16-01-87 2.100.000 100.00 2.71 97.29 1.045.420 N. Series PP. 9.0755 6-15-78 7.4e 2.100.000 163.064 M. 6-15-08 70.000.000 98.81 1.27 97.55 4 Series WP. Iles, I-9 18.14 . 70.000,000 7.%e.000 5.65 - 6.45 6-01-70 6-08-98 9.300.000 100.00 , 39. Series 80. 9.05 2.80 97.20 4.56 9.300.000 tie.000
- 40. 10-15-78 le- 15-os 70.000.000 100.00 1.22 to.78 ,
Series 55.10.3MI 3-15-79 9.93
- 70.000.000 6.951.000
- 41. 3-15-99 150.000.030 300.00 .66 99.34 10.45 Series llP. Ges. 1-15 154.000.000 15.675.000 5.e55 - 7.1255 7-01 79 7-et-09 3.000.000 800.00
- 42. Series inf. 10.0755 4.13 95.07 7.40 3.000.000 9-15-79 9-15-09 100.000.000 99.20 201.200 1.07 98.13 II.09 300.000.000 linsecured Promisse Q ht: 18.090.000
- 43. V U ld) D ateres f uases 16-14 77 7-01-04 155.000.000 300.00 .16 99.84
- 13.24 Installace 5 ale , Centrac h: . 95.000.000 12.578.000 !
- 44. Series T g_ '
I i
- 45. Series e 6-01-73 6-el.03 46.000.000 100.00 1.56 9e.44 ; 5.78 5-01-74 5-05-04 22.550.000 500.00 62.e00.eM 2.427.600
- 46. Series C 2.40 97.60 a 7.73 21.e50.8 6 7-15-74 7-IS-e4 13.000.000 100.00 3.59 M.4 8
- 3.627.165 e.38 3.006. 20 315.700
- 47. r ssery 16 tes 1900 1980
- 48. 50.000.000 500.00 .99 99.91 11.05 58.000.000 Series 1980A. 27.Mt 1980 1987 50.000.000 300.00 3.13 5.525.000
- 49. Series 1980s 12. Ms 1980 9e.87 13.00 50.000.000 6.500.000 2000 300.000.000 100.00 .54 50.* Series EMP 7.M5 - 9.55 99.46 12.33 100.000.000 12.8 2.000 19e0 1994 4.350.000 100.00 3.05*
St. Series CP. 7.M8 - 105 1980 M.95 9.28 4.350.000 403.60s 2007 25.000.000 300.00 3.0l* M.99
- 52. Series DP. 7.755 - 108 1980 19.82 25.000.000 2.505.000 2010 10.M0.000 100.00 3.46* M.54 issueJfn19 W.20 18.750.000 1.096.500
- 53. N)listlos Co.8J:
ntrol seeenue sends test 1986-2011
- 54. TelAL 60.000.000 300.00 3.00* 97.00 9.4e 88.000.000 55.
5.600.000 Long Term Debt Cost este $2.3e6.945.000 $282.891.112 0.765 So.~e: Co.P.e, e.,e ts t. .mi.i .a 9,se,m Se,eu. -iss 4.n. Sec.,nP Co,e 0 655, .e4 linness ,.*Sm b r3!L *h
- Estimate M O W
= " ;; -' .
=5 o PP'
. ?
o 8 0 D(1 _ _.--- -___ . _ _ _ _ _ _ _ _ _--_ __ __ _ _ _ _ _. __ _ _ _ __ _ _ _ _ o - __ - _
l CASE NO. w-d488 EXN181Tlii>. ~ SCHEDULE No. WITNESS: G. StoJie DATE: Page 9 of 1 Pages l DETR01T EDISON COMPANY SHORT-TERM DE87 COST RATE December 31, 1979 Line Percent of Dollat' Short-Te rm Cost Weighted No. DeserIptIon Amount Debt Raee cest Bank Loans
- 1. Detrol t Bank & Trust $ 6,000,000 4.163 14.25 % 59%
5,000,000 3.47 14.70
- 2. National Bank of Detrolt 7,000,000 51 4.86 15.25 74 6,500,000 4.51 15.00 .68 3 Barclay's Bank International 10,000,000 6.93 14.28 99 10,000,000 6.93 14.28 10,000,000 99
- 6.93 15 75 1.09 15,000,000 10.40 15.25
- 4. Continental Illinois 6,000,000 1 59 4.16 14.10 59 Comercial Pacer 5 Lehman Commercial Paper Inc. 4,998,048 3.47 14.05 .49 4.974.767 3.45 13 975 .48 4,971,320 3.45 14.75 51 5,339,679 3. 70 14.375
, 53 Trust Demand Notes
- 6. Detroit Bank & Trust 10,000,000 7 6.93 13.7 95 Manufacturers National Bank of Detroit 10,000,000 6.53 13.7 95 Notes Payable
- 8. Renaissance Energy Company 28,432,383 19.72 15 33 3.02
- 9. Total $144,216,197 100.00% 14.70%
Source: Company Reports to the Michigan Public Service Commission O
, .m e- e -p ,,w--. ,--w,+mw, . - - - - - . ,y+- a w ,,--wyy,-,.,,--<e, s , ,m-, ,
w-- --w...- - - - , - - - _ , _ , _ - - - - - - - - -
A CASE NO. U-6488 i EXHIBIT NO. 7 SCHEDULE No. I WITNESS: G. Stojic DATE: i
\ -
Page to of 1 Pages DETRolT EDISON COMPANY PRIME RATE - $NORT-TERM DEBT RATE RELATION $ HIP Prime Commercial Bank Note Demand Note Line Interest Paper Rate as % Rate as % of Rate as % of No. Date Rate of Prime Rate Prime Prime Rate {
- 1. January, 1979 11.75% 93% 92% 90%
- 2. February, 1979 11. 75 90 88 3 Mar 2, 1979 11 75 90 88
- 4. Ap ril, 1979 11.75 90 87 5 May, 1979 11 75 91 91 88
- 6. June, 1979 11 50 93 93 88 7 July, 1979 11.75 89 93 86 O 8. Augus t, 1979 12.25 88 95 87 9 Sep tember, 1979 13 50 83 88 88
- 10. Oc tobe r, 1979 15.00 97 84 90
- 11. November, 1979 15.50 98 94 92
, 12. December, 1979 15.25 98 99 90 13 Average 92 92 89 Source: I rving Trust Publication, Money Market Rates and Applicant. I l 1 O 1 I
l CASE NO. U-6488 EXHIBIT No.
)
1 SCHEDULE NO. WITNESS: G. S toile I O, DATE: Page 11 of 1 Pages l DETRoli EDISDN COMPANY ESTIMATED SHORT-TERM DEST COST December 31, 1981 Line Percent of ' Estimated Weigh ted Dollar Sho rt-Term Cost Cost
~~
No. Des crip t ion Amount Debt Rate Ra te (000's) (A) (8) (C) (D)
- 1. Cornercial Paper $ 20,284 17.52% 11.04% 1 93%
- 2. Bank Notes 75,500 65.21 11.04 7.20 3 Demand Notes 20,000 17.27 10.68 1.84
- 4. Total $115,784 10 37%
O Source: Company Reports to the Michigan Public Service Comission and the Wi tness. l l O !
i O O O - DETRoli EDISON CoHPANY
- PREFERRED STOCK COST .
December 31. 1979 Annual Price Expense Net Number Total Value Line Dividend Annual Par to of Proceeds to of shares of Net Cost Dollar e No. Descri.ition Requirement Value Public Financing Company outstanding Proceeds Rate Amount (5) T B T 7 0) (D) (E) (F) (G) (N) (1)
- l. 51% Series 5 5.50 $100.00 $ -- $2.19 $ 97.81 463.480 $ 45.332.979 5.62% $ 2.547.713 j 2. 9 32% Series 9 32 100.00 100.00 2.01 97.99 499.089 48.904.849 9.51 4,650.851
- 3. 7.68t Series 7 68 100.00 100.00 1.69 98.31 500.000 49.155.000 7.81 3.839.006
- 4. 7.45t Serles 7.45 100.00 100.00 1.54 98.46 600 000 59.076.000 7.57 4.472.053
- 5. 7.361 Series 7.36 100.00 100.00 1.38 98.62 750.000 73.965.000 7.46 5.517.789
- 6. 9.721 series 9 72 100.00 100.00 1.54 98.46 600.000 59.076.000 9.87 5.830.801
- 7. 9.601 series 9.60 100.00 --
1.11 355,000 98.89 35.105.950 9.71 3.408.788
- 8. Total
$370.615.778 $30,267.001 9 Cost Rate 8.17%
Source: Company Reports to Michigan Public Service Commission. YSECC {MME5M
~ ::: E"=
. T -i P fL P .5 E
x i T
O O .O . 3 DETROIT EDis0N COMPANY PREFERRED STOCK C0si
- December 31, 1980 Annual Price Expense Het Number Total Value Annual Line Dividend Par Proceeds to of shares No.
to of of Net Cost collar Description Requirement Value Public Financing Company Outstanding Proceeds Rate Amount
- 1. Sit series (A)
S 5.50 tat-
$100.00 $
(C) (D) (E) (F) (G) W (I)
$2.19 $97.81 314,390 $ 30.750.486 5.62% $ 1.728.177
- 2. 9.321 series 9.32 100.00 100.00 2.01 97 99 499.080 48,904,849 9.51 4.650.851
- 3. 7.68% series 7.68 100.00 100.00 1.69 98.31 500.000 49.155.000 7.81 3.839.006
- 4. 7.451 Series 7.45 100.00 100.00 1.54 98.46 600.000 59.076.000 7.57 4.472.053
- 5. 7.36% series 7. 36 100.00 100.00 1 38 98.62 750.000 73.965.000 7.46 5.517.789
- 6. 9 721 series 9.72 100.00 100.00 1.54 600,000 98.46 59.076.000 9.87 5.830.801 1980 issues 7 9.601 series 9.60 100.00 --
70 99.30 650.000 6,241.502 64.545.000 9.67
- 6. 12.8% series 12.80 100.00 --
1.69 98.31 400.000 39.324.000 th.02 5.119.985
- 9. 12.4% series 12.40* 100.00 --
1.59* 98.41 49,205.000 500.000* 12.60* 6.199.830
- 10. Total $474,001,335 $43.599.994 II. Cost Rate 9.20%
Source: Company Reports to the Michigan Public service Commission
'ESMOS hkhh5 2 Estimated "
.N m,
- E :4 5 OO o
- 2 a M
n
.a
O O aO - I DETROIT EDISON C0HPANY PREFERREO STOCK COST December 31, 1981 Annual Price Expense Net Number Total Value Annual Line Dividend Par to of Proceeds to of shares of Net Cost Dollar No. Description Requi remen t Value Public Financing Company outstanding Proceeds Rate Amount (A) (8) (C) (D) (E) (F) G) (N) (1)
- 1. 51% Series $ 5.50 $100.00 $ -- $2.19 $97.81 169,680 $ 16,(596,401 5.62% $ 932,718
- 2. 9.321 Series 9.32 100.00 100.00 2.01 97.99 499,080 48,904,849 9 51 4,650,851
- 3. 7.681 Series 7.68 100.00 100.00 1.69 98.31 500,000 49,155,000 7.8I 3,839,006
- 4. 7.45% Series 7.45 100.00 100.00 1.54 98.46 600,000 59.076,000 7 57 4,472,053
- 5. 7.36% Series 7.36 100.00 100.'00 1.38 98.62 750,000 73.965,000 7.46 5,517,789
- 6. 9.721 Series 9 72 100.00 100.00 1.54 98.46 600,000 59,076,000 9.87 5,830,801 1980 issues
- 7. 9.60% Series 9.60 100.00 --
70 99.30 650,000 64.545,000 9.67 6,241,502 1 8. 12.8% Series 12.80 100.00 -- 1.69 98.31 400,000 39,324,000 13.02 5,119,985 l' 9 12.4% Series 12.40* 100.00 -- 1.59* 98.41 500,000* 49,205,000 12.60* 6,199,830 1981 issues
- 10. 12.4% Series 12.40* 100.00 --
1.59* 98.41 900,000* 88,569,000 12.60* 11 I59,694 II. Total $548,416,250 $53.964,229
- 12. Cost Rate ' 9.84%
2EfEEh
$AYNEm
" ::: 8 "
Source: Conpany Reports to the Michigan Public Service Commission ; Im"E . z5
- Estimated o P* c p
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1.
---y ,, . . _ _-. , - _ , _ _ _ _ _
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DriRoli [D150N COMPANY - PRliCRlNCl. STOCK COST
- Dec enitie r 31, 1979 Annual Price Lxpense Net Numlie r Total Value Annual Line Olvidend Par to of Proceeds to of $liares of Net Cost Dollar I
No. Description~ Requ i ressen t Value Pulillc financing Cawnpany Outstanding Proceeds Rate Announ t i . IAl ~IE ~(CT (D) lE (F) (G) (H) (l)
- 1. $2.75 Series $2.75 $1.00 $25.00 $1.21 $23.79 1,998,400 $ 47.541,936 11 561 5 5,495,848
- 2. $2 75 Serles B 2.75 1.00 25.00 1.23 23.77 2,000,000 47,540.000 11.57 5,500,378
- 3. $2.28 Series 2.28 1.00 25.00 1.05 23.95 2,000,000 47,900,000 9.52 4,560,080 l
- 4. lotal $142,988,936 $15,556,306 l
l 5. Cost Rate 10.88% i I Source: Cinnpany Reports to Michigan Pul>lic Service Causuelssion i
.aua_.age i ; r r, " g .
- * ??
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i
O O dO i j DETRolT EDISON COMPANY * , PREFERENCE STOCK COST December 31, 1980 i ) Annual Price Expense Net Number Total Value Annual j Line Dividend Par to of Proceeds to of shares of Net Cost Dollar i No. Description Requi rement Value Public Finan acin Company outstanding Proceeds Rate Amount } i (A) (B) (C) (D) (E) (F) (G) W (1) ,
- 4
- 1. $2 75 Series $2 75 $1.00 $25.00 $1.21 $23.79 1,897,980* $ 45,152,944 11 56% $ 5,219,680
- 2. $2 75 Series a 2.75 1.00 25.00 1.23 23.77 1.944,220* 46,214,109 11.57 5,346,97D
- 3. $2.28 Series 2.28 1.00 25.00 1.05 23 95 2,000,000 47,900,000 9.52 4,560,080 1
0* i9al $139,267,053 $ 15,1 N,62 1 5 Cost Rate 10.86% Source: Company Reports to Michigan Public Service Convoission
- Estimates of Applicant and Witness a5EbNEh M W E E ,,,
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LETROIT EDISON COMPANY j PREFERENCE STOCK COST - j Decenee r 31, 1981 I l l Annual Price Expense Net Nundser Total Value Annual ) Line Dividend Par to of Proceeds to of shares cf Net Cost Dollar No. Description Requirement Value Public Financing Company Proceeds Outstanding Rate Amount i (A) (B)' (C) (D) (E) (F) (C) (H) (1) j l. $2.75 Series $2.75 $1.00 $25.00 $1.21 $23.79 1,797,980* $ 42,773,944 11 56% $ 4,944,668 l 2. $2.75 Series a 2.75 1.00 25.00 1.23 23.77 1,844,220* 43,837,109 5,071,954 11.57
- 3. $2.28 Series 2.28 1.00 25.00 1.05 23.95 2,000,000 47,900,000 9.52 4,560,080
- 4. Total $134,511.053 $14,576,702 i
t
- 5 Cost Rate 10.84%
I i 1 , Source: Conpany Reports to Michigan Public Service Coannission i
- Es timates of Applicant and Witness j
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CASE NO. U-6':88 0 E b. ) WITNESS: G. Stojic O DATE: 1 (. Page 18 of , 1 pages DETROIT EDISON COMPANY A'.0 i COMPARABLE COMPANIES BETA COEFFICIENTS i Line Beta No. Comcany Coefficient
- 1. American Electric Power .65
- 2. Conononwealth Edison .70 3 Consolidated Edison .65
- 4. Consumers Power Company 70 5 Detroit Edison Company .60
- 6. Duke Power Company 70 0 7. ' e i i e 'le~ti e .55
- 8. Middle South Utilities 70 9 Niagara Mohawk .60
- 10. Northeast Utili ties 55 l 11. Pacific Gas & Electric 50
- 12. Philadelphia Electric .60 13 Public Service Electric & Gas 70 14 Southern California Edison 70 15 Southern Company .65
- 16. Virginia Electric & Power 70 l
I ! Source: Value Line Investment Survey i l O 1 - l
CASE No. U-6488 ; EXHI8IT No. 1 SCHEDULE NO. I WITNESS: G. Stojic l i Page 19 of 25 pages I~ DATE: DETRolf EDISON COMPANY AND COMPARABLE COMPANIES EARNED RATES OF RETURN ON AVERAGE COMMON EQUITY Five Line Year No. Company 1975 1976 1977 1978 1111 Average
- 1. American Electric Power 12.30 % 13.12 % 11.36 % 10 33 % 10.52 % 11.53 %
- 2. Commonwea l th Ed i s on 11.07 11.57 10.15 ft.78 8.91 10.70
- 3. Consolidated Edison 11.11 11.58 11.74 10.51 10.52 11.09 4 Consumers Power Company 9.33 13.11 11.36 11 34 11.20 11.27 5 Duke Power 9 56 12.66 12.24 12.77 13.49 12.14
- 6. Long Island Lighting 13.37 14.20 14.03 12.37 12.19 13.23
- 7. Middle South Utilities 10.73 11.38 13.16 14.19 11.85 12.26
- 8. Niagara Mohawk 12.26 9.68 10.39 11.07 11.44 10.97 9 Northeast Utilities 10.68 10.96 9.70 9.83 9 22 10.08
- 10. Pacific Gas & Electric 9.84 10.35 10.86 11.20 11.75 10.80 111 . Philadelphia Electric 9 39
- 9.87 9.62 9.71. 9 81 9.68
- 12. Public Service Electric & Gas 8.88 11.05 10.84 10.89 10.29 10.39
. Southern California Edison 10.05 11.22 11.80 10.52 13.61 11.44
. Southern Company 13.62 10.08 11.27 8.43 8.91 10.46 0 15 Virginia Electric & Power 10.54 9.66 10.05 9.63 8.42 9 66
- 16. Average 10.85 % 11.37 % 11.24 % 10.97 % 10.31 % 11.05 %
17 Detroit Edison 7.88 % 8.79 % 10.40 % 9.23 % 10.09 % 9 28 % Source: Standard & Poor's Compustat utility File E l t I l I O l t
CASE NO. U-6488 EXHISIT No. SCHEDULE No. WITNESS: G. Stojic Page 20 of 1 pages DATE: DETR0lT EDISON COMPANY AND COMPARA8LE COMPANIES MARKET TO BOOK RATICS (Market Price Expressed as a Percentage of Book Value) Line Five Year No. Lompany g 1976 1977 1978 g Ave rage
- 1. American Electric Power .87 % 1.09 % 1.15 t 1.06 % 95 % 1.02 *
- 2. Commonwealth Edison 99 1.06 1.06 92 .81 97 3 Consolidated Edison 33 50 .60 .58 56 51
- 4. Consumers Power company .52 75 .85 .82 .76 74 5 Duke Power Company .78 1.03 1.08 96 .85 94
- 6. Long Island Lighting .77 98 1.04 98 .85 92 Middle South Utilities .86 92 95 .87 .78 .88 7.
Niagara Mohawk .64 .83 93 .86 .80 .81 8. Northeast Utilities .66 .83 .87 .75 .72 .77 9 Pacific Gas & Electric .76 .81 .86 .82 .80 .81 10.
- 11. Philadelphia Electric .68 .86 1.00 90 .81 .85
- 12. Public Service Gas & Electric .61 .80 91 .83 .76 78 Southern California Edison .62 .66 75 .76 .76 .71 13 14 Southern Company .71 91 99 90 77 .86 Virginia Electric & Power .61 77 .81 .77 .66 72 15
- 16. Average .69 % .85 % 92 % .85 % 77 : .82 2 17 Detroit Edison Company 59 % 76 % .88 % .30 % 75 % 76 :
Source: Standard & Poor's Compustat Utility File - - . , n- ,- -- -- - _ , - - - -a- -.-,-- . - - - - - , , , - - -n- , - - - - - -
CASE No. U-6488 EXH181T No. SCHEDULE NO. WITNESS: G. Sto_ii c
- DATE:
Page 21 of 25 Pages Adjustment Required to Maintain a Market Price - Book Value Ratio of 1.04 , t
- 1. Basic Model: P = rSo(1-b) k-br
- 2. Then: P = r(1-b)
Io k-br 3 Let P/Bo = 1.04
- 4. Then: 1.04 = r(1-bl k=Cr 5 And: (1.04) (k-b r) = r(1-b)
- 6. 1.04k - 1.04 be -
r(1-b)
- 7. 1.04k =
r(1-b) + 1.ckbr
- 8. 1.04k = r-b r + 1.04br 9 1.04k = r + .04 br .
- 10. 1.04k =
r(1 + .04b) O 11. Or: e = 1.04k 1+.040
- 12. Where: P = Market Price S = Sock Value r = Expected Return b = Retention Rate k = Ols count Rate 13 For k = 13.61%: (1.0373)(.1361) = 14 ~ 0'
1+(.0373)( 1778) l l O 1
CASE No. U-6488 EXHISIT NO. SCHEDULE NO. Oq - WITNESS:
~
DATIi ~' G. Stojic Fage 22 of 25 Pages l DETR01T EDISON COMPANY l Consnon Stock issuance Expense ! I Line 1978 1977 1976 No. Description Issue issue issue (A) (8) (C) 1 Price to Public $16.38 $16.00 $13.88 2 Less Underwriting Fee 48 52 55 , 3 Less Flotation Expenses .04 .08 .04 l i 4 Net Proceeds to Company $15.86 515.40 S13.29 5 Expenses as a Percent of Price 3.17% 3.75% 4.25% 6 Average 3 73% O 1 'O
CASE No. U-6kS8 EXHIBIT No. SCHEDULE N0. WITNESS: G. Steile Og DATE: Page 23 of 25 Pages AISK FREE AATE OF AETURN AND MARKET RISK PREMIUM - INFLATION REGRES$10N EQUATION Long-Term Sho rt-Term Line U. S. Government U. S. Government No. Interest Rate
- Interest Rate *
- 1. September 3 11.02% 10.78%
- 2. August 27 11.32 11.34
- 3. August 20 11.10 10.87
- 4. August 13 10.87 9.92 5 Average! 11.08% 10.73%
- 6. Estimated Market Return: 11.08% + 8.17% =
19.25% 7 Regression Equation:
- 8. Market Risk Premium = 16.33 -
2.21 x Inflation Expectation
?. t-value =
(3 16) (-2.05) 10, R2 =
.15
- 11. .86 - ,16.33 -
2.21 x 7
- 12. Regression Data:
O 1/53 0.62 -11.47 l 1/54 -0.50 31.71 1/55 0.37 31.E2 1/56 2.86 10.14 1/57 3.02. -15.03 1/58 1.76 35.75 1/59 1.50 17.03 1/60 1.48 - 9.29 1/61 0.67 26.32 1/62 1.22 -14.77
- 1/63 1.65 21.14 1/64 1.19 12.54 1/65 1.92 13.25 1/66 3.35 - 8.33 1/67 3.04 25.95 1/68 4. 72 15.32 1/69 6.11 - 0.03 1/70 5.49 -11.68 1/71 3.36 5 43 1/ 72 3.41 1 7.40 1/73 8.80 -11.46 1/74 12.20 -27.37 1/75 7.01 34.44 1/76 4.81 6.81 1/77 6.77 - 0.17 1/78 9 03 16.90 0
- So urce: Standard & Poor's Publication, The Outlook.
CASE No. U-6488 EXHIBIT No. SCHEDULE No. WITNESS: G. Stolic O, DATE: Page 24 of 25 Pages DETR0lT EDISON COMPANY COMMON EqulTY COST RATE ESTIMATES CAPITAL ASSET PRICING MODEL Line No. Basic Model
- 1. kg = Rf + b; (k ,- A f)
- 2. 13. 79 -
11.08 + .60 (4.52) 3 13 44 = 10.73 .60 (4.52) O O
us t w. 8.' : <esa EXHIBIT NO. SCHEDULE NC. WITNESS: G. Stojic DATE: Page 25 of 25 Pages DCF REGRESSION ESTIMATED REGRES$10N EQUATION Line No.
- 1. 0 =
11 35 + 4.83 seca coefficient - 32 Growth Rate P
- 2. t values: (8.73) (2 36 (-4.20) 2 3 R = .60 O
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l i
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SCHEDULE MO. I EXHISIT NO. l WITNESS: George A. Stojic O,
= 'a '
THE DETRoli EDISON COMPMY Capital Structure, Capital Costs, Related Financial Data, and Rate of Return GEORGE R. ST0JIC Michigan Public Service Commission Staff Vitness October, 1980 0
e - , O. 5 TATE 0F MICHIGAN OEFORE THE MICHIGAN PUBLIC SERVICE COMMISSION e**** In the matter of the application ) of THE DETA0lT EDISON COMPANY ) for authority to file, establish ) and make effective increased ) Case No. U-M88 - rates throughout all of I ts ser- ) vice area and for other related ) authorizations. )
)
O DIRECT TESTIMONY and EXHIBITS of GEORGE A. ST0JIC October, 1980 i l i l
e . O ,.- The Detroie Edison Company U-6488 1 ;j Q. Please state your name, position, and business address. f 2 l* A. My name is Georga R. StoJIc. I serve as a staff economist in the Financial l 3j Analysis Section of the Michigan Public Service Comunission. My business
;! address is 6545 Mercantile way, l.ansing, Michigan 48909 5 Q. What is the purpose of your testimony in this proceeding?
6 A. The purpose of my testimony is to reconunend a fair rate of return for The
't 70 Detroit Edison Company.
3; Q. Would you please state your education and professional experience which 9,!* qualifies you to make such a reconsnendation? 10 g A. I received a Bachelor of Science degree froen Ferris State College in 1974, 11 majoring in public administration with a concentration of study in economics. 12 I also studied as an undergraduate at Michigan Sta;e University for two it 13 terms, majoring in economics. I received my Master of Arts degree in 1977 14 ;! from Michigan State University, majoring in economics, and have since attended 15'l graduate classes in finance and economics at Michigan State Un'iversity. I 13j in 1977, I joined the Michigan Public Service Conunission as a staff I 17 1 economist. My experlence with the Censnission has included the submission
.I 13 jj of testimony on fair rate of return in .several rate cases, the estimation
!t 19 of future capital costs for case U-6150, and various special studies. In 20 j addition to my work at the Public Service Conunission, I teach economics at 21 " Lansing Consnunity College.
22 j Q. Hwd y u plan to pr ceed with y ur determination f a fair rate of return a for The Detroit Edison Company? 23 .ls 24 A. My determination follows the cost of capital approach, a method wnich identi-
.n j fies the various sources of capital that support a company's rate base, l
O. ,
+
1 calculates the relativs proportions of those various capital items to the 2l' company's total capital structure, and computes the cost of each type of 3l capital item to determine an overall required rate of return. 4 q. Beginning with the task of identifying the company's sources of capital, 5 please describe the capital structure that you have used in this case. 6j A. I have developed an estimated capital structure for Detroit Edison as I project it to look at December 31, 1981. The projected December 31, 1981 7l 3g capital structure ratios that I have developed appear on exhibit page 1. 9
- q. I show you a document marked for identification as Exhibit S- . Is this 10y document, captioned " Detroit Edison Company, Capital Structure, Capital 11 Costs, Related Financial Data, and Rate of Return", the exhibit you have 12 previously made reference to?
13 ' A. Yes, it is. I 1,., , Q. Was the information in this exhibit prepared by you or under your direction? 15 A. Yes,it was.
.I 16 Q. Please explain page 1 of your exhibit to the Cormaission.
17(( A. Page 1 depicts the rate of return that I am recomending Detroit Edison be 18 al lowed to earn on i ts capi ta l . As I mentioned previously, this calculation
;g is based upon an estimated December 31, 1981 capital structure. Column (A) 20 ,1 .
shows the calculated percentage of each capital item to the total capital 21 structure. Column (8) exhibits the cost rate of the various capital compo-22 !;' nents, as estimated for 1981, and Column (C) gives the weighted cost rate of 23 each capital component. The overall cost rate, ranging from 8.93% to 9.09%, i is shown on line 9 of Column (C). 25jj Q. Please describe the derivation of your estimated 1981 capital structure. O
l 1 y A. I began by estimating the December 31, 1980 capital structure and then used 2 {'l the estimated 1980 capital structure and the Company's filing in its current 3 securities case, U-6557, as the basis for estimating the December 31, 1981 4 capital structure. I 5 Page 2 of my exhibit portrays the capital structure that I have esti-6i mated for December 31, 1980. Beginning with the actual August 31, 1980 cap-7 Ital structure balances, shown in Column (A) of page I, I have made adjust-8h ments, show in Column (B), to take into account certali Company planned 9 securities offerings, other Company supplied estimates and estimates that i 10 j,l have made myself regarding securities issuances and interim rate relief, 11 Tne adjustments shown in Column (B), to the August 31, 1980 capital structure 12 balances result in the estimated December 31,1980 capital structure balances 13 ] shown in Column (C) of exhibit page 2. Column (0) of that page depicts the 14 percentage that each capital item represents of the estimated December 31 t 15 3 1980 capital structure. 16 (( The derivation of my estimated December 31, 1981 capital structure is 17 shown on page 3 of the exhibit. Following the process described above, i 18); began with the estimated December 31, 1980 capital structure and made adjust-
"s ,
19 ,} ments to take into consideration certain Company planned securities offerings 20 F to be made at various times during 1981 (most of which are stated in Detroit 1 21 Edison's application in security case U-6557), other Canpany supplied esti-22 , mates that I have found to be reasonably acceptable and estimates that i 23 y have made myself regarding security issuances and issuance expenses, stock i.
- conversion and rate relief. Column (A) of exhibit page 3 depicts the capital 25 structure amounts estimated to be outstanding at December 31, 1980; wnile
O .
+
1l' the amounts in Column (B) represent the adjustments previously mentioned. 2 Combining Columns (A) and (8) yields Column (C), the estimated amounts of 3 each capital item outstanding at December 31, 1981. Column (D) of page 3 4 depicts the percentage of total capital that each item of capital represents 5 and serves as the estimated December 31, 1981 capital structure that appears 6 on exhibit page 1. Giancing down Column (D), one may observe that the 7 estimated capital structure will consist of 39 37% long-term debt, 56% 8 short term debt, 9.44% preferred stock, 2.32% preference stock, 29 98% 9 conunon equity, 9 99% accumulated deferred taxes and 8.34% 8elle River finan-1 10 ! l cing. 1 11 q. Please explain your inclusion of the Belle River financing as zero cost cap-12 , Ital in your estimated December 31, 1981 capi tal structure. 13 A. Due to the nature of the Belle River financial arrangement, it is possible 14 to identify the specific financial source for this construction project. 15 1 i Besides identifying the source of capital for the project, the arrangement 16 ff calls for the capitalization of interest, thereby allowing the em oany to 17 l utilize the capital at no current cos t. In effect, it is a source of zero 18 cost capital. By including the financing in my capital structure at zero cost, 19 its economic cost, staf f has offset the effect that the Selle River 20 l project would have on the company's revenue deficiency by being included in I l 21; the rate base. , 22 ' q. What does your exhibit page 4 show? l 23 A. Exhibit page 4 depicts the actual, average capital structure for the 13 24ll months ended December 31, 1979 Of Interest on this page are the capitali-N 25.4 zation ratios in Column (B), and the close approximation they bear to the
l l .. t i capital structure that I have estimated for 1981. I believe this close re-l l 2 lationship supports the reasonableness of the capital structure I am advo-3 cating in this case. 4 Q. Have you examined Detroit Edison's historical capital structures? ( 5 A. Yes, I have. Page 5 of my exhibit depicts Detroit Edison's year end capital 6 structures for the five years ended December 31,1979 Examining the lower 7 portion of page 5 allows one to observe the change in the capital structure 8 ratios from year to year. It can be seen that the ratios have not changed 9 appreciably over the last couple years, and have changed only modestly over 10 the last five years. In my opinion, it is not unreasonable to expect the 11 1981 capital structure to bear a close relationship to the recent historical I O 12 aercenta es. 13 q. Please explain page 6 of your exhibit. 14 A. Pages 6a and 6b of my exhibit show the derivation of. Detroit Edison's aver-15 age long-term debt cost for 1979 To the far left of the page, one will 16 note a description of Edison's Individual long-term debt items. Columns (A) 17 and (s) record the issuance and maturity dates of these individual items, 18 and Column (C) shows the amount of each issue. Column (D) states the costs 19 of the various issues to the public, while Column (E) represents the expenses 20 of financing the various issues as a percent of the bond value. In Column (F), 21 net proceeds to the Company of each issue are recorded and Column (G) displays ; 22 the cost of each issue based on net proceeds. The annual interest (the amount 23 outstanding in Column (H) multiplied by the cost Column (G)) results in the I 1 24 amounts shown in Column (1) . The cost of long-term debt is computed by divi- l 25 i ding total annual cost by the total amount cuestanding and can be seen to l
. e 1 result in a cost rate of 8.41% at December 31, 1979, for Detroit Edison 2 company, as shown on line 49, column (G) of page 6b.
3 q. What do you estimate Detroit Edison's long-term debt cost rate to be for 1980 4 and 19817 5 A. As shown on exhibit pages 7a and b and 84 and b, I am estimating Detroit 6 Edison's long' term debt cost rate to be 8.86% for 1980 and 8.76% for 1981. 7 le is the latter cost rate for long-term debt, 8.76%, that I an using in my . s 8 rate of return recommendation found on page 1 of my exhibit. 9 q. What have you calculated Detroit Edison's short-term debt cost rate to be 10 at December 31, 19797 11 A. As shown on exhibit page 9, the average cost rate of Edison's short-term 12 debt stood at 14.70% at December 31, 1979 At the same time, the prime rate 13 reached 15.25%, indicating Detroit Edison's ability to raise short-term cap-14 leal at rates below the preva'iling prime rate. Sage 10, of my exhibit, 15 details the relationship between the prime rate and the various Detroit 16 Edison short-term debt instruments for the 12 months ended December 31, 17 1979 Excluded from the page 10 calculations are the Renaissance Energy 18 Company notes payable. I have excluded these notes from the computation l 19 because of the uncertainty that exists with respect to how much longer this 20 line of short-term credit will be available to Detroit Edison. Examina tion 21 of page 10 does, indeed, reveal that Detroit Edison has been able to raise 22 its short-term debt capital at sub-prime rates. l 23 q. What have you based an estimate of Detroit Edison's 1981 short-term debt 24 cost rate upon? 25 , A. I have based my estimate of Detroit Edison's 1981 short-term debt cost rate m-- ---- - - , ,e-
(- 1 on a prime rate of 12% and on the observations made from exhibit page 10 2 which Indicates that Detroit Edison can raise short-term debt at sub prime 3 rates. 4 in order to compute a short-term debt cost rate figure for December 31, 5 1981, I have weighted each short-term debt instrument by the amount of that 6 Item outstanding at December 31, 1979 Additionally, noting the uncertainty 7 involved, I have excluded the Renaissance Energy Company notes payable from 8 the calculation. Page 11 of my exhibit shows tne calculation for my esti-9 mate of the short-term debt cost rate to be used in my estimated 1981 10 capital structure. Perusal of page 11 Indicates that I am recommending a 11 cost rate of 10 97% for short-term debt in this case. - 0 12 Before continuine wit
- mv discussion of ostroit edieon s caaltai costs.
13 it may prove helpful to point out how volatile short-term debt rates can be. 14 From a high of 20% this spring, the prime rate has declined to 12% at the 15 time this testimony was being prepare'. d Clearly, short-term debt rates are 16 highly sensitive to economic conditions and the actions of the Federal j 17 Reserve Board. Considering the uncertainty that exists with respect to 18 inflation, national output, and the actions of the Federal Reserve, it is l l 19 difficult to predict the course of short-term debt rates for the near l 20 future. Because of this situation and the volatility of short-term debt 21 rates, the Commission may want to use a more recent prime rate figure i f the I 22 rate changes significantly between the areparation time of this testimony l 23 and the time the case is. decided. - 24 Q. Please continue with the explanation of your exhibit. 25 A. Turning to page 12, we find the calculations for Detroit Edison's preferrea
. e 1 I stock cost at December 31, 1979 As indicated on line 9 of Column (H),
2 the calculations result in a preferred stock cost of 8.172. 3 q. Does 8.17% also become the preferred stock cost rate for 1980 and 19817 4 A. No. Detroit Edison has Indicated that it intends to issue either preferred 5 or preference, stock in the fourth quarter of 1980 and in 1981. I have assumed ' 6 that the company will Issue preferred stock in each year. Because of the 7 Issuances, the cost of preferred stock will increase in 1980 and 1981. This 8 Increase can 'be seen on exhibit pages 13 and 14 to result in a 1980 preferred 9 stock cost of 9 2ct and a 1981 preferred stock cost of 9.84t. It is the 10 9.84 preferred stock cost rate estimate for 1981 that is used in the esti-11 mated 1981 ca' p ital structure which appears on exhibit page 1. O 12 a vh c h v== c i= i t s a treit reis n s areference st ' c=st' 13 A. Page 15 of the exhibit shows that the calculation for Detroit Ediscn's pre-14 ference stock results in a cost rate of 10.88% for 1979 Since I have 15 assursed that the company will issue preferred stock in 1980 and 1981, the 16 only changes that will occur to the preference stock balances will be the 17 result of sinking fund provisions for the $2.75 series and 52.755 series of 18 preference stock. The sinking fund provisions will result in a slight decline 19 in the preference stock cost rates for 1980 ar'd 1981. These changes can te 20 seen on pages 16 and 17 to result in preference stock cost rates of 10.86 21 for 1980 and 10.84% for 1981. The 1981 figure of 10.84 represents the 22 cost of preference stock that appears in the estimated 1981 capital struc-23 ture found on exhibit page 1. 24 Q. Please continue with your discussion of the scurces and cost of Oetroit 25 Ecison's capital. O
O . 9 1 A. On line 6 of page 1 we note that deferred income taxes and investment tax 2 credits represent 7.81% of Edison's total capitalization. These items are 3 provided by the ratepayers and represent a source of cost-free capital for 4 Edison; therefore, I have given them a zero cost rate. Consistent with the 5 Commission's policy regarding accumulated deferred Job Development invest-6 ment Tax Credits, I have included the estimated 1981 balance of these credits 7 in my estimated 1981 capital structure at the overall rate of return. The 8 Job Develosment Investment Tax Credits can be seen on line 7 of exhibit page 9 1, to amount to 2.18% of Detroit Edison's total capital for the test year. 10 As seen on line 8 of page 1, Belle River financing is estimated to 11 represent 8.34% of the Company's total capital at December 31, 1981, and as O 12 noted areviousiv. i have eiven this item a zero cost rate. 13 q. What standards have you taken into consideration in determining a pricer . 14 rate of return to reconnend on Detroit Edison's common equity? 15 A. I have taken into consideration standards that have been established by the 16 U.S. Supreme Court. The Supreme Court, in the Federal Power Commission vs. 17 Hoon Natural Gas Company case (51 PUR NS 193, 1944), established standards 18 that regulatory consnission have used in determining a proper return to grant 19 on common equity, in that case the Court stated: 20 "From the investor or c.ompany point of view, it is impor-tant that there be enough revenue, not only for the - 21 operating expenset, but also for the capital costs of the business. These include service on the debt and 22 dividends on the consnon stock. By that standard, the return to the equity owner should be commensurate with 23 the return on investments in other enterprises having corresponding risks. . . . . That return, moreover, should 24 be sufficient to assure confidence in the financial inte-grity of the enterprise, so as to maintain its credit O 25 and attract capital."
I 1] The Court, however, failed to identify those factors which constitute 2: corresponding risk, or the magnitude of a return necessary to assure confi-3j donca in the financial integrity of t5e company and to allow it to attract i 4l capital. Instead, the Court left the identification and evaluation of 5h these factors to the Judgment of regulatory consnissions. These commissions a 63 base their decisions on the testimony of witnesses who are knowledgeable 7 of the subject matter and who support their reconenendations with studies 8y involving empirical evidence. 9j Q. Have you performed any such studies to determine a fair rate of return on 10 ,j comon equity for Detroit Edison? l 11 oh A. In evaluating a fair rate of return on consnon equity for Yes, I have. 12 Detroit Edison, I have examined earnings of comparable companies, utilized 13 !! a discounted cash flow study (DCF) and employed a capital asset pricing 14 ' . model (CAPM). 15 i;l Q. Please describe the procedure you have used in selecting comparable companies. 16j A. Keeping in mind that no two companies are the same, I believe that the pro-17 j; cedure I followed resulted in companies that are comparable to Detroit la ;. Edison. I began by selecting Value Line investment Survey's electric util-19 itles with 1979 total capital in excess of 2.5 billion dollars. From this I il ; 20 jj initial group, I chose those companies with beta coefficients of between .50 21 p and .70. My final group of comparable companies and their beta coefficients il 22 ] are listed on exhibit page 18. H 23 } Q. How do you Intend to use your comparable companies to determine a fair
.i 24 J equity return rate in this case? . 25l A. The Supreme Court, in the Bluefield Waterworks and immrovement Cemeany vs.
O
Oi 1 Public Service Correission of West Virginia case (262 U.S. 679) stated that: 2 "A public utility is entitled to such rates as will permit it to earn a return on the value of the property which it employs 3 for the convenience of the public equal to that generally being made at the same time and in the same general part of 4 the country on investments in other business undertakings which are attended by corresponding risks and uncertaintles; 5 but it has no constitutional right to profits such as are realized or anticipated in highly profitable enterprises or 6 speculative ventures." 7 it would be wise, then, to examine the returns earned by these other businesses 8 having corresponding risks and uncertaintles. 9 Q. What were the results of your examination of the earnings of comparable 10 companies? 11 A. As shown on line 16 of exhibit page 19, the average return rate earned by 12 the thirteen comparable companies for the most recent year,1979, is 10.8%. 13 The return rates earned by the companies over the past five years, as shown 14 on line 16 of the far right-hand column, can be seen to average 11.05%. 15 Detroit Edison's average return rate on common equity over the same five-16 year period of time was substantially lower as witnessed by the 9.28% return 17 rate reported on line 17 of the far right-hand column of page 19 18 Q. Did you take any other factors into consideration before arriving at a rate 19 of return recommendation based upon the earnings of compareble companies? 20 A. Yes, I did. In order to evaluate the sufficiency of the earnings of the 21 comparable companies, I examined the market-to-book ratios of those comparable 22 firms over the period 1975-1979 23 Q. Why did you examine market-to-book ratios? 24' A. They may give an indication of the adequacy of historical earnings. Economic 1 25 ; theory asserts that if a firm earns, or is expected to earn, a return on its O -
l O . l 1 equity that is equivalent to the yield at which a share of that firm's common 2 stock is selling in the market, the market price of that firm's stock should 3 approach the stock's book value. If the firm's earnings deviate from the 4 market yield on the firm's stock, the market price to book value ratio will 5 deviate from unity, other things remaining constant. Thus, a market-to-book 6 ratio consistently below unity wuld tend to indicate that a firm's earnings
~
7I have been less than the investor's regulre'd' return for thit Virm".
~ "
8 Q. What was the result of you examination of the market-to-book ratios of the 9 comparable companies? 10 A. On page 20 of the exhibit, the five year market-to-book ratios, as shown on 11 line 16, can be seen to average .82%, while Detroit Edison's market-to-book O 12 < ti " r e d 752-
- 13 Q. Do you arrive at any determination from your examination of the earnings and 14 market-to-book ratios of your comparable companies?
15 A. Yes, I do. From my examination of the data, I conclude that 11% represents 16 , the minimum return rate consistent with established standards for determina-17 tion of a proper rate of return in rate case proceedir:gs, and seems to be 18 less than the return required by Investors in these comparable companies anc 19 Detroit Edison, as attested to be the continuous low market-to-book ratio. 20 Q. Do you have any other consnents to make regarding your return rate recommenda-21 tion based on your study of comparable companies? 22 A. Evaluation of return recommendations based upon comparable companies should 23 ; be made with the knowledge that performance in the past may not be an accurate 24 fl indicator of current needs. For example, a period of poor performance may 25 yield low earnings and suggest a low return which may be just the ooposite of 4
-- -,, - , ~ , , --
, _c-.,,-- - . - - . - - ,_ --,.-,,--_.,-,,-.,.~.n,.-
i
. , 1 1
1 what is needed. In addition, studies of comparable companies are subject to 2 the defect of circular reasoning dich leaves them vulnerable theoretically. I i 3 i l Finally, the earned return on equity may not be the actual cost of equity. ! 4 ! It is desirable to grant a utility a return equal to its cost of capital, ; 5 because by so doing, the consumer pays no more than his fair share for utility 6 service and the conpany receives the revenue it needs to maintain its financial 3 7 Integrity, attract capital and earn rates of return comparable to those being I 8 earned in the market by conparable firms. Q. I 9 How does one measure a firm's cost of equity capital? 10 , A. A firm's cost of equity capital can be estimated by use of a DCF or CAPM. I 11 I Q. How does a DCF allow one to. determine.a company's required return rate? O 12 A. The conventional theory behind this technique argues that the value of a 13 share of stock, like the value of any other asset, can be represented by the 14 present value of the cash flows the stock, or asset, is expected to provide 15 for its owner. Secause the benefit of holding a convnen stock is its dividena, 16 the problem of determining the cost of equity becomes the problem of deter-17 mining what discount rate the market is using to establish the present value i 18 * (price) of the dividends on a share of cononon stock. The DCF estimates enis l 19 d discount rate with use of the formula- k=h+G l 20
,*ere.
k = Investor required return 21 D = anticipated annual dividend P = market price of the share . G = expected growth rate l in measuring the required return, or cost of equity, on a share of stock , tne 24 i dividend yield is easily determined by dividing the anticipated divid end by 1 25 the share's price. ! The long run dividend growth expectation is much more l 1
--w----- - - , . . , - . . , . - -_ . , , . , _ . , _ - -
1* difficult to ascertain. 2 If a corporation is expected to earn a rate of return of "r" on its 3 consnon eculty and if it retains a portion, "b", of those earnings, then 4 earnings, per share can be expected to increase by "br" In the subsequent 5 y ea r. Thus ','br" measures the rate at which earnings can be expected to grow 6 and. If the firm has a normal dividend payout ratio, it is a good measure of 7 future dividend growth. 8 q. What values for "b" and "r" have you used to determine expected growth in 9 dividends ? 10 A. Since investors evaluate the past performance of a company in deriving future 11 expectations,' I have used historical values of "b" and "r" in estimating Detroit 12 Edison's growth rate. In cornputing growth rates from historical figures, 13 however, one must make assumptions regarding how much weight investors place 14 on particular historical growth rates. 15 4 Please explain your growth rate estimation procedure. 16 A. I began with three possible scenarios on how investors may weight historical i 17 g rowth ra tes . The first s'cenario assumes that investors place most weight on 13 current earnings and that the significance of past earnings declines continua:Iy 19 wi th time. The second scenario assumes that investors place less significance 20 on current earnings and more on earnings A lch occured in the recent past ano 21 then less significance, again, on earnings that occurred further in the past. 22 Restated, this scenario suggests that the significance of past earnings first 23 , increases and then declines with time. The third scenario assumes that in-2r. ! vestors weight historical earnings equally. I 25 i To test which scenario most accurately describes investor ::enavior, I l l
I l Q, I I utilized the OCF formula which I previously discussed, and regressien analysis. 2 In using the DCF formula, I rearranged terms somewhat to derive the express!an: 3 ;-a-g 4 The formula implies that there is a negative or Inverse relationship between 5 firms' dividend yields and growth rates. The inverse relationship impIIes 6 that firms with higher anticipated growth rates should have lower dividend 7 yields than firms with lower growth rates if the companies are of comparable 8 risk. 9 Consistent with the three scenarios describing investor behavior, I have 10 generated three sets of weighted, historical growth rates. The growth rates 11 were computed by using historical figures for "r" and "b" for Detroit Edison 12 and each of the comparable correantes that appear on exhibit page 18. Each 13 set consists of three, five, seven and ten years of historical gemth rates 14 for Detroit Edison and the fif teen comparable companies. The first set, 15 which conforms to the first scenario of continually declining significance 16 ' with time, was weighted by use of the concept of sum of the years digits. By 17 using the sum of the years digits methodology to generate growth rate weights 18 and then applying these weights for three, five, seven and ten years of histor-19 Ical data, I gave progressively less weight to growth rates which occurred 20 l further in the past. I The second set of growth rates, which conforms to the second scenario of I 21 l' 22 ' first increasing and then decreasing historical significance, was generated by 23 weights that were computed with the use of a second degree, lagged, polynomical 24 ' equation. The weights were generated by econometric estimation of the equation ! t 25 } parameters and then applied to the historical growth rates. i l l
1 The third set of growth rates, which treat the significance of past years 2 equally, represent the averages of the past three, five, seven and ten years 3 of growth rates. 4 Q. Please continue with your explanation of growth rate estimation. 5 A. My next ? ;ep was to determine, statistically, which of the growth rates, 6 from the three sets, best represented Investors behaviors. In order to make 7 such a determination i used regression analysis on the equation: -- 8 E=k-g P 9 i Regression analysis is a statistical technique that allc><s one to 10 evaluate whether or not a statistically significant relationship exists 11 between one variable, called a dependent variable, and one or more other 12 variables, called an independent varlaole(s), it also allows one to determine 13 what effect the Independent variable (s) has and how strongly it is related to 14 I the dependent variable. As an example, we might think of a person's weight as l 15 being dependent, in part, on a person's height. In such a case a person's 16 !, weight would be the dependent variable and a person's height would be the i independent variable. Statistically, through a regression analysis, we could
~
17 !' 18 evaluate the data and determine If weight and height are indeed related anc I 19 the effect that a person's height might have on his or her weight. l 20 in evaluating the formula y = k - g, I used the three, five, seven and 21 ten year growth rates, from the three sets previously discussed, individually
- 22 as proxies for the "g" portion of the expression. The "k" portion of the 1
23 ! equation, which consists of an inflation and risk component, should be l 24 invariant over the sample since the companies are of comparable risk and O 25 i the d.ta is e,ess-s.ction.i. hevertheiess, it is impossieie to seiect companies
~
1 l- that are of precisely the same risk. Therefore. I have included each firm's 2 beta coefficient in the regression model as a proxy to account for any 3 differences in risk that may exist among the companies. 4 My procedure involved successively regressing the companies' beta 5 coefficients and weighted growth rates on the companies dividend yields 6 until each weighted growth rate had been regressed on the dividend yields. 7 For exangle, first the beta coefficients and the sum 31 years digits weighted g growth rates for the past three years were regressed on the companies' g dividend yields. Next, the beta coefficients and sum of years digits weighted 10 growth rates for the previous five years were regressed on the dividend y8 elds. 11 The procedure was followed until the three, five, seven and ten year growth 12 rates for all three sets of data were regressed on the dividend yields. 13 The growth rates that I used were for the three, five, seven and ten l g years ending in 1979 The beta coefficients used for each company are the 15 same as th se shown on page 18 of the, exhibit. Finally, the dividend yields 15 ; were coneuted by using the average of the high and low March 1980 market
$7 price for each company.
18 The final step in my growth rate estimation procedure was to determine 19 which of the weighted growth rates fit the dividend yleid data best. I ussJ 20 the coefficient of determination in order to evaluate the best fit. After 21 examinin9 the results of the regressions, I have found that growth rates for the 22 three previous years weighted by the sum of years digit method fit the data best. 23 Therefore, I have used this procedure in order to determine Detroit Edison's l 24 l expected growth rate. The best fi t equation appears on exhibit page 25 l 25 4 Using the procedure enar you have ust described. what growth rate have ycu
I 1 calculated for Detroit Edison? 2 A. The procedure that I have adopted results in an expected growth rate of 159% 3 for the Detroit Edison Conpany. 4 4 How did you calculate the D/P portion of the formula in this case? 5 A. The "D" portion of this expression is sitriply the anticipated dividend for 6 the next 12 months. The price used in the formula is simply the average of-7 the high and low market price for Detroit Edison for the quarter ending g July 31, 1980, as reported in the June, July and August, 1980, Standard & g Poor's Stock Guide publications. The result of dividing the dividend, $1.60, 10 by the average rnarket price, $13.31 results in a dividend yield of 12.02%. 11 Q. What is the next step in the determination of the investor's required return 12 rate? 13 A. The next s tep is the addition of the growth rate to the dividand yield to 14 determine the investor's required return for Detroit Edison. The 1 59% growth 15 rate added to dividend yield of 12.02% results in a required return of 13.61%. 16 Q. Does the 13.61% represent the cost of all cormen equity for Detroit Edison? 17 A. No. New common equity generally has a higher cost attached to it than existing 18 comron equity because of the expenses locurred ir. Issuing new stock. I have 19 estimated a reasonable allowance for these issuance expenses of 3.73% for 20 ? Detroit Edison. If the Cornission desires to grant Detroit Edison an allow-21 ance for these issuance expenses, the 13.61** figure should be increased by 22 3. 73%. The calculation to make this adjustment can be found on exhibit page ! 23 21, and on line 13 of that page can be seen to result is a cost rate for ce=en 1 24 I equity of 14.023. In granting an allowance for Issuance 7xp' ens ~es , ~however, ene t 25 commission may wish to take into consideration the fact that only a small
1 .p ortion of the Coe,any's common equity is subject to the issuance expenses. 2 A major portion of the company's corinon equity is not subject to such expenses 3 and therefore such an allowance may overstate somewhat the true cost of equity 4 to the fi rm. 5 Q. How have you derived an allowance for issuance expenses of 3.73%7 6 A. I arrived at an allowance of 3 73% by examining the expenses associated with 7 three of Detroit Edison's common stock offerings. As shown on line 6 of 8 exhibi t page 22, these expenses can be seen to amount to 3.73%. 9 q. Are you reccamending that the Commission grant Detroit Edison an allowance for 10 market pressure in this case? 11 A. No. I believe that a market pressure allowance would be inappropriate in this 12 3 case. 13 q. Please describe how the CAPM can be used to estimate the cost of comen equity? 14 A. The first step in understanding how the CAPM can be used to estimate cocmon 15 equity cost rates is to observe the risk of a stock in relation to a portfolio. 16 in general, tr.: sundard deviation of market returns (riskiness) of a portfolio 17 of assets is less than the average of the standard deviations of the individual 18 assets. The Irglication of this observation is that some, but not all, cf 19 the risk from holding an asset, sucn as a share of stock, can be diversiffeo 20 away by holding a portfolio of securities. That portion of a stock's total 21 risk that can be reduced through diversification is termed unsystematic risk. 22 while that portion which cannot be diversified away is called systematic risk. 23 , it is the systematic risk of a stock that is relevant to capital market theo rY . 24: since some of the total risk, cthe unsystematic portion, can be diversified t O 2Si - <- s=='=''=":*"=v'===="='"=*- v
i 1 effected by general stock market movements. 2 4 How does one measure a firr.'s systematic risk? 3 A. As noted previously, the systematic risk of a stock is the tendency of its 4 own market return to move with changes in the entire stock market's return 5 (henceforth referred to as the market return). This tendency can be captured 6 by regressing'the returns of an Individual stock on the market return. The 7 coefficient on the market return from such a regression is called the beta 8 coefficient and it measures the change in an Individual stock's return as the 9 market return changes. I f, for example, a stock has a beta = 1.0, then we 10 would expect that stock's return to change in direct proportion to changes in 11 the market's return. A beta = .80 would indicate that if the market return O 12 increased by 1.0%, we.could expect that firm's return to increase by .80%. To 13 reiterate, the systematic risk of a stock represents a risk that cannot be 14 diversified away and is measured by the firm's beta coefficient. 15 Q. Please continue wa th your explanation of how the CAPM can be used to estimate 16 l the cos t o f cormnon equi ty. 17 A. Economic theory asserts that as the risk of an asset increases,the return 18 required by investors for holding that asset also increases, and conversely 19 as the risk of an asset decreases so does the return required by investors. 20 Even if an asset had zero risk, however, Investors wuld still require a return 21 for investing in that asset. 22 , investors would require a return for investing in a risk-free l 23 l asset to compensate themselves for giving up the use of their money for a l 1 period of time. As an Illustration, if an a.sset had no risk associated with
- 24l I O. 25 !i it and the,e was ne tareat of inflatien. an investor wouie repuire a return
w e nu. uecas
, . EXHIBIT NO.
SCHEDULE NO. WITNESS: G. Stolic OATE: Page 1 of 25 Pages Of- REGRESSION ESTIMATED REGRESSION EQUATION Line No. 32 Growth Rato
- 1. D = 11.35 + 4.83 sera coefficient P
(2.36 (-4.20)
- 2. t-values: (8.73)
R 2 - .60 3 0 . 4 1 .mu O .
CASE No. U-6488 EXHIBIT No.
$CHEDULi NO.
WITNESS: G. StoIIc DATE: [ )- Page 23 of 25 Pages Al5K FREE RATE OF r4 TURN AND MARKET RISK PREMlUM - lNFLATION REGRESSION EQUATION Long-Te rm Short-Term Line U. S. Government No. U. S. Government Interes t Rate
- Interest Rate *
- 1. september 3 11.02%
- 2. 10.78%
August 27 11.32 11.34
- 3. August 20 11.10 10.87
- 4. August 13 10.87 Average 9 92 5 11.08% 10.73%
- 6. Estimated Market Return: 11.08% + 8.17% = 19.25%
7 Regression Equation:
- 8. Market Risk Premium =
16.33 - 2.21 x Inflation Expectation 9 t-value = (3 16) (-2.05)
- 10. R2 =
.15
- 11. .86 = 16.33 -
2.21 x 7
- 12. Regression Data:
() 1/53 0.62 -11.47 1/54 -0 50 31.71 1/55 0.37 31.82 1/56 2.86 10.14 1/57 3.02 -15.03 1/58 1.76 35 75 1/59 1.50 17.03 1/60 1.48 - 9.29 1/61 0.67 26.32 1/62 1.22 -14.77 1/63 1.65 21.14 1/64 1.19 12.54 1/65 1.92 13.25 1/66 3.35 - 8.33 1/67 3.04 25.95 1/68 4.72 15 32 1/69 6.11 - 0.03
. 1/ 70 5.49 -11.68 1/ 71 3.36 5.43 1/72 3.41 17.40 1/73 8.80 -11.46 1/74 12.20 -27 37 1/75 7.01 34.44 1/76 4.81 6.81 1/77 6.77 - 0.17 1/78 9.03 16.90
()
- Source: Standard & Poor's Publication, The Outlook.
( G 1 for investing in tnat asset as compensation for not being able to use that 2 money himself. This return is known as bare rent or the pure Interest rate. 3 in addition if Investors expect inflation to occur dile they are holding an 4 asset, they will require a return as compensation for the loss of purchasing S power their money exuriences while it is invested. This is true even if it l 6 Is invested in an asset that has no risk of dafault. Taken together, the i 7' bare rent and caseensation for inflation that Investors require from an asset 3 enat has no risk are known as the riskiess or risk-free rate of return, ni g addition to the riskiess rate of return, if an asset possessas risk, then an 10 additional return or premium must be awarded to investors to coacensate them 11 for the risk assumed in hciding that asset. As noted previc.asly, ne greater 12 , the risk, the greater the premius or additional return aoove the risk-f ree 13 rate that Investors will require frors that asset. 14 , The required return on a stock consists of the risk-free rate of return 15 plus a premium to concensate Investors for tne additional risk assumed in 16 l,' purchasing the stock. This relationship can be exoressed in the form: h 17 ki=Af + ai 13 where kg = Investors' required return on ene firm's stock i 13 Af = tne riskless rate of return 20 Pi = the risk premium on the firm's stock 21 The risk premium required for the market as a wnole is equal to (k, - Af ), l 22 l eere k, is equal to tne market's required return rate and Rf is the riskiess ! 23 rate of return. wita knowledge of the market's risk premium, one can esti-4te ! 24 ene required return for any fir , stock by utilizing the equation. 25 k; = Rf + b; (k,- A f) O o
4 I where kg , k, and Rf = defined as before 2 bg = firm's beta coefficient 3 in narrative form, the equation expresses a firm's required return as the sum 4 .of the risk-free rate of return and the firm's risk premium, which can be 5 expressed as the market's premium multiplied by the firm's beta coefficient. 6 If a firm has a beta coefficient of less than unity, it will command a 7 smaller than average risk premium, and if its beta exceeds unity, its risk 8 premium will be greater than average. A beta equal to unity implies a risk 9 premium, for that firm, equal to the market's risk premium. 10 Q. How did you derive an estimato for the merket's required rate of return? 11 A. In order to estimate the market risk premium, I computed the historical 12 spread between the market rate of return earned by the stock market and the 13 market rate of return earned on long-term government bonds. The spread gives 14 us the return earned by the market in excess of that earned by a risk-fret 15 asset, or a stock market risk premiuni estimate. 16 in order to estimate the stock market and government long-term debt 17 market returns, I used monthly observations of the Standard & Poor's 500 Ig market index and Federal Reserve Board figures respectively. After computing 1 19 the monthly market returns for the period running from January of 1953 to j 20 December of 1978, I subtracted the government bond returns from the stock 21 market returns and aggregated the monthly differences on an annual basis 22 consistent with calendar years. The average annual rate, 8.172, serves as an 23 estimate of the vrket risk premium. 24 Q. Based upon your market risk premium estimate, what have you estimated the O 25 r" = < a 'r d r>= ' < t r" == * ' 1 ? l l 1
f + . 1 1 A. The market's current required rate of return can be estimated by adding the 2 market's historical risk premium over debt to the current long-term government 3 debt yields. Using the average premium that I generated of 8.17% and the 4 average long-term government debt yleid for the four weeks ending September.3, 5 1980, of 11.084, one derives an estimate of the markets rate of return of 6 19.25%. This calculation is shown on page 23 of the exhibit. 7 q. Old you take any other factors into consideration in estimating the markets 8 required rate of return? 9 A. Yes, I did. While the market risk premium may be Insensitive to many macro-10 economic disturbances, it is theoretically sensitive to the rate of inflation. 11 The risk premium sensitivity to inflation derives from the relative changes in 12 the expected variances o'f the real value of the returns from equity and debt 13 with changing expectations of inflation. Consistent with the theory, we could 14 expect the premium to decline during periods of time characterized by increas-15 ing expectations of Inflation. 16 f f this sensitivity is not taken into consideration, the use of an 17 estimated market rate of return of 19.2% could seriously overstate a firm's 18 cost of equity capi tal . 19 Q. Hcnv have you taken the risk premium sensitivity to inflation into account in 20 estimating Detroit Edison's equity cost rate? 21 A. I have taken this inflation sensitivity into account by estimating the effect 22 that inflation expectations have on the risk premium and then adjusting the 23 risk premium accordingly. In order to estimate the inflation sensitivity, 1 24 have regressed inflation rates, which I used as a proxy for inflation expecta-25, cions, for the years 1953 through 1978 on the annual risk premiums that I
O I computed for each of those years. The data used in the regression and the 2 estimated equation appear on exhibit page 23 Evaluation of the equation 3 Indicates that the regression coefficient is negative, Indicating an inverse 4 relationship between inflation and the market risk premium. This relation-5 ship is consi, stent with the theory enunciated previously. Add! ;ionally, the 6 t-value of -2205 indicates that the regression coefficient is Indeed 7 different from zero at the 95% level of confidence. 8 in order to take inflation expectations into account, one could " plug" g a number for inflation expectat'lons into the equation and conmute an inflation-10 adjusted risk proelua. While it is difficult to estimate expectations of .' 11 inflation, In'a recant case I have estimated a market expected rate of 12 Inflation of 7% for the next 30-35 years. Using this number as a proxy for 13 expectations, one can compute a risk premium of .862, this calculation appears 14 on line 11 of exhibit page 23. 15 As indicated, the 73 figure is a' proxy for actual expectations. To the 16 l: degree that it differs from actual expectations, the estimated risk adjusted 17 j premium will be inaccurate. Nevertheless, it is important to take inflation i 18 expectations into account in estimating the market risk preimium. In order 19 to take the effect of Inflation expectations into account in estimating tne 20 j market risk premium, I have averaged the inflation adjusted figure and the historical figure to derive an inflation-adjusted market risk premium of 21 lI - 22 4.522 -(8.17% + .862) 2 .
. Using the 4.52% premium and a government long-term 23, debt rate of 11.083,1 compute a market required rate of return of 15.60%
i 24; t (11.08% + 4.523). It is this figure that I have used in my CAPM. 25 Q. What does knowledge of the market rate of return serve?
l l
. e.
i 1 A. It may prove helpful to remember that the market return rate consists of a 2 risk-fres rate of return and a premium above the risk-free rate to compensate 3 the investor for the risk of the market. Iny given firm's coersnon equity may 4 be more or less risky than the stock market as a whole depending upon how 5 that firm's return moves as the market return c' hinges. "Thl's' efskTas descrThed 6 previously, can be measured by the firm's beta coefficient. If a firm's beta 7 coefficient is less than the market average beta, which is unity, that firm is g less risky than t* e market and therefore requires a smaller risk premium over 9 the risk-free return rate than'the market requires. Just the coposIte is true 10 i f the firm has a beta coef ficient greater than the market average. A firm's 11 risk premium over the riskiess rate of return is dependent on the market pre-12 mium and the firm's beta coefficient. By multiplying the firm's beta by the 13 market return rate, one can compute the firm's risk premium over the risk-free 14 rate of return, and den this premium is added to the risk-free rate, it results 15 in the firm's required rate of return'. 16 q. What have you estimated as the risk-free return rate to be used in your CAPM7 17 A. The best estimate available for the risk-free rate of return is the yield on 13 U. S. Government securities. During periods of time in which short-term yiel:s 19 differ from long-term yields, however, there is some cuestion as to which yiele 20 to use. Some analysts prefer to use the long-term rate because it reflects 21 expectations of inflation for the long run and is not subject to radical 22 fluctuations that may be caused by temporary conditions in the money markets 23 or price levels. Other analysts argue that the short run rates are the best 24 Indication of the risk-free rate at any point in time; fully reflecting the Invest c's expectations of inflation. cn page 23 of my exhibit, I have computec 25 O l l'
0 1 both the long-term rates and the short-term rates on government securities 2 for the four weeks ending september 3,1980. It can be seen on line 5 of that 3 page that the three month rate on hvernment securities has averaged 10.732 4 for the renth, while long-term rates have averaged 11.083. 5 6 q. What cost rate for common equity have you estimated for Detroit Edison using 7 the CAPM7 8 A. As shown on line 2 of exhibit page 24, I derive a cost rate estimate of 9 13.79% for cetroit Edison based upon a market rate risk premium of 4.52% and 10 a risk-free rate of return of 11.084. 11 My estimate for Detroit Edison's cost of equity capital declines to 12 13.44% If a market risk premium of 4.52% and a risk-free rate of return 13 of 10.73%. 14 q. Based upon your examination of the earnings of comparable companies your use 15 of the CCF and CAPM, what cost rate a're you ?scommending the company be allowed 16 to earn on its equity in this proceeding? 17 A. Throgh a combination of tschniques, I have derived a range of return rates 18 running f rom 11.05 to 14.022. A concentration of returns, however, using tee 19 DCF and CAPM falls between 13.44% and 14.02%. The results of my studies lead 20 ** to conclude that a range of return from 13.5% to 14.0%, on equity. Is fair 21 and reasonable in this case. 22
- q. What overall cost rate on total capitalization does this recommendation result I"I 23 24 A. On page 1 of my exhibit, we find that a rate of return of from 13.5% to 14.0%
25, on the connon equity computes to an overall return rate range from 8.93 to 9.09%.
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CASE NO. U-64C3 EXHlBIT NO. SCHEDULE NO. WITNESS: G. 5toJic O DATE: Page 1 of 25 pages DETRolf EDISON COMPANY RATE OF RETURN December 31, 1981 Percent of Weighted Line Total Cost Cost No. Description Capital Rate Rate (A) (8) (C)
- 1. Long-Term Debt 39 37 % 8.76 % 3.45 %
- 2. Short-Term Debt 56 10.97 .06 3 Preferred Stock 9.44 9.84 93 4 Preference Stock 2.32 10.84 .25 5 Cononon Equity 29.98 13 5-14.0 4.05-4.20
- 6. Accumulated Deferred income Taxes and I.T.C. 7.81 7 Accumulated Deferred J.D.I.T.C. 2.18 8.93-9 09 .19 .20
- 8. Belle River Financial Arrangement UtIIIzed 8.34 9 Total 100.00 % 8.93-9 09%
i Source: Column (A): Exhibit page 3, Column D l Column (B): Exhibit pages !
)
l 1 l g ) O - l 1 t t l
w s nu, u aeos EXHISIT NO. SCHEDULE No. WITNESS: G. 5:elic DATE:
, Page 7 of ?c Pages DETROIT EDISON COMPANY ESTIMATED CAPITAL STRUCTURE December 31, 1980 (Dollars in Thousands)
Es timated Percen t Line Balance at Salance at No. Descriotion of Total 8-31-80 Adjustments 12-31-80 Caoltal (A) (S) (C) (D)
- 1. Long-Term Debt $2,296,928 5 7,200 $2,304,128
- 2. Unarmrtized Long-Term Debt Expense 20,226 (480) 19,746
- 3. Total Long-Term Debt 2,276,702 7,680 2,284,382 44.46%
4 Short-Term Debt 31,431 (12,062) 19,369 38
- 5. Preferred Stock 439,947 41,400 481,347
, 6. Preferred Stock Expense 7.135 7,591 456 7 Total Preferred Stock 432,812 40,944 473,756 9.22
- 8. Preference Stock 146,055 146,055 9 Preference Stock Expense 6,784 6,784
- 10. Total Preference Stock 139,271 139,271 2.71
- 11. Common S tock 1,143,310 61,065 1,204,375
- 12. Comon S tock Expense 30,156 2,088 32,244
- 13. Retained Earnings 345,706 22,918 368,624
- 14. Total Cormen Equity 1,458,860 81,895 1,540,755 29.93 15 Accumulated Deferred income Taxes and ITC 366,661 10,563 377.224
- 16. 7 34 Accumulated Deferred JOITC 98,711 5,079 103,790 2.c2
- 17. Belle River Financial Arrangement Utilized 138,256 61,744 200,000 3.89
- 18. Total Capital $4,9k2,704 $195,843 $5,138,547 100.0C%
J N Source: Certain estimates supplied by coccany and other estimates supplied by witness.
CASE NO. U-6kS8 EXHIBIT N0. SCHEDULE h0. WITNESS: G. Stojic QATE: Page 3 of 25 Pages DETRolf E0lSON COMPANY ESTIMATED CAPITAL STRUCTURE December 31, 1981 (Dollars in Thousands) Es timated Es timated Percent Line Balance at No. Descriotion Balance at of Total 12-31-80 Ad J us t. men t s 12-31-81 Capital (A) (B) (C) (D)
- 1. Long-Term Debt $2,304,128 5 105 $2,304,233
- 2. Unamortized Long-ferm Debt Expense 19,746 24 19,770 3 Total Long-Term : Deb t 2,284,382 81 2,284,463 39.37%
4 Short-Term Debt 19,369 T3,050 32,419 56
- 5. Preferred Stock i 481,347 75,091 556,438
- 6. Preferred Stock.Excense 7,591 1,105 8.696
- 7. Total Preferred Stock 473,756 73,986 O 547,742 9.44
- 8. Preference Stock 146,055 ( 5,000) 141,055 9 Preference Stock Expense 6,784 ( 245) 6,539
- 10. Total Preference Stock 139,271 ( 4,755) 134,516
, 2.32
- 11. Conwnon S tock 1,204,375 198.517 1,402,892
- 12. Cortnon S tock Expense 32,244 5,336 37,560
- 13. Retained Earnings 368,624 5,823 374,447 14 Total Common Stock 1,540,755 199,004 l 1,739,759 29 98
- 15. Accumulated Deferred income ;
Taxes and ITC 377,224 76,015 453,239 7.81
- 16. Accumulated Deferred JOITC 103,790 22,537 126,327 2.18 -
- 17. Belle River Financial Arrangement Utilized 200,000 284,000 484,000 1
8.34
- 18. Total Capital $5,138,547 s 663,918 55,502,465 100. Cat J
Source: Certain estimates sucolieo my Company , Applicant's Case u-6557 and otner e,timates supplied by Witness.
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CASE NO. U-6488 EXHl3>T NO. SCHESULE NO. WITNESS: G. Stojic Page L of L Pages DATE: DETA0lT EDISON COMPANY CAPITAL STAUCTUAE THIRTEEN MONTH AVERAGE ENDED DECEM8EA 31, 1979 Line Description OcIlar Percent of
- No. Amount Total (000) CapitaIizaeion (A) (3)
- 1. Long-Ter:n Debt
$2,039,774 46.66 %
- 2. Short-Tens Debt 78,352 1 79 3 Preferred Stock 352,508 8.06 4
Preference Stock 143,023 3.27
- 5. Common Equity 1,322,366 30.25 6.
Accumulated Deferred income Taxes and Investment Tax Cred i ts 328,457 7.51 O 7. a DeveioPment in est ent Tax Credits 107,573 2.46
- 3. TOTAL
$4,372.053 100.00 %
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O- O DEla0li fol50N COMPAuf Pete i of I lonG TIRrlid8T COST
- C((lle(R 31. 1980 Date Date Assount Price Cast Line of of of to het financing Based on Asuunt Annual
! Jeg penrlpilo!g Naturit,y Offerine Public gacgg, Proceed 1 j(ssue g)" Net Proc h G Ju tan ,fost Ge! m t 6 n!ndj_ng A) TI) @) gf 7 FT MJ (R)_ ding W lbrlease :
- 1. Series I 2.75: 9 01-47 9-o b 82 1 60.000.000 101.us 1.0n 100.06: 2.75:
- 2. Series J. 2.755 3-01-50 8 59.975.000 $ t.649.111 3-01-85 35.000.000 102.27 .98 181.29 2.69 35.000.000
- 3. Series ll. 2.8755 3-15-54 945.500
- 4. 3-15-04 40.000.000 99.25 1.08 98.17 2.9F 39.995.000 Series P. 4.8755 4-15-57 8-15-ST 1.187.852
- 5. 70.000.000 --
.45 99.55 4.90 66.325.000 Series Q. 4.6255 6-01-59 6-01-85 40.000.000 3.249.925
- 6. Series R 65 2.42 97.58 4.78 37.695.000 1.801.821 12-01-66 12-01-96 100.000.000 100.80 1.00 99.00 6.07
- 7. Series 5. 6.45 10-01-68 10-01-98 100.000.0 % 6.070.000
- 4. M0.000.000 99.75 1.37 98.63 6.50 150.00u 000 Series T. 95 12 01-69 12-01-99 15. @ .000 99.73' l.45 9.750.000
- 9. Series U 9.151 98.55 9.14 75.000.008 6.455.000 7-01-70 7-01 00 75.000.002 100.00 1.18 98.82 9.27
- 10. Series V. 8.I58 12-15-70 75.800.000 6.952.500 12-15-00 500,000.000 160.90 1.12 98.88 8.25 II. Series X. 8.1255 6-15-11 6-15-01 IM.000.000 8.250.000
- 12. Series T. 7.3755 100.000.000 99.50 I.65 98.35 8.2F 100.000.000 8.270.fue 11-15-71 11-15-05 60.000.000 100.00 1.25 98.75
- 13. Series 2. F.55 7.48 60.000.000 4.488.000 34.
I-15-73 1-15-03 100.000.000 100.36 .5F 92.43 7.55 Series AA. 9.8755 5-01-74 5-01-04 100.009.004 F.550.000
- 15. 100.000.000 99.25 1.93 98.07 10.08 100.000.000 Series CC. 12.755 I-15-75 l-15-82 50.000.000 100.00 10.000.000
- 16. 1.84 98.16 13.16 50.000.000 6.580.000 Series 00P. Isos. l.9 F1 - 9.255 11-01-75 11-01-95 14.305.000 100.00 4.02 IF. Series EE. II.8758 95.98 9.21 13.545,000 1.241.ni 12-15-75 12-15-00 50.000.000 100.00 1.84 98.16 4.844.0u,o}
- 18. Series Fis. Nos.1-13 12.11 48.000,n00 5.51 - 8.51 12-15-75 12-15-00 35.000.000 100.00 3.55
- 19. Series IF8. see. 14, 7.1255 96.45 8.60 34,500.000 2.967.000 6-01-77 2-01-0I 10.600.000 100.00 1.79 98.21 7.29
- 20. Series CGP,1805. 1-7 38.600.000 772.740 5.55 - 8.1255 6-15-76 6 15-96 28.500.000 100.00 3.22
- 21. Series GGP. seos. 8-22, 96.78 8.16 28.500.000 2.325.600 4.45 - 6.108 10-01-77 6- 15-% 13.800.000 100.00 3.87 96,13
- 22. Series 688, 10.6251 6.26 13.800.000 863.880 7-15-76 7-15-06 50.000.000 100.00 1.83 98.17 10.83
- 23. Series IIP. Isos. I-F. 50.000.000 5.415.000
. 58 - 71 3-01-77 3-04-05 2.750.000 100.00
- 24. 4.F1 95.29 7.27 2.758.800 199.925 Series llP. slos. 8-22.
5.855 - 75 3-01-79 3-01-05 1.000.000 99.82 9.13
- 25. Series JJP. See, 1-F. 90.69 7.87 1.000.000 78.700 55 - 75 3-01-77 3-01-05 5.850.000 100.00 3.99 26 96.01 7.21 5.850.000 421.785 Series JJP No. 8. F.255 9-11-79 3 01-05 1.000.000 100.00 3.21 96.79 7.54
- 27. Series REP. mos. I-7 1.000.000 75.400 55 - is 3-01-77 3 01-05 13.350.000 100.00 1.40 96.60 7.15
- 28. Series EEP No. 8. 7.255 9-01-79 13.358.800 954.525 3 01-05 1.540.000 100.00 3.01 .96.99 7.52 I.540.000
- 29. Series llP. anos.1-7* . 115.808 ,
51 - 6.6255 3-01-77 3-01-91 5.600.000 100.00 3.74 96.26 6.Se
- 30. Series LtP. nos. 5-15. 5.608.000 380.000 l 6 1 - 6. 71 3-61-79 3-08-91 3.250.000 100.00 2.66 97.34 6.82 3.250.000 221.650 9e ** sa e sEY N X
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Ol[Iletta 31. 1981 Date Date Ammunt Price Cost line of of of to financing Net Baseet en Aucunt Annesal
. .#9 t 9tS.ifftil!9 )ue Nturity offerl,nB goceed , Cos t_
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- 1. Series 1. 2.755 1-01-47 9-01 82 $ 60,000,000 101.135 1.071 100.065 2.751 $ 59.975.one $ l.649.313
- 2. Series J. 2.751 3 01 50 3-08-85 35.000.000 102.27 .98 101.29 2.69
- 3. 35.000.000 941.500 Series m. 2.8751 3-15-54 3-15-84 40.000.000 99.25 1.00 98.1F 2.97
- 4. Series P. 4.8755 39.995.000 1.187.852 8 15 57 8 15-87 70.000.000 -- .45 99.55 4.90 66.325.000 5 Series Q. 4.6255 6-01-59 6 81-89 3.249.925 6
40.000.000 -- 2.42 97.58 4.78 37.695.000 1.801.821 Series 8. 61 52-08-66 12 01-96 100.000.000 100.00 1.00 99.00 6.0F
- 7. Series 5. 6.45 100.000.010 6.0FA.000 10-01-68 10-01-98 150.000.000 99.75 1.37 98.63 6.50
- 9. Series I. 95 150.000.000 9.750.000 12-01-69 12-01-99 75.000.000 99.75 1.45 98.55 9.14
- 9. Series u. 9.155 7-01-70 75.000.030 6.855.000 7-01-00 75.000.000 300.00 1.88 98.82 9.27 75.000.003
- 10. Series V. 8.151 17-15-70 12-15-00 6.952.500
- 11. 100.000.000 100.00 1.12 98.88 8. .'$ 100.000.000 8.250.000 Series I. 8.1255 6-15-71 6-15-01 100.000.000 99.50 1.65 98.35 8.27 8.270,000
- 12. Series T. F.3755 11-15-78 100.000.000 11-15-01 60.000.000 100.00 1.25 98.75 F.48 60.000.000
- 13. Series F. F.51 1-15-73 4.488.000 14 1-15-0) 100.000.000 100.36 .57 99.43 7.55 100.000.000 F.550.000 Seeles A4. 9.8755 5-01-74 5-01 04 100.000.000 99.25 1.93 98.07 10.08
- 15. Series (C. 12.755 l 15-75 100.aco.000 10.000.000 16 l-15-82 50.000.000 100.00 1.84 98.16 13.16 50.000.000 6.580,0n0 Series DIP. Itos.1-9 75 - 9.251 11-01-F5 11-01-95 14.305.000 100.00 4.02 95.98 IF. 9.28 12.705.800 1.179.024 Series it. II.8755 12-15-75 12-15-00 50.000.000 100.00 1.84 98.16 12.58 37.500.000 18 Series Ife. Nos.1-13 4.541.250 5.55 - 8.55 12-15-75 12-15 00 35.000.000 100.00 3.55 M.45 8.63
- 19. Series fra. Ilo. 14. 7.1251 34.000.000 2.934.200 6-01-77 20101- 10.600.000 100.00 1.79 98.21 F.29 10.600,0no
- 20. Series CGP. 810s. 1-7 172.740 5.51 - 8.1255 6 15-76 6-15-96 28,500.000 100.00 3.22 96.74 8.22
- 21. Series GGP. Nos. 8 22 27.780.000 2.276.940 4.45 - 4.108 10-01-77 6-15 96 I).800.000 100.00 3.87 M.13 4.26
- 22. Series 184. 10.6251 13.800.n00 863.880 7-15 76 7-15 06 50.000.000 100.00 1.83 98.17 10.8) 50.000.000
- 23. Series llP. seos. I-F. 5.415.000 55 - FE 3-0 8- F7 3 08-05 2.750.000 100.00 4.78 95.29 24'. F.27 2.750.000 199.925 Series llP. Ibs. 3-22 5.855 - FI 3-01-79 3 01-05 1.000.000 99.82 9.13 90.69 F.87
- 25. Series JJP. plee.1-1, 1.800.000 78.700 55 - 75 3 01-77 3-01-05 5.850.000 100.00 3.99 M.08 26 F.21 5.850.000 421.785 Series JJP No. 8. F.25% 9-11-79 3-01-00 1.000,000 100.00 3.21 96.79 F.54 1.000.000
- 27. 75.400 Seeles EEP. Mos. 1-7 51 - 78 3 01-77 3-01 05 13.350.000 100.00 3.40 M.60 1.15
- 28. 13.350.0no 954.525 Series EEP lea. 8. 7.255 9-01-79 3 01-05 1.540.000 100.00 3.01 96.99 F.52 1.540.000 115.800
- 29. Series llP. as s. I F.
55 - 6.6255 3-01-77 3-01-91 5.600.0n0 100.00 3.74 96.26 6.80 5.600.000
- 30. 380.000 Series itP. Ilus. 5 15 61 - 6.Fs 9 01-19 3 01-91 3.250.000 100.00 2.66 97.34 6.82 3.250.000 221.650 E$bNE 1MME5,h
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CASE NO. U-6488 EXHISIT NO. SCHEDULE N0!' WITNESS: G. Stojic O,- DATE: Page 9 of 2c Pages DCTRolf EDISON COMPANY SHORT-TERM DEST COST RATE December 31, 1979 Line Percent of i Dollar Sho rt-Te rm Cost Weighted No. Description Amount Deb t Rate Cost Bank Loans
- 1. Detroi t Bank & Trus t $ 6,000,000 4.16% 14.25 % 59%
5,000,000 3.47 14.70
- 2. 51 National Bank of Detroit 7,000,000 4.86 15.25 74 6,500,000 4.51 15.00 .68
- 3. Barclay's Bank international 10,000,000 6.93 14.28 99 10,000,000 6.93 14.28 99 10,000,000 6.93 15.75
- 1.09 15,000,000 10.40 15.25
- 4. Continental Illinois 1.59 6,000,000 4.16 14.10 59 Commercial Pacer 5 Lehman Commercial Paper Inc. 4,998,048 3.47 14.05 .49 4,974,767 3.45 13.975 .48 4,971,320 3.45 14.75 51 5,339,679 3. 70 14.375 53 Trus t Demand Notes
- 6. Detroic sank & Trust 10,000,000
- 7. 6.93 13.7 95 i Manufacturers National Bank l of Detroit 10,000,000 6.93 13.7 .95 Notes Payable ,
- 8. Renaissance Energy Company 28,432,383 19.72 15 33 3.02 9 Total $144,216,197 100.00% 14.70%
Source: Company Reports to the Michigan Public Service Commission t l l O l l
CASE No. U-6488 EXHISIT No. SCHEDul.E No. WITNESS: G. Stolic O ,-- _ DATE: Page 10 of L Pages CETRolT EDISCN COMPANY PRIME RATE - SHORT-TERM DEST RATE RELATIONSHIP P rime Conene rcial Bank Note Demand Note Line Interest Paper Rate as % Rate as % of No. Rate as % of Date Rate of Prime Rate Prime Prime Rate
- 1. January, 1979 11.75% 93% 92% 90%
- 2. Februa ry , 1979 11. 75 00 88 3 March. 1979 11.75 90 88 4 Aoril, 1979 11.75 90 87
- 5. May, 1979 11 75 91 91 88
- 6. June, 1979 11.50 93 93 88 7 July, 1979 11.75 89 93 86 O 8. Aueuse. i979 12.25 88 95 87 9 Septemmer, 1979 13 50 33 38 88
- 10. Oc tobe r, 1979 15.00 97 84 90
- 11. No vem.b e r, 1979 15.50 '98 94 92
- 12. Cecer.be r, 1979 15.25 98 99 90 13 Average $2 92 89 Source: I rving Trus t Publication. Menev Market Rates and Applicant.
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CASE NO. U-6488 EXHISIT NO. SCHE 0ULE No. WITNESS: G. Stojic DATE:
.. Page 1T of 2c Pages DETRolT EDISON COMPANY ESTIMATED SHORT-TEAM DEST COST December 31, 1981 Percent of ' Estimated Weighted Line Dollar Sho rt-Te rm Cost Cost No. Oes cric tion Amcunt Debt Rate Rate (000's)
(A) (8) (C) (D)
- 1. Comercial Paper $ 20,284 17.522 11.04% 1 93%
- 2. Bank Notes 75.500 65.21 11.04 7.20 3 Demand Notes 20,000 17.27 10.68 1.84 4 Total $115.784 10 972 O
Source: Company Reports to the Micnigan Public Service Commission and the Witness, a . O
O- O O - DEIRolT EolSON CoHPANY PREFERREO SloCK COST - oecember 31. 1979 Annual Price Expense Net Number Total Value Annual Line olvidend Par to Proceeds to of shares of Net No. of Cost Dollar Description Requirement Value Public financing Cosapany outstanding Proceeds Rate Amount (A) TBT (C) (D) (E) (F) (G) (H) (1)
- 1. 511 series S 5.50 $100.00 $ -- $2.19 $ 97.88 463,480 $ 45.332.979 5.62% $ 2.547.713
- 2. 9.32% Series 9.32 100.00 100.00 2.01 -97.99 499,080 - 48.904,849 9.51 4.650.851 3 7.681 series 7.68 100.00 100.00 1.69 , 98.31 500.000 49.155,000 7.81 3.839.006
- 4. 7.451 series 7.45 100.00 100.00 1.54 98.46 600 000 59.076,000 7.57 4.472.053 5 7.361 Series 7.36 100.00 100.00 1.38 98.62 750.000 73.965.000 7.46 5.517.789
- 6. 9.72% series 9.72 100.00 100.00 1.54 98.46 600.000 59.076.000 9.87 5.830.801 7 9.601 series 9.60 100.00 --
1.11 98.89 355.000 9.71 3,408.788 35.305.950
- 8. Total
$370.615.778 $30.267,001
- 9. Cost Rate 8.l?t Source: Company Reports to Michigan Public Service Consnission.
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O. O O . DETR0li EDISON COMPANY PREFERREO STOCK COST Decemlier 31 1980 Annual Price Expense Net Numiser Total Value Line Annual Dividend Par to of Proceeds to of shares of Net No. Cost Dollar Description Requirement Value Public Financing Company Outstanding Proceeds Rate Amount
- 1. Sit series (A)
$ 5.50 76F T ~
$100.00 $ --
(D) (E) (F) (G) W (I)
$2.19 $97.81 314.390 $ 30.750.486 5.62t $ l.728.177
- 2. 9.321 series 9 32 100.00 100.00 2.01 97.99 499.080 48,904,849 9 51 4.650.851
.. 7.681 series 7.68 100.00 100.00 1.69 98.31 500.000 49.155,000 7.81 3.839.006 4
8 7.45% Serles 7.45 100.00 100.00 1 54 98.46 i 600.000 59.076.000 7.57 4.472.053 j 5 7.36% Series 7.36 100.00 100.00 1.38 98.62 750.000 73.965.000 7.46 5.517.789
- 6. 9.721 series 9.72 100.00 100.00 1.54 98.46 600.000 59.076.000 9.87 5.830.801 1980 Issues 7 9.601 series 9.60 100.00 --
70 99.30 650.000 64.545.000 9.67 6.241.502
- 8. 12.8% 3eries 12.80 100.00 --
1.69 98.31 400.000 39.324.000 13.02 5.119.985 9 12.4% Series 12.406 100.00 -- 1 59* 98.41 500.000* 49.205.000 12.604 6.199.830
- 10. Total $474,001.335 $43.599.994 II. Cost Rate 9.20%
Source: Company Reports to the Miclaigan Public Service Commission "EfNE9 hkhh5 A Estimated "
- = s ;=
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g DETROIT EDISON COMPANY PREFERREO STOCK COST December 31, 1981 i 1 Annual Price Expense Net Number Total Value Annual Line Dividend Par to of Proceeds to of shares of Net Cost Dollar j _No. Description Requi rement Value Public Financing Company outstanding Proceeds Rate Amount j (A) (B) (C) (D) E) (F) (I)
- 1. 51% Series $ 5.50 $100.00 $ --
$2.19 $3(7.81 169,680 $ 16,(C)596,401 5(H) 622 $ 932,718 i 2. 9.32% Series 9 32 100.00 100.00 2.01 97.99 499,080 48,904,849 9 51 4,650,851
) 3 7.681 Series 7.68 100.00 100.00 1.69 98.31 500,000 49,155,000 7.81 3,839,006 i j 4. 7.451 series 7.45 100.00 100.00 1.54 98,46 600,000 59,076,000 7.57 4,472,053
- 5. 7.36% series 7.36 100.00 100.'00 1.38 98.62 750,000 73,965,000 7.46 5,517,789
- 6. 9.72% series 9 72 100.00 100.00 1.54 98.46 600,000 59,076,000 5,830,801 9.87
! 1980 issues i 7 9.601 series 9.60 100.00 -- 70 99.30 650,000 64,545,000 9.67 6,241,502 i j 8. 12.8% series 12.80 100.00 -- 1.69 98.31 400,000 39,324,000 13.02 5,119,965
- 9 12.4% series 12.40* 100.00 --
1.59* 98.41 500,000* 49,205,000 12.60* 6,199,830 1_981 issues
- 10. 12.4% series 12.40* 100.00 --
1.59* 98.41 900,000* 88.569,000 12.60* 11,159,694 II. Total $548,416,250 $53,964,229 ] 12. Cost Rate 9.84% [ E 5 { Q {, Q O -m
. A. m W MC=
Source: Conpany Reports to the Michigan Public Service Commission ; . m " .g { "
- Estimated
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DETR0lT EDISON COMPANY PREFERENCE STOCK COST December 31, I979 Annual Price Expense Net Number Total Value Annual Line Dividend Par to of Proceeds to of Shares of Net Cost Dollar No. Description- Requirement Value Public Financing Company Outstanding Proceeds Rate Amount (A) (B)- (C) (D) (E) (F) (G) (H) (a)
- 1. $2 75 Series $2 75 $1.00 $25.00 $1.21 $23.79 1,998,400 $ 47,541,936 11 56% $ 5,495,848
- 2. $2 75 Series a 2.75 1.00 25.00 1.23 23 77 2,000,000 47.540,000 11.57 5,500,378 3 $2.28 Series 2.28 1.00 25.00 1.05 23.95 2,000,000 47,900,000 9.52 4,560,080
- 4. Total $142,981,936 $15,556,306
- 5. Cost Rate 10.88%
i i Source: Company Reports to Michigan Public Service Commission
'2 ,1 # E 5 "l
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i DETROIT EDISON COMPANY PREFERENCE STOCK COST December 31, 1980 i Annual Price Expense Net Line Olvidend Par Number Total Value Annual ) Description to of Proceeds to of shares of Net Cost Dollar _ No . Requirement Value Public Financing Company ~ Outstanding Proceeds Rate Amount (A) 77 77 (D) (E) (F) (G) ~(IIT (1)
- 1. $2 75 Series $2.75 $1.00 $25.00 $1.21 $23.79 1,897,980* $ 45,152,944
- 11 561 $ 5,219,680
- 2. $2 75 Series 8 2 75 1.00 25.00 1.23 23 77 1,944,220* 46,214,109 11.57 5,346,972
- 3. $2.28 Series 2.28 1.00 25 00 1.05 23.95 2,000,000 47,900,000 9.52 4,560,080
( . i
- 4. Total j
$l39,267,05' $15,126,732 l
S. Cost Rate 10.861 i i i ! Source: Coupany Reports to Michigan Public Service Commission Estimates of Applicant and Witness 1 j MMME-m "O85= Sn r H O e a m . i j 00 o . I
' M o
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o 2
O' - o fO I DETRoli EolSON CoHPANY - I PREFERENCE STOCK COST Decensbe r 31, 1981 Net Number Total Value Annual Annual Price Expense Proceeds to of shares of Net Cost Dollar Line Dividend Par to of Rate Amount Requirement Value Public Financing Company __ outstanding Proceeds No. Description (A) (8) lf (D) (E) (F) (G) '(H) (l) 1,797,980* $ 42,773,944 11.56t $ 4,944,668
- 3. $2.75 series $2.75 $1.00 $25.00 $1.21 $23 79 1,844,220* 43,837.109 11.57 5,071,954
- 2. $2.75 series a 2.75 1.00 25 00 1.23 23.77 2,000,000 47.900,000 9.52 4,560,080
- 3. $2.28 Series 2.28 1.00 25.00 1.05 23.95
$134,511.053 $14,576,702
- 4. Total 10.84%
5 Cost Rate Source: Company Reports to Michigan Public Service Consnission
# Estimates of Applicant and Witness E$ $h snn " 0: 8 '" =
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^
l CASE NO. U-6488 CXH1817 No. SCHEDULE N0. WITNESS: G. Stojic () q . DATE: Page 18 of , 1 pages
)
DETA0li EDISON C0dPANY AND COMPARA8LE COMPANIES 8 ETA COEFFICIENTS Line 8 eta No. Company Coefficient
- 1. 3 American Electric Power .65
- 2. Commonwealth Edison 70 3 Consolidated Edison .65
- 4. Consumers Power Company 70 5 Detroit Edison Company .60
- 6. Duke Power Company .70
- 7. Long Island Lighting .65
({])
- 8. Middle South Utilities 70 9 Niagara Mohawk .60
- 10. Northeast Utili ties - 55
- 11. Pacific Gas & Electric 50
- 12. Philadelphia Electric .60 13 Public Service Electr.c & Gas .70 14 Southern California Edison 70 15 Southern Company .65
- 16. Virginia Electric & Power 70 Source: Value Line investment Survey O
CASE NO. U-6488 EXHlBIT No. SCHEDULE No. WITNESS: G. Stojic 9' Page 19 of 25 pages DATE: DETR0lT EDISON COMPANY AND COMPARABLE COMPANtES EARNED RATES OF RETURN ON AVERAGE COMMON EQUITY Five Yetr Line 1*77 1978 1979 Average No. Comoany_ 1975 1976 12.30 % 13 12 % 11 36 % 10 33 % 10.52 : 11.53 t
- 1. American Electric Power 8.91 10.70 11.07 11 57 10.15 11.78
- 2. Coewenweal th Ed i s on 10.52 11.09 11.11 11.58 11.74 10.51 3 Consolidated Edison 11 34 11.20 11.27
- 4. Consumers Power Company 9.33 13.11 11.36 9 56 12.66 12.24 12.77 13.49 12.tk 5 Duke Power 12.1* 13 23 Long Island Lighting 13.37 14.20 14.03 12 37
- 6. 14.19 11.85 12.26 Middle South Utilities 10.73 11.38 13 16 7 11.07 11.44 10.97
- 8. Niagara Mohawk 12.26 9.68 10.39 10.68 10.96 9.70 9.83 9.22 10.08 9 Northeast utilities 10.86 11.20 11.75 10.80
- 10. Pacific Gas & Electric 9.84 10.35 Philadelphia Electric 9.39
- 9.87 9.62 9.71 9.81 9.68 11 1 . 10 39 8.88 11.05 10.84 10.89 10.29
- 12. Public Service Electric & Gas 11.80 10.52 13.61 11.e4 Southern California Edison 10.05 11.22 10.46
() 8.43 8.91 Southern Company 13.62 10.08 11.27 10.54 9.66 10.05 9.63 8.42 9.66 15 Virginia Electric & Power 10.85 t 11.37 % 11.24 4 10.97 % 10.81 4 11.05 t
- 16. Average 7.88 % 8.79 % 10.40 % 9 23 % 10.09 % 9 28 %
17 Detroi t Edison Source: Standard & Poor's Compustac Utility File t i e O
CASE No. U-6488 ' EXNIBIT NO. SCHEDULE NO. WITNESS: G. Stojic O*f Page 20 of 25 pages DATE: w. DETR0lT EDISON CCMPANY AND COMPAAA8LE COMPANIES ~ MARKET T0 800K RATICS (r.arket Price Expressed as a Percentage of Book Value) Line Five Year No. Company 1,jf71 1976 1977 1978 1,j]71 Ave rage
- 1. American Electric Power .87
- 1.09
- 1.15 t 1.06
- 95 t 1.02 2
- 2. Commonwealth Edison 99 1.06 1.06 92 .81 97 3 Consolidated Edison 33 .50 .60 58 .54 51
- 4. Consumers Power Company 52 .75 .85 .82 .76 74 5 Duke Power Company 78 1.03 1.08 96 .85 94
- 6. Long island Lighting .77 98 1.04 98 .85 92
- 7. Middle South Utilities .86 92 95 .87 .78 .88
- 8. Niagara Mohawk .64 .83 93 .86 .80 .81 9 Northeast Utilities .66 .81 .87 75 .72 .77
- 10. Pacific Gas & Electric 76 .81 .86 .32 .80 .81
- 11. Philadelphia Electric .68 .86 1.00 90 .81 .85
- 12. Public Service Gas & Electric .61 .80 91 .83 .76 .78 -
13 Southern California Edison .62 .66 75 76 76 .71 14 Southern Company .71 91 99 90 77 .86 15 Virginia Electric & Power .61 77 .81 77 .66 72
- 16. Average .69 % .85 % 92 % .85 % 77 % .82 t 17 Detroit Edisen Company 59 % 76 % .88 % .80 75 t 76 %
Scurce: Standard & Poor's Compustat utility File i l O . l
l CASE NO. U-6b88 EXHIBIT NO. SCHEDULE NO. WITNESS: G. sto_iic OATE:
- Page 21 of 1 Pages Adjust:nent Required to Maintain a Market Price - Book Value Ratio of 1.04
- 1. Basic Model: P = rBo(1-b) k-br
- 2. Then: P = r(1-b)
E k-br 3 Let P/Bo = 1.04 4- Then: 1.04 = r(1-b) k-or 5 And: (1.04) (k-o r) = r(1-b)
- 6. 1.04k -
1.04 br - r(1-b)
- 7. 1.04k =
r(1-b) + 1.04br 8- 1.04k = r-br + 1.04br 9 1.04k = r + .04 br
- 10. 1.04k =
r(1 + .04b)
- 11. Or: r = 1.04k 1+.04b
- 12. Where: P = Market Price S = Book Value r = Espected Return b =
Retention Rate k = Olscount Rate
- 13. For k = 13.61%: (1.0373)(.1361) = 1 .02%
1+( .03 73) ( .1778) l l i l
CASE No. U-6488 ' EXHlBIT NO. SCH200LE No. WITNESS: G. Stojic DATt: "' Page 22 of 25 Pages OETA0lT EDISON COMPANY Cosmon Stock issuance Expense Line No. 1978 1977 1976 Descriotion issue issue issue (A) (S) (C) 1 Price to Pubile $16.38 $16.00 $13.88 2 Less Underwriting Fee .48 52 55 3 Less Flotation Expenses .04 .08 .04 4 Net Proceeds to Cosmany $15.86 315.40 $13.29 5 Expenses as a Percent of Price 3.17% 3.75% 4.25% 6 Average 3.73% O i { l
l CASE No. U-6488 EXHIBIT NO. SCHEDULE NO. WITNESS: G. StoJIe DATE: h, Page 23 of 25 Pages RISK FREE RATE OF RETURN AND MARKET RISK PREMluM - INFLATION REGRESSION EQUATION Long-Term Short-Term Line U. S. Governawnt U. S. Government No. Interest Ra W_ Interest Rate *
- 1. September 3 11.02% 10.78%
- 2. August 27 l 11.32 11.34 August 20
- 3. 11.10 10.87
- 4. August 13 10.87 9.92
- 5. Average 11.082 10.73%
- 6. Estimated Market Return: 11.08% + 8.17% = 19.25% 1
- 7. Regression Equation:
- 8. Market Risk Premium = 16.33 -
2.21 x Inflation Expectation 9 t-value = (3 16) (-2.05)
- 10. R2 = .15
- 11. .86 = 16.33 -
2.21 x 7 l 1 l
- 12. Regression Data:
1/54 -0 50 31.71 1/55 0.37 31.82 1/56 2.86 10.14 1/57 3.02 l
-15.03 1/58 1. 76 ' 35 75 1/59 1.50 17.03 1/60 1.48 - 9.29 1/61 0.67 26.32 1/62 1.22 -14.77 "
1 1/63 1.65 21.14 1/64 1.19 12.54 1/65 1.92 13.25 1/66 3.35 - 8.33 1/67 3.04 25.95 1/68 4.72 15.32 l 1/69 6.11 - 0.03 1/70 5.49 -11.68 1/ 71 3.36 5.43 1/72 3.41 17.40 1/73 8.80 -11.46 1/74 12.20 -27 37 1/75 7.01 34.44 1/76 4.81 6.81 1/77 6.77 - 0.17 l 1/78 9 03 16.90 i ( O
- Source: Standard & Poor's Publication, The Outlock.
l l l
CASE No. U-65.88 EXHIBIT No. SCHEDULE No. WITNESS: G. Stojic DATE: O. Page 24 of 25 Pages DETROIT EDISON COMPANY COMMON EqulTY COST RATE ESTIMATES CAPITAL ASSET PRICING MODEL Line No. ! Sasic Model
- 1. kg = Rf + bg (k ,- Rr)
- 2. 13.79 -
11.08 + .60 (4.52) 3 13 44 = 10.73 .60 (4.52) O O
-
- vo r, mu. U-otee ;
EXHislT NO. l SCHEDULE No. i WITNESS: G. Stojic CATE: l O. Page 25 of 25 Pages DCF REGRESSION ESTIMATED REGRES$1CN EquATICM Line No.
- 1. O,
= 11.35 + 4.83 sera Coefficient -
32 Grcosth Rate P
- 2. t-values: (8.73) (2 36 (-4.20)
R 2 = .60 3 0 l l l l 1 i
, - - , , - - - . , ,}}