ML20003F008
| ML20003F008 | |
| Person / Time | |
|---|---|
| Site: | Comanche Peak  |
| Issue date: | 09/30/1980 |
| From: | Olson C DALLAS POWER & LIGHT CO. |
| To: | |
| Shared Package | |
| ML19240B984 | List:
|
| References | |
| NUDOCS 8104170665 | |
| Download: ML20003F008 (38) | |
Text
OLSON PAGE 1
1 TESTIMONY OF CHARLES E. OLSON 2
3 Q.
PLEASE STATE YOUR NAME AND BUSINESS ADDRESS.
4 A.
My name is Charles E. Olson and my business address is 2000 L Street, N. W.,
5 Washington, D. C. 20036.
6 Q.
WlIAT IS YOUR OCCUPATION?
7 A.
I am an economist and President of Olson & Company, Inc.
8 Q.
PLEASE OUTLINE YOUR EDUCATION AND EXPERIENCE.
9 A.
I attended and received the following degrees from the University of Wisconsin at 10 Madison:
B.B.A. In 1964 (Senior Honors), M.S. in 1966, and Ph.D. in 1968. My 11 doctoral dissertation analyzed the structure of the electric power industry.
12 I joined the University of Maryland in 1968 as an Assistant Professor and 13 taught full-time in the College of Business and Management.
I have taught 14 graduate courses in managerial economics, public utilities and transportation and 15 undergraduate courses in public utilities and transportation.
16 In 1971 I was promoted to Associate Professor, the rank I held untilIleft in 17 September,1976, to join H. Zinder & Associates as Senior Economist.
In 18 December,1977, I was elected Vice President and in December,1979, I was elected 19 Senior Vice Presir' ant, in September,1980 I resigned my position with H. Zinder &
20 Associates and assumed my present position.
21 During the past ten years I have authored or coauthored many papers, 22 articles, reports and other published material. I have published in the Public 23 Utilities Fortnightly, Land Economics, the Transportation Journal, Business Hor-24 izons, and the Highway Research Record. The Institute of Public Utilities at 25 Michigan State University published a revised version of my thesis which is titled 26 Cost Considerations for Efficient Electricity Supply. I also have contributed to 27 two other volumes, Regional Economic Effects of Alternative Ilighway Systems 28 (Ballinger Publishing Co.,1974) and Studies in Electric Utility Regulation (Ballinger 810.417 0(r(/5
OLSON PAGE 2
1 Publishing Co.,1975).
2 I have given speeches, workshops and papers to many groups, both academic 3
and business.
I have been a coordinator and lecturer in the American Gas 4
Association's annual Rate Fundamentals Course at the University of Wisconsin 5
since 1971. The topics I have lectured on in this course include pricing, utility 6
accounting, rate level determination, cost of capital and rate of return, and cost of 7
service analysis. I have also lectured to other American Gas Association short 8
courses.
9 During the past several years as a consultant, I have worked on more than 125 10 rate and certificate cases and have presented testimony more than 100 times. I 11 have testified before the Federal Communications Commission, the Postal Rate 12 Commission, the Federal Energy Regulatory Commission, the New York Energy 13 Planning Board, the Dallas City Council, and public utilities commissions in 26 14 states and three Canadian provinces. The cases involved electric, gas, water, and 15 telecommunications utilities. I have also testified in oil pipeline and taxi cases.
16 My testimony has covered numerous subjects, including: fair rate of return, rate 17 base, revenue requirements, revenue and expense adjustments, pricing, and rate 18 design.
19 In addition, I have been a consultant on numerous projects and studies, 20 including a study of the Uniform System of Accounts for telephone companies and 21 a study of entry and fare determination policy for the taxicab industry in 22 Washington, D. C.
Working for the Development Advisory Service of Ilarvard 23 University, I advised the government of Columbia on public utility rates in 1969. In 24 1977-1978 I directed a gas demand study for the gas distribution utilities in New 25 York. Finally, I directed a study on gas rate design for the ERA in 1977-1978.
26 I have also donc a significant amount of community service work, testifying 27 in a number of cases on a pro bono basis. I have presented testimony before two 28 Congressional committees. I was a member of two Federal Power Commission
OLSON PAGE 3
1 National Power Survey Advisory Committees. Finally, I was Vice Chairman of the 2
FPC's Gas Policy Advisory Counsel, Transmission, Distribution and Storage-3 Technical Advisory Task Force-Rate Design.
4 I am a member of the American Economic Association and its Transportation 5
and Public Utilities Group, the Association for Evolutionary Economics, the 6
Transportation Research Forum, and the American Society of Traffic and Trans-7 portation.
8 Q.
WHAT IS YOUR ASSIGNMENT IN THIS CASE?
9 A.
The management of Dallas Power & Light Company (DP&L) has requested that I 10 make a study to determine the appropriate return on common equity capital for the 11 Company. The return on equity capital that I develop will be utilized in the 12 Company's presentation on the fair rate of return.
13 Q.
WHAT MATERIALS DID YOU UTILIZE IN THE PREPARATION OF YOUR TES-14 TIMONY AND EXHIBITS?
15 A.
Most of the information I utilized was from standard financial sources, including 16 alnual reports, prospectuses, published financial reports, market reports and so on.
17 In addition, I have met with the financial management of Dallas Power & Light l
18 Company. Finally, I presented return on equity testimony for the Company in 19 Docket Nos.1526 and 2572.
20 Q.
WILL YOU PLEASE EXPLAIN THE MEANING OF THE FAIR RATE OF RETURN?
21 A.
Any business, whether regulated or unregulated, must earn enough dollars of profit 22 to compensate present investors if new capital is to be attracted on reasonable 23 terms. If new capital cannot be attracted on reasonable terms, a business will have 24 difficulty providing reliable and adequate service. The fair rate of return is a 25 percentage figure, which, when applied to the appropriate rate base, will yield the 26 earnings required to attract capital on reasonable terms. This amount, known as 27 the earnings requirement, must be added to reasonable operating expenses, 28 depreciation, and taxes to determine the total revenue requirement that must be l
OLSON PAGE 4
3 obtained from the rates charged.
2 Q.
HOW SilOULD TIIE RATE OF RETURN BE DETERMINED UNDER PUBLIC 3
UTILITY REGULATION?
A.
The prevention of monopoly profits, i.e., a competitive result, suggests that the 4
5 purpose of public utility regulation with respect to rate of return is to permit the E
6 regulated company to earn its cost of capital. By permitting a regulated company 7
to earn its cost of capital, regulation prevents inadequate earnings as well.
8 Earnings levels above the cost of capital in the long-run imply monopoly profits; 9
li.<ewise long-run earnings levels below the cost of capital indicate inability to 10 attract capital on reasonable terms. The principle has been stated as follows:
jj Regulation should assure that the average expected rate of return on desired new investment is equal to the utility's cost of capital.1/
12 This statement is a correct one, but can be expanded upon for sake of clarity and 13 proper application to the present case.
14 Under competition a firm cannot expect to earn more on a project it is about 15 to undertake than its cost of capital. If more were expected the project would be 16 undertaken by the firm's competitors and the actual rate of return would be driven 17 down. While more than the cost of capital may be hoped for, the rational firm 18 operating in a competitive market cannot expect more than the competitive rate 19 of return or cost of capital from a given project. In a similar fashion there is no 20 reason to expect any nonregulated firm to undertake a project that will produce a 21 rate of return that is below the cost of capital.
22 Presumably, a regulated firm such as DP&L can carn more than its cost on at 23 least some of its projects; otherwise there would be no reason for its being 24 regulated. If the rate level objective of utility regulation is to approximate what 25 would happen in competitive markets, then it follows that the average expected 26 27 1]
Stewart C. Myers, "The Application of Finance Theory to Rate Cases, " The Bell Journal of Economics and Management Science, Vol. 3, No.1 (Spring 1972),
28 p.80.
OLSON PAGE 5
1 return on all new investments is held to the cost of capital. This does not mean 2
that all new investments should be expected to earn the cost of capital because the 3
regulatory agency may have public policy dictated nonrate level objectives that 4
call for cross-subsidy between investments. The point is that the average expected 5
rate of return on new investment in total should be equal to the cost of espitalif 6
the competitive norm is taken as the standard.
7 In practice there is a significant complication that must be considered if the 8
rate of return is to be based on the competitive standard. It results from the fact 9
that actual or embedded debt costs at any given time are not equal to current debt 10 costs. When embedded debt costs are combined with the cost of equity capital 11 (which is the current cost), the result is a weighted cost of capital that is above or 12 below what the cost would be if both the debt and equity were priced on a current 13 basis.
14 The difference between the current cost of capital and the traditional or 15 embedded cost can be shown using a sir ple example. Assume that a utility has 60 16 Percent debt capital and 40 percent equity. If the equity cost is found to be 16 17 percent and the embedded cost is 8 percent, the weighted cost is considered to be 18 11.2 percent, as computed below:
19 Capital Cost
% of Weighted Component Rate Capital Cost 20 Debt 8%
60 %
4.8%
21 Equity 16 40 6.4 11.2 %
22 The 11.2 percent figure is the one that is assumed to meet the so-called cost or 23 competitive standard. But it does not if the current cost of debt capital is not 8 24 percent. If the same utility would have to pay 12 percent for its debt capitalin the 25 current market, its weighted cost of capital would be 13.G percent as computed 26 below:
27 28
i OLSON PAGE 6
Capital '
Cost
% of Weighted 1
Component Rate Capital Cost 2
Debt 12 %
60 %
7.2%
Equity 16 40 6.4 3
13.6 %
4 Why does the 11.2 percent cost of capital figure not meet the competitive 5
standard while the 13.6 percent does?
The answer is straightforward.
The 6
competitive norm is forward-looking while the embedded cost concept is historical.
7 Expected rates of return govern what the cost of capital is, not historical ones.
8 New projects must be financed with new capital and the market price must be paid l
9 for such capital. A firm operating in a competitive market could obtain a profit or 10 loss depending on the timing of its debt issues. If debt capitrJ was issued for a 30-11 year term in the 1950's at a 4 percent rate of interest, a profit will result from the 12 use of this capital when interest ' rates on comparable debt exceed 4 percent.
13 Likewise, if a firm issued 11 percent bonds in 1974, it suffered losses once interest i
14 rates declined.
Thus, to repeat the point that was stated earlier:
Under I
15 competition the relevant cost of debt capitalis the cost at the margin which is the l
16 current cost. No other cost is consistent with this standard.
i 17 Q.
IN ANSWERING THE LAST QUESTION YOU STATED THAT THE COST OF 18 CAPITAL SHOULD BE EARNED ON DESIRED NEW INVESTMENT.
WHAT 19 RETURN SHOULD BE EARNED ON THE EXISTING INVESTMENT?
20 A.
I will again frame my answer in terms of the competitive standard. This standard 21 is important in terms of proper resource allocation. The incremental or current 22 cost of capital should be earned on the competitive market value of the firm's 23 assets. In other words, whatever the assets of a utility are worth in a competitive 24 market should determine their value for ratemaking purposes. This approach to 25 ratemaking is equivalent to long-run marginal cost pricing. Depending on the 26 relationship between marginal cost and average costs, the rate of return on a rate 27 base determined under the competitive market value approach could be higher or 28 lower than on a book value rate base.
l
OLSON PAGE 7
1 Q.
WOULD YOU NOW DISCUSS THE HISTORIC GUIDELINES TO THE DETERMINA-2 TION OF THE FAIR RATE OF RETURN FOR REGULATED UTILITIES?
3 A.
The Bluefield and Hope cases as decided by the U. S. Supreme Court provide the 4
background to the determination of a fair rate of return. In 1923 in the Bluefield 5
Water Works case the U. S. Supreme Court set forth criteria as follows:
6 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 for the conven-7 ience of the public equal to that generally being made at the same time and in the same general part of the country on investments in other 8
business undertakings which are attended by corresponding risks and uncertainties; but it has no constitutional right to profits such as are g
realized or anticipated in highly profitable enterprises or speculative ventures. The return should be reasonably sufficient to assure con-10 fidence in the financial soundness of the utility and should be adequate, under efficient and economical management, to maintain and support 11 its credit and enable it to raise the money necessary for the proper discharge of its public duties. A rate of return may be reasonable at 12 one time and become too high or too low by changes affecting opportunities for investment, the money market and business conditions 13 generally. 262 U.S. 679,692-93 (1923) 14 In 1944 in the Hope Natural Gas Company case, the Court elaborated on this 15 as follows:
16
... the return to the equity owner should be commensurate with returns on investments in other enterprises having corresponding risks.
17 That return, moreover, should be sufficient to assure confidence in the
(
financial integrity of the enterprise, so as to maintain its credit and to attract capital. 320 U.S. 591,603 (1944) 18 4
What do these decisions mean in terms of how the rate of return should be 19 20 calculated? The Bluefield case states that a utility should be permitted a return 21
" equal to that generally being made... on investments in other business 22 undertakings attended by corresponding risks and uncertainties." Likewise, the 23 llope case states that "the return to the equity owner should be commensurate with 24 returns on investments in other enterprises having corresponding risks." These 25 statements imply that the fair rate of return to a regulated utility should be 26 comparable to the returns on investments in other businesses having corresponding 27 risks. The opinions of the Court appear to raise more questions than they answer.
28 The Bluefield case implies that the fair rate of return should be equal to that being
OLSON PAGE 8
1 earned by businesses having corresponding risks but the H_og case refers to the 2
return on equity capital only. What is meant by corresponding risks?
Against 3
whose investment should the return be measured, that of the original owner or 4
equity holder in the business or that of the prospective buyer of the business or the 5
stock in the business?
6 Given that there are differences in the embedded cost of debt capital 7
between companies and given that the Court referred to the equity owner in the 8
Hope case, it would appear that the so-called comparable earnings standard is 9
intended to be a measure of the cost of equity capital when it can be measured and 10 not the overall return. In practice this is the way the standard has been applied.
11 Finally, if we decide that we understand just what the Court meant by 12 corresponding risks and have found a sample of companies for measurement 13 purposes whose stocks are publicly traded, against what investment do we measure 14 the returns? That of the potential investor who would buy stock today? Or do we 15 measure the returns on book value? And do we take the Court seriously in its statement in Bluefield that the measurement should be limited to the "same time 16 17 and in the same general part of the country?"
18 l Fortunately, the Court spelled out another standard in both the Bluefield and l
19 Ilope cases which is far easier to understand and implement; it is also consistent t
20 with the comparable earnings standard. In Bluefield the Couit said the following:
l l
"The return should be reasonably sufficient to assure confidence in the financial 21 22 soundness of the utility and should be adequate, under efficient and economical 23 management, to maintain and support its credit and enable it to raise the money f
24 necessary for the proper discharge of its public duties." Likewise, in Ilope the l
25 Court said: "That return, moreover, should be sufficient to assure confidence in 26 the financial integrity of the enterprises, so as to maintain its credit and to attract capital." The so-called capital attraction standard is a far easier one to deal with.
27 l
28 It means that the regulated utility should be permitted to earn its cost of capital t
L
OLSON PAGE 9
1 because this is what is necessary to attract the capital that is adequate to enable 2
the utility to discharge its public duties. It also meets the basic objectives of rate 3
level regulation as discussed above.
4 Q.
HOW DOES THE CAPITAL ATTRACTION TEST OF THE HOPE AND BLUEFIELD 5
CASES SQUARE WITH THE COMPARABLE EARNINGS STANDARD? ARE THEY 6
CONSISTENT?
7 A.
The answer is a qualified yes. The market place will adjust the pnces of common 8
stock to the level at which the cost of capital is just being earned through the 9
actions of buyers and sellers action in their own best interests. Presumably, the 10 market takes into account differences in risk, taking care of one of the problems 11 discussed above. Thus, when comparable earnings are viewed in the context of' 12 rational capital markets, there is no problem because risk adjusted opportunities 13 are equivalent.
14 Q.
HOW IS THE FAIR RATE OF RETURN DETERMINED FOR A REGULATED 15 ENTERPRISE SUCH AS DP&L?
16 A.
The fair rate of return is detc;' mined through the use of the cost of capital 17 approach. Under the cost of capital approach, separate determinations are made 18 of the cost of each type of capital utilized by the utility. If, for example, a utility 19 is financed with long-term debt, preferred stock, and common equity, the cost of 20 each of these components is estimatee individually. Then the cost rate of each 21 component is weighted by the appropriate percentage that it bears to the overall 22 capitalization. The sum of the weighted cost rates is the overall cost of capital 23 and is used as the basis of the fair rate of return.
24 Q.
DR. OLSON, DID YOU PREPARE ANY EXHIBITS FOR USE IN THIS CASE?
25 A.
Yes. CEO Exhibit Nos.1-12 were prepared under my direction and supervision.
26 Q.
WHAT IS THE CAPITAL STRUCTULE THAT IS PROPOSED BY DP&L FOR THE 27 PURPOSES OF DETERMINING THE WEIGHTED COST OF CAPITAL IN THIS 28 CASE?
OLSON PAGE 10 1
A.
As shown on CEO Exhibit No.1, the capital structrue of DP&L at June 30,1980, as 2
adjusted, consisted of 39.33 percent long-term debt, 0.02 percent notes payable, 3
11.82 percent preferred stock, 6.18 percent accumulated deferred investment tax 4
credits, and 42.65 percent common equity.
5 Q.
IS THE PROPOSED CAPITAL STRUCTURE OF DP&L A REASONABLE ONE FOR 6
RATEM AKING PURPOSES IN THIS CASE?
7 A.
Yes, in my opinion, it is. As is explained in Mr. Karney's testimony, the Company 8
must attract substantial amounts of additional capital during the next several years 9
in order to finance the ongoing construction program. Unlike the construction 10 programs of most electrie utilities, the DP&L program is largely replacement 11 related rather than growth related. The Company must continue to replace its gas 12 and oil-fired base load units with lignite and nuclear generation because of the 13 declining availability of gas and oil.
The Company, of course, must also be 14 prepared to supply the growth related electric power needs of its service territory.
15 In order.to be able to finance a construction program that continues at 16 relatively high levels, the company must be capitalized in a prudent manner. In 17 simple terms, the equity ratio must be high enough to permit additional debt-18 capital to be issued at any time without an adverse effect on the company's credit 19 rating. ?f the capital structure does not permit some margin for additional debt 20 financing at all times, the company is subject to the potential adverse impact of 21 tight credit conditions.
22 Q.
PLEASE DISCUSS IN MORE DETAIL THE RELATIONSHIP BETWEEN CREDIT 23 CONDITIONS AND CAPITAL STRUCTURE FOR A REGULATED UTILITY SUCH 24 AS DP&L.
25 A.
The Federal Reserve Board controls the supply of money in the United States.
26 Because it is widely believed that there is a close relationship between growth in 27 the money supply and inflation, the possibility always exists that the growth in 28 money supply will be slowed or even halted by the Federal Reserve Board. Thus,
OLSON PAGE 11 1
when inflationary pressures exist, a natural policy reaction is to slow monetary 2
growth. This in turL produces tight credit conditions, difficulty in borrowing, and a 3
depressed stock market.
4 Currently (September,1980), we have seen how changes in Federal Reserve 5
Board policy can impact on the ecst and availability of money. In October,1979 6
the Fed announced ti;hter policies with respect to growth rates in money and 7
credit. In large measure this was due to the decline of the dollar relative to other a
currencies. Further tightening was done earlier this year. The result was record 9
interest rates. Since then, interest rates declined but have now begun to move up 10 again.
11 The problem facing a company such as DP&L is that it is difficult to 12 anticipate the timing and duration of Federal Reserve Board credit and monetary 13 policy. All a company such as DP&L can do is develop and maintain a strong credit 14 rating so that borrowing is possible whenever it is required.
15 Q.
WOULD YOU NOW EXPLAIN Tile METilODOLOGY YOU WILL USE TO ESTI-16 MATE TIIE COST OF EQUITY CAPITAL IN Tills CASE?
17 A.
Yes.
Equity owners share in the residual that remains from revenues after 18 expenses, including interest, are paid. Thus, there is no contractual relationship as 19 to required earnings between the common shareholder and the corporation.
20 Earnings on equity can only be judged in terms of whether they prcduce market l
21 prices for the common shares that permit capital attraction on terms that are 22 considered fair and reasonable.
23 From an investor viewpoint the cost of common equity capital to a given 24 company is the minimum expected return which willinduce him to buy stock at the 25 going market price. For example, if an investor will buy a stock that is selling at 26
$50 per share but will not buy it at a higher price, and expects to receive $5.00 in 27 dividends and to sell it in exactly one year at $53, the investor's expected return is 28 16 percent ($8.00+ $50.00). Unfortunately, the task is not this easy because we do
OLSON PAGE 12 1
not know what investors really do expect when they decide to buy or sell a given 2
stock.
3 In my opinion, the most reasonable way to go about estimating the cost of 4
common equity is to utilize the so-called discounted cash flow (DCF) approach.
5 The discounted cash flow approach to estimating the cost of equity capitalis based 6
on the premise that the investor is buying two things when he purchases common 7
stock - dividends and growth. Investors in American corporations have come to 8
expect growth in earnings and dividends per share of common stock because of a 9
public policy that is committed to increasing Gross National Product. In addition, 10 the experience of most U.S. corporations since the end of World War II has been 11 one of increased dividends and earnings per share. The cost of equity capital using 12 the discounted cash flow method is that discount rate which equates a given 13 market price of a stock with the expected future flow of dividends.
14 Q.
WILL YOU ESTIMATE THE COST OF EQUITY CAPITAL FOR DP&L USING THE i
15 DCF METHODOLOGY?
16 A.
Yes, although not directly. Most of the common shares of DP&L are owned by 17 Texas Utilities Company. Texas Utilities is a holding company and also owns all of 18 the common shares of Texas Power & Light Company, Texas Electric Service 19 Company, and five other subsidiaries which perform specialized functions within 20 the system. The common shares of Texas Utilities Company are widely held and its 21 cost of equity capital can be reasonably estimated. I will determine the cost of 22 equity capital for Texas Utilities using the DCF approach and impute the result to 23 DP&L.
24 Q.
IS THE DCF METHOD TIIE ONLY APPROACH YOU CONSIDER IN DETER-25 MINING TIIE COST OF EQUITY CAPITAL FOR DP&L?
26 A.
No, I review and analyze all the information that is available to me in estimating 27 the cost of equity capital for DP&L or any other utility. In this regard I will I
28 present several checks on my DCF estimate of the cost of equity to DP&L.
OLSON PAGE 13 1
liowever, it is my view that the DCF approach is the best single method for 2
determining the cost of equity capital when it can be applied to the company whose 3
rates are at issue.
4 Q.
WHAT INFORMATION IS AVAILABLE AND USEFUL FOR PURPOSES OF MAKING 5
A DCF ESTIMATE OF 'lHE COST OF EQUITY CAPITAL TO TEXAS UTILITIES?
6 A.
We know, and presumably investors are aware, of current conditions in the 7
economy. During the second quarter of 1979 GNP growth flattened; a recession 8
began in January,1980. Consumer prices have increased at a rapid rate, as shown 9
below:
10 Increase in Year Consumer Prices 11 1974 12.2 %
12 1975 7.0 1976 4.8 13 1977 6.8 1978 9.0 14 1979 13.3 15 Inflation rates accelerated early in 1980 and the best that can currently be hoped 16 for is a 12 percent increase in consumer prices in 1980. ilere it should be again 17 noted that the wage-price guidelines have had little impact on the rate of inflation.
18 The prime rate reached 20 percent in April but has since eased to the 11 percent 19 range. Unemployment is currently at 7.8 percent and is expected to rise as the 20 recession deepens.
Finally, money supply growth has been slowed by current j
21 Federal Reserve Board policy.
22 The type of information mentioned above is available in detail. Presumably, 23 investors understand the state of the economy and have their own opinions about 24 GNP growth, interest rates, and other factors.
This influences their return 25 expectations, and thereby determines the maximum price they will pay for a 26 security. Thus, because investors take the economic situation into account in their 27 decision-making, information concerning the economy is reflected in the prices of 28 stocks and bonds at any given time.
OLSON PAGE 14 1
If the discounted cash flow methodology is employed to determine the cost of 2
equity capital of Texas Utilities, the significance of the economic situation is 3
properly thought of in terms of its effect on the share price of the Company's 4
common stock. Just exactly how economic information is translated into share 5
prices is not clear. But it is evident that, to the extent investors are rational, they 6
at least make their best judgment as to the effect of economic conditions on their 7
buying and selling decisions. In this sense, investor perceptions are embedded in 8
Texas Utilities' share price and do not have to be considered separately.
9 Q.
WilAT MARKET INFORMATION IS AVAILABLE TO INVESTORS CONCERNING 10 TEXAS UTILITIES COMPANY?
11 A.
Investors are likely to have the following information regarding Texas Utilities:
12 (1)
Market price data for Texas Utilitics' common shares 13 (2)
Past and present dividends 14 (3)
Past and present earnings 15 (4)
Past, present, and forecasted capital expenditure data 16 (5)
Yicids on the bonds and preferred stocks of Texas Utilities' subsidiaries 17 (6)
Short-term forecasts by security analysts for Texas Utilities' 18 carnings and dividends 19 (7)
Rate decisions of the Texas PUC 20 Q.
IlOW IS TilIS INFORMATION UTILIZED BY INVESTCRS?
21 A.
It is reasonable to assume that it is utilized in investment decision making. In all 1
22 likelihood, the more recent the information, the more weight it is given. Ilowever, 23 it is not reasonable to expect that past trends are ignored. In addition to the above 24 market information, investors are aware of statements by Company management 25 and know that the Texas Utilities subsidiaries are involved in regulatory proceed-26 ings.
27 Q.
PLEASE EXPLAIN IIOW YOU llAVE IMPLEMENTED TIIE DCF APPROACli IN 28 DETERMINING DP&L'S COST OF EQUITY CAPITAL.
OLSON PAGE 15 1
A.
As I indicated earlier, my analysis focuses on the cost of equity to Texas Utilities, 2
the parent of DP&L. I will begin by considering the dividend yield. At the present 3
time the dividend rate on the common shares is $1.76 and price is $17.25; the 4
current yield is therefore 10.2 percent. It is, however, conceptually undesirable to 5
base the return on equity on conditions that exist at a given point in time as they 6
may not be representative of conditions that will exist when the new rates will be 7
in effect. Instead, it is preferable to obtain a current average that eliminates 8
market extremes while still being reflective of present interest rate levels.
9 CEO Exhibit No. 2 shows market prices, dividends and dividend yields for 10 10 years ending December 31, 1979.
As shown, Texas Utilities' dividend yield 11 increased from 3.35 percent in 1970 to 8.89 percent in 1979. The information 12 presented on this schedule is intended to present a historical profile of Texas 13 Utilities' cost of common equity capital, but does not purport to show actual cost 14 levels yeu by year. CEO Exhibit No. 3 presents dividend yields by quarter from 15 the beginning of 1977 into the third quarter of 1980. Yields were in the 6.5 to 7.0 16 percent range in 1977 and have incre9 sed since then. For the first quarter of 1980 17 the Texas Utilities' dividend yield w1s 10.51 percent. The second quarter yield was 18 9.88 percent and so far in the third quarter the avera;;3 yield is 9.68 percent.
19 I believe that the best dividend yield to utilize for purposes of a current DCF 20 analysis is one based on the indicated dividend rate of $1.76 and a simple average 21 of the high and low prices during 1980 (to date). During this period the low price 22 was $14-7/8, the high $19-3/8 and the average $17.12. Using this average price and 23 current dividend the indicated yield is 10.3 percent.
24 Q.
WilAT WAS TIIE DIVIDEND YIELD IN EARLY MARCil,1980 WilEN TEXAS 25 UTILITIES OFFERED FIVE MILLION COMMON SIIARES FOR SALE TO Tile 26 PUBLIC AT $15.50 PER SIIARE?
27 A.
Based on the indicated dividend rate of $1.76, the yield to the buyers of the new 28 shares was 11.4 percent. This is well above the yield of 10.3 percent that I have
OLSON PAGE 16 1
proposed.
2 Q.
IN ITS PAST PRESENTATIONS THE PUC STAFF UTILIZES A FORWARD DIV-3 IDEND YIELD CONCEPT THAT UTILIZES THE EXPECTED DIVIDEND PAYMENT 4
DURING THE COMING YEAR. WHAT WOULD THE TU DIVIDEND YIELD BE ON 5
TH AT BASIS?
6 A.
The TU dividend has been increased by 12e per common share during each of the 7
past three years; in all of these years the increase was declared in February. In my 8
apinion it is reasonable to assume that the dividend will be increased to an.mnual 9
rate of $1.88 per common share or 474 per quarter in February. Combining one 10 quarter at the present rate of 44c with three quarters at the " expected" 47c rate 11 results in a forward dividend of $1.85. When $1.85 is divided by the current price 12 of $17.25, the result is 10.7 percent. This of course is identical to the dividend 13 yield that my analysis produced.
14 Q.
PLEASE EXPLAIN HOW YOU DERIVED YOUR ESTIMATED GROWTH RATE FOR 15 TEXAS UTILITIES.
16 A.
My exhibits present data on Texas Utilities' growth rate in recent years. As was 17 indicated earlier in my tastimony, investors buy both yield and anticipated growth 18 in purchasing a common stock. The growth they buy is expected future growth; 19 this must be estimated using past and current data for U.d company and the 20 economy. I have utilized earnings, dividends, and book value data for purposes of 21 evaluating what investor growth expectations for Texas Utilities are likely to be, l
22 but have placed more weight on the dividend and earnings growth rates.
l 23 CEO Exhibit No. 4 presents earnings data and growth rates for the 11 years l
l 24 ending December 31,1979. Earnings data are important to investors because they 25 reveal what each share produces; they also provide the basis for the payment of 26 dividends. The figures in the column entitled " Percentage Increase Over Prior l
27 Year" show tiac year-to-year increases in earnings per share. The column entitled 1
28
" Rate of Increase to 1979" shows the compound rate of increase for each of the l
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OLSON PAGE 17 1
years shown through 1979. For example, the increase from $1.51 in 19S9 to $2.45 2
in 1979 meant that the compound rate of increase for the period was 6.0 percent.
3 If $1.51 had been put in the bank at 5.0 percent interest at the end of 1969, and 4
interest had been earned on both that amount and the ye.wiy accumulations of 5
interest, there would have been $2.45 at the end of 1979.
6 CEO Exhibit No. 5 presents data on Texas Utilities' dividends and dividend 7
growth since 1969. As can be seen, the compound rate of increase in dividends per 8
share was 6.9 percent for the entire period. Further, dividends were increased in 9
each of the years shown.
10 CEO Exhibit No. 6 presents similar information for the 11-year period 11 beginning in 1970. Estimated dividends can be utilized for 1980 because of the 12 recent dividend increase (February,1980). Again, the pattern is one of steady 13 increase at a level above 6 percent per year.
14 CEO Exhibit No. 7 presents data on Texas Utilities' payout ratio from 1969 to 15 1979. The payout ratio is the percentage of earnings that is paid to the common 16 shareholders in a given period of time. For example, if a company earned $1.00 per 17 share in 1979 and declared cash dividends of $.50 per share, the payout ratio would 18 be 50 percent. Payout ratio data should be considered in the evaluation of dividend 19 growth rates because they indicate how likely it is that past dividend increases will 20 be maintained, decreased, or increased.
A rising payout ratio indicates that 21 dividends are increasing relative to earnings; other things being equal this is a sign 22 of financial weakening.
23 The data presented on CEO Exhibit No. 7 reveals that Texas Utilities' 24 dividends have increased relative to earnings since the early 1970's. Payout ratios l
25 averaged less than 55 percent from 1969 to 1974; for 1979 the payout was nearly 67 26 percent of earnings. This raises a serious question as to whether investors perceive 27 that the 7 percent dividend increases of the past decade can be maintained.
28 CEO Exhibit No. 8 presents data on Texas Utilities' book value per common t
OLSON PAGE 18 1
share from 1969 through 1979.
Column 2 shows the data without the Job 2
Development Investment Credits while column 5 includes these credits. As shown, 3
the rates of increase are rather substantiel, averaging 7 percent without the 4
investment credits and 8 percent with them. In my opinion, the rates of increase in 5
the book value figures are not sustainable. An important reason that they are so 6
high is that there were numerous common stock issues at prices above book value 7
during the early part of this period. With market prices currently being close to 8
book value it 11 no longer reasonable to assume that issues of stock in excess of 9
book value will contribute significantly to growth. On the other hand, if investors 10 expect the Commission to grant some return on the accumulated investment tax 11 credits, then it is clear that book value growth is being maintained at a high level.
12 Q.
DR. OLSON, DO YOU HAVE A CONCLUSION AS TO THE PROPER GROWTH 13 RATE TO UTILIZE IN COMBINATION WITH THE DIVIDEND YIELD OF 10.3 14 PERCENT THAT YOU ESTIMATED EARLIER?
15 A.
Yes. In my opinion, the appropriate growth rate to utilize with the previously 16 estimated dividend yield of 10.3 percent is between 5.5 and 6.0 percent. This 17 figure is above the 10-year earnings growth rate but below the rates of increase in 18 dividends during the past 10 years.
When it is combined with the previously 19 estimated dividend yield of 10.3 percent the result is an investor return require-20 ment of between 15.8 and 16.3 percent.
21 In my earlier discussion relative to Texas Utilities' payout ratio I pointed out 22 that historical dividend growth rates could not be maintained in the face of a 23 declining retention ratio, other things being held constant. By itself, the decrease 24 in Texas Utilities' retention ratio is an indication that an expected growth rate of 25 5.5 to 6.0 percent is not likely. But another factor has been at work that has 26 slowed Texas Utilities' rate of increase in earnings below what investors would 27 expect for the future. Texas Utilities' realized return on common equity capital 28 has declined in recent years, from approximately 15 percent in the 1969 to 1972
OLSON PAGE 19 1
period to 12.2 percent in 1979. Rational investors do not expect this pattern to 2
continue for Texas Utilities because they are aware that its subsidiaries (including 3
DP&L) are being authorized common equity returns of approximately 15 percent.
4 Earned returns of 15 percent on common equity would produce internal growth of 6 5
percent if 60 percent of carnings are paid out (15 percent times 0.40 is 6.0 6
percent).
7 CEO Exhibit No. 9 demonstrates this point. Earnings per share are computed 8
at a 15 percent return level for each of the yests 1969 through 1979 on book value 9
figures that are adjusted to eliminate the sales of stock at prices above and below 10 book value. As shown, the growth rates are generally above 5.5 percent. This 11 growth pattern is evidence that the underlying growth in Texas Utilities' earnings is 12 above the actual level of the past several years.
13 Q.
DO YOU HAVE ANY CHECKS ON THE REASONABLENESS OF THE 15.8 TO 16.3 14 PERCENT INVESTOR REQUIREMENT FOR TEXAS UTILITIES?
15 A.
Yes.
My first check makes use of current returns on net worth for leading 16 manufacturing corporations.
According to the April,1980 Monthly Economic 17 Letter, a publication of Citibank, the returns on net worth in 1978 and 1979 for 18 1,280 manufacturing corporations were 15.9 and 18.4 percent. I realize there are 19 limitations in utilizing such data for ecmparative purposes, but I do so keeping two 20 factors in mind.
First, investment by American industry is lagging because 21 expected returns on many projects are inadequate. To the extent that expected 22 returns are a function of current returns, present equity earnings are not 23 considered attractive by industry. This point has been made in the Economie 24 Report of the President. In the 1978 Report at page 16, the President made the 25 following statement:
26 Business investment has lagged during the recovery for several reasons. Some of the fears engendered by the steep recession and 27 severe inflation of 1973-75 have remained and have reduced the incentive for businesses to invest. Uncertaintics about energy supplies 28 and energy prices have also been a deterrent to investment, and so have
OLSON PAGE __20_
1 concerns about governmental regulations in a variety of areas. Finally, high costs of capital goods and a depressed stock market have dimin-2 ished the incentives and raised the costs to businesses of investment in new plant and equipment.
3 Second, stock market prices in general are close to book value. The Dow Jones 4
Industrial Avuage is about 95 percent of book value. The S&P 400 Industrials are 5
trading about 25 percent above book value. This is a strong 'ndication that the 6
returns earned by most corporations do not include monopoly profits.
7 A second alternative estimate of the cost of common equity can be obtained 8
by reviewing the common equity returns of a broad cross-section of American 9
industry. This infor: nation is presented on CEO Exhibit No.10. Average returns on 10 common equity have increased from about 14 percent in 1973-74 to 16.6 percent in 11 1979. These returns would be even higher if they didn't include the utilities whose 12 realized common equity returns have not been high enough to maintain market 13 prices at levels above book value. A review of the data present on CEO Exhibit 14 No.10 indicates that many firms have the opportunity to earn in excess of 17 15 percent on their common equity capital. Most of these firms have common equity 16 ratios that are far higher than that of DP&L.
17 A third check on my estimate of the cost of common equity can be obtained 18 by utilizing the interest premium approach. In that the payment of bond interest 19 must be made before dividends can be distributed, the cost of debt capital is 20 clearly below the required commca equity return. Information on the premium 21 that investors require over the bond yield can be obtained from a Paine Webber 22 Mitchell Hutchins Inc. publication titled "A Survey of Investor Attitudes Toward 23 the Electric Power Industry." Large institutional investors numbering 158 were 24 surveyed in April-May,1980 and 115 responded. When asked to assume that Double 25 A long-term utility bonds were yielding 12.5 percent, 63 percent of institutional 26 investors in the sample said they would require a return of 16 percent or higher.
27 Some 27 percent said they would require a return of 15 to 16 percent and only 10 28
OLSON PAGE 91 1
percent said that less than 15 percent would be required. In that Texas Utilities' 2
bonds currently yield about 12.5 percent, it is clear that most investors would 3
require 16 percent or more to invest in Texas Utilities.
4 A risk premium of at least 3.5 percent (16 percent less 12.5 percent) above 5
the corporate bond return is consistent with actual investor experience over the 6
last 50 years. In Stocks, Bonds, Bills, and Inflation: The Past (1926-1976) and the 7
Future (1977-2000), Roger G. Ibbotson and Rex A. Sinquefield have shown that 8
common stocks have produced returns that average 5 percentage points more than 9
corporate bond returns. This is consistent with the Mitchell Hutchins survey which 10 showed a mean spread of 4.2 percentage points.
11 Q.
IS THE 15.8 TO 16.3 PERCENT INVESTOR RETURN REQUIREMENT THE COST 12 OF EQUITY CAPITAL TO TEXAS UTILITIES?
The 15.8 to 16.3 percent investor requirement must be increased to 13 A.
No, it is not.
14 allow for finsacing costs and market breaks. Fairness to existing investors dictates 15 that Texas Utilities should be able to issue common equity at prices that produce 16 net proceeds per share that are above book value.
17 In my opinion the market-to-book ratio should be set high enough to permit 18 equity financing with net proceeds equal to or in excess of book under most market 19 conditions. The minimum market-to-book ratio under most conditions should be 20 110 percent and the average higher, depending on the volatility of the common 21 shares of the company whose rates are at issue.
22 The market-to-book premium, in addition to protecting the investor against 23 market volatility, is also required to compensate for the transactions costs that are 24 incurred when common equity is issued. CEO Exhibit No.11 presents acta on the 25 transactions or financing costs associated with Texas Utilities' common s* ;T<
26 offerings during the past 4 years. The January,1979 issue was at $19.50 per share 27 and the net proceeds were $18.91; the transaction cost was thus 3.0 percent.
28
OLSON PAGE ___22.
1 Financing costs tend to increase sharply during down markets. For example, 2
when Texas Utilities issued common shares at $19.50 in October,1974 net proceeds 3
were $16.45 and the financing costs were 5.4 percent. Thus, the risk of down stock 4
markets is compounded; it pulls down the market price and increases the 5
transactions cost.
This double-barreled effect must be taken into account by 6
allowing for an adequate market-to-book equity ratio. As I stated earlier, the 7
minimum market-to-book ratio under most conditions should be 110 percent.
8 When the 15.8 to 16.3 percent investor requirement is increased by 10 l
percent the resulting cost of equity is between 17.4 and 17.9 percent. When it is 9
10 increased by 20 percent the cost is between 19.0 and 19.6 percent.
11 The financing cost adjustment must be applied to the entire investor 12 requirement in order to avoid dilution on a given issue. Assume tnat a utility has a 13 book value of $25.00 per common share and financing costs are 5 percent of the 14 issue price. If a return on common equity that is just equal to the investor 15 requirement is authorized and earned, the shares will trade at $25.00. If new 16 shares are issued, net proceeds available for investment will be $23.75 per share; 17 this of course dilutes the investment of existing shareholders. In order to avoid 18 dilution, the share price must be increased by 5 percent; this is done by increasing 19 the investors' required return by 5 percent.
20 Q.
IF A PREMlUM OF BETWEEN 10 AND 20 PERCENT IS APPLIED TO THE 21 DIVIDEND YIELD INSTEAD OF TO THE INVESTOR REQUIREMENT WILL THE 22 COMMON SHARES TRADE AT 10 TO 20 PERCENT ABOVE BOOK VALUE UNDER 23 NORMAL M ARKET CONDITIONS?
24 A.
No. It is unreasonable to assume that if an investor requirement of between 15.8 25 and 16.3 percent wil' produce a market-to-book equity ratio of 1.0, that a return on 26 equity of less than 17.4 percent (15.8 times 1.10) will produce a market-to-book 27 ratio of 1.10. Such an assumption implies irrational investor behavior.
28 Careful reasoning makes it clear that the market-to-book equity ratio will
OLSON PAGE at 1
increase in proportion to the percentage increase in the equity return above the 2
investor requirement.
For example, if the expected return on Texas Utilities' 3
common shares were zero percent, the shares would trade at zero price. If the 4
expected return on book value were one-half the investor requirement, the shares 5
would trade at one-half of book value. At a return on book value equal to the 6
investor requirement, the shares would trade at book value. Why then should the 7
shares trade at 10 percent above book value if the investor requirement is 8
increased by less than 10 percent? The answer is they will not.
9 Q.
IF THE MARKET-TO-BOOK PREMIUM WERE APPLIED TO THE DIVIDEND YIELD 10 AS A MATTER OF REGULATORY PRACTICE, COULD A UTILITY INFLUENCE 11 ITS AUTHORIZED RATE OF RETURN?
12 A.
Yes. The application of the market-to-book premium to the dividend yield would 13 mean that a utility could increase its return on equity by increasing the dividend 14 payout ratio to 100 percent.
15 Assume, for example, that the regulatory authority determines that a utility's 16 dividend yield is 10.0 percent and the investor requirement is 15.0 percent.
17 Further, assume a 10 percent market-to-book premium is deemed to be appro-18 priate. If this is applied to the yield, the required equity return is 16.0 percent (.10 19 times 10 percent plus 15 percent). But then if the utility increases the payout ratio 20 to 100 percent then the premium rises to 1.50 percent (15.0 percent times 10 21 percent) and the return on equity to 16.5 percent.
22 Q.
ASSUME THAT A UTILITY PAID NO DIVIDENDS AND HAD TO OBTAIN ADDI-23 TIONAL AMOUNTS OF EQUITY CAPITAL EXTERNALLY. IF THE MARKET-TO-24 BOOK PREMIUM WERE APPLIED TO THE DIVIDEND YIELD, WHAT WOULD THE 25 PREMIUM BE?
26 A.
Zero. This of course demonstrates the fallacy of applying the marke*.-to-book 27 premium to the dividend yield. A company such as Texas Utilities that retains a 28 high perceratage of its earnings to help finance its construction program is
OLSON PAGE. 24 1
penalized for keeping its payout ratio low if the market-to-book premium is applied 2
to the dividend yield.
3 Q.
WHAT IS YOUR RECOMMENDED RETURN ON EQUITY?
4 A.
In my opinion the return on equity should be set between 17.0 and 18.0 percent.
5 This level of return includes no implicit allovrance for attrition, i.e., it must be 6
earned if capital is to be attracted on reasonable terms under most market 7
conditions.
8 Q.
DR. OLSON, HAVE THE RETURNS ON COMMON EQUITY THAT HAVE BEEN 9
AUTHORIZED FOR THE TEXAS UTILITIES SUBSIDIARIES IN RECENT YEARS to BEEN ADEQUATE?
11 A.
No. As shown on CEO Exhibit No.12, Texas Utilities' market-to-book ratio has 12 declined since the implementation of the Public Utility Regulatory Act.
The 13 authorized returns have increased, but not rapidly enough to keep pace with the 14 increases in other interest rates.
15 Q.
DOES THIS COMPLETE YOUR TESTIMONY?
16 A.
Yes, it does.
17 18 l
19 1
20 21 l
22 23 l
24 l
l 25 t
26 27 28 l
l I
- _ _ ~ _, _.,
CEO Exhibit No.1 DALLAS POWER & LIGHT COMPANY Capital Structure at June 30, 1980 As Adjusted Capital Percent of Component Amount Capital Structure Long-Term Debt
$348,463,018 39.33 Notes Payable 202,821 0.02 Preferred Stock 104,721,530 11.82 Accumulated Deferred Investment Tax Credits 54,754,385 6.18 i
Common Equity 377,887,842 42.65 Totals
$886,029,596 100.00 Source: Dallas Power & Light Company
DALLAS POWER & LIGHT COMPANY Market Prices, Dividends, and Dividend Yields Texas Utilities Company 1970 - 1979 l
1 (1)
(2)
(3)
(4)
(5)
(6)
Market Price Per Sharc Dividends Dividend Year High Low Average Declared Yield 1970 1/
$30.81
$22.94
$26.88
$.90 3.35%
1971 1/
32.31 27,44 29.88
.96 3.21 1972 36.00 25.75 30.88 1.00 3.24 1973 34.50 20.50 27.50 1.04 3.78 f
1974 25.00 15.25 20.12 1.12 5.57 1975 25,25 16.75 21.00 1.24 5.90 l
1976 22.25 17.00 19.62 1.32 6.73 i
1977 23.375 18.875 21.12 1.40 6.63 1978 22.25 18.00 20.12 1.52 7.55 l
1979 20.125 16,75 18.44 1.64 8.89 h
O
?
I 1/
Adjusted for two for one stock split May 19, 1972.
[W 4
Source: Texas Utilities Company, Annual Report 1979; Moody's Dividend Record and y
Standard & Poor's Stock Guide.
N
DALLAS POWER & LIGHT COMPANY Quarterly Average Market Price and Indicated Dividend Rate for Texas Utilities Company 1977 - 1980 To Date i
(1)
(2)
(3)
(4)
(5)
(6)
Indicated 1/
Market Price Per Sharc Dividend Dividend Quarter High Low Average Rate Yield 1977 I
$22.00
$19.125
$20.56
$1.40 6.81%
II 22.25 18.875 20.56 1.40 6.81 U2 23.375 20.50 21.94 1.40 6.38 IV 22.75 19.75 21.25 1.40 6.59 1978 I
22.125 19.25 20.69 1.52 7.35 II 21.25 19.25 20.25 1.52 7.51 D2 22.25 20.00 21.12 1.52 7.20 IV 20.375 18.00 19.19 1.52 7.92 1979 I
20.125 18.125 19.12 1.64 8.58 H
19.875 18.00 18.94 1.64 8.66 III 19,75 18.125 18.94 1.64 8.66 IV 19.625 16.75 18.19 1.64 9.02 1980 I
18.625 14.875 16.75 1.76 10.51 H
19.375 16.25 17.81 1.76 9.88 III 18.875 17.00 17.94 1.76 9 81 O
t9 O
1/
Dividend rate is an annual disbursement based on the last quarterly declaration.
{5 Source: Texas Utilities Company, Annual Report 1979: Barron's and w
Standard & Poor's Stock Guide.
Z P
w
DALLAS POWER & LIGitT COMPANY Earnings Per Share and Growth in Earnings Per Share for Texas Utilities Company 1969 - 1979 (1)
(2)
(3)
(4)
Percentage Rate of Ea rning s Increase Over Increa se to Year Pe r Sha re Prior Yea r 1979 1969
$1.51 11.9 %
- 5. 0%
1970 1.66
- 9. 9
- 4. 4 1971 1,74
- 4. 8
- 4. 4 1972 1.95 12.1
- 3. 3 1973 2.01 3.1
- 3. 4 1974 2.18
- 8. 5
- 2. 4 1975 2.02
-7.3 4.9 1976 2.29 13.4
- 2. 3 1977 2.40
- 4. 8
- 1. 0 O
1978 2.54
- 5. 8
-3.5 M
O 1979 2.45
-3.5 M
o~W Z
Source: Texas Utilities Company, Annual Report 1979, op. 30-31.
6
I l
DALLAS POWER & LIGilT COMPANY Dividends Per Share and Growth in Dividends Per Share Texas Utilities Company 1969 - 1979 l
~
(1)
(2)
(3)
(4)
Dividends Decla red increase Rate of l
Over Prior Increase to Year Dividend s Year 1979 1969
$.84
- 6. 9%
1970
.90 7.1%
- 6. 9 l
1971
.96
- 6. 7 6.9 t
1972 1.00
- 4. 2
't. 3 l
1973 1.04
- 4. 0
- 7. 9 l
1974 1.12
- 7. 7
- 7. 9 1975 1.24 10.7
- 7. 2 i
l 1976 1.32
- 6. 5
- 7. 5 1977 1.40 6.1
- 8. 2 0
1978 1.52
- 8. 6
- 7. 9
?
Mj.
1979 1.64
- 7. 9 Ei I
W h
Source: Texas Utilities Company, Annual Report 1979, pp. 30-31.
tn
~
DALLAS POWER & LIGHT COMPANY 4
Dividends Per Sha re and G rowth in Dividends Per Sha re 4
Texas Utilities Company l
1970 - 1980 t
(1)
(2)
(3)
(4)
Dividends De cla red Inc rea se Rate of Over Prior Increase to Year Dividend s Year 1980 1970
$.90 7,1 %
- 6. 9%
1971
.96
- 6. 7
- 7. 0 l
1972 1.00
- 4. 2
- 7. 3 J
1973 1.04
- 4. 0.
- 7. 8 4
1974 1.12
- 7. 7
- 7. 8 i
1975 1.24 10.7
- 7. 3 1976 1.32
- 6. 5
- 7. 5 1
j 1977 1.40 6.1
- 7. 9 1978 1.52
- 8. 6
- 7. o n
1979 1.64
- 7. 9
- 7. 3 trl 1980 1.76
- 7. 3 g
erW l
Z 1
O j
Source: Texas Utilities Company, Annual Report 1979, pp. 3 and 30-31.
4 1
DALLAS POWER & LIGIIT COMPANY Ea rnings Per Sha re, Paid Dividends and Payout Ratios Texas Utilities Company 1969 - 1979 (1)
(2)
(3)
(4)
Decla red Payout Ea rning s Dividend s Ratio Year Per Share Per Share (3) + (2) i 1969
$1.51
$.84 55.6%
1970 1.66
.90 54.2 1971 1.74
.96
- 35. 2 1972 1.95 1.00 51.3 4
1 1973 2.01 1.04 51.7 1974 2.18 1.12 51.4 1975 2.02 1.24 61.4 i
1 1976 2.29 1.32 57.6 1977 2.40 1.40 58.3 1978 2.54 1.52 59.8 O
1 M
O 1979 2.45 1.64 66.9 y
b Mean Payout, 1969 - 1979 56.7%
I
)
Source: Texas Utilities Company, Annual Report 1979, pp. 30-31.
DALLAS POWER & LIGHT COMPANY Book Value and Growth in Book Value Texas Utilities Company 1969 - 1979
]
(1)
(2)
(3)
(4)
(5)
(6)
(7)
Yea r-End Year-End Book Value Book Value Excl. Job Inc rea se Rate of Incl. Job Inc rea se Rate of Development Over Prior Increase to Development Over Prior Increase to Year Credits Year 1979 Credits Year 1979 1969
$10.42 11.6 %
7.2%
$10.42 11.6%
- 8. 8%
1970 11.18
- 7. 3 7.1 11.18
- 7. 3
- 9. 0 1971 12.45 11.4 6.6 12.57 12.4
- 8. 5 1972 13.40
- 7. 6
- 6. 5 13.68
- 8. 8
- 8. 5 1973 15.09 12.6
- 5. 5 15.50 13.3
- 7. 7 l
1974 16,30
- 8. 0
- 5. 0 16.85
- 8. 7
- 7. 5 1975 17.07
- 4. 7 5.1 17.95
- 6. 5
- 7. 8 i
1976 18.09
- 6. 0 4.8 19.37
- 7. 9
- 7. 7 i
1977 19.10
- 5. 6 4.4 21.19
- 9. 4
- 6. 9 h
O 1978 20.14
- 5. 4
- 3. 3 22.94
- 8. 3
- 5. 6 M
N 1979 20.80 3
24,22
- 5. 6
.if I
oo Source: Annual Reports to Stockholders, 1979.
CEO Exhibit No. 9 DALLAS POWER 8c LIGHT COMPANY Earnings and Growth in Earnings on Adjusted Book Value at a 15% Return Texas Utilities Company 1969 - 1979 (1)
(2)
(3)
(4)
Adjusted Year-End Book Value Earnings Rate of Per Per Share Increase to Year Common Share 1/
@ 15% Return 1979 1969
$10.42
$1.56 6.5%
1970 11.18 1.68
- 6. 4 1971 11.96 1.79
- 6. 4 1972 12.91 1.94 6.1 1973 13.88 2.08
- 5. 9 l
l' 1974 14.94 2.24
- 5. 5 1975 15.72 2.36
- 5. 6 1976 16.69 2.50
- 5. 4 1977 17.69 2.65
- 5. 2 1978 18.71 2.81
- 4. 3 1
1979 19.52 2.93 l
l l
1/
Excludes Job Development Credits.
I
DALIAS POWER & LIGIIT COMPAIN Returns on Common Equity Capital Industry Composites 1973 - 1979 Industr1 Gry p 1973 1974 1975 1976 1977 1978 1979 Aerospace 11.4%
12.4%
11.9%
13.9%
15.3%
20.3%
21.7%
Airlines 5.2 7.5
-1.8 8.0 13.4 20.3 6.8 Appliances 15.4 6.1 5.7 16.0 18.5 15.7 9.3 Au tomo tiv e 16.1 7.0 6.5 17.2 19.1 16.8 11.3 Banks & Eank Holding Cos.
13.0 13.5 12.4 11.7 12.2 14.3 15.2 Beverages 14.5 14.5 13.6 18.2 17.5 13.2 14.6 Building Materials 15.1 12.6 9.6 14.0 14.6 16.9 15.8 Chemicals 14.8 19.2 14.9 16.6 13.5 14.4 17.1 Conglomerates 11.3 11.8 11.3 13.2 12.9 13.5 18.0 Containers 11.6 14.0 12.0 12.7 11.9 12.1 13.4 Drugs 20.0 19.6 18.9 17.8 18.2 20.4 20.8 Electrical, Electre.nics 15.1 13.4 12.3 18.1 18.2 18.6 19.7 Food Processing 13.6 14.7 14.8 14.9 14.2 14.8 15.4 Food & Lodging 13.6 13.1 11.6 15.1 15.7 18.1 17.1 General Machinery 12.4 13.0 13.1 14.3 14.2 17.5 17.5 Instruments 17.2 15.2 14.4 14.9 14.8 15.3 15.9 Leisure Time Industries 11.3 10.8 12.9 14.6 15.5 18.8 18.0 Metals & Mining 11.0 15.J 7.1 7.7 6.3 10.0 19.4 Miscellaneous Manufacturing 14.4 14.0 11.0 14.1 14.8 16.0 19.3 Natural Resources (Fuel) 15.1 (1) 19.1 13.1 14.4 13.4 13.9 21.5 Nonbank Financial 10.9 10.8 11.4 13.1 16.1 18.8 17.1 Of fice Equipment, Computers 17.1 16.9 16.4 17.9 19.0 20.4 19.8 011 Service & Supply 12.1 18.0 21.8 24.0 21.0 20.5 20.6 Papet and Forest Products 13.6 18.4 13.7 15.6 14.3 15.5 17.7 Personal Care Products 00.7 19.4 17.8 19.5 19.2 20.0 18.2 Publishing 14.4 14.5
- 12. f 13.1 18.6 19.4 20.6 Radio & TV Broadcasting 10.8 16.6 14.7 20.0 21.7 22.3 22.0 Railroads 6.3 7.9 6.4 0.0 8.9 9.3 12.9 Real Estate & Housing 12.6
-0.1 3.2 10.1 14.0 18.4 21.0 Retailing (Food) 9.6 11.4 7.4 11.7 11.7 15.4 15.5 Retailing (Nonfood}
13.3 11.6 9.1 13.2 14.6 14.9 14.5 Savings & Loan 11.9 9.1 9.8 13.6 17.2 18.4 15.4 Service Industries 14.1 15.9 15.3 16.0 16.3 18.2 19.3 Special Machinery 15.9 14.0 17.4 18.7 18.6 18.4 16.5 Steel 9.1 16.0 9.5 7.6 0.8 7.8
'5.4 Textiles & Apparel 10.8 8.8 7.2 12.1 11.9 12.7 13.5 Tire & Rubber 11.6 9.7 7.9 7.7 10.2 5.4 7.8 Tobacco 16.7 16.5 17.3 16.6 N.A.
19.7 20.5 Trucking 20.7 19.4 N.A.
22.2 21.6 21.4 16.9 Utilities 11.9 11.1 11.2 11.9 12.1 12.7 12.8 All Industry Composite 14.0 14.0 11.8 14.0 14.1 15.1 16.6 Q
O (1) Oil companies only.
Source: Business Week.
?
E
DALLAS POWER & LIGIIT COMPANY Offerings of Common Stock for Texas Utilities Company 1976 - 1980 Dnte of Offering March 16, 1976 October 26, 1976 May 3, 1977 March 14, 1978 January 23, 1979 March 4, 1980 Number of Shares Sold 5,000,000 5,000,000 5,000,000 5,000,000 5,000,000 5,000,000 Price Per Share S18.00
$19.125
$19.'15
$20.00 S19.50
$15.50 Gross Proceeds at S90,000,000
$95,625,000
$96,875,000 $100,000,000
$97,500,000 S77,500,000 Offering Undar hriters Discount
$3,150,000
$3,000,000
$2,800,000 S2,750,000 S2,750,000
$3,250,000 or Commission Proceeds to Issuer S86,850,000
$ 92,6 25,0 00
$94,075,000 S97,250,000
$94,750,000
$74,250,000 Istuance Expenses
$175,000 S175,000
$185,000
$190,000
$185,000
$220,000 Nat Proceeds
$86,675,000
$92,450,000
$93,890,000
$97,060,000
$94,565,000
$74,030,000 Nat Proceeds Per Share
$17.34
$18.49
$18.78
$19.41
$18.91
$14.81 Latest Published Earn-
$2.01
$2.19
.S2.35
$2.40
$2.54
$2.48 ings at Issuance Dividend Rate at Date
$1.24
$1.32
$1.40
$1.52
$1.52
$1.76 of Issuance Dividend Net Proce9ds 7.15%
7.14%
7.45%
7.83%
8.044 11.89%
Ratio Earnings Net Proceeds 11.594 11.841 12.514 12.364 13.434 16.75%
Ratio Pintncing Costs 3.69%
3.324 3.08%
2.944 3.014 4.48%
o M
O
's
?
d DALLAS POWER & LIGHT COMPANY Book Values, Market Values, and Market-to-Book Equity Ratios for Texas Utilities Company 1969 - 1979 i
l (1)
(2)
(3)
(4)
Market to Year End Average Book Equity Book Value Market Value Ratio Year Per Share Per Share (3) + (2) i 1969
$10.42
$27.44 2.63 1970
- 11. 18 26.88 2.40 1971 12.45 29.88 2.40 1972 13.40 30.88 2.30 1973 15.09 27.50 1.82 1974 16.30 20.12 1.23 1975 17.07 21.00 1.23 1976 18.09 19.62 1.08 i
)
1977 19.10 21.12 1.11 h
O 1
1978 20.14 20.12 1.00 M
i 1979 20.80 18.44
.89 2
.if 1
Source: Texas Utilities Company, Annual Report 1979, and Standard & Poor's Stock Guide.
THE DISTRICT OF COLUMBIA
)
BEFORE the undersigned authority on this day personally appeared CHARLES E. OLSON, who, having been placed under oath by me, did depose as follows:
"My name is Charles E.
Olson.
I am of legal age and a resident of the State of M4<-'and.
The foregoing testimony, and exhibits, offered by me on behalf of Dallas Power & Light Company, are true and correct, and the opinions stated therein are, to the best of my knowledge and belief, accura'te, true, and correct."
w $.
CHARLES E.
OLSON SUBSCRIBED AND SWORN TO BEFORE ME by the said Charles E.
Olson this 17th day of September, A.D. 1980.
/ u.c
[
/e,.Nbtary Public in and for the Distrit:t of Columbia My commission expires )[
/
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I DIRECT TESTIMONY OF J0E 0. KARNEY FOR DALLAS POWER & LIGHT COMPANY SEPTEMBER 1980
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