[Federal Register Volume 71, Number 185 (Monday, September 25, 2006)]
[Notices]
[Pages 55825-55826]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 06-8098]


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DEPARTMENT OF TRANSPORTATION

Surface Transportation Board

[STB Ex Parte No. 664]


Methodology To Be Employed in Determining the Railroad Industry's 
Cost of Capital

AGENCY: Surface Transportation Board.

ACTION: Request for comments.

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SUMMARY: The Board is seeking comments on the appropriate methodology 
to be employed in determining the railroad industry's estimated cost of 
capital to be used in future annual cost-of-capital determinations. We 
are also soliciting comments on how evidence should be submitted and 
analyzed in future cost-of-capital proceedings.

DATES: Comments are due on or before November 6, 2006.

ADDRESSES: Send comments (an original and 10 copies) referring to STB 
Ex Parte No. 664 to: Surface Transportation Board, 1925 K Street, NW., 
Washington, DC 20423-0001.

FOR FURTHER INFORMATION CONTACT: Paul Aguiar, (202) 565-1527. 
[Assistance for the hearing impaired is available through the Federal 
Information Relay Service (FIRS) at 1-800-877-8339.]

SUPPLEMENTARY INFORMATION: Section 205 of the Railroad Revitalization 
and Regulatory Reform Act of 1976 (4R Act) first codified the 
requirement for the Board or its predecessor to establish and maintain 
standards for railroad revenue adequacy. This provision stated that 
railroad revenues should provide a flow of net income plus depreciation 
adequate to support prudent capital outlays, assure the repayment of a 
reasonable level of debt, permit the raising of needed equity capital, 
cover the effects of inflation, and attract and retain capital in 
amounts adequate to provide a sound transportation system in the United 
States. Subsequent laws (including the ICC Termination Act of 1995) 
have retained this requirement. Thus, each year the Board makes a 
determination of which railroads are or are not revenue adequate.
    The annual determination of the railroad industry's cost of capital 
is used in evaluating the adequacy of railroad

[[Page 55826]]

revenues each year. It may also be utilized in other Board proceedings, 
including, but not necessarily limited to, those involving the 
prescription of maximum reasonable rate levels.
    The cost-of-capital calculation has three elements: (1) The 
railroads' cost-of-debt capital; (2) the railroads' cost of preferred 
stock equity capital; (3) the railroads' cost of common stock equity 
capital; and (4) the capital structure mix of the railroad industry on 
a market value basis. With respect to the cost of equity, there are 
essentially two general approaches. It can be estimated directly by 
estimating its component parts, the factors for which investors ask 
compensation. These parts are the real time value of money, a premium 
for expected inflation, and a premium for risk. This is commonly 
referred to as the Capital Asset Pricing Model (CAPM) methodology. 
Alternatively, it can be estimated indirectly on the basis of the 
return expectations embodied in the prices investors are willing to pay 
for stocks, the Discounted Cash Flow (DCF) methodology. The point has 
often been raised, most notably by the railroads, that investors place 
less importance on historical growth factors than on the analysts' 
forecasts, thus making the forecast more meaningful. Other parties 
contend that investors do rely on historical trends and tend to 
discount the analysts' forecasts as being overly optimistic.
    The Board has, for all previous cost-of-capital determinations, 
relied upon the DCF methodology to determine the railroads' cost of 
capital. We have also used the Institutional Brokers Estimate System 
(IBES) consensus forecast data to determine the growth rate (``g'') 
component of the DCF formula. While the Board has relied on the use of 
the DCF methodology for determining the cost of common equity, there 
are other methodologies that could be employed. These include the CAPM, 
risk premium methods other than CAPM, earnings-price ratios, and the 
comparable earnings method.
    We are seeking comments on the appropriate techniques and 
methodologies to be used to develop and evaluate the evidence submitted 
for the cost of capital. Parties should discuss any changes in 
underlying railroad industry economic conditions that would create the 
need to change the methodology currently employed by the Board, and how 
any proposed methodology will overcome the shortcomings, if any, of the 
currently used DCF method.
    This proceeding will provide all interested parties an opportunity 
to comment on the DCF model, the proper source for the inputs to that 
model, and whether the Board should adopt an alternative to that 
method, such as the CAPM model, for future cost of capital 
determinations.
    This action will not significantly affect either the quality of the 
human environment or the conservation of energy resources.
    Pursuant to 5 U.S.C. 605(b), we certify that the proposed action 
would not have a significant economic impact on a substantial number of 
small entities within the meaning of the Regulatory Flexibility Act.
    Board decisions and notices are available on our Web site at http://www.stb.dot.gov.

    Decided: September 15, 2006.

    By the Board, Chairman Nottingham, Vice Chairman Mulvey, and 
Commissioner Buttrey.
Vernon A. Williams,
Secretary.
[FR Doc. 06-8098 Filed 9-22-06; 8:45 am]
BILLING CODE 4915-01-P