Opinion ID: 413378
Heading Depth: 2
Heading Rank: 1

Heading: Data Assumptions

Text: 162 Petitioners challenge three separate data assumptions: (1) that industry-wide rather than company-specific data should be used for the rate of return on equity; (2) that the inflation rate should not be allowed to exceed the rate of return on equity; and (3) that the cost of financing an investment is best measured by the company's long-term debt-equity ratio rather than the cost of any particular debt or equity instrument. 163
164 Faced with the question whether a source's past investment performance or the current investment opportunities available to the industry as a whole would better predict future returns on investment, EPA opted for the industry-wide averages, see 45 Fed.Reg. 50,137-39 (1980), despite the fact that it requires source-specific data for the marginal income tax rate and the debt-equity ratio. EPA's choice requires sources to pay the same penalty regardless of recent investment history. Petitioners argue that it is unreasonable to assume that the investment opportunities available to the industry as a whole represent the opportunity available to a particular source. EPA argues, however, that the past performance of an individual firm may have been influenced by non-recurring factors and that the industry-wide averages can be verified far more easily. We are unable to say that EPA's choice was arbitrary or capricious and thus affirm the use of industry-wide rather than company-specific data for the rate of return on equity.
165 EPA's model assumes that in the long run the inflation rate will not exceed the rate of return on equity. EPA admits that in the short run inflation may outstrip investment returns, making compliance expenditures rather costly to a company, but argues that the appropriate time frame to consider is the long run. See 45 Fed.Reg. 50,134-35 (1980). Petitioners argue, nonetheless, that the model should be adjusted to allow a source owner to demonstrate that the use of an inflation rate higher than the rate of return is appropriate to its circumstances. In affirming EPA's decision to operate in light of the long run assumption as neither arbitrary nor capricious, we note that the situation industry envisions is more likely to occur when the period of noncompliance is short and when the resulting penalty adjustments will occur relatively quickly.
166 EPA assumes that the best data for determining the cost of investment is a source's average debt-equity ratio for the last five years, see 45 Fed.Reg. 50,140 (1980), but admits that this may cause the model to overestimate temporarily the benefits of noncompliance to a company that chooses to finance pollution control equipment with low-cost development bonds. This choice is based on the assumption that, due to investors' behavior, firms tend to maintain an equilibrium debt-equity ratio over the long run. In addition, EPA does take into account the availability of development bonds when calculating the interest rate to be applied to debt, even if it does not when projecting an individual company's capital structure. EPA's choice is reasonable, and we affirm it. 167
168 Once a source has come into compliance, its penalty payments cease and a final readjustment is made. If an overpayment has been made, the source is entitled to a refund; if an underpayment has been made, an additional payment is assessed. These refunds and assessments include interest at appropriate prevailing rates (as determined by the Secretary of the Treasury). Sec. 120(d)(4)(A), (B). In accordance with the Secretary of the Treasury's directive, EPA maintains that the interest on underpayments is the rate of return on equity, while the rate for overpayments is that equal to the average rate of interest on Treasury notes over the period of noncompliance. See 45 Fed.Reg. 50,094 (1980). 169 Petitioners argue that, because the rate on overpayments may be lower than that of the rate of return on equity, overpayment could yield penalties in excess of the value of delayed compliance. EPA does not contest this, but argues that the overpayer is taking, in effect, advantage of the fact that its investment is placed in the relatively risk-free hands of the Treasury. Although we are not convinced that this particular dual interest structure is the wisest policy, we hold that EPA has reasonably implemented the statutory mandate which directs that the interest rates be set by the Secretary of the Treasury. 170