Opinion ID: 1140706
Heading Depth: 1
Heading Rank: 4

Heading: ivrate of return

Text: Prior to the proceedings under review, the rate of return last allowed to Mountain Bell was 6.69%. This was established by order in 1953, effective January 1, 1954. The protestants ask that we reverse the Commission with respect to its allowance of a 7.5% rate of return and that we order the Commission to confine the rate of return to 7%. In its findings the Commission made the following pertinent observations concerning rate of return: The difference between revenues and expenses is the net operating income of the utility which produces the return on rate base. The rate of return in percent may be computed by dividing such net operating income by the rate base. The rate of return is a crucial determination, as it is the dollars produced by this rate of return that compensate the utility for its costs of capital. The costs of capital consist of interest on long term debt and associated expenses of debt service (fixed charges), costs of preferred stock, if any, with the balance of net operating income being available to the common equity investors. This balance must be such that capital may be attracted on reasonable terms and must therefore be sufficient to provide for a reasonable and adequate dividend, for a reasonable accumulation of surplus, and for the maintenance of the financial integrity of the utility. The total revenue requirements then consist of all the expenses that may be determined proper, including adjustments, and the above mentioned return on capital costs. The foregoing might be characterized as a condensation of the excellent expositions to be found in Bluefield Waterworks and Improvement Co. v. Public Service Commission, 262 U.S. 679, 43 S.Ct. 675, 67 L.Ed. 1176 and Federal Power Commission v. Hope Natural Gas Co., 320 U.S. 591, 64 S. Ct. 281, 88 L.Ed. 333. Counsel for Mountain Bell appropriately defined rate of return as the percentage by which a utility's rate base is multiplied to determine the wages of capital. Inherent in fixing a rate of return is a determination of debt cost, i. e., interest paid and other expenses incident to the utility's indebtedness. A determination must also be made of a reasonable return to the stockholders of the utility; and we will refer to such return as equity cost. In the computation of rate of return, both costs must be incorporated on a weighted ratio. If the amount of debt were equal to the value of the stockholders' equity and if the debt cost were 6% and a reasonable equity cost were 10%, then the calculated rate of return would be 8% computed as follows: Type of Capital Cost of Proportional Capital Structure Capital Cost ------- ---------- ------- ------------ Debt 50% 6% 3% Equity 50% 10% 5% ___ Overall rate of return 8% In contrast, if the debt ratio were only 20% the calculated rate of return would be 9.2% computed as follows: Debt 20% 6% 1.2% Equity 80% 10% 8.0% Overall rate of return 9.2% Debt ratio is the percentage of debt in the capital structure. The debt ratio of all of the companies in the Bell System is an average approximately of 35%, and the parent company is seeking to achieve a debt ratio for the operating companies of 40%. However, the debt ratio of Mountain Bell in 1967 was only 29%. The equity, constituting approximately 71% of the capital structure, was found by the Commission to be 11,304,429 shares of common stock applicable to the Colorado intrastate operations. These shares had an average book value of $18.65 per share. We should mention parenthetically that the Commission rejected Mountain Bell's request for valuation of property under a present value theory, and the Commission adopted the principle of original cost less the actual accumulated provisions for depreciation (allocated depreciation reserve). The average interest rate paid by Mountain Bell on its indebtedness at the end of 1967 was 4.59%, varying on different issues of debentures from 2.59% to 6.04%. Three witnesses testified with respect to rate of return: Dr. Burton A. Kolb, a professor of finance at the School of Business at the University of Colorado, who appeared as a witness for Mountain Bell; Mr. James W. Heckman, a Mountain Bell vice president; and Mr. David A. Kosh of Washington, D. C., a witness for the Commission staff. Both Dr. Kolb and Mr. Heckman predicated their opinions upon comparable rates of return of industrial companies. Dr. Kolb recommended a rate between 7.5% and 8.5% of present value. Mr. Heckman expressed the opinion that the equity cost should be 13%. He applied a hypothetical debt ratio of 40%, i. e., an additional 11%, and placed the interest cost for this additional indebtedness at 5.42%. He recommended a rate of return between 9% and 10% based upon the following computation: Type of Capital Cost of Proportional Capital Structure Capital Cost ------- --------- ------- ------------ Debt Present 29% 4.59% 1.33% Additional 11% 5.42% .60% Equity 60% 13.00% 7.80% _____ Overall rate of return 9.73% Mr. Kosh used a hypothetical debt ratio of 50% with an average interest cost of 4.81%, and stated that he would allow a 9% equity cost. He recommended a 7% rate of return based upon the following computations: Type of Capital Cost of Proportional Capital Structure Capital Cost ------- --------- ------- ------------ Debt 50% 4.81% 2.4% Equity 50% 9.00% 4.5% ____ Overall rate of return 6.9% Mr. Kosh stated that at the 7% rate and with the 50% debt ratio the Colorado intrastate operations of Mountain Bell could withstand a depression more severe than that of the 1930's. The Commission in large part rejected the testimony of Dr. Kolb and Mr. Heckman because it found that in this respect industrial companies are not comparable to regulated monopolies such as Mountain Bell. Additionally, as previously indicated, the Commission rejected the reasonable value theory of valuation of property used by Dr. Kolb in his computation of rate base. In its findings the Commission related its 7.5% rate of return to the situations developed by the expert witnesses. It found that by using the actual 29% debt ratio this rate would produce a 9.2% return on equity, which is comparable to the equity cost favored by Mr. Kosh. It found that, by applying Mr. Heckman's 40% debt ratio and additional debt cost of 5.42%, the 7.5% rate of return would realize a return for equity of 9.28%. Applying the 7.5% rate of return to Mr. Kosh's hypothetical structure of 50% debt ratio and average interest cost of 4.81%, it calculated return on equity to be 10.2%. In effect, it found these equity costs under the 7.5% rate of return to be reasonable in each of the computed examples. Counsel for the protestants have presented the following argument: Since the Commission rejected the testimony of Dr. Kolb and Mr. Heckman, the only testimony remaining upon which the Commission can base its rate of return was that of Mr. Kosh. Thus, they contend, in allowing the 7.5% rate of return instead of the 7% rate recommended by Mr. Kosh, the Commission reached a conclusion not supported by the evidence. The fallacy of this argument is that the Commission must adopt in toto the recommendations of Mr. Kosh. The Commission had an obligation to arrive at a rate of return consonant with its statement of definition and objectives contained earlier in this opinion. In this most voluminous record and among the many exhibits is to be found ample, competent evidence to support the Commission in its findings relating to rate of return. The determination of this end result is not an exact science. The Commission, in addition to the consideration of arithmetical figures and algebraic equations, must evaluate the effect of a large number of factors. This evaluation flows as a stream bounded on each side by the limits of discretion. We hold that the Commission in fixing this rate of return stayed within its discretionary channels. Some or all of the members of this court may feel that the Commission should have evolved the 7% rate; but to do so involves the transmutation of this body from a court to a commission. To quote the apt words of our brother Kelley: The determination of the rate of return, like the fixing of rates, involves many questions of discretion and judgment, which, as we pointed out above, is the task of the Commission and not the courts. So, if the findings of fact on which the rate of return is founded have a legally adequate basis in the evidence and pass the constitutional tests heretofore outlined, the courts cannot disturb the Commission's determination. Public Utilities Commission v. Northwest Water Corp., Colo., 451 P.2d 266. Reference is made to the last paragraph of our following discussion on the subject of abnormal inflation. Conceivably, this may require some reduction by the Commission of the 7.5% rate of return.