10 CFR Appendix I to Part 504, Procedures for the Computation of the Real Cost of Capital
(a) The firm's real after-tax weighted average marginal cost of capital (K) is computed with equation 1.
(b)Information on parameters used in Equation 1.
(1) The parameters used in equation 1 will be the best practicable estimates. They will be obtained from the firm, accepted rating services (e.g., Standard & Poors, Moody's), government publications, accepted financial publications, annual financial reports and statements of firms, and investment bankers.
(2) The predicted nominal cost of debt (R d) may be estimated by determining the current average yield on newly issued bonds - industrial or utility as appropriate - which have the same rating as the firm's most recent debt issue.
(3) The predicted nominal cost of preferred stock (R p) may be estimated by determining the current average yield on newly issued preferred stock - industrial or utility as appropriate - which has the same rating as the firm's most recent preferred stock issue.
(A) The predicted nominal cost of common stock (R e) is computed with equation 2.
(B) The “beta” coefficient is computed with regression analysis techniques. The regression equation is Equation 3.
The regression analysis is done with sixty months of data. The first month (t = 1) is sixty months before the month in which the firm's current fiscal year started. The last month (t = 60) is the last month of the past fiscal year.
(5) Where the parameters specified above are not obtainable, alternate parameters that closely correspond to those above may be used. This may include substituting a bond yield for nominal cost of preferred stock where the former is not available. Where the capital structure does not consist of any debt, preferred equity, or common equity, an alternate methodology to predict the firm's real after-tax marginal cost of capital may be used.
Example of using alternate parameters that closely correspond to those above are:
(A) In the case of industrials, who do not typically issue preferred stock, the predicted nominal cost of preferred stock (R P) can be estimated by determining the current average yield on newly issued industrial bonds which have the same rating as the firm's most recent debt issue.
(B) If necessary, the following assumptions can be made to determine the nominal cost of debt or preferred stock and their flotation costs.
(i) Where a company issued privately placed debt that was not rated, the rating, applied to preferred stock could be used to determine the cost of debt and its flotation cost.
(ii) Where a company issued privately placed preferred stock that was not rated, the rating applied to debt could be used to determine the cost of preferred stock and its flotation costs.
(iii) In the case where all issues were privately placed, the current average yield on all newly issued debt or preferred could be used to determine the cost of debt or preferred respectively, and an average flotation cost, for debt or preferred, could be used.
(C)Evidence Requirements. Copies of this calculation with notations as to the source of the data must be submitted.
(1) Ibbotson, R.E. and R.A. Sinquefield, Stocks, Bonds, Bills, and Inflation, Charlottesville, Va.: The Financial Analysts Research Foundation, 1977, cited by Ernst & Whinney, Costs of Capital and Rates of Return for Industrial Firms and Class A&B Electric Utility Firms, June 1979, p. 3-8.
(2) As an option, R f t can be developed with the following equation: