El Paso Electric Company, Texas PUC Docket No. 9945, on behalf of the Office of Public Utility Counsel, April 1991.

Transcription

1 EXHIBIT ESB-2 Page 6 of 7 Peoples Natural Gas Company, Rate Areas Two and Three on behalf of the Nebraska Municipalities Served, November Southern Union Gas Company El Paso Service Area, Public Utility Regulatory Board of El Paso on behalf of the City of El Paso, November City of Round Rock, Texas Water Commission Docket No M, on behalf of Brushy Creek Municipal Utility District, October El Paso Electric Company, Texas PUC Docket No. 9945, on behalf of the Office of Public Utility Counsel, April Houston Lighting & Power Company, Texas PUC Docket No. 9850, on behalf of the Office of Public Utility Counsel, February Greeley Gas Company, Kansas Corporation Commission Docket No. 170,588-U, on behalf of the Citizens' Utility Ratepayers Board, August Rio Grande Valley Gas Company, Texas Railroad Commission Docket No. 7604, Consolidated, on behalf of the Intervener Cities, May Southern Union Gas Company El Paso Service Area, Public Utility Regulatory Board of El Paso on behalf of the City of El Paso, October Texas Utilities Electric Company, Texas PUC Docket No. 9300, on behalf of the Intervener Cities, April Gulf States Utilities Company, Texas PUC Docket No. 8702, on behalf of the Intervener Cities, July Central Power & Light Company, Texas PUC Docket No. 8646, on behalf of the Intervener Cities, June Lower Colorado River Authority, Texas PUC Docket No. 8400, on behalf of several wholesale customers, February Lower Colorado River Authority, Texas PUC Docket No. 8032, on behalf of several wholesale customers, June Tawakoni Water Utility Corporation, Texas Water Commission Docket No R, on behalf of Tawakoni Water Consumers Association, January Hill Country Waterworks Company, Texas Water Commission Docket No. 172-W, on behalf of the City of Hill Country Village and the City of Hollywood Park, July

2 EXHIBIT ESB-2 Page 7 of 7 Detroit Edison Company, Michigan PSC, Case No. U-8683, on behalf of North Star Steel Michigan, May Gulf States Utilities Company, Texas PUC Docket No. 7195, on behalf of North Star Steel Texas, January Rio Grande Valley Gas Company, Texas Railroad Commission Docket No. 4717, 1984 and Docket No. 3858, on behalf of the Rio Grande Valley Cities, March Lower Colorado River Authority, Texas PUC Docket No. 6027, on behalf of several wholesale customers, March Houston Lighting and Power Company, Texas PUC Docket No. 4540, August 1982, on behalf of the City of Houston. Houston Lighting & Power Company, Texas PUC Docket No. 3320, September 1980, on behalf of the Texas Public Utility Commission. Inquiry by Public Utility Commission of Texas into Certain Affiliate Transactions of Texas Electric Service Company, Texas Power and Light Company and Dallas Power and Light Company, Texas PUC Docket Nos. 1517, 1813 and 1903, February 1979, on behalf of the Texas Public Utility Commission

3 EXHIBIT ESB-3 Page 1 of 3 LIST OF SPONSORED/CO-SPONSORED SCHEDULES FOR ELLEN BLUMENTHAL SCHEDULE I-A SCHEDULE I-A-1 SCHEDULE II-B SCHEDULE II-B-1 SCHEDULE II-B-2 SCHEDULE II-B-3 SCHEDULE II-B-5 SCHEDULE II-B-6 SCHEDULE II-B-7 SCHEDULE II-B-8 SCHEDULE II-B-9 SCHEDULE II-B-10 SCHEDULE II-B-1 I SCHEDULE II-B-12 SCHEDULE II-B-12 Attach SCHEDULE II-C-I SCHEDULE II-C-1.1 SCHEDULE II-C-2.1 SCHEDULE II-C-2.4 SCHEDULE II-C-2.4a SCHEDULE II-C-2.5 SCHEDULE II-C-2.6 SCHEDULE II-C-2.7 SCHEDULE II-C-2.8 SCHEDULE II-C-2.9 SCHEDULE II-C-2.10 SCHEDULE II-D-1 SCHEDULE II-D-1.1 SCHEDULE II-D-2 SCHEDULE II-D-2.1 SCHEDULE II-D-2.2 SCHEDULE II-D-2.3 SCHEDULE II-D-2.4 SCHEDULE II-D-2.4a SCHEDULE II-D-2.5 SCHEDULE II-D-2.6 SCHEDULE II-D-2.6a SCHEDULE II-D-2.6b SCHEDULE II-D-2.6c SCHEDULE II-D-2.7 SCHEDULE II-D-2.8 Cost of Service Summary Total Cost of Service by Function Summary of Rate Base Plant General Plant Communication Equipment Depreciation - Plant Plant Held for Future Use Accumulated Provisions Materials and Supplies Cash Working Capital Prepayments Other Rate Base Items Regulatory Assets Regulatory Assets Rate of Return Calculation Rate of Return Method Weighted Average Cost of Capital Weighted Average Cost of Short-Term Debt Adjusted Cost of Long-Term Debt Weighted Average Cost of Short-Term Debt Security Issuance Restrictions Capital Requirements and Acquisition Plan Historical Financial Statistics Growth in Earnings, Dividends, and Book Value Rating Agency Reports O&M Expense Monthly O&M Expense A&G Expense Monthly A&G Expense Bad Debt Expense Summary of Advertising, Contributions, & Dues Summary of Advertising Expense Capitalized Advertising Summary of Contribution & Donation Expense Summary of Membership Dues Expense Summary of Industry Organization Dues Summary of Business/Economic Dues Summary of Professional Dues Outside Services Employed - FERC 900 Series Expenses Factoring or Sale of Accounts Receivable Expense

4 EXHIBIT ESB-3 Page 2 of 3 SCHEDULE II-D-2.9 SCHEDULE II-D-3 SCHEDULE II-D-3.1 SCHEDULE II-D-3.2 SCHEDULE II-D-3.3 SCHEDULE II-D-3.4 SCHEDULE II-D-3.5 SCHEDULE II-D-3.6 SCHEDULE II-D-3.7 SCHEDULE II-D-3.8 SCHEDULE II-D-3.9 SCHEDULE II-D-3.10 SCHEDULE II-D-4 SCHEDULE II-E-1 SCHEDULE II-E-2 SCHEDULE II-E-2.1 SCHEDULE II-E-3 SCHEDULE II-E-3.1 SCHEDULE II-E-3.2 SCHEDULE II-E-3.3 SCHEDULE II-E-3.4 SCHEDULE II-E-3.5 SCHEDULE II-E-3.6 SCHEDULE II-E-3.7 SCHEDULE II-E-3.8 SCHEDULE II-E-3.9 SCHEDULE II-E-3.10 SCHEDULE II-E-3.11 SCHEDULE II-E-3.12 SCHEDULE II-E-3.13 SCHEDULE II-E-3.14 SCHEDULE II-E-3.15 SCHEDULE II-E-3.16 SCHEDULE II-E-3.17 SCHEDULE II-E-3.18 SCHEDULE II-E-3.19 SCHEDULE II-E-3.20 SCHEDULE II-E-3.21 SCHEDULE II-E-3.22 SCHEDULE II-E-3.23 SCHEDULE II-E-3.24 SCHEDULE II-E-3.25 SCHEDULE II-E-3.26 Rents and Leases Payroll Expense Payroll Information Regular and Overtime Payroll by Function Functionalized Regular Payroll by Category Payroll Capitalized vs. Expensed by Function Number of Employees by Function Payments Other Than Standard Pay by Function General Employee Benefit Information Pension Expense Postretirement Benefits Other Than Pension Administration Fees Summary of Exclusions from Test Year Depreciation Expense Taxes other than FIT Ad Valorem Taxes & Plant Balances FIT Reconciliation of Test Year Net Book Income to Taxable Net Income Reconciliation of Timing Differences Plant Adjustments Consolidated Taxes Consolidation Benefits Consolidation/Inter-Corporate Tax Allocation ADFIT ADFIT - Description of Timing Differences Adjustments to ADFIT ADFIT and ITC - Plant Adjustments & Allocations Analysis of Investment Tax Credits Utilized Generated But Not Utilized Utilized - Stand Alone Basis ITC Election FERC Account 255 Balance Analysis of FIT - Tax Method 2 Analysis of Deferred FIT Analysis of Additional Depreciation Requested Amortization of Protected and Unprotected Excess Deferred Taxes Analysis of Deferred Taxes by Timing Difference Effects of Post Test Year Adjustments List of FIT Testimony History of Tax Normalization Tax Elections, IRS Audit Status and Private Letter Rulings Method of Accounting for ADFIT Related to NOL Carryforward

5 EXHIBIT ESB-3 Page 3 of 3 SCHEDULE II-E-4 SCHEDULE II-E-4.1 SCHEDULE II-E-4.2 SCHEDULE II-E-4.3 SCHEDULE II-E-4.4 SCHEDULE II-E-4.5 SCHEDULE II-E-5 SCHEDULE II-F SCHEDULE II-G-1 SCHEDULE III-A-1 SCHEDULE III-B SCHEDULE III-B- I SCHEDULE III-B-2 SCHEDULE III-B-3 SCHEDULE III-B-4 SCHEDULE III-B-5 SCHEDULE III-B-6 SCHEDULE III-B-7 SCHEDULE III-B-8 SCHEDULE III-B-9 SCHEDULE III-B-10 SCHEDULE III-B-11 SCHEDULE III-B-12 SCHEDULE 111-C SCHEDULE III-D-1 SCHEDULE III-D-2 SCHEDULE III-D-3 SCHEDULE III-D-4 SCHEDULE III-E-1 SCHEDULE III-E-2 SCHEDULE III-E-3 SCHEDULE III-E-4 SCHEDULE III-E-5 SCHEDULE V-K-1 SCHEDULE V-K-2 SCHEDULE V-K-3 SCHEDULE V-K-4 SCHEDULE V-K-5 SCHEDULE V-K-6 SCHEDULE V-K-7 SCHEDULE V-K-8 SCHEDULE V-K-9 SCHEDULE V-K-10 SCHEDULE V-K-11 SCHEDULE V-K-12 Other Expenses Deferred Expenses from Prior Dockets Below the Line Expenses Nonrecurring or Extraordinary Expenses Regulatory Commission Expenses Rate Case Expenses Other Revenue Items Functional Allocation Factors Status of Nuclear Decommissioning Funds Summary of Total Cost of Service by Function Rate Base by Function Original Cost of Utility Plant General Plant Communication Equipment Construction Work in Progress Accumulated Depreciation Plant Held for Future Use Accumulated Provision Balances Materials and Supplies Cash Working Capital Prepayments Other Rate Base Items Regulatory Assets Rate of Return O&M Expense A&G Expense Payroll Expenses Summary of Exclusions from the Reporting Period Depreciation Expense Taxes Other Than Income Taxes Federal Income Taxes Other Expenses Revenue Credits Affiliate Expenses by FERC Account Adjusted Affiliate Expenses Organization Chart Description of Services Capital Projects Adjustments to Test Year Expenses Statutory Requirements Services Provided to Affiliates Allocation of Affiliate Costs Controls Description of Affiliate Billing Methods Amounts Billed to Each Affiliate

6 PUC DOCKET NO APPLICATION OF SHARYLAND UTILITIES, L.P. TO ESTABLISH RETAIL DELIVERY RATES, APPROVE TARIFF FOR RETAIL DELIVERY SERVICE, AND ADJUST WHOLESALE TRANSMISSION RATE PUBLIC UTILITY COMMISSION OF TEXAS DIRECT TESTIMONY AND EXHIBITS OF ROBERT B. HEVERT ON BEHALF OF SHARYLAND UTILITIES, L.P. May 31,

7 PUC DOCKET NO APPLICATION OF SHARYLAND UTILITIES, L.P. TO ESTABLISH RETAIL DELIVERY RATES, APPROVE TARIFF FOR RETAIL DELIVERY SERVICE, AND ADJUST WHOLESALE TRANSMISSION RATE PUBLIC UTILITY COMMISSION OF TEXAS TABLE OF CONTENTS 1. INTRODUCTION...1 II. PURPOSE OF TESTIMONY...2 III. SUMMARY OF CONCLUSIONS...4 IV. REGULATORY GUIDELINES AND FINANCIAL CONSIDERATIONS...6 V. PROXY GROUP SELECTION VI. COST OF EQUITY ESTIMATION A. Constant Growth DCF Model B. CAPM Analysis C. Bond Yield Plus Risk Premium Approach...24 VII. BUSINESS RISKS AND OTHER CONSIDERATIONS A. Small Size Effect and Undiversified Stand-Alone Risk...27 B. Regulatory Environment C. Financial Leverage and the Cost of Equity...33 VIII. CAPITAL MARKET ENVIRONMENT A. Relationship Between Historically Low Treasury Yields and the Cost of Equity B. Incremental Credit Spreads C. Yield Spreads...45 D. Electric Utility Relative Stock Price Performance IX. CAPITAL STRUCTURE AND COST OF DEBT X. SUMMARY AND CONCLUSION PAGE Direct Testimony and Exhibits i Docket No

8 EXHIBITS RBH-1 RBH-2 RBH-3 RBH-4 RBH-5 RBH-6 RBH-7 RBH-8 RBH-9 RBH-10 RBH-11 RBH-12 RBH-13 Resume Prior Testimony List of Schedules Sponsored Constant Growth DCF Results Market Risk Premium Calculations Beta Coefficients Capital Asset Pricing Model Results Bond Yield Plus Risk Premium Analysis Small Size Premium Analysis Review of Recently Authorized ROEs Proxy Group Capital Structure Analysis Effect of Leverage on the Cost of Capital Weighted Average Cost of Debt Direct Testimony and Exhibits ii Docket No

9 1 DIRECT TESTIMONY AND EXHIBITS OF ROBERT B. HEVERT 2 I. INTRODUCTION 3 Q. PLEASE STATE YOUR NAME, POSITION, AND BUSINESS ADDRESS. 4 A. My name is Robert B. Hevert. I am Managing Partner of Sussex Economic Advisors, 5 LLC Inc. ("Sussex"). My business address is 161 Worcester Road, Suite 503, 6 Framingham, Massachusetts Q. ON WHOSE BEHALF ARE YOU SUBMITTING THIS TESTIMONY? 8 A. I am submitting this direct testimony ("Direct Testimony") before the Public Utility 9 Commission of Texas ("Commission") on behalf of Sharyland Utilities, L.P. 10 ("Sharyland Utilities" or the "Company"). 11 Q. PLEASE DESCRIBE YOUR EDUCATIONAL BACKGROUND AND 12 PROFESSIONAL EXPERIENCE. 13 A. I hold a Bachelor's degree in Business and Economics from the University of 14 Delaware, and an MBA with a concentration in Finance from the University of 15 Massachusetts. I also hold the Chartered Financial Analyst designation. 16 I have worked in regulated industries for over twenty-five years, having 17 served as an executive and manager with consulting firms, a financial officer of a 18 publicly-traded natural gas utility (at the time, Bay State Gas Company), and an 19 analyst at a telecommunications utility. In my role as a consultant, I have advised 20 numerous energy and utility clients on a wide range of financial and economic issues 21 including corporate and asset-based transactions, asset and enterprise valuation, 22 transaction due diligence, and strategic matters. I have provided my resume as 23 Exhibit RBH Q. HAVE YOU PREVIOUSLY SUBMITTED TESTIMONY TO THE PUBLIC 25 UTILITY COMMISSION OF TEXAS? 26 A. Yes, I have. As an expert witness, I have provided testimony in approximately proceedings regarding various financial and regulatory matters before the Federal 28 Energy Regulatory Commission, and numerous state utility regulatory agencies, Direct Testimony and Exhibits 1 Docket No

10 1 including the Commission. A list of my testimony in prior proceedings provided as 2 Exhibit RBH-2. 3 II. PURPOSE OF TESTIMONY 4 Q. WHAT IS THE PURPOSE OF YOUR TESTIMONY? 5 A. The purpose of my Direct Testimony is to present evidence and provide the 6 Commission with a recommendation regarding the Company's Return on Equity 7 ("ROE"),' capital structure, and cost of debt. My analysis and conclusions are 8 supported by the data presented in Exhibit RBH-4 through Exhibit RBH-13, which 9 have been prepared by me or under my direction. 10 Q. DO YOU SPONSOR ANY SCHEDULES INCLUDED AS PART OF THE 11 RATE FILING PACKAGE? 12 A. Yes. A list of the schedules that I sponsor or co-sponsor is provided as Exhibit RBH Q. WERE YOUR TESTIMONY AND EXHIBITS PREPARED BY YOU OR 15 UNDER YOUR DIRECTION? 16 A. Yes. 17 Q. WHAT ARE YOUR CONCLUSIONS REGARDING THE APPROPRIATE 18 COST OF EQUITY, CAPITAL STRUCTURE, AND COST OF DEBT? 19 A. My analyses indicate that the Company's Cost of Equity currently is in the range of percent to percent. Based on the quantitative and qualitative analyses 21 discussed throughout my Direct Testimony and Sharyland Utilities' risk profile, I 22 conclude that an ROE of percent is reasonable and appropriate. In addition, I 23 conclude that a capital structure that consists of percent equity and percent debt is appropriate, and the Company's weighted average debt cost of 6.73 is 25 reasonable. ' Throughout my testimony, I interchangeably use the terms "ROE" and "Cost of Equity". Direct Testimony and Exhibits 2 Docket No

11 1 Q. PLEASE PROVIDE A BRIEF OVERVIEW OF THE ANALYSES THAT LED 2 TO YOUR ROE RECOMMENDATION. 3 A. As discussed in more detail in Section VI, in light of recent market conditions, and 4 given the fact that equity analysts and investors tend to use multiple methodologies in 5 developing their return requirements, it is important to consider the results of several 6 analytical approaches in determining the Company's ROE. In order to develop my 7 ROE recommendation, I therefore applied the Constant Growth Discounted Cash 8 Flow ("DCF") model, the Capital Asset Pricing Model ("CAPM"), and the Risk 9 Premium approach. As discussed later in my testimony, it is important to consider a 10 range of factors, both quantitative and qualitative, in arriving at an ROE 11 determination. 12 In addition to the methodologies noted above, my recommendation also takes 13 into consideration: (1) the Company's small size relative to the proxy group 14 companies; (2) the regulatory environment in which the Company operates; and (3) 15 the Company's financial risk relative to the proxy group. While I did not make any 16 explicit adjustments to my ROE estimates for those factors, I did take them into 17 consideration when determining where the Company's Cost of Equity should be 18 established within the range of results. 19 Q. HOW IS THE REMAINDER OF YOUR DIRECT TESTIMONY 20 ORGANIZED? 21 A. The remainder of my Direct Testimony is organized as follows: 22 Section III - Provides a summary of my conclusions and recommendations as they 23 relate to the Cost of Equity; 24 Section IV - Discusses the regulatory guidelines and financial considerations 25 pertinent to the development of the cost of capital; 26 Section V - Explains my selection of the proxy group of electric utilities used to 27 develop my analytical results; 28 Section VI - Explains my analyses and the analytical bases for my ROE 29 recommendation; Direct Testimony and Exhibits 3 Docket No

12 1 Section VII - Provides a discussion of specific business risks that have a direct 2 bearing on the Company's Cost of Equity; 3 Section VIII - Briefly discusses the current capital market conditions and the effect of 4 those conditions on the Company's Cost of Equity; 5 Section IX - Addresses the reasonableness of the Company's capital structure and 6 cost of debt; and 7 Section X - Summarizes my conclusions and recommendations. 8 III. SUMMARY OF CONCLUSIONS 9 Q. WHAT ARE THE KEY FACTORS CONSIDERED IN YOUR ANALYSES 10 AND UPON WHICH YOU BASE YOUR RECOMMENDED ROE? 11 A. My analyses and recommendations considered the following: 12 The Hope and Bluefield decisions2 that established the standards for determining a 13 fair and reasonable allowed Return on Equity, including consistency of the allowed 14 return with other businesses having similar risk; adequacy of the return to provide 15 access to capital and support credit quality; and that the end result must lead to just 16 and reasonable rates. 17 The effect of the current capital market conditions on investors' Return on Equity 18 requirements, and in particular, the Company's ability to access the capital markets. 19 The Company's business risks relative to the proxy group of comparable companies 20 and the implications of those risks in arriving at the appropriate ROE. 21 Q. WHAT ARE THE RESULTS OF YOUR ANALYSES? 22 A. The results of my analyses are summarized in Tables 1 a and 1b, below Bluefield Waterworks & Improvement Co. v. Public Service Commission of West Virginia, 262 U.S. 679 (1923); Federal Power Commission v. Hope Natural Gas Co., 320 U.S. 591 (1944). Direct Testimony and Exhibits 4 Docket No

13 2 Table la: Summary of Constant Growth DCF Results3 Low Growth Rate4 Mean Growth Rates High Growth Rate6 30-Day Average 8.55% 10.30% 12.15% 90-Day Average 8.75% 10.51% 12.36% 180-Day Average 8.79% 10.55% 12.40% 11 3 Table lb: Summary of Risk Premium Results7 Bloomberg Value Line Sharpe Ratio Derived Derived Derived Market Market Risk Market Risk Risk Premium Premium Premium Average Bloomberg Beta Coefficient Current 30-Year Treasury (3.16%) 8.09% 10.07% 9.96% Near Term Projected 30-Year Treasury (3.30%) Long Term Projected 30-Year Treasury (5.10%) 8.23% 10.22% 10.10% 10.03% 12.02% 11.90% Average Value Line Beta Coefficient Current 30-Year Treasury (3.16%) 8.21% 10.25% 10.14% Near Term Projected 30-Year Treasury (3.30%) Long Term Projected 30-Year Treasury (5.10 /o) 8.36% 10.40% 10.28% 10.16% 12.20% 12.08% Bond Yield Plus Risk Premium Approach Current 30-Year Treasury (3.16%) 10.25% Near Term Projected 30-Year Treasury (3.30%) 10.26% % 3 See also Exhibit RBH-4, both the mean and median results are calculated. ' The "Low Growth Rate" results are calculated using the lowest of the three earnings growth rate estimates for each proxy group company. 5 The "Mean Growth Rate" results are calculated using an average of the three earnings growth rate estimates for each proxy group company. 6 The "High Growth Rate" results are calculated using the highest of the three earnings growth rate estimates for each proxy group company. ' See also Exhibit RBH-7 and Exhibit RBH-8. Direct Testimony and Exhibits 5 Docket No

14 Long Term Projected 30-Year Treasury (5.10%) Bloomberg Value Line Sharpe Ratio Derived Derived Derived Market Market Risk Market Risk Risk Premium Premium Premium 10.77/ Based on the analytical results presented in Tables la and lb, and in light of the considerations discussed throughout the balance of my Direct Testimony regarding the Company's business risks relative to the proxy group, it is my view that a reasonable range of estimates is from percent to percent, and within that range, an ROE of percent is reasonable and appropriate based on my consideration of the Company's risk profile. 7 IV. REGULATORY GUIDELINES AND FINANCIAL CONSIDERATIONS 8 Q. PLEASE PROVIDE A BRIEF SUMMARY OF THE GUIDELINES 9 ESTABLISHED BY THE UNITED STATES SUPREME COURT (THE 10 "COURT") FOR THE PURPOSE OF DETERMINING THE RETURN ON 11 EQUITY. 12 A. The Court established the guiding principles for establishing a fair return for capital 13 in two cases: (1) Bluefield Water Works and Improvement Co. v. Public Service 14 Comm 'n. ("Bluefield");g and (2) Federal Power Comm 'n v. Hope Natural Gas Co. 15 ("Hope").9 In Bluefield, the Court stated: 16 A public utility is entitled to such rates as will permit it to earn a return 17 on the value of the property which it employs for the convenience of 18 the public equal to that generally being made at the same time and in 19 the same general part of the country on investments in other business 20 undertakings which are attended by corresponding risks and 21 uncertainties; but it has no constitutional right to profits such as are 22 realized or anticipated in highly profitable enterprises or speculative 23 ventures. The return should be reasonably sufficient to assure 24 confidence in the financial soundness of the utility and should be 25 adequate, under efficient and economical management, to maintain (1923). 8 Bluefield Water Works and Improvement Co. v. Public Service Comm 'n., 262 U.S. 679, Federal Power Comm 'n v. Hope Natural Gas Co., 320 U.S. 591, 603 (1944). Direct Testimony and Exhibits 6 Docket No

15 1 and support its credit and enable it to raise the money necessary for the 2 proper discharge of its public duties The Court therefore recognized that: (1) a regulated company cannot remain 5 financially sound unless the return it is allowed to earn on its invested capital is at 6 least equal to the cost of capital (the principle relating to the demand for capital); and 7 (2) a regulated company will not be able to attract capital if it does not offer investors 8 an opportunity to earn a return on their investment equal to the return they expect to 9 earn on other investments of the same risk (the principle relating to the supply of 10 capital). 11 In Hope, the Court reiterated the financial integrity and capital attraction 12 principles of the Bluefield case: 13 From the investor or company point of view it is important that there 14 be enough revenue not only for operating expenses but also for the 15 capital costs of the business. These include service on the debt and 16 dividends on the stock... By that standard the return to the equity 17 owner should be commensurate with returns on investments in other 18 enterprises having corresponding risks. That return, moreover, should 19 be sufficient to assure confidence in the financial inte^rity of the 20 enterprise, so as to maintain its credit and to attract capital In summary, the Court clearly has recognized that the fair Rate of Return on 22 Equity should be: (1) comparable to returns investors expect to earn on other 23 investments of similar risk; (2) sufficient to assure confidence in the company's 24 financial integrity; and (3) adequate to maintain and support the company's credit and 25 to attract capital. 26 Q. DOES TEXAS PRECEDENT PROVIDE SIMILAR GUIDANCE? 27 A. Yes. The Commission and the Texas courts uphold the precedents of the Hope and 28 Bluefield cases, and regularly acknowledge that a utility is entitled to a fair and (1923). 10 Bluefield Water Works and Improvement Co. v. Public Service Comm 'n., 262 U.S. 679, " Federal Power Comm 'n v. Hope Natural Gas Co., 320 U.S. 591, 603 (1944). Direct Testimony and Exhibits 7 Docket No

16 1 reasonable return. The Public Utility Regulatory Act describes the Commission's 2 obligation with regard to establishing a reasonable return: 3 In establishing an electric utility's rates, the regulatory authority shall 4 establish the utility's overall revenues at an amount that will permit the 5 utility a reasonable opportunity to earn a reasonable return on the 6 utility's invested capital used and useful in providing service to the 7 public in excess of the utility's reasonable and necessary operating 8 expenses.12 9 This mandate was affirmatively stated in Gulf States Utilities Company v. Public 10 Utility Commission of Texas, where the court stated: 11 The Commission's rate fixing power operates exclusively within a 12 range of reasonableness, bounded on the one hand by the utility's 13 constitutional right to a fair and reasonable return, and on the other 14 hand by its customers' statutory right to rates that are not unreasonable 15 or exorbitant Based on those standards, the consequence of the Commission's order in this case 17 should enable the Company to earn a fair and reasonable return and maintain its 18 financial flexibility over the period during which rates are expected to remain in 19 effect. 20 Q. ASIDE FROM THE STANDARDS ESTABLISHED BY THE COURTS, IS IT 21 IMPORTANT FOR A UTILITY TO BE ALLOWED THE OPPORTUNITY TO 22 EARN A RETURN THAT IS ADEQUATE TO ATTRACT EQUITY CAPITAL 23 AT REASONABLE TERMS? 24 A. Yes, it is. A return that is adequate to attract capital at reasonable terms, under 25 varying market conditions, will enable the subject utility to provide safe, reliable 26 electric service while maintaining its financial integrity. While the "capital 27 attraction" and "financial integrity" standards are important principles in normal 28 economic conditions, the practical implications of those standards are even more 29 pronounced when, as discussed in more detail in Section VIII, continued equity 30 market volatility, together with sustained increases in the incremental spread on 12 TEx. UTIL. CODE Gulf States Utilities Company v. Public Utility Commission of Texas, 784 S.w.2d 519, n.2 (Tex. App.-Austin 1990), affd, 809 S.W. 201 (Tex. 1991). Direct Testimony and Exhibits 8 Docket No

17 1 utility debt (i.e., the difference in debt yields of utilities varying credit ratings) have 2 intensified the importance of maintaining a strong financial profile. 3 V. PROXY GROUP SELECTION 4 Q. AS A PRELIMINARY MATTER, WHY IS IT NECESSARY TO SELECT A 5 GROUP OF PROXY COMPANIES TO DETERMINE THE COST OF 6 EQUITY FOR SHARYLAND UTILITIES? 7 A. First, it is important to bear in mind that the Cost of Equity for a given enterprise 8 depends on the risks attendant to the business in which the company is engaged. 9 According to financial theory, the value of a given company is equal to the aggregate 10 market value of its constituent business units. The value of the individual business 11 units reflects the risks and opportunities inherent in the business sectors in which 12 those units operate. In this proceeding, we are focused on estimating the Cost of 13 Equity for Sharyland Utilities. Since the ROE is a market-based concept and 14 Sharyland Utilities is not a publicly-traded entity, it is necessary to establish a group 15 of companies that are both publicly traded and comparable to the Company in certain 16 fundamental respects to serve as its "proxy" in the ROE estimation process. 17 Even if Sharyland Utilities were a publicly-traded entity, it is possible that 18 short-term events could bias its market value in one way or another during a given 19 period of time. A significant benefit of using a proxy group, therefore, is that it 20 serves to moderate the effects of anomalous, temporary events that may be associated 21 with any one company. 22 Q. DOES THE SELECTION OF A PROXY GROUP SUGGEST THAT 23 ANALYTICAL RESULTS WILL BE TIGHTLY CLUSTERED AROUND 24 AVERAGE (I.E., MEAN) RESULTS? 25 A. Not necessarily. The DCF approach is based on the theory that a stock's current price 26 represents the present value of its future expected cash flows. The Constant Growth 27 form of the DCF model is defined as the sum of the expected dividend yield and 28 projected long-term growth. Notwithstanding the care taken to ensure risk 29 comparability, market expectations with respect to future risks and growth 30 opportunities will vary from company to company. Therefore, even within a group of Direct Testimony and Exhibits 9 Docket No

18 1 similarly situated companies, it is common for analytical results to reflect a seemingly 2 wide range. At issue, then, is how to select an ROE estimate from within that range. 3 That determination necessarily must be based on the informed judgment and 4 experience of the analyst. 5 Q. PLEASE PROVIDE A SUMMARY PROFILE OF SHARYLAND UTILITIES. 6 A. Sharyland Utilities is a rapidly-growing Texas-based utility that provides electric 7 transmission and distribution services. The Company has five geographically 8 separated divisions, and as of December 31, 2012 served approximately 46,000 9 metered retail accounts. For clarity, I refer to the Brady, Celeste, Colorado City, and 10 Stanton divisions as "Sharyland," the McAllen division as "Sharyland-McAllen" and 11 the entire utility as "Sharyland Utilities." The four Sharyland divisions were acquired 12 in July 2010 from Cap Rock Energy. The Stanton division is located in the area 13 surrounding the cities of Midland and Stanton, and the Colorado City division is 14 located near Colorado City. The Brady division is located in the Texas Hill Country, 15 and the Celeste Division is located northeast of Dallas. Collectively, as of 16 December 31, 2012, the Sharyland divisions served 43,247 metered accounts, with a 17 total load of MW. Sharyland Utilities' fifth division, McAllen, is located in 18 South Texas between the cities of McAllen and Mission. Sharyland-McAllen 19 consists of a 6,000-acre mixed use real estate development in which Sharyland on 20 December 31, 2012 served approximately 2,898 metered accounts. 21 Sharyland Utilities' five divisions are currently split between the Southwest 22 Power Pool ("SPP") and Electric Reliability Council of Texas ("ERCOT") grids, and 23 only Sharyland-McAllen has implemented retail competition. The Colorado City and 24 Stanton divisions are currently interconnected to SPP, but pursuant to the 25 Commission's order in Docket No , will be disconnected from SPP by the end 26 of 2013 and interconnected with ERCOT. The Brady and Celeste divisions are 27 connected to ERCOT. The four Sharyland divisions currently have bundled retail 28 rates, but will transition to retail competition in Direct Testimony and Exhibits 10 Docket No

19 1 Q. HOW DID YOU SELECT THE COMPANIES INCLUDED IN YOUR PROXY 2 GROUP? 3 A. With the objective of selecting a proxy group that is highly representative of the risks 4 and prospects faced by Sharyland Utilities, I used the following criteria: 5 I began with the universe of companies that Value Line classifies as Electric 6 Utilities, which includes a group of 49 domestic U.S. utilities; 7 I excluded companies that do not consistently pay quarterly cash dividends; 8 All of the companies in my proxy group have been covered by at least two 9 utility industry equity analysts; 10 All of the companies in my proxy group had investment grade senior bond 11 and/or corporate credit ratings from Standard and Poor's; 12 I excluded companies whose regulated operating income over the three most 13 recently reported fiscal years comprised less than percent of the 14 respective total operating income for that company; 15 I excluded companies whose regulated electric operating income over the 16 three most recently reported fiscal years represented less than percent of 17 total regulated operating income; 18 I eliminated companies that are currently known to be party to a merger, or 19 other significant transaction. 20 Q. WHAT COMPANIES MET THOSE SCREENING CRITERIA? 21 A. The criteria discussed above resulted in a proxy group of the following seventeen 22 companies: Direct Testimony and Exhibits 11 Docket No

20 1 Table 2: Initial Screening Results Company American Electric Power Company, Inc. Cleco Corporation Duke Energy Corporation Edison International Empire District Electric Company Great Plains Energy Inc. Hawaiian Electric Industries, Inc. IDACORP, Inc. Northeast Utilities NV Energy, Inc. Otter Tail Corporation Pepco Holdings, Inc. Pinnacle West Capital Corporation PNM Resources, Inc. Portland General Electric Company Southern Company Westar Energy, Inc. Ticker AEP CNL DUK EIX EDE GXP HE IDA NU NVE OTTR POM PNW PNM POR SO WR 2 Q. 3 A IS THIS YOUR FINAL PROXY GROUP? No, it is not. I examined the operating profile of each of the sixteen companies that met my initial screens to be certain that none displayed characteristics that were inconsistent with my intent to produce a proxy group that is fundamentally similar to the Company. As a result, I excluded Edison International ("EIX") based on recent financial information. In 2011, EIX recorded a loss of $1.09 billion in its competitive power generation segment14 resulting from an after-tax earnings charge (recorded in the fourth quarter of 2011) relating to the impairment of its Homer City, Fisk, Crawford and Waukegan power plants, wind related charges, and other expenses. 15 In an SEC 8-K filing dated October 5, 2012, EIX noted its plan to commence a 14 See Edison International, SEC Form 10-K for the fiscal year ended December 31, 2011, at Ibid., at 54. Direct Testimony and Exhibits 12 Docket No

21 1 Chapter 11 case and restructure Homer City Funding LLC.16 On December 17, 2012, 2 Edison Mission Energy, a wholly-owned subsidiary of EIX, filed for bankruptcy 3 protection under Chapter 11 of the U.S. Bankruptcy Code.17 In light of its recent 4 losses and its restructuring plans, it is difficult to assess the degree to which regulated 5 electric utility operations would be expected to contribute to the company's 6 consolidated financial performance in the future. Consequently, I have excluded EIX 7 from my final proxy group. 8 Q. BASED ON THE CRITERIA AND ISSUES DISCUSSED ABOVE, WHAT IS 9 THE COMPOSITION OF YOUR PROXY GROUP? 10 A. The final proxy group is presented in Table 3 (below). 11 Table 3: Final Proxy Group Company American Electric Power Company, Inc. Cleco Corporation Duke Energy Corporation Empire District Electric Company Great Plains Energy Inc. Hawaiian Electric Industries, Inc. IDACORP, Inc. Northeast Utilities NV Energy, Inc. Otter Tail Corporation Pepco Holdings, Inc. Pinnacle West Capital Corporation PNM Resources, Inc. Portland General Electric Company Southern Company Westar Energy, Inc. Ticker AEP CNL DUK EDE GXP HE IDA NU NVE OTTR POM PNW PNM POR SO WR See Edison International, SEC Form 8-K, Filed October 5, 2012 at See SNL Financial, Edison Mission files Chapter 11 reorganization plan, December 17, Direct Testimony and Exhibits 13 Docket No

22 1 VI. COST OF EOUITY ESTIMATION 2 Q. PLEASE BRIEFLY DISCUSS THE ROE IN THE CONTEXT OF THE 3 REGULATED RATE OF RETURN. 4 A. Regulated utilities primarily use common stock and long-term debt to finance their 5 permanent property, plant, and equipment. The overall Rate of Return ("ROR") for a 6 regulated utility is based on its weighted average cost of capital, in which the cost 7 rates of the individual sources of capital are weighted by their respective book values. 8 While the costs of debt and preferred stock can be directly observed, the Cost of 9 Equity is market-based and, therefore, must be estimated based on observable market 10 information. 11 Q. HOW IS THE REQUIRED ROE DETERMINED? 12 A. The required ROE is estimated by using one or more analytical techniques that rely 13 on market-based data to quantify investor expectations regarding required equity 14 returns, adjusted for certain incremental costs and risks. By their very nature, 15 quantitative models produce a range of results from which the market required ROE 16 must be selected. As discussed throughout my Direct Testimony, that selection must 17 be based on a comprehensive review of relevant data and information, and does not 18 necessarily lend itself to a strict mathematical solution. Consequently, the key 19 consideration in determining the Cost of Equity is to ensure that the methodologies 20 employed reasonably reflect investors' view of the financial markets in general, and 21 the subject company (in the context of the proxy group) in particular. 22 Q. WHAT METHODS DID YOU USE TO ESTIMATE THE COMPANY'S COST 23 OF EQUITY? 24 A. I used the Constant Growth DCF model as my initial approach, and considered the 25 results of the CAPM, and Bond Yield Plus Risk Premium approach in assessing the 26 reasonableness of the DCF results and my ROE recommendation. Direct Testimony and Exhibits 14 Docket No

23 1 Q. WHY DO YOU BELIEVE IT IS IMPORTANT TO USE MORE THAN ONE 2 ANALYTICAL APPROACH? 3 A. Because the Cost of Equity is not directly observable, it must be estimated based on 4 both quantitative and qualitative information. As a result, a number of models have 5 been developed to estimate the Cost of Equity. As a practical matter, however, all of 6 the models available for estimating the Cost of Equity are subject to limiting 7 assumptions or other methodological constraints. Consequently, many finance texts 8 recommend using multiple approaches when estimating the Cost of Equity. When 9 faced with the task of estimating the Cost of Equity, analysts and investors are 10 inclined to gather and evaluate as much relevant data as reasonably can be analyzed 11 and, therefore, are inclined to rely on multiple analytical approaches. 12 In essence, practitioners and academics recognize that financial models simply 13 are tools to be used in the ROE estimation process, and that the strict adherence to 14 any single approach, or to the specific results of any single approach, can lead to 15 flawed or misleading conclusions. That position is consistent with the Hope and 16 Bluefield finding that it is the analytical result, as opposed to the methodology, that is 17 controlling in arriving at ROE determinations. Thus, a reasonable ROE estimate 18 appropriately considers alternate methodologies and the reasonableness of their 19 individual and collective results. Such use, however, must be tempered with due 20 caution as to the results generated by each individual approach. 21 A. Constant Growth DCF Model 22 Q. ARE DCF MODELS WIDELY USED IN REGULATORY PROCEEDINGS? 23 A. Yes, in my experience the Constant Growth DCF model is widely recognized in 24 regulatory proceedings. Nonetheless, neither the DCF nor any other model should be 25 applied without considerable judgment in the selection of data and the interpretation 26 of results. 27 Q. PLEASE DESCRIBE THE DCF APPROACH. 28 A. The DCF approach is based on the theory that a stock's current price represents the 29 present value of all expected future cash flows. In its simplest form, the DCF model Direct Testimony and Exhibits 15 Docket No

24 1 expresses the Cost of Equity as the sum of the expected dividend yield and long-term 2 growth rate, and is expressed as follows: _ ng ^ n^ 3 P C1+k3 ^ (1+k)2 ^... ^ Cifk7^ [1] 4 Where P represents the current stock price, Dl... D. represent expected 5 future dividends, and k is the discount rate, or required ROE. Equation [1] is a 6 standard present value calculation that can be simplified and rearranged into the 7 familiar form: 8 k D, (1+g) + 9 [2] P 9 Equation [2] often is referred to as the "Constant Growth DCF" model, in 10 which the first term is the expected dividend yield and the second term is the 11 expected long-term growth rate. 12 Q. WHAT ASSUMPTIONS ARE REQUIRED FOR THE CONSTANT GROWTH 13 DCF MODEL? 14 A. The Constant Growth DCF model requires the following assumptions: (1) a constant 15 average growth rate for earnings and dividends; (2) a stable dividend payout ratio; (3) 16 a constant price-to-earnings multiple; and (4) a discount rate greater than the expected 17 growth rate. 18 Q. WHAT MARKET DATA DID YOU USE TO CALCULATE THE DIVIDEND 19 YIELD COMPONENT OF YOUR DCF MODEL? 20 A. The dividend yield is based on the proxy companies' current annualized dividend, 21 and average closing stock prices over the 30, 90, and 180-trading days as of 22 March 31, Q. WHY DID YOU USE THREE AVERAGING PERIODS TO CALCULATE 24 THE AVERAGE STOCK PRICE? 25 A. I did so to ensure that the model's results are not skewed by anomalous events that 26 may affect stock prices on any given trading day. At the same time, the averaging 27 period should be reasonably representative of expected capital market conditions over Direct Testimony and Exhibits 16 Docket No

25 1 the long term. In my view, the use of the 30-, 90- and 180-day averaging periods 2 reasonably balances those concerns. 3 Q. DID YOU MAKE ANY ADJUSTMENTS TO THE DIVIDEND YIELD TO 4 ACCOUNT FOR PERIODIC GROWTH IN DIVIDENDS? 5 A. Yes, I did. Since utility companies tend to increase their quarterly dividends at 6 different times throughout the year, it is reasonable to assume that dividend increases 7 will be evenly distributed over calendar quarters. Given that assumption, it is 8 appropriate to calculate the expected dividend yield by applying one-half of the long- 9 term growth rate to the current dividend yield. 18 That adjustment ensures that the 10 expected dividend yield is, on average, representative of the coming twelve-month 11 period, and does not overstate the dividends to be paid during that time. 12 Q. IS IT IMPORTANT TO SELECT APPROPRIATE MEASURES OF LONG- 13 TERM GROWTH IN APPLYING THE DCF MODEL? 14 A. Yes. In its Constant Growth form, the DCF model (i.e., as presented in Equation [2] 15 above) assumes a single growth estimate in perpetuity. In order to reduce the long- 16 term growth rate to a single measure, one must assume a constant payout ratio, and 17 that earnings per share, dividends per share and book value per share all grow at the 18 same constant rate. Over the long term, however, dividend growth can only be 19 sustained by earnings growth. Consequently, it is important to incorporate a variety 20 of measures of long-term earnings growth into the Constant Growth DCF model. 21 Q. PLEASE SUMMARIZE YOUR INPUTS TO THE CONSTANT GROWTH 22 DCF MODEL. 23 A. I applied the DCF model to the proxy group of electric utility companies using the 24 following inputs for the price and dividend terms: The average daily closing prices for the 30-trading days, 90-trading days, 26 and 180-trading days ended March 31, 2013 for the term Po; and The annualized dividend per share as of March 31, 2013 for the term Do. 28 I then calculated the DCF results using each of the following growth terms: 18 See Exhibit RBH-4. Direct Testimony and Exhibits 17 Docket No

26 1 1. The Zacks consensus long-term earnings growth estimates; 2 2. The First Call consensus long-term earnings growth estimates; and 3 3. The Value Line long-term earnings growth estimates. 4 Q. HOW DID YOU CALCULATE THE HIGH AND LOW DCF RESULTS? 5 A. I calculated the proxy group mean high DCF result using the maximum EPS growth 6 rate as reported by Value Line, Zack's, and First Call for each proxy group company 7 in combination with the dividend yield for each of the proxy group companies. The 8 average mean high result then reflects the average maximum DCF result for the proxy 9 group as a whole. I used a similar approach to calculate the proxy group mean low 10 results, using instead the minimum growth rate as reported by Value Line, Zack's, 11 and First Call for each proxy group company. 12 Q. WHAT ARE THE RESULTS OF YOUR DCF ANALYSIS? 13 A. My Constant Growth DCF results are summarized in Table 4, below (see also Exhibit 14 RBH-4). 15 Table 4: DCF Results19 Low Growth Rate Mean Growth Rate High Growth Rate 30-Day Average 8.55% 10.30% 12.15% 90-Day Average 8.75% 10.51% 12.36% Q Day Average 8.79% 10.55% 12.40% DID YOU GIVE ANY WEIGHT TO THE MEAN LOW DCF RESULTS IN DEVELOPING YOUR ROE RANGE AND RECOMMENDATION? 19 A. No, the mean low results are well below any reasonable estimate of the Company's 20 Cost of Equity. Of the 1,402 electric utility rate cases provided by Regulatory 21 Research Associates since 1980 that disclosed the awarded ROE, for example, only 22 one included an authorized ROE of 9.00 percent or lower. On that basis alone, the 19 See also Exhibit RBH-4. Direct Testimony and Exhibits 18 Docket No

27 1 mean low results are highly improbable. As such, I did not give those estimates any 2 weight in arriving at my ROE range and recommendation. 3 Q. DID YOU UNDERTAKE ANY ADDITIONAL ANALYSES TO SUPPORT 4 YOUR DCF MODEL RESULTS? 5 A. Yes. As noted earlier, I also applied the CAPM and Bond Yield Plus Risk Premium 6 approach in assessing the reasonableness of the DCF results and my ROE 7 recommendation. 8 B. CAPM Analysis 9 Q. PLEASE BRIEFLY DESCRIBE THE GENERAL FORM OF THE CAPM 10 ANALYSIS. 11 A. The CAPM analysis is a risk premium approach that estimates the Cost of Equity for 12 a given security as a function of a risk-free return plus a risk premium (to compensate 13 investors for the non-diversifiable or "systematic" risk of that security). As shown in 14 Equation [3], the CAPM is defined by four components, each of which theoretically 15 must be a forward-looking estimate: where: k = rf $ j8(r. - rf) [3] 18 k = the required market ROE; 19 0 = Beta coefficient of an individual security; 20 rf= the risk-free rate of return; and 21 r,,, = the required return on the market as a whole. 22 In Equation [3], the term (rm - rf) represents the Market Risk Premium. According to 23 the theory underlying the CAPM (and as discussed in Section VII), since 24 unsystematic risk can be diversified away by adding securities to their investment 25 portfolio, investors should be concerned only with systematic or non-diversifiable 26 risk. Non-diversifiable risk is measured by the Beta coefficient, which is defined as: 27 l Tx p,.,. [4] M Direct Testimony and Exhibits 19 Docket No

28 1 Where u, is the standard deviation of returns for company 'J"; rr,,, is the standard 2 deviation of returns for the broad market (as measured, for example, by the S&P Index), and pj,,. is the correlation of returns in between company j and the broad 4 market. Thus, the Beta coefficient represents both relative volatility (i.e., the standard 5 deviation) of returns, and the correlation in returns between the subject company and 6 the overall market. 7 Q. HAS THE CAPM BEEN AFFECTED BY RECENT ECONOMIC 8 CONDITIONS? 9 A. Yes, for example, the risk free rate, "rf", in the CAPM formula is represented by the 10 yield on long-term U.S. Treasury securities. During periods of increased equity 11 market volatility investors tend to allocate their capital to low-risk securities such as 12 Treasury bonds, thereby bidding down the yield on those securities. In addition, since 13 the 2008 Lehman Brothers bankruptcy filing, the Federal Reserve has focused on 14 maintaining low long-term interest rates. However, the capital markets continue to 15 change, by some measures quite significantly. For example, in the 90-trading days 16 ended March 31, 2013, the 30-year Treasury yield ranged from a low of 2.73 percent 17 to a high of 3.26 percent. Further, as discussed in Section VIII (below), the Equity 18 Risk Premium is not constant, and tends to move in the opposite direction as changes 19 in interest rates. 20 Q. WITH THOSE OBSERVATIONS IN MIND, WHAT ASSUMPTIONS DID 21 YOU INCLUDE IN YOUR CAPM ANALYSIS? 22 A. Since utility assets represent long-term investments, I used three different estimates of 23 the risk-free rate: (1) the current 30-day average yield on 30-year Treasury bonds Direct Testimony and Exhibits 20 Docket No

29 1 (i.e., 3.16 percent); (2) the projected 30-year Treasury yield (i.e., 3.30 percent) ;20 and 2 (3) the long-term projected 30-year Treasury yield (i.e., 5.10 percent).21 3 Q. WHAT MARKET RISK PREMIUM DID YOU USE IN YOUR CAPM 4 ANALYSIS? 5 A. For the reasons discussed above, I did not use a historical average; rather, I developed 6 two forward-looking (ex-ante) estimates of the Market Risk Premium. 7 Q. PLEASE DESCRIBE YOUR FIRST EX-ANTE APPROACH TO 8 ESTIMATING THE MARKET RISK PREMIUM. 9 A. The first approach is based on the market required return, less the current 30-year 10 Treasury bond yield. To do so, I relied on data from two sources: (1) Bloomberg; and 11 (2) Value Line. For Bloomberg, I calculated the market capitalization weighted 12 expected dividend yield (using the same one-half growth rate assumption described 13 earlier), and combined that amount with the market capitalization weighted projected 14 earnings growth rate to arrive at the market capitalization weighted average DCF 15 result. I then subtracted the current 30-year Treasury yield from that amount to arrive 16 at the market DCF-derived ex-ante Market Risk Premium estimate. For Value Line, I 17 calculated the projected long-term market return based on the implied annual price 18 appreciation and dividend yield for Value Line's composite index. The results of 19 those two calculations are provided in Exhibit RBH Q. PLEASE NOW DESCRIBE THE SECOND EX-ANTE APPROACH. 21 A. The second approach assumes a constant Sharpe Ratio, which is the ratio of the risk 22 premium relative to the risk, or standard deviation of a given security or index of 23 securities. The Sharpe Ratio is relied upon by financial professionals to assess the 24 incremental return received for holding a risky (i.e., more volatile) asset rather than a 20 See Blue Chip Financial Forecasts, Vol. 32, No. 3, March 1, 2013, at 2. Consensus projections of the 30-year Treasury yield for the six quarters ending June As noted above, the 30-year Treasury yield ranged from 2.73 percent to 3.26 percent in the 90-trading days ended March 31, See Blue Chip Financial Forecasts, Vol. 31, No. 12, December 1, 2012, at 14. Consensus projections of the 30-year Treasury yield for the period Direct Testimony and Exhibits 21 Docket No