Download verified direct testimony of adrien m. mckenzie, cfa on behalf of indianapolis power & light PDF

Titleverified direct testimony of adrien m. mckenzie, cfa on behalf of indianapolis power & light
LanguageEnglish
File Size877.0 KB
Total Pages126
Table of Contents
                            McKenzie IPL Direct Testimony
	I. INTRODUCTION
	II. EXECUTIVE SUMMARY
	III. FINANCIAL CHALLENGES FACING IPL
		A. Indianapolis Power & Light Company
		B. Capital Market Conditions
	IV. COMPARABLE RISK PROXY GROUP AND CAPITAL STRUCTURE
		A. Selection of Proxy Group
		B. Capital Structure
	V. COST OF EQUITY FOR IPL
		A. Economic Standards
		B. Discounted Cash Flow Analyses
		C. Capital Asset Pricing Model
		D. Empirical Capital Asset Pricing Model
		E. Utility Risk Premium
		F. Expected Earnings Approach
		G. Non-Utility Benchmark
		H. Other Considerations
		I. Recommended COE Range
	VI. FAIR RETURN ON FAIR VALUE
		A. Fair Value Ratemaking
		B. Fair Return on Fair Value for IPL
		C. Implications of Depreciation Expense Under Fair Value Regulation
IPL AMM Verification
McKenzie IPL Attachments 1 through 16
                        
Document Text Contents
Page 1

VERIFIED DIRECT TESTIMONY

OF

ADRIEN M. MCKENZIE, CFA





ON BEHALF OF

INDIANAPOLIS POWER & LIGHT COMPANY














INCLUDING IPL WITNESS AMM ATTACHMENTS 1 THROUGH 16






mbecerra
Typewritten Text
44893

mbecerra
File Stamp

Page 2

i

i

DIRECT TESTIMONY OF ADRIEN M. MCKENZIE


TABLE OF CONTENTS





I. INTRODUCTION ...............................................................................................................1

II. EXECUTIVE SUMMARY .................................................................................................3

III. FINANCIAL CHALLENGES FACING IPL ......................................................................6
A. Indianapolis Power & Light Company ....................................................................6
B. Capital Market Conditions .....................................................................................13

IV. COMPARABLE RISK PROXY GROUP AND CAPITAL STRUCTURE .....................18
A. Selection of Proxy Group.......................................................................................18
B. Capital Structure ....................................................................................................20

V. COST OF EQUITY FOR IPL............................................................................................21
A. Economic Standards...............................................................................................22
B. Discounted Cash Flow Analyses ...........................................................................27
C. Capital Asset Pricing Model ..................................................................................41
D. Empirical Capital Asset Pricing Model .................................................................45
E. Utility Risk Premium .............................................................................................47
F. Expected Earnings Approach .................................................................................52
G. Non-Utility Benchmark .........................................................................................55
H. Other Considerations .............................................................................................59
I. Recommended COE Range ...................................................................................64

VI. FAIR RETURN ON FAIR VALUE ..................................................................................66
A. Fair Value Ratemaking ..........................................................................................66
B. Fair Return on Fair Value for IPL ..........................................................................70
C. Implications of Depreciation Expense Under Fair Value Regulation ...................80

Page 63

IPL Witness McKenzie 60

similar accounting treatment to ensure that equity flotation costs are recorded and 1

ultimately recognized. No rate of return is authorized on flotation costs necessarily 2

incurred to obtain a portion of the equity capital used to finance plant. In other words, 3

equity flotation costs are not included in a utility’s rate base because that portion of the 4

gross proceeds from the sale of common stock used to pay flotation costs is not 5

available to invest in plant and equipment, nor are flotation costs capitalized as an 6

intangible asset. Unless some provision is made to recognize these issuance costs, a 7

utility’s revenue requirements will not fully reflect all of the costs incurred for the use of 8

investors’ funds. Because there is no accounting convention to accumulate the flotation 9

costs associated with equity issues, they must be accounted for indirectly, with an 10

upward adjustment to the cost of equity being the most common and appropriate 11

mechanism. 12

Q99. IS THERE A THEORETICAL AND PRACTICAL BASIS TO CONSIDER THE 13

IMPACT OF FLOTATION COSTS IN THIS CASE? 14

A99. Yes. First, an adjustment for flotation costs associated with past equity issues is 15

appropriate, even when the utility is not contemplating any new sales of common 16

stock. The need for a flotation cost adjustment to compensate for past equity issues 17

been recognized in the financial literature. In a Public Utilities Fortnightly article, for 18

example, Brigham, Aberwald, and Gapenski demonstrated that even if no further stock 19

issues are contemplated, a flotation cost adjustment in all future years is required to 20

keep shareholders whole, and that the flotation cost adjustment must consider total 21

Page 64

IPL Witness McKenzie 61

equity, including retained earnings.45 Similarly, New Regulatory Finance contains the 1

following discussion: 2

Another controversy is whether the flotation cost allowance should still 3
be applied when the utility is not contemplating an imminent common 4
stock issue. Some argue that flotation costs are real and should be 5
recognized in calculating the fair rate of return on equity, but only at 6
the time when the expenses are incurred. In other words, the flotation 7
cost allowance should not continue indefinitely, but should be made in 8
the year in which the sale of securities occurs, with no need for 9
continuing compensation in future years. This argument implies that 10
the company has already been compensated for these costs and/or the 11
initial contributed capital was obtained freely, devoid of any flotation 12
costs, which is an unlikely assumption, and certainly not applicable to 13
most utilities. … The flotation cost adjustment cannot be strictly 14
forward-looking unless all past flotation costs associated with past 15
issues have been recovered.46 16

Q100. WHAT IS THE MAGNITUDE OF THE ADJUSTMENT TO THE “BARE 17

BONES” COST OF EQUITY TO ACCOUNT FOR ISSUANCE COSTS? 18

A100. There are a number of ways in which a flotation cost adjustment can be calculated, but 19

the most common methods used to account for flotation costs in regulatory 20

proceedings is to apply an average flotation-cost percentage to a utility’s dividend 21

yield. Based on a review of the finance literature, Regulatory Finance: Utilities’ Cost 22

of Capital concluded: 23

The flotation cost allowance requires an estimated adjustment to the 24
return on equity of approximately 5% to 10%, depending on the size 25
and risk of the issue.47 26


45 E.F. Brigham, D.A. Aberwald, and L.C. Gapenski, “Common Equity Flotation Costs and Rate Making,”
Public Utilities Fortnightly, May, 2, 1985.
46 Roger A. Morin, “New Regulatory Finance,” Public Utilities Reports, Inc. at 335 (2006).
47 Id. at 323.

Page 125

FAIR VALUE RATEMAKING IPL Witness AMM Attachment 16

IPL 2016 Basic Rates Case

IMPACT OF DEPRECIATION EXPENSE Page 3 of 4

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Page 126

FAIR VALUE RATEMAKING IPL Witness AMM Attachment 16

IPL 2016 Basic Rates Case

IMPACT OF DEPRECIATION EXPENSE Page 4 of 4

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