Calculation of Return on Equity (Ke) Presentation to Stakeholders 8 th October 2008

Transcription

1 Calculation of Return on Equity (Ke) Presentation to Stakeholders 8 th October

2 Overview (1) Tariffs set by Energy Regulator based on Allowable Revenue Tariff 1 Tariff 2 Tariff 3 Allowable Revenue 2

3 Overview (2) Allowable Revenue = (RAB x WACC) + E + T + D + F ± C Where: RAB = Regulatory Asset Base WACC = effective weighted average cost of capital E = Expenses: maintenance and operating expenses for the tariff period under review T = Tax: notional tax expense in the for the tariff period under review D = Depreciation: the charge for the tariff period under review F = approved revenue addition to meet debt obligations for the tariff period under review. C = Claw back adjustment (to correct for differences between actual and forecasts in formula elements as well as efficiency gains) from the immediately preceding tariff period 3

4 Overview (3) WACC WACC E Dt * Ke Kd Dt E Dt E * Where: E = equity Dt = debt Ke = the cost of equity derived from the Capital Asset Pricing Model (CAPM) Kd = the cost of debt 4

5 Capital Asset Pricing Model Formula to calculate Return on Equity (Ke) Ke real 12 m 1 25 Rf 1* (1- t) Rm- Rf * 1- t m 2 12 y 1 25 y CRA * 5

6 COST OF EQUITY Where Ke= After tax allowable real cost of equity. Rf1 = The real risk-free rate of interest. This is the mark to market risk-free rate for the preceding 12 months for all government bonds with at least 10 years maturity as at two months before the commencement of the forthcoming tariff period t = current corporate tax rate for the licensee Rm = the real market return. The proxy used for the market is the JSE ALL Share Index, converted from a nominal to real value, inclusive of dividends (Total return) Rf2 = the real risk-free rate for the corresponding period to the market returns for the previous 25 years. This is the mark to market risk-free rate for the preceding 25 years for all government bonds with at least 10 years maturity, as at two months before the commencement of the forthcoming tariff period CRA = country risk adjustment for assets outside South Africa and for the country concerned. CPI = Consumer Price Index beta, the systematic risk parameter for regulated entities providing pipeline, storage and loading facility services. The beta must be determined by proxy. As a proxy the average of six (6) pipeline companies selected by the Energy Regulator and listed on stock exchange. 6

7 Taxation rules applied When converting nominal rates to real rates it is very important to ensure that like is compared with like: CPI is at a nominal rate ( post tax ). Market return (MR) is mostly nominal post tax (except for capital gains tax) and is assumed to be set at post tax as the intention for the investor is assumed to hold the investment to maturity. Risk free (Rf) is a nominal pre tax rate and has to be converted to a nominal post tax rate; converted to real post tax. Used the current tax rate, 28%, in all years 7

8 The Calculation of MRP for March 1984 Year ending 31 March 1984 Equity return (post tax) a 32.71% CPI b 12.30% Real MR Post tax c=(1+a)/(1+b) % Rf nominal Pre tax d 13.29% Rf nominal Post tax e=d*(1-tax) 9.57% Rf real Post tax f=(1+e)/(1+b) % MRP Real Post tax g=(1+c)/(1+f) % 8

9 Date Equity return (post tax) CPI Real MR Rf nominal Pre tax Rf nom post tax Rf real post tax MRP Real post tax a b c=(1+a)/(1+b)-1 d e=d*(1-tax) f=(1+e)/(1+b)-1 g=(1+c)/(1+f)-1 31 Mar % 12.30% 18.17% 13.29% 9.57% -2.44% 21.12% 31 Mar % 11.53% -6.96% 16.05% 11.56% 0.03% -6.99% 31 Mar % 16.29% 28.17% 16.83% 12.12% -3.59% 32.94% 31 Mar % 18.65% 29.75% 15.82% 11.39% -6.13% 38.21% 31 Mar % 16.16% % 15.61% 11.24% -4.23% % 31 Mar % 5.86% 35.79% 9.46% 6.81% 0.90% 34.58% 31 Mar % 3.39% 23.99% 9.19% 6.62% 3.13% 20.23% 31 Mar % 3.40% 52.23% 7.88% 5.67% 2.20% 48.95% 31 Mar % 4.64% 31.54% 8.00% 5.76% 1.07% 30.15% 25 Mar % 7.10% 7.02% 8.27% 5.96% -1.07% 8.18% Average 21.89% 9.84% 11.18% 13.68% 9.85% 0.11% 11.08% 9

10 Calculation of Rf1 Date Equity return (post tax) CPI Real MR Rf nominal Pre tax Rf nominal post tax Rf real post tax MRP Real Post tax a b c=(1+a)/(1 +b)-1 d e=d*(1- tax) f=(1+e)/ (1+b)-1 g=(1+c)/ (1+f)-1 25 Mar % 7.10% 7.02% 8.27% 5.96% -1.07% 8.18% Risk free (real) (Rf1) -1.07% Nominal (1 year) 5.96% CPI (1 year) 7.10% 10

11 Beta Calculation Beta Calculation Industry beta. (Calculation of a proxy beta for the industry as per the methodology) Size of company Construction Risk (Green fields / start up / size of construction) Instruments available for obtaining capital Dominance in market (Market share) Private / Government company Total beta

12 Calculation of Ke Beta (slide #8) a 1.00 MRP (slide#6) b 11.08% Cross Country risk adjustment c 0.00% MRP ( Real) after country risk adjustment d=(a*b)+c 11.08% Risk free (real) (Rf1) e -1.07% Ke (Real) f=d+e 10.01% 12

13 THANK YOU 13