[Federal Register Volume 72, Number 156 (Tuesday, August 14, 2007)]
[Notices]
[Pages 45493-45494]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E7-15888]


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DEPARTMENT OF TRANSPORTATION

Surface Transportation Board

[STB Ex Parte No. 664]


Methodology To Be Employed in Determining the Railroad Industry's 
Cost of Capital

AGENCY: Surface Transportation Board, DOT.

ACTION: Notice.

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SUMMARY: The Board proposes to revise its method for calculating the 
railroad industry's cost of capital by computing the cost of equity 
using a capital asset pricing model.

DATES: Comments on this proposal are due by September 13, 2007. Reply 
comments are due by October 15, 2007.

ADDRESSES: Comments may be submitted either via that Board's e-filing 
format or in the traditional paper format. Any person using e-filing 
should attach a document and otherwise comply with the instructions at 
the E-FILING link on the Board's Web site, at http://www.stb.dot.gov. 
Any person submitting a filing in the traditional paper format should 
send an original and 10 copies to: Surface Transportation Board, Attn: 
STB Ex Parte No. 664, 395 E Street, SW., Washington, DC 20423-0001.
    Copies of written comments will be available from the Board's 
contractor, ASAP Document Solutions (mailing address: Suite 103, 9332 
Annapolis Rd., Lanham, MD 20706; e-mail address: [email protected]; 
telephone number: 202-306-4004). The comments will also be available 
for viewing and self-copying at the Board's Public Docket Room, Room 
131, and will be posted to the Board's Web site.

FOR FURTHER INFORMATION CONTACT: Paul A. Aguiar at (202) 245-0323. 
[Assistance for the hearing impaired is available through the Federal 
Information Relay Service (FIRS) at 1-800-877-8339.]

SUPPLEMENTARY INFORMATION: The Surface Transportation Board (the Board) 
has issued a notice seeking public comments on the following proposed 
change to the methodology to calculate the railroad industry's cost of 
capital. To calculate the cost of equity component of the cost of 
capital, we propose to replace the Discounted Cash Flow method 
currently used with a Capital Asset Pricing Model (CAPM).
    To calculate the cost of equity, we propose to use the following 
simple single-Beta version of the CAPM model: Cost of equity = RF + 
[beta]*RP. In this equation, RF is the annual economy-wide risk-free 
rate, RP is the annual market-wide risk premium, and [beta] (or Beta) 
is the measure of systematic, non-diversifiable risk of a particular 
carrier. The industry-wide cost of capital will be determined as a 
weighted average of individual railroad costs, using the same 
methodology as is used now.
    To calculate the annual risk-free rate, we propose to use the 10-
year Treasury Bond rate. The FRB uses a short-term Treasury Bill rate 
and the CTA uses both short-term and long-term rates. We believe a 
longer rate is superior and the 10-year is the longest Treasury Bond 
that has been continuously issued. A comprehensive study found that 70% 
of corporate and financial advisors use Treasury bond yields of 
maturities of 10 years or greater. See Bruner, Eades, Harris, and 
Higgins, Best Practices in Estimating the Cost of Capital: Survey and 
Synthesis, Fin. Practice & Educ. at 13-29 (Spring/Summer 1998) (Best 
Practices). Moreover, the risk-free rate used by investors should be 
risk free over the time period of the investment, and railroad assets 
are often long-lived. Finally, an advantage of using long-term rates is 
that they contain long-term inflation expectations. Using a 10-year 
risk-free rate therefore makes the proposed CAPM calculation more 
forward looking.
    To calculate the annual market-wide risk premium, we propose to use 
monthly New York Stock Exchange (NYSE) data over a 50-year time period. 
Because this calculation is essentially an average return, a longer 
time period is usually chosen. We invite comments on the appropriate 
time period. While we propose to calculate the market risk premium each 
year, we also seek

[[Page 45494]]

comments on the use of a fixed number instead.
    To calculate the Beta for each carrier, we propose to use that 
carrier's monthly, merger-adjusted \1\ stock return data for the prior 
10 years in the following standard equation:
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    \1\ ``Merger-adjusted'' means that, in instances where a carrier 
has been formed by merger of several predecessor railroads, data for 
the shares of predecessor railroads are included in such a way as to 
show total performance as if the merger had already occurred.

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R - RF = [beta] (RM - RF) + [egr]

R = merger-adjusted monthly stock return for the railroad;
RF = monthly 10-year U.S. Treasury bond rate;
RM = monthly return on the NYSE; and
[egr] = random error term

    Using a simple, ordinary least squares (OLS) regression technique, 
the Board would estimate [beta], the coefficient of systematic, non-
diversifiable risk. OLS regression technique is a simple but accepted 
statistical tool one can use to develop an unbiased estimate of the 
true Beta. There would always be 120 months of data. Each year, 12 
months of new data would be added to the data set and the oldest 12 
months of observations would be removed.
    In selecting a 10-year time period to estimate Beta, we seek to 
balance the desire to eliminate statistical noise and achieve stability 
in the estimate, while allowing for the fact that Beta may change over 
time. Using earlier data might cause results to be skewed by events 
that are no longer important. On the other hand, using a shorter 
timeframe--while capturing changes in industry risk profiles more 
rapidly--would introduce more variability and noise in the estimate. We 
also invite comment on the use of 25-year or 5-year time periods. 
Anything less than five years appears to add too much noise. Green, 
Lopez, & Wang, Formulating the Imputed Cost of Equity Capital for 
Priced Services at Federal Reserve Banks, FRBYU Econ. Policy Rev. at 70 
(Sept. 2003).
    We invite comments on whether it would be reasonable to assume that 
Beta equals 1, thereby eliminating the need to estimate Beta. Finance 
theory predicts that Beta will move towards 1 over time, and this has 
proved true for banks and other firms that provide payment processing 
services. See Hearing Tr. at 25. We also invite comments on the 
inclusion of an intercept term in the regression.
    We have reviewed and reject other suggested changes to our existing 
procedures. First, we reject WCTL's suggestion that parties should be 
permitted to argue for an alternate approach to be used in a particular 
year. Second, we will not adjust the debt portion of capital to reflect 
the capitalization of operating leases, as requested by WCTL. Third, we 
reject WCTL's suggestion to replace the current-year debt-to-equity 
ratio with a multi-year average to avoid alleged ``artificial'' 
fluctuations in the capital structure used to calculate the weighted 
average. Finally, we will not expand the scope of this rulemaking to 
re-examine how this cost-of-capital determination is used in the 
Board's annual revenue adequacy determinations and consider using a 
replacement-cost analysis, as suggested by the AAR.
    In a decision served on August 14, 2007, the Board has discussed 
each of these proposals in detail and explained how each addresses 
concerns raised in this proceeding. Because these proposals have 
significance for rail carriers and their shippers, all interested 
parties are invited to comment.
    Additional information is contained in the Board's decision. To 
obtain a free copy of the full decision, visit the Board's http://www.stb.dot.gov Web site.
    Pursuant to 5 U.S.C. 605(b), the Board certifies that the proposed 
action should not have a significant economic effect on a substantial 
number of small entities within the meaning of the Regulatory 
Flexibility Act.
    This action will not significantly affect either the quality of the 
human environment or the conservation of energy resources.

    Decided: August 8, 2007.

    By the Board, Chairman Nottingham, Vice Chairman Buttrey, and 
Commissioner Mulvey.
Vernon A. Williams,
Secretary.
[FR Doc. E7-15888 Filed 8-13-07; 8:45 am]
BILLING CODE 4915-01-P