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STB changes calculation method for rail industry's cost of equity

Shippers spoke, and the Surface Transportation Board (STB) has listened. Yesterday, the board announced it's revising the method used to calculate a key component of the rail industry's cost of capital to a more "theoretically sound" model.

Since 1982, the STB has employed a single-stage discounted cash flow (DCF) method to determine the cost of equity. Each year, the board calculates the rail industry's cost of capital, a figure used in various types of regulatory proceedings, such as determining the reasonableness of a challenged rail rate and line abandonment cases. Now, the STB will use a Capital Asset Pricing Model (CAPM) — a more current and precise techniques, according to the board — to calculate the cost of equity as part of cost-of-capital proceedings.

"While the CAPM approach has become the industry norm to estimate the cost of equity, best practices can change and evolve over time. Therefore, we are not foreclosing the possibility that we may need to modify the CAPM assumptions in future cost-of-capital proceedings," STB members said in their decision. "We will entertain petitions for a rulemaking to revise the CAPM standard adopted here to keep our cost-of-capital calculation abreast with current finance practices."

The board plans to begin a proceeding to seek public comments on how to construct a "useable, multi-stage DCF" for future use in conjunction with the CAPM.

"If a suitable model is presented and a record developed demonstrating that using a combination of the two approaches can reduce the potential for volatility and improve the precision of our cost-of-equity estimate, we will consider further modifying our approach," STB members said in their decision. "If parties do not provide the necessary record to support such a decision, we will discontinue that proceeding and rely solely on CAPM."

In 2006, the STB's cost of capital calculation method was challenged by a group of shippers. Since that time, the board held two public hearings and reviewed five rounds of written testimony and exhibits to analyze its calculation model. The core debate focused on determining the best way to estimate the cost of equity, which measures the returns shareholders require as compensation for the use of their capital.

Parties involved in an ongoing proceeding to calculate the rail industry's cost of capital in 2006 will be directed to submit necessary information for the STB to render a decision, the board said.

Contact Progressive Railroading editorial staff.

More News from 1/18/2008