Analysis of the rate of cost of capital proposed by PTC

Risk-free interest rate

PTC mentions that ICP-ANACOM’s Decision on this matter establishes that the risk-free interest rate should be calculated using the 10 year Treasury Bond rate, and that the series to be used should correspond to the monthly observations of the last two years.

Having analyzed the monthly series of the last two years (2009 and 2010), PTC concludes that this rate changed materially, rising to 4.80%, compared with the 4.47% defined in the Decision on this matter.

About this figure, note that ICP-ANACOM recreated PTC´s calculations, and found the same value – 4.80% for the average 10 year Treasury Bonds rate between January 2009 and December 2010.

Tax rate

PTC says that Article 2 of Law 12-A/2010 of 30 June, concerning additional measures relating to the budget consolidation of the State accounts, has now set an additional rate of 2.5% on the taxable profit, corresponding to the state local tax. PTC’s nominal tax rate thus became 29%.

ICP-ANACOM agrees with the update of the nominal interest rate stated by PTC, which is now 29% as opposed to the 26.5% rate defined by the Determination of February 2010.

Furthermore, PTC mentions that besides the rate of IRC (corporation tax) and the municipal and state taxes, it also pays tax in the form of Independent Taxation, the amounts of which rose under the budget consolidation measures.

Notwithstanding this reference to the worsening of its fiscal obligations, PTC does not consider them in the calculations presented within the review of the rate of the cost of capital. ICP-ANACOM agrees with the approach suggested by PTC.

Risk Premium

Concerning the review of the parameter representing the risk premium, PTC notes that “the complexity of the calculation introduced by ICP-ANACOM implies the use of data to which PTC has no access under its normal activity; therefore its update should be the Regulator’s responsibility”.

It should be recalled that under the process leading to the Decision of February 2010 it was stipulated that the review mechanism can be triggered by ICP-ANACOM or by PTC, with the proposer, however, being responsible for collecting the information. In addition, the figures that support its calculation are available to any party, since they are not confidential or subject to restricted access.

Review for 2010

Considering the previously mentioned changes to the risk-free interest rate, PTC updated the calculation of the rate of the cost of capital and obtained a result of 10.97% (vide table 2), compared with the 10.28% that calculated under the Decision, determining an impact of about +0.7 per cent, thereby producing at the outset the conditions triggering a review of the mechanism.

Source: PTC and  ICP-ANACOM Calculations

ICP-ANACOM recalculated the rate of the cost of capital considering the same changes, determining a rate of 10.97%, as PTC did.

ICP-ANACOM therefore agrees that the necessary factors are in place to activate the mechanism for reviewing the previously defined rate.

Review for 2011 and new glide path

PTC considers that “given that we are on a transition period of rate adjustment it seems fundamental to evaluate the impact of these changes on the estimate of the rate for the end of that period (2011), and the consequent need to reassess the pace defined for the downward-path”.

PTC has therefore devised a scenario for 2011 which considers that the tax rate will remain at 29%, and that the risk-free interest rate will be at least 5.40%, on the assumption that the average value of the 10 year Treasury Bonds in 2011 will not be below the 2010 average.

Considering the abovementioned data, PTC presented the calculation for the 2011 fiscal year, finding a figure of 11.73% for the rate of the cost of capital (vide table 3).

Source: PTC Calculation

Based on this new assumption, PTC proposes to use the rate calculated for 2011 as an arrival point, and the rate of the 2009 financial year, 12.3%, as the departure point for defining a new glide path (vide table 4).

Source: PTC Calculation 

So, PTC proposes that the rate of the cost of capital to be used for the 2010 financial year should be 12.02%.

It is important to mention that although ICP-ANACOM expresses its agreement with the need to review the rate of the cost of capital, the same understanding is not possible with respect to the figures presented, notably because PTC’s proposal is based on the extrapolation of 2010 data, thus creating a hypothetical scenario for interest rates in the 2011 financial year.

Furthermore, the purpose of the review mechanism of the rate of the cost of capital is to prevent any situations arising that might have a disproportionate influence on the rate of the cost of capital corresponding to the financial year under analysis, and therefore the PTC calculation falls outside spirit of this mechanism by extrapolating data for the future.

Given the above, it is ICP-ANACOM’s position that the rate of the cost of capital at the end of the considered period (2011) should not be calculated based on hypothetical scenarios, and therefore we now present the updated rate, according to the calculations of ICP-ANACOM.

In order to incorporate the changes in the risk-free interest rate and the tax rate, ICP-ANACOM determines a new glide path by establishing the rate of the cost of capital applied in 2009 as the starting point (12.3%), also suggested by PTC, and the rate obtained with the most recent changes as the arrival point, and still considering the figures from the two last financial years (now 2009 and 2010), 10.97% (vide table 2), resulting in a rate of 11.6% for 2010 and of 11% for 2011 (vide table 5).

Source: ICP-ANACOM calculation
*Tx 09 – ((Tx 09 – Tx 09/11)*0.5)

 
Given the above, we determine that the rates of the cost of capital should be 11.6% and 11% for the 2010 and 2011 financial years respectively, noticing that if any extraordinary situation occurs in the 2011 financial year that has a significant impact on the premises considered, the parameters that are now defined can be reviewed under the terms defined by the Decision of February 2010. As long as it is properly justified, this review can be triggered on the initiative of ICP-ANACOM or PTC until the first quarter of 2012, the proposers being responsible for collecting information.

Other Parameters

It is PTC’s belief that the parameters related to the company itself, notably Beta, gearing and debt premium, should be reviewed, since, given the significant changes that occurred within the macroeconomic framework, it cannot be expected that those parameters have not changed, but this responsibility is left to the Regulator.

However, as defined in the Decision, these parameters cannot be reviewed during the 2009-2011 three year period, since the benchmark used for finding them is broad enough to consider any variations and to accommodate some volatility, although they will surely be reviewed when the rate for the next three year period is defined.

In any case, during the next review of the rate of the cost of capital for PTC for the period subsequent to 2011, the adequacy of the considered parameters will have to be appraised.