Core References

• A Back-of-the-Envelope Approach to Assess the Cost of Capital for Network Regulators The World Bank, December 1997. Alexander, I., and A. Estache

  Provides a description of how to estimate cost of capital in a developing country context.

• Infrastructure Concessions, Information Flows, and Regulatory Risk. Note no. 203 in Public Policy for the Private Sector. Washington, D.C.: World Bank Group, December 1999. Burns, P., and A. Estache

  Holds that regulators need to compute the weighted average cost of total capital (debt plus equity) to ensure a return to investors and sustain the asset base. Describes how to identify the cost of debt. Examines techniques for estimating the cost of equity with market data. Finds that in developing countries, however, concessionaires are often unlisted, so market data are not available, or the concessionaires may be part of a larger conglomerate, so market data will cover not only the regulated activity but others as well. Examines using comparators to solve these problems. Also discusses using benchmark ratios based on international best practice.

• Gas Control Inquiry: Final Report New Zealand, 2004. Commerce Commission of New Zealand

  Explains components of the weighted average cost of capital and how to estimate them. Provides cases using gas companies in New Zealand.

• The Cost of Capital and Access Arrangements in Infrastructure Regulation and Market Reform: Principles and Practice, edited by Margaret Arblaster and Mark Jamison. Canberra, Australia: ACCC and PURC, 1998, pp. 161-184. Davis, Kevin, and John C. Handley

  Analyzes cost of capital methodologies. Considers the importance of access arrangements, alternatives to the Capital Asset Pricing Model, factors affecting the derivation of beta risk and the feasibility of international benchmarks, determination of beta risk for an operator with markets with different levels of competition, the impact of price cap regulation, the treatment of depreciation in the cost of capital, the relationship between beta risk, pricing principles and asset valuation methodologies, and the treatment of stranded assets.

• Taxation and the Cost of Capital: A Review of Overseas Experience NERA, April 1999. Houston, Greg, Jeff Makholm, Richard Hern, and Ann Whitfield

  Examines issues of nominal versus real approaches to the weighted average cost of capital, pre-tax versus post-tax formulations, and the use of short versus long-term estimates of the effective tax rate.

• The Cost of Capital: Intermediate Theory Cambridge UK: Cambridge University Press, 2005. Armitage, Seth

  Describes issues regarding how to measure the cost of capital.

• Regulation and the Cost of Capital in Crew, M. and D. Parker, eds., International Handbook on Economic Regulation, Northhampton, MA: Elgar, 2008. Jenkinson, Tim

  Discusses difficulties in estimating risk and the appropriate equity cost of capital. Examines the trend towards high levels of debt in utility capital structures. Discusses whether capital structure should be regulated. Finally, examines issue of “financeability” – whether the projected revenues, profits and cash flows are such as to enable the company to maintain a strong credit rating.

• Regulatory Risk and the Cost of Capital: Determinants and Implications for Rate Regulation New York: Springer. 2006. Pedell, Burkhard

  Develops a comprehensive concept of regulatory risk using theoretical and empirical research, focusing on how the design of the regulatory system influences the risk of a rate-regulated firm. Also examines appropriate methods for determining rate base and the allowed rate of return.

• A Study into Certain Aspects of the Cost of Capital for Regulated Utilities in the U.K. Smithers & Co Ltd, London, U.K. February 13, 2003. Wright, Stephen, Robin Mason, and David Miles

  Examines key areas of the cost of capital, including the common components of the cost of equity, a comparison of asset pricing models for regulation, practical issues in estimation of asset pricing parameters for utilities, the case for consistency in setting the cost of capital, and regulatory risk.

Sectoral References

ELECTRICITY

• The Rate of Return for Electricity Distribution IPART Discussion Paper, Sydney, Australia, November 1998. Independent Pricing and Regulatory Tribunal of New South Wales

  Describes processes for estimating the cost of capital. Explains with cost of capital is important. Covers weighted average cost of capital, effective tax rate, cost of equity, cost of debt, and inflation.

WATER

• Testing for Financeability: An Assessment 2006. OXERA

  Examines rationale for Ofwat's financeability adjustments in the 2004 periodic review and the potential for alternative approaches.

• The Capital Structure of Water Companies October 11, 2002. OXERA

  Examines appropriate capital structure for water companies in the U.K. Considers effects of capital structure on the cost of capital, whether an operator should be expected to choose an optimal capital structure from the regulator’s perspective, and appropriate regulatory responses to capital structure issues.

Other References

• Regulatory Structure and Risk and Infrastructure Firms: An International Comparison Policy Research Working Paper No 1698, The World Bank, 1996. Alexander, I., Mayer, C. and Weeds, H.

  Provides an econometric analysis of how forms of regulation affect cost of capital.

• Understanding Risk & Return 2001 Marshal Lectures, University of Cambridge, 2001. Campbell, John Y.

  Explains why simple models have difficulty explaining some puzzles in asset pricing.

• Corporate Ratings Criteria 2003. Standard & Poor’s

  Describes Standard & Poor’s criteria for rating corporations, including industrials and utilities. Considers country risk, sovereign risk, cyclicality, regulation, and loan covenants.

Key Words

Cost of Capital, Equity, Debt, Taxes, WACC, CAPM, Risk