WACC
Introduction
9.109 After asset valuation, WACC has the next most significant impact on the calculation of excess returns. In Chapter 6, the Commission, established the following approach to determining WACC:
- WACC is computed using the tax-adjusted Brennan-Lally CAPM.
- The cost of debt is estimated for the same period as that used to determine the risk-free rate (the period for which prices are set) and not the duration of the airport's assets or its debt.
- The period of the risk-free rate should match the revision frequency of pricing on the basis that landing charges should reflect expected costs and risks over the period for which prices are set, but not be affected by the expectations of rates beyond that period. In determining the rate used, the Commission's approach is to use an average yield on Government stock over the period in which an airport consults with its substantial customers (ending with the point at which any new prices come into effect) and with a maturity matching the point at which prices will again be reviewed (at maximum five years). The rate also reflects compound interest.
- The Commission does not consider any of the various approaches to estimating MRP to be better than any other. The Commission adopts a tax-adjusted MRP of 8%, within a range of 7-9% in recognition of uncertainty surrounding the estimate.
- The Commission uses a tax rate of 33% in computing the cost of equity, but the statutory corporate tax rate (which in the late 1980s was 28%) in computing the after-tax cost of debt.
- In selecting comparators to use to determine beta, the Commission considers a number of factors. In the case at hand, the regulatory environment is fundamental to the performance of the airports and is, therefore, the dominant factor considered in choosing comparators. Benchmarks for an asset beta for airfield activities are, therefore, United States firms engaged in electricity generation and/or distribution that are subject to rate-of-return regulation (which gives them a considerable degree of certainty on rate of return), and electricity firms in the United Kingdom subject to CPI-X price caps.
- A firm's actual leverage ratio - based on the market values of debt and equity at the time prices are set - should be used (consistent with the debt premium used).
- The Commission uses a nominal WACC in order to be consistent with its approach to asset base and analysis of historical returns. Any asset revaluations are included in income.
9.110 The above approach is now applied to determine WIAL's WACC for airfield activities.
Estimate Adopted by WIAL
9.111 In 2000, pursuant to the Airport Authorities (Airport Companies Information Disclosure) Regulations 1999, WIAL disclosed an estimate of the WACC for its identified airport activities. WIAL's WACC estimate, and its derivation, is provided in Table 43.
Table 43: WACC Estimates Disclosed by WIAL 2000
| Rf | 7.3% |
| tc | 33% |
| tint | = tc =33% |
| PTMRP | 9% |
| Debt Premium | 1.5% |
| Rd | 8.8% |
| Wd | 50% |
| We | 50% |
 a | 0.45 to 0.6 |
| e | 0.9 to 1.2 |
| Re | 12.991 to 15.691% |
| Nominal Tax-Adjusted WACC | 9.5 to 11.5% |
Views of Substantial Customers
9.112 The airlines disagree with WIAL's estimate of its WACC with respect to the risk-free rate, the post-tax market risk premium, the debt premium, and the asset beta. The Airlines consider the following figures are appropriate, compared in the table with those of WIAL.394
Table 44: Differing Views of Airlines on WACC Components
| | WIAL | Airlines | Difference |
|---|
| Rf | 7.3% | 6.5% | -0.8% |
| PTMRP | 9% | 8% | -1% |
| Debt Premium | 1.5% | 0.8% | -0.7% |
| a | 0.45 to 0.6 | 0.3 to 0.35 | -0.15 to 0.25 |
9.113 Based on these alternative figures, the airlines consider the appropriate WACC for WIAL is 7.02-7.42%.
Appropriate WACC
9.114 Each airport may have its own unique characteristics which can result in a distinct risk profile and WACC. The Commission considers that the appropriate WACC for the airfield activities of WIAL, as at its last price reset on 1 July 1997, is as follows:
Table 45: Appropriate WACC for WIAL Airfield Activities as at 1 July 1997
| Rf | 7.62% |
| tc | 33% |
| tint | 33% |
| PTMRP | 7 to 9%, point est. 8% |
| Debt Premium | 1% |
| Rd | 8.62% |
| Wd | 25% |
| We | 75% |
| a | 0.4 to 0.6, point est. 0.5 |
| e | 0.53 to 0.8, point est. 0.67 |
| Re | 8.84 to 12.31%, point est. 10.44% |
| Nominal Tax-Adjusted WACC | 8.07 to 10.67%, point est. 9.27% |
9.115 Full details of the Commission's computation of WACC for WIAL are contained in Appendix 15. Comments are included in the spreadsheet that explain various inputs and assumptions. In accordance with the approach determined in Chapter 6, the risk-free rate of 7.62% shown in Table 45 above is the five-year Government stock rate averaged for the first six months of 1997.
9.116 The asset beta is the most significant parameter that WIAL and airlines disagree on. WIAL favours an asset beta of 0.45 to 0.6, while the airlines favour a beta of about 0.3. Using the benchmarks adopted in Chapter 6, and based on advice from Dr Lally, the Commission considers that an asset beta of 0.5, within a range of 0.4 to 0.6, is appropriate for WIAL's airfield activities.
9.117 The estimates of WACC shown above for WIAL that are favoured by WIAL and the airlines are current estimates, relevant to the setting of prices from 1 July 2002. To assess the current prices (set in terms of the Deed on 1 July 1997), the Commission has derived an estimate of WIAL's WACC as at 1 July 1997. While not strictly comparable to the current estimates of WIAL, the Commission notes that its WACC range of 8.07% to 10.67% overlaps slightly (at the upper end) with the current WACC range adopted by WIAL. The Commission's estimate is outside (below) the lower bound of WIAL's range.
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