WACC
Introduction
10.93 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.
10.94 The above approach is now applied to determine CIAL's WACC for airfield activities.
Estimates Adopted by the Airports
10.95 In 2000, pursuant to the Airport Authorities (Airport Companies Information Disclosure) Regulations 1999, CIAL disclosed an estimate of the WACC for its identified airport activities. This WACC was used by CIAL to determine its new landing charges announced December 2000. CIAL's WACC estimate, and its derivation, is provided in Table 64.
Table 64: WACC Estimates Disclosed and Adopted by CIAL 2000
| Rf | 5 year rate - 6.23% |
| tc | 33% |
| tint | = tc =33% |
| PTMRP | 9% |
| Debt Premium | 0.5% |
| Rd | 6.73% |
| Wd | 40% |
| We | 60% |
 a | 0.65 |
| e | 1.0833 |
| Re | 13.924% |
| Nominal Tax-Adjusted WACC | 10.15%432 |
Views of Substantial Customers
10.96 The airlines disagree with CIAL'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 CIAL.433
Table 65: Differing Views of Airlines on WACC Components
| | CIAL | Airlines | Difference |
|---|
| Rf | 6.23% | 6.5% | 0.27% |
| PTMRP | 9% | 8% | -1% |
| Debt Premium | 0.5% | 0.8% | 0.3% |
| a | 0.65 | 0.3 to 0.35 | -0.3 to 0.35 |
10.97 Based on these alternative figures, the airlines consider the appropriate WACC for CIAL is 7.09-7.59%.
Appropriate WACC
10.98 Each airport may have its own unique characteristics that can result in a distinct risk profile and WACC. The Commission considers that the appropriate WACC for the airfield activities of CIAL, as at its last price reset on 1 January 2001, is as follows:
Table 66: Appropriate WACC for CIAL Airfield Activities as at 1 January 2001
| Rf | 7.04% |
| tc | 33% |
| tint | 33% |
| PTMRP | 7 to 9%, point est. 8% |
| Debt Premium | 1% |
| Rd | 8.04% |
| 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 | 8.45 to 11.92%, point est. 10.05% |
| Nominal Tax-Adjusted WACC | 7.68 to 10.28%, point est. 8.88% |
10.99 Full details of the Commission's computation of WACC for CIAL are contained in Appendix 17. Comments included in the spreadsheet explain various inputs and assumptions. In accordance with the approach determined in Chapter 6, the risk-free rate of 7.04% shown in Table 66 above is an average of yields on three-year government stock over the six month period of February to August 2000.
10.100 The asset beta is the most significant parameter that CIAL and airlines disagree on. CIAL favours an asset beta of 0.65, 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 CIAL's airfield activities.
10.101 The Commission notes that the WACC estimate of 10.15% adopted by CIAL in setting current prices just falls within the range of 7.68% to 10.28% considered appropriate by the Commission (at the upper bound). The Commission's point estimate of WACC is significantly lower than CIAL's figure.
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