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March 04, 2013
Brattle Economists Author Two Reports on Estimating Cost of Equity and Cost of Debt for Regulated Companies in Australia

Brattle economists recently completed two reports on behalf of the Australian Pipeline Industry Association for submission to the Australian Energy Regulator (AER) and the Western Australia Energy Regulatory Authority (ERA). In light of recent changes to Australia’s National Gas Rules, the reports discuss how to ensure that the rules’ requirements pertaining to the estimation of the costs of debt and equity are appropriately reflected. Specifically, the new rules require that decision makers consider relevant estimation methods, financial models, market data, and the prevailing conditions in the market for equity funds. The reports discuss the key characteristics of the various cost of equity and cost of debt estimation methods available to decision makers and circumstances under which each method may be more or less suitable. The authors argue that, in both cases, it is imperative that the choice of model(s) and their implementation take into account the prevailing economic conditions, industry specifics, and the risk characteristics of the firm for which the cost of equity/debt is being determined, because each model can show bias depending on the circumstances. Therefore, the authors emphasize that there is no single or formulaic approach to estimating these costs. To estimate cost of equity, the authors find that different models should be applied to a set of comparable firms, rather than the single firm for which the cost of equity is to be determined, because all methods introduce significant noise or uncertainty. Because the cost of debt interacts with the cost of equity and could impact capital expenditures, the second report argues that a decision maker must take into account specifics about the company, industry and economy. “Estimating the Cost of Equity for Regulated Companies” was authored by Brattle consultants Bente Villadsen, Paul Carpenter, Michael Vilbert, Toby Brown, and Pavitra Kumar. The report was accompanied by an introduction by MIT professor and Brattle principal Stewart C. Myers. “Estimating the Cost of Debt,” was authored by Bente Villadsen and Toby Brown. Both reports are available for download below.