Decision No. 538-R-1993
August 10, 1993
IN THE MATTER OF the determination of the 1994 cost of capital rate for Canadian Pacific Limited, pursuant to the Railway Act, R.S.C., 1985, c. R-3.
File No. T 7355/94-1
Order-in-Council P.C. 1976-894 provides that the National Transportation Agency (hereinafter the Agency) establish minimum compensatory rates for the transportation of various canola products. Pursuant to subsection 348(1) of the Railway Act, the Agency shall, in computing the costs of a company, include a cost of capital.
The following sets out the Agency's 1994 Cost of Capital determination for Canadian Pacific Limited (hereinafter CP).
Net Rail Investment
The Agency notes that the working capital study of 1988 resulted in an allowance of $102.3 million. No other study was performed since that year and therefore the 1988 allowance (the latest approved amount) was used.
"Accumulated Amortization of Foreign Exchange on Long-Term Debt" has been transferred from net rail investment to equity in accordance with the Report on Cost of Capital Issues Considered Resolved by the Technical Committee of May 25, 1984 (an increase to net rail investment of $42.179 million).
Unearned Donations and Grants were adjusted by an amount of $22.3 million (a decrease to net rail investment).
The Agency also notes that the capital structure was increased by $3.956 million as a result of the adjustment made to net rail investment in regard to working capital . The adjustment was made to long-term debt (debentures).
Agency Decision No. 87-R-1990 dated February 16, 1990 determined that the amount of deferred taxes estimated to be over-accrued should be phased-in over a four-year period. The over-accrued deferred taxes had been totally amortized at the end of 1991. It was also decided that fifty percent of the amount transferred should be treated as a deemed dividend (financed by long-term debt).
The common equity reported in the capital structure included extraordinary gains from the sale of land. The Agency has determined that these gains be deemed as a special dividend financed by long-term debt (debentures).
The Agency has included restructuring charges relating to manpower reduction payments for the years 1991 and 1992.
The opening balance of deferred taxes was adjusted.
Investment Tax Credits were decreased by an amount of $22.3 million.
The cost rate of long-term debt was recalculated as a result of the adjustments to the capital structure and was changed from 7.53 percent to 8.72 percent.
The after-tax cost of common equity for CP of 11.58 percent was based on the average of the results obtained from the Discounted Cash Flow Model and the Capital Asset Pricing Model (hereinafter the CAPM). The beta in the CAPM was adjusted to correct the tendency of the beta to move to unity over time. This is a better predictor than the historical beta used by CP. The adjusted beta is 1.19. Also, the risk-free rates were adjusted in light of more current information available to the Agency. The average risk-free rate was established at 5.82 percent.
The after-tax cost of common equity for CP Rail for the costing of canola movements of 11.08 percent was based on a business risk adjustment from CP to CP Rail of 0.5 of a percentage point.
In light of the foregoing, the Agency hereby determines that the CP 1994 cost of capital rate is 12.8 percent for the purposes of setting minimum compensatory rates for the transportation of canola and canola products by rail in Eastern Canada.
Submission of 1995 Cost of Capital Rate
CP is directed to submit by May 6, 1994 the 1995 cost of capital rate to be used pursuant to Order-in-Council P.C. 1976-894.
The Agency will consider the release of the CP submission on the 1995 cost of capital rate as well as the decision of the Agency, in whole or in part, pursuant to section 350 of the Railway Act. Any comment CP wishes to make on the release of this information will be considered by the Agency.