that month. He develops a composite dividend yield of 2.68% for 1992.13 This is 0.44 percentage point lower than the 1991 dividend yield (3.12%).

Flotation Costs:

As is true with the issuance of new debt instruments, flotation costs are also incurred with the issuance of new equity securities. In Adequacy of Railroad Revenue (1979 Determination), 363 I.C.C. 344, 352 (1979), the Commission concluded that flotation costs for equity capital should not be considered unless new equity had, in fact, been issued. This has been

13

The composite monthly dividend yields for 1992 using the AAR's data are as follows:

reaffirmed in subsequent cost of capital decisions. Because no railroad issued any new common equity capital during 1992, no flotation cost factor has been included in the DCF formula.

Conclusion - Cost of Common Equity Capital:

Using the truncated average IBES growth rate (g) of 10.14%, the dividend yield (D(0)/P(0)) of 2.68%, and the Commission's DCF formula, the AAR determined the cost of common equity for 1992 to be 12.95%. We have reviewed the evidence contained in the record, and have determined that the AAR's calculations are acceptable and that the 1992 cost of common equity using the DCF method and the formula shown above is 12.95% (rounded to 13.0%). This is 0.1 percen higher than the cost of common equity for 1991.

Market Value of Common Equity

The AAR computes the market value of common equity by taking the number of shares outstanding times the daily closing price for each trading day during the year for each of the sample railroads. The average market value for the year 1992 is computed to be $33,200.2 million. We have reviewed the AAR's calculations and find them to be correct.

Cost of Preferred Equity

PREFERRED EQUITY

Preferred equity has some of the characteristics of debt and some of the characteristics of equity. Essentially, preferred issues are like common stocks in that they have no maturity dates, and represent ownership in the company (usually with no voting rights attached). They are like debt in that they usually have fixed dividend payments (akin to interest payments). There are many different types of preferred stock. Some have provisions which accumulate prior dividends that have not been paid and prevent any common dividends until all prior preferred dividends are paid; some do not have such provisions. Some, called participating preferred, may share in earnings and can have variable dividends. Others are convertible into common stock or are subject to redemption provisions.

The AAR has examined the five preferred stock issues of the sample railroads and has determined their cost in several different ways, depending on the type of preferred issue. The AAR uses the dividend yield method (dividends divided by market price) to determine the cost of four preferred issues (one by Burlington Northern, one by Conrail, one by Kansas City Southern, and one by Norfolk Southern)." One preferred stock issue (Burlington Northern) is not convertible to common stock but has a mandatory redemption schedule. The AAR computes the cost of this stock using its internal rates of return (current price equal to present value of dividends plus redemption price). The AAR computes the cost of these four preferred issues for 1992 to be 4.79%. This is approximately 0.35 percentage point lower than the 1991 figure (5.14%).

We have examined the AAR's evidence and have determined the AAR's computations to be correct, employing techniques which we have previously approved in prior proceedings. We, therefore, conclude that the cost of preferred equity equals 5.14% (rounded to 5.1%) for 1992.

Market Value of Preferred Equity

The AAR computes the market value of preferred stock by multiplying the average quarterly price for each issue times the number of shares outstanding during the quarter. This is the same procedure used in previous cost of capital determinations. The AAR computes the market value of preferred stock during 1992 to be $602.5 million. We have examined these calculations and determined that they are correct.

CAPITAL STRUCTURE MIX

In Railroad Cost of Capital - 1982, supra, the Commission concluded that a market-value based capital structure mix would be used in determining the cost of capital. This is the eighth proceeding that includes the market value of preferred equity as well as the market value of debt and common equity.

The AAR's computations of market values and the capital structure mix for 1992 are shown in Table 5.

14 The Conrail issue accounts for approximately 81% of the total value of the five preferred stock issues.

The market value of bonds, preferred stock, and common equity for 1992 is $8,326.9 million higher than the market value for 1991.16 The percentage share of common equity increased from 68.5% in 1991 to 70.9% in 1992. The percentage share of debt decreased from 30.2% in 1991 to 27.8% in 1992. The percentage share of preferred equity remained the

same.

We have examined the data provided by the AAR and have determined that its development of the capital structure mix is in accordance with the same procedures which we have found to be acceptable in past cost of capital decisions, modified for inclusion of preferred equity. We, therefore, determine that the capital structure for 1992 equals 27.8% debt, 1.3% preferred equity, and 70.9% common equity.

COMPOSITE COST OF CAPITAL

Based on the evidence furnished in the record, and our adjustments due to rounding, we conclude that the composite cost of capital for 1992 for the railroad industry, as set forth in Table 6, is 11.42%, rounded to 11.4%.

15 Includes capitalized leases and miscellaneous debt totalling $1,988.7 million in the

market value of debt.

16 Much of this growth is due to the sharp rise in common stock prices during 1992. The value of common shares increased by almost $7 billion during 1992.

The methodology employed by AAR to develop the composite cost of capital is consistent with the Statement of Principle established by the Railroad Accounting Principles Board: "Cost of capital shall be a weighted average computed using proportions of debt and equity as determined by their market values and current market rates."

w17

The 1992 cost of capital is 0.2% lower than the 1991 cost of capital rate, which was 11.6%.

CONCLUSIONS

We find for 1992:

1. The current cost of railroad debt was 7.7%.

2. The cost of common equity was 13.0%.

3. The cost of preferred equity was 4.8%.

4. The capital structure mix of the railroads was 27.8% debt, 1.3% preferred equity, and 70.9% common equity.

5. The composite railroad industry cost of capital was 11.4%.

Environmental and Energy Considerations

We conclude that this action will not significantly affect either the quality of the human environment or the conservation of energy resources.

17 Railroad Accounting Principles Board Final Report, Vol. 1, 19 (1987).