OAR 150-308-0250
Derivation of Capital Structure and Discount Rates for Valuing Industrial Properties and Department-Assessed Properties
(1)
CAPITAL STRUCTURE. The capital structure of a company refers to the make-up of its financial structure, i.e., long-term debt and equity. For ad valorem appraisal purposes, the appropriate capital structure for a company is the typical capital structure for the industry group to which the property belongs based upon current market cost of debt and equity. If it can be shown that use of an industry capital structure would not reflect the market value of the property because of the unique nature of the property or its operation, the current owner’s capital structure may be used. The procedures to be followed in determining capital structure are as follows:(a)
Select industry group, i.e., electric utility, airline, railroad, lumber, food processing, etc.(b)
Determine if it is necessary to have industry sub groups. Sub groups are groupings of properties within an industry type that have similar characteristics and that are different from other sub groups within the industry type. Sub groups have similar qualities such as bond ratings, degree of risk if unrated, business activities and size.(c)
For each group or sub group, a sufficient number of companies should be selected that have publicly traded securities and similar debt ratings (e.g., Moody’s Aa, A, Baa, etc.). The company or companies whose property is subject to appraisal may be included as part of the data set.(d)
The appropriate capital structures shall be determined by a correlation of the capital structures of the companies in the selected group.(e)
Capital structures for companies with nonrated debt must be estimated from the best data available, such as balance sheets, public utility commission-approved structures, sales data, lenders’ opinions, industry recommendations, or patterns established by companies with rated debt within the same industry.(2)
BASIC DISCOUNT RATE. Basic discount rate, cost of capital, and capitalization rate are synonymous as used herein. The band-of-investment method is the preferred method for calculating basic discount rate. An example of this method, assuming a capital structure of 50 percent debt, 10 percent preferred stock, and 40 percent common equity, is shown below: [Table not included. See ED. NOTE.](a)
The band-of-investment capitalization rate can readily be converted to an after-tax rate. The after-tax interest rate is substituted for the current cost of debt in the band-of-investment procedure. This after-tax cost of debt is calculated by multiplying the current cost of debt by one minus the corporate tax rate. When the after-tax cost of capital is used, the tax expense of the prospective purchaser must be deducted from the income to be capitalized as though the property had no tax shelter from debt interest to avoid double counting the deduction for income taxes.(b)
Cost of Debt. The cost of debt is the current market rate for new securities. The embedded rate on securities previously issued is not a proper measure. In order to determine the cost of debt the appraiser should:(A)
Refer to the rates for seasoned bond issues from Moody’s Utility, Industrial, and Transportation weekly news reports or other rating services for at least two months immediately prior to the appraisal date. This should be done by bond rating (Aa, A, Baa, etc.) and industry type.(B)
Obtain information on new bond issues by industry type and bond rating from Moody’s Bond Survey or other publications for at least two months immediately prior to the appraisal date.(C)
Consider recommendations on debt rates submitted by industry.(D)
Select rates for each industry group by bond rating after analyzing the data in the steps above.(c)
Preferred Stock. The cost of preferred stock is determined from the current market rates, not the embedded rate.(d)
Cost of Equity. The two preferred methods for determining the cost of equity capital are the Discounted Cash Flow (DCF) model and Capital Asset Pricing Model (CAPM). The appraiser should consider other models if circumstances and data justify their use.(A)
The DCF model, stated mathematically, is as follows: [Table not included. See ED. NOTE.] Information on the estimated annual dividend for the next period (year) and the expected rate of growth can be obtained from such financial publications as Value Line. The current price for the common stock is the average price near the appraisal date. The DCF equity rate for the industry group is determined by correlating equity rates of return computed for the companies in the industry capital structure group.(B)
The CAPM, stated mathematically, is as follows: [Table not included. See ED. NOTE.] Information on the risk free rate (Rf) can be obtained from the Federal Reserve Bulletin containing rates for U.S. Treasury notes or bonds as near the appraisal date as possible. Data for Beta (Bi) and the market rate (Rm) shall be obtained from a reliable source such as Value Line. A single number for risk premium (Rp) such as those published by Ibbotson Associates, Kidder Peabody, and others may be used. The CAPM equity rate for the industry group is determined by correlating equity rates of return computed for the companies in the industry capital structure group.(3)
EFFECTIVE DATE: This rule first applies to property valuations as of January 1, 1990.
Source:
Rule 150-308-0250 — Derivation of Capital Structure and Discount Rates for Valuing Industrial Properties and Department-Assessed Properties, https://secure.sos.state.or.us/oard/view.action?ruleNumber=150-308-0250.