Cost of Capital for Mobile Termination Rates, Fixed-Line, and Broadcasting Price Controls May 2019 - 1 - Europe Economics is registered in England No. 3477100. Registered offices at Chancery House, 53-64 Chancery Lane, London WC2A 1QU. Whilst every effort has been made to ensure the accuracy of the information/material contained in this report, Europe Economics assumes no responsibility for and gives no guarantees, undertakings or warranties concerning the accuracy, completeness or up to date nature of the information/analysis provided in the report and does not accept any liability whatsoever arising from any errors or omissions. © Europe Economics. All rights reserved. Except for the quotation of short passages for the purpose of criticism or review, no part may be used or reproduced without permission. Contents 1 Executive Summary ....................................................................................................................................................... 1 1.1 Theoretical Approach ....................................................................................................................................... 1 1.2 Generic Parameters in the CAPM .................................................................................................................. 1 1.3 Specific Parameters in the CAPM ................................................................................................................... 2 1.4 Pre-tax WACCs ................................................................................................................................................. 2 2 Introduction .................................................................................................................................................................... 4 2.1 Markets within the scope of the analysis ...................................................................................................... 4 2.2 Estimation approach .......................................................................................................................................... 4 3 Generic Parameters in the WACC-CAPM Model ................................................................................................ 6 3.1 Risk-Free Rate ..................................................................................................................................................... 6 3.2 The Equity Risk Premium ............................................................................................................................... 11 3.3 Taxation .............................................................................................................................................................. 14 3.4 Conclusion on Generic Parameters ............................................................................................................. 14 3.5 Evolution of generic parameters since 2014 .............................................................................................. 14 4 Specific Parameters in the WACC-CAPM Model ............................................................................................... 17 4.1 Set of comparators .......................................................................................................................................... 17 4.2 Gearing ................................................................................................................................................................ 18 4.3 Equity and Asset Beta ...................................................................................................................................... 18 4.4 Debt Premium ................................................................................................................................................... 21 5 Mobile WACC ............................................................................................................................................................. 22 5.1 Gearing ................................................................................................................................................................ 22 5.2 Equity Beta ......................................................................................................................................................... 25 5.3 Debt Premium ................................................................................................................................................... 28 5.4 Overall Mobile WACC ................................................................................................................................... 31 6 WACC for an Irish Fixed-Line Incumbent with an Efficient Capital Structure ............................................ 32 6.1 Gearing ................................................................................................................................................................ 32 6.2 Equity Beta ......................................................................................................................................................... 34 6.3 Data sampling and logic for market data .................................................................................................... 37 6.4 Overall fixed line WACC ............................................................................................................................... 39 7 Broadcasting WACC .................................................................................................................................................. 40 7.1 The WACC in Market A and Market B ...................................................................................................... 40 7.2 Regulatory Approaches to Broadcasting .................................................................................................... 41 7.3 Gearing ................................................................................................................................................................ 42 7.4 Debt Premium ................................................................................................................................................... 44 7.5 Equity Beta ......................................................................................................................................................... 46 7.6 Overall Broadcasting WACC ........................................................................................................................ 48 8 Comparison of Overall Costs of Equity and WACCs, Evolution Through Time and Aiming Up .......... 49 8.1 Pre-tax WACCs ............................................................................................................................................... 49 8.2 Aiming up............................................................................................................................................................ 50 8.3 Evolution of specific parameters since 2014 .............................................................................................. 51 9 Appendix 1: The CAPM-WACC framework ....................................................................................................... 56 9.1 The Regulatory Cost of Capital .................................................................................................................... 56 9.2 The WACC-CAPM Approach ...................................................................................................................... 56 9.3 Cost of Equity.................................................................................................................................................... 57 9.4 Cost of debt ....................................................................................................................................................... 57 9.5 Inflation and Taxation ...................................................................................................................................... 58 10 Appendix 2: Alternatives to the CAPM ................................................................................................................. 59 10.1 Alternatives to the CAPM .............................................................................................................................. 59 10.2 The Fama-French three factor model ......................................................................................................... 59 10.3 Dividend Growth Model ................................................................................................................................. 60 10.4 Residual Income Model ................................................................................................................................... 61 10.5 Third moment CAPM ...................................................................................................................................... 62 10.6 Conclusion on Theoretical Approach ......................................................................................................... 62 11 Appendix 3: Gearing and the Modigliani-Miller Theorem ................................................................................. 64 12 Appendix 4: Alternative approach .......................................................................................................................... 67 12.1