Estonian Competition Authority

2013 Guidelines for the Determination of Weighted

Average Cost of Capital

Tallinn 2013
Introduction
Weighted average cost of capital (WACC) is the cost of all interest-bearing debt capital
(borrowed capital) and equity capital, which is determined considering the proportional
weight of both capital components. The Competition Authority uses WACC for calculation of
the justified return included in the prices of goods and services sold by undertakings.
According to the long term regulatory practice it is assumed that if the justified return or
operating profit of an undertaking does not exceed the WACC, then the profit earned by the
undertaking is within a reasonable limit. Thus, the WACC is the rate of return allowed by the
regulator.

In the preparation of these guidelines the Competition Authority has relied primarily on the
following sources: the ERRA1 handbook Price Regulation and Tariffs, the analysis Cost of
Capital and Financeability at PR09, Report by Europe Economics 2, The World Bank
handbook3 Resetting Price Controls for Privatized Utilities. A Manual for Regulators, the
database of the CEER countries4.

According to the Competition Authoritys Methodologies for the evaluation of the

justifiability of energy and water prices and the Minister of Economic Affairs and
Communications regulation nr 51 Imposition of Temporary Prices for Heating 12 and
regulation nr 95 The Rules and Conditions for the Imposition of Temporary Prices for Water
Services 9 the undertakings justified return or operating profit consists of the
multiplication of the cost of the property used for the provision of the certain service with
WACC.

In regulatory applications the WACC5 is determined by the following formula (see Formula
1):

Formula 1: WACC ke EC k DC
DC EC d DC EC

Where:

k e is the cost of equity capital (%);

k d is the cost of debt capital (also referred to as borrowed capital) (%);
EC is the share of equity capital determined by the regulator (%);
DC is the share of debt capital determined by the regulator (%);
DC + EC is the sum of the shares of equity capital and debt capital determined by regulator
(%).

1
Energy Regulators Regional Association (ERRA). Price Regulation and Tariffs. June 2006.
2
Analysis prepared by the Europe Economics Chancery House 53-64 Chancery Lane London WC2A
1QU, 21.July 2009.
3
Green, Richard; Pardina, Martin Rodriguez. Resetting Price Controls for Privatized Utilities. A
Manual for Regulators. Washington", D.C.: The World Bank 1999.
4
CEER Council of European Energy Regulators
5
The formula does not reflect the tax shield, as due to specifics of the Estonian income tax regulation
the corporate income tax is imposed only on dividend payments.

2
The variables DC/DC+EC and EC/DC+EC in Formula 1 reflect the structure of capital, i.e.
the ratio between debt capital and equity capital and the total capital, where the total capital is
the sum of the shares of equity capital and debt capital. For example, if the share of debt
capital is 50% and the share of equity capital is 50%, then the total is 100% and thus the ratio
of both equity and debt capital to the total capital is 0,5 or 50% (50%/100%=0,5).

In the following the basics of WACC components formation in Formula 1 is dealt with.

1. Formation of the cost of debt

The cost of debt capital is formed as the sum of the nominal risk-free rate, the Estonian
country risk premium and the debt risk premium of an undertaking.
1.1 Nominal risk-free rate and Estonian country risk premium
The nominal risk-free rate is the income which excludes risk and the investor expects a risk-
free profit. The calculation of the nominal risk-free rate is based on the profit level of
government bonds.
For the calculation of the nominal risk free rate6 the Competition Authority (hereinafter the
CA) uses the 5-year (2008-2012) average interest rate of the German government 10-year
bonds to which it adds the Estonian country risk premium. The reason for using the German
bonds is the circumstance that the Estonian state has not issued long term bonds so far. The
German bond is appropriate as it is the biggest Euro-zone country. Also, the 10-year bonds
are much more similar to company shares rather than the 1-year bonds.

Annual interest rates of German 10-year bonds

6,00
5,27
4,80 4,78
4,58 4,50
Interest rate %

4,50 4,07 4,04 4,22

3,76 3,98
3,35
3,22
3,00 2,74
2,61

1,50
1,50
1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012
Years

Figure 1 - Interest rates of German government 10-year bonds

The annual interest rates of the German 10-year bonds presented in Drawing 1 are published
at: http://stats.oecd.org/Index.aspx.

6
The source of the risk free rate estimates is data from the OSCD web site.
3
The average interest rate for the years 2008-2012 is 2,810%
((3,98+3,22+2,74+2,61+1,50)/5 = 2,810%).

Since the annual interest rates of the German bonds change over time, the cost of debt and
equity capital and the WACC also changes in time.

According to an evaluation by the Bank of Estonia in May 2006 the country risk is
determined by the relative amount of money that the Estonian state has to pay in excess
compared to the countries with higher credit rating (e.g. Germany), when it borrows from
international markets. Most simple way is to compare the differences in the interest rates of
governmental bonds. The Government of Estonia has no such bonds and therefore the country
risk can be evaluated by the comparison of the differences in money markets, basing on the
difference between Talibor and Euribor quotations. In relation to the introduction of euro in 1
January 2011 the Estonian Bank has stopped publishing the Talibor of debt and deposit
interest rates between banks since 30 December 2010. For that reason the CA has contacted
the Estonian Bank with the following question: Which indicator can justifiably be used for the
measurement of the Estonian country risk premium instead of the comparison of the Talibor
and Euribor money market interest rates? On 27 December 2011 the Estonian Bank gave the
following reply:

As in Estonia no aftermarket exists for long-term government bonds there is no direct way to
evaluate the Estonian country risk premium. It can be done by an indirect comparison of
Estonia with countries that have issued government bonds. The results depend on the
presumptions made in regards to the chosen methodology as well as the indicators taken into
consideration. Due to the tensions on markets of the government bonds of developed countries
the level of uncertainty is very high and it is difficult to give quantitative evaluations.
Currently, based on our evaluation, national credit ratings express the country risk premiums
the best and presently the Estonian country risk premium should be based on that. Since
autumn of 2011 the Ministry of Finance deals with credit ratings in Estonia. Therefore we
suggest you to approach the Ministry of Finance for a reply to your question.
On 14 December 2012 CA approached the Ministry of Finance and on 3 January 2013
received the following reply:
As of the end of 2012 no aftermarket exists in Estonia for government bonds and therefore it
is impossible to give a direct quantitative evaluation to the Estonian country risk premium.
Last year (year 2012) we based our evaluation of country risk premiums on the credit country
rating published by the rating agencies. At that time there where many countries in Europe
(Slovakia, Slovenia, Czech Republic) whose credit ratings where similar to Estonia and who
had issued government bonds.
As of the end of 2012 those countries had the following long-term credit ratings:

Estonia (S&P/Moodys/Fitch): AA-/ A1/ A+;

Slovakia (S&P/Moodys/Fitch): A/ A2/ A+;
Slovenia (S&P/Moodys/Fitch): A/ Baa2/ A-;
Czech Republic (S&P/Moodys/Fitch): AA-/ A1/ A+;

4
Many of the aforementioned countries credit ratings have been decreased and currently only
Czech Republic has a similar credit rating with Estonia. The interest rate of Czech Republic
government 10-year bonds in 2012 was 3,005 %. Therefore, based on the Czech Republic
example, the Estonian country risk premium would be 3,005 % minus the average interest
rate of the German government bonds.

(The information about Czech Republic derives from Bloomberg; the appropriate graph is
attached below).

Figure 2 - Interest rates of Czech Republic government 10-year bonds in 2012 (source:
Bloomberg)

Based on the data from Figure 1 and the information received from the Ministry of Finance
(see Figure 2) we obtain the Estonian country risk premium which is the difference between
the Czech Republic government bonds average interest rate in 2012 of 3,005% and the
average interest rate of the German government 10-year bonds of 1,495%. As the result the
Estonian country risk premium is 1,510% (3,005 1,495 = 1,510).

Due to the aforementioned the CA considers as the Estonian country risk premium
1,510% for the year 2013.

As the credit ratings change in time, the cost of debt capital and equity capital and WACC
change in time as well.

1.3 Company debt risk premium

The CA uses the experience of other EU Member States for determining the debt risk
premium of an undertaking.
5
Particularly, the CA has determined the company debt risk premium under the average level
applied by the regulatory authorities of other countries. The CA has access to the CEER
countries7 database for electricity and gas networks. No data for district heat supply networks
is available, but in Estonia these networks are natural monopolies operating in conditions
which are similar to the conditions of gas supply networks. In Western Europe district heat
supply is not spread and for space heating purpose mainly individual natural gas fired
facilities is used and for that reason there is no database for district heating. Thus, the district
heat supply undertakings can be compared with gas networks.
The electricity, gas and district heat supply undertakings are comparable for the similarities of
their services. In Estonia the district heat supply undertakings are in a market dominant
position for several reasons: conversion to another type of heat supply is technically
complicated and often even impossible; installation of an individual source of heat requires
obtaining of an emission licence; an extra power capacity is not available due to electricity
supply system limitations and alike. In addition to above most local municipal authorities
have established district heat supply areas that makes local district heating a monopoly with
exclusive rights in which a change of the type of heat supply is totally impossible. For district
heat supply undertakings the energy undertakings average debt capital risk premium shall
indicate the debt capital risk premium of district heat supply undertakings.
In Estonia an undertaking that operates public water and sewerage system is also in market
dominant position. It is very difficult for a customer in a supply of public water and sewerage
services area to obtain a licence from the local municipal authority for constructing a personal
water abstraction point (at first, the possibility of using the public water system will be
assessed) and to organise the treatment of waste water up to the required standard (the waste
water collection areas are approved with a directive of the Minister of the Environment). In
waste water collection areas with pollution load of more than 2000 population equivalent it is
obligatory to construct a public sewerage system (Water Act 241 (4)) except in cases where
the construction of the public sewerage system would inflict unjustified costs. Therefore if a
public sewerage system exists and the consumer is located in an area with a pollution load of
more than 2000 population equivalent then the new consumers are not allowed to construct a
personal water abstraction point nor clean the waste water.
For the reasons named above water and energy undertakings are undertakings operating in a
dominant position and are comparable due to the nature of their services and therefore the
risks bared by those undertakings can also be compared. Thus, the debt capital risk premium
for water undertakings is the average energy undertakings debt capital risk premium.

The CA will use the CEER countries arithmetic mean indicators to secure equal treatment.
CA believes that by using the average indicators of other EU Member States an adequate
result will be achieved.

The following Table 1 presents the arithmetic mean indicators based on the CEER countries
debt capital risk premium. As CEER countries consider the national indicator to be

7
CEER. IBP 5 Internal Report on Investment Conditions in European Countries: September 16,
2011.
6
confidential8 the Table 1 does not present the debt capital risk premium indicators by
countries.

Table 1 - CEER countries debt capital average risk premiums

Debt Capital Risk

Electricity Electricity Gas Gas
transmission distribution transmission distribution
undertaking undertakings undertaking undertakings
Arithmetic mean 1,03% 1,07% 1,12% 1,07%
Energy undertakings
average 1,07%
According to the amendment of Natural Gas Act 7 (2)9 in 2012 the transmission of gas
within the meaning of the act is the transport of gas through a high pressure pipeline to a
consumer installation or an agreed supply point. The use of an upstream pipeline network and
the use of high-pressure pipelines for local distribution of gas are not regarded as transmission
of gas. Therefore it is not justified to use the uniform average risk premium for the gas
transmission system operator and the gas distribution system operator, but they will be used
separately for each group.

Based on the data presented in Table 1 the CA will apply for the undertakings debt capital
risk premiums the following arithmetic means:

Electricity Transmission Undertaking 1,03%;

Electricity Distribution Undertakings 1,07%;
Gas Transmission Undertaking 1,12%;
Gas Distribution Undertakings 1,07%;
District Heat Supply Undertakings 1,07%;
Water Undertakings 1,07%.

2. Formation of cost of equity

The cost of equity can be determined by either historical data or monetary-theoretical models.
Most regulatory authorities use capital assets pricing model, hereinafter the CAPM, which is
the basis for evaluation of financial assets of companies. In order to use the CAPM model for
equity cost estimates for a company that is not quoted in stock exchange the beta coefficients
of similar companies shall be used. The cost of equity that is determined by the CAPM is
expressed by the following formula:
Formula 2: ke = Rf + Rc + (*Rm)
Where:

k e is the cost of equity;

R f is the risk-free rate of return;

8
In a letter sent to the CA on 16 February 2012 CEER asked CA not to publish the named indicators.
9
[RT I, 28.06.2012, 2 entry into force 08.07.2012]
7
R c is the country risk premium;
Rm is the equity market risk premium or the market rate of return;
is the beta coefficient.

2.1 Nominal risk-free rate and Estonian country risk premium

The formation of nominal risk-free rate and the Estonian country risk premium is dealt with in
section 1.1

2.2 Equity market risk premium

The equity market risk premium indicates how much investors can earn in addition to the risk-
free rate of return. Thus, the equity market risk premium is a compensation for taking a
systematic risk. Two approaches can be used to determine the equity market risk premium:
either on the basis of historical data or by an expected risk premium. Regarding historical data
shorter or longer historical periods can be considered. Such options are referred to in the
analysis carried out by the market regulatory authority of Great Britain.10

The CA has studied the equity market risk premiums applied in various CEER countries.11

For comparison, in Table 2 below the arithmetic mean based on the CEER countries equity
market risk premiums is presented. As CEER countries consider this indicator to be
confidential, Table 2 does not present the equity market risk premium indicators by countries.

Table 2 - Equity market risk premiums applied in CEER countries

Equity market
risk premium
Arithmetic mean 4,72%

Table 2 shows that the arithmetic mean of the different equity market premiums applied by
EU regulators is 4,72%.

The CA has taken in its regulation practice for the equity market risk premium the value of
5%, which corresponds to the recommendations of McKinsey12 and also takes into account
the experience of the market regulators of other EU Member States. The arithmetic mean
presented in Table 2 provides a similar result as the 5% value applied by the CA.

10
A Study into Certain Aspects of the Cost of Capital for Regulated Utilities in the U.K.Stephen Wright
Birkbeck College and Smithers & Co, Robin Mason, University of Southampton and CEPR, David
Miles, Imperial College and CEPR On Behalf Of: Smithers & Co Ltd 20 St Dunstan's Hill London
EC3R 8HY February 13, 2003. www.ofgem.gov.uk.
11
CEER. IBP 5 Internal Report on Investment Conditions in European Countries: September 16,
2011.
12
Copeland, Tom; Koller, Tim; Murrin, Jack (2000). Valuation Measuring and Managing the Values
of Companies. 3rd Ed. New York etc.: John Wiley & Sons
8
2.3 Beta coefficient and capital structure
Beta coefficient (hereinafter beta) indicates whether a companys risk level on the market is
lower or higher than the risk level of an average company. The market index beta is one
(Komgi 2006: 15313). If a beta of a share is below one, then the risk of the share is below
the market average. If a beta of a share is above one, then the risk of the share is above the
market average.
Beta is a relative measure of a systematic risk of a share. Systematic risk is the part of a
security-related risk that cannot be mitigated through portfolio diversification. There is no
comparable stock exchange quoted energy undertakings in Estonia whose data could be used.
For the undertakings which are not quoted in stock exchange the solution is the using of a
comparative method where the beta estimate is based on an average beta for stock exchange
quoted undertakings operating in the same field of activity. (Komgi 2006: 15414).
For beta estimates an equity capital beta shall be determined, which is either unlevered beta
a with zero debt capital or levered beta e. An unlevered beta of the branch of economy is
used as the basis, which is corrected by an average financial leverage of respective sector. To
that end Millers formula is used by most CEER regulators. Herewith it is assumed that an
increase in the proportion of debt capital raises the undertakings risk. Thus, the more an
undertaking uses debt capital the higher is the systematic risk related to its shares.
The Millers formula (see Formula 3) is expressed as follows:
Formula 315: e = a* (1+DC/EC)

Where:

e is a levered beta of the undertaking,

a is an unlevered beta of the branch of economy,
DC/EC is the regulatory determined ratio of debt and equity capital.

It appears from Formula 3 that the CA does not use balance sheet data of the undertakings.
In market regulatory practice the regulators may intervene in the financing related decisions
of an undertaking and require certain capital structure or alternatively, calculate service prices
with certain capital structure which may differ from the actual structure employed in an
undertaking (Pedell 2006: 5216). Specialists of the faculty of economics of Tartu University
are of the opinion that the structure of capital (50% of debt and 50% of equity capital) has a
very little impact on WACC as the ratio does not affect significantly the value of WACC.
First of all WACC is determined by a business risk of an undertaking and risk-free rate of
return of the markets.
On the basis of the aforementioned for calculating WACC the CA uses the capital structure in
which 50% is debt capital and 50% is equity capital (the same structure is used, for example,
in the electricity transmission and distribution networks and gas transmission in Luxembourg

13
M. Komgi. rirahandus. Tartu likooli Kirjastus, 2006.
14
M. Komgi. rirahandus. Tartu likooli Kirjastus, 2006.
15
The formula does not reflect tax shield, as due to the Estonian income tax regulation the tax shield is
not present
16
B. Pedell. Regulatory Risk and the Cost of Capital. Springer, 2006.
9
and gas distribution networks in Luxembourg and Portugal. Thus, the above Millers formula
simplifies to the following Formula 4:

Formula 4: e = a* 2.

2.3.1 Beta for gas and electricity undertakings

Finnish energy market regulator is in a similar position to Estonia as the number of
undertakings regulated is over a hundred and most of them are not quoted in a stock exchange
which means that there is no statistical data. Accordingly, for finding out beta the Finnish
energy market regulator has been analysing the indicators of similar companies in Europe and
USA.17 Analogous approach for finding out beta has been used by the energy market regulator
in the United Kingdom, for the latter has observed the quoted energy undertakings but also
analysed undertakings from other infrastructures and the statistical indicators of betas of the
undertakings operating in other sectors.18 Thereat both of the regulators have brought out the
range of betas of undertakings regulated by statistical data. For the making of the final
decision the risks of the specific sector have also been taken into account.

In Table 3 below the arithmetic means of electricity and gas networks unlevered betas which
are based on the indicators of CEER19 countries, are presented for comparison. As the
countries consider the named indicator to be confidential,20 Table 3 does not present the
unlevered betas by countries.

Table 3 Arithmetic means of unlevered betas of CEER countries

Unlevered beta ( a)
Electricity Electricity Gas Gas
transmission distribution transmission distribution
undertaking undertakings undertaking undertakings
Arithmetic mean 0,38 0,38 0,45 0,43

Due to the amendments of Natural Gas Act which came into force on 8 July 2012 it is not
justified to use the same uniform average beta for gas transmission undertaking and gas
distribution undertakings in year 2013, but they must be used separately for each group.
The CA uses the CEER countries database in relation to electricity and gas networks because
of the small number of companies operating only on the network market. Most of the
companies belong to a big concern.
The CA uses the following unlevered betas (a):

17
Electricity Distribution Price Control Review Background information on the cost of capital
March 2004 www.ofgem.gov.uk.
18
A Study into Certain Aspects of the Cost of Capital for Regulated Utilities in the U.K.Stephen
Wright Birkbeck College and Smithers & Co, Robin Mason, University of Southampton and CEPR,
David Miles, Imperial College and CEPR On Behalf Of: Smithers & Co Ltd 20 St Dunstan's Hill
London EC3R 8HY February 13, 2003. www.ofgem.gov.uk.
19
CEER. IBP 5 Internal Report on Investment Conditions in European Countries: September 16,
2011.
20
In a letter sent to the CA on 16 February 2012 CEER asked CA not to publish the named indicators.
10
Electricity transmission undertaking 0,38;
Electricity distribution undertakings 0,38;
Gas transmission undertaking 0,45;
Gas distribution undertakings 0,43.
Provided that for determining the WACC a financial leverage of 50/50 and Formula 4 have
been used then the levered betas (e) are the following:
Electricity transmission undertaking 0,76;
Electricity distribution undertakings 0,76;
Gas transmission undertaking 0,90;
Gas distribution undertakings 0,86.

2.3.2 Beta for District Heat Supply Undertakings

As it is difficult to find district heat supply undertakings that are quoted in a stock exchange,
because district heating is spread only in Northern countries and mid- and Eastern-Europe, the
CA determined the beta for district heat supply undertakings based on the energy
manufacturing undertakings (93 undertakings) average levered beta of 1,35 as presented by
professor Aswath Damodaran (Stern School of Business, New York University) in his
database (http://pages.stern.nyu.edu/~adamodar/21, last update 24 January 2013, see also
Appendix 1 of the present Guidelines).

In A. Damodarans database the aforementioned 93 undertakings average financial leverage

(DC) is 59,81%, the average share of equity capital (EC) is 40,19%, the ratio between average
financial leverage and average share of equity capital (DC/EC) is 148,82%, that is 1,4882
(59,81 / 40,19 = 1,4882) and the average income tax rate is 8,66%, that is 0,0866 (8,66 / 100 =
0,0866).

For the conversion of levered beta =1,35 to unlevered beta ( ) the following Millers
formula with a tax shield is used (see Formula 5):

Formula 5: [ ( ) ]

Where:

(1-T) is the tax shield, where T is the income tax rate.

Unlevered beta is found with the following formula (see Formula 6) that derives from
Formula 5:

Formula 6:
[ ( ) ]

Based on Formula 6 and provided that the income tax rate is 8,66% the average unlevered
beta for the aforementioned 93 energy manufacturing undertakings is 1,126, because
a=1,35/[1+(1-0,866)*1,4882]=1,126. If the income tax rate is 0 (in Estonia the tax shield

21
Database: Cost of Capital by Industry Sector
11
does not come up) then the undertakings average unlevered beta is 0,543, because
a=1,35/[1+(1-0)*1,4882]=0,543.

By using Formula 4, the capital structure (50% of debt capital and 50% of equity capital) that
is accepted by the CA and the average unlevered beta of 0,543 for 93 energy manufacturing
undertakings (with an income tax rate of 0) the levered beta for district heat supply
undertakings is 1,09 because e = 0,543*2=1,09.

2.3.3 Beta for Water Undertakings

The CA based the finding of water undertakings beta on professor Aswath Damodarans
(Stern School of Business, New York University) latest data in his database
(http://pages.stern.nyu.edu/~adamodar/22, last update 24 January 2013, see also Appendix 2 of
the present Guidelines) on water sector undertakings (11 undertakings) average levered beta
which is 0,66.

In professor A. Damodarans database the aforementioned 11 undertakings average financial

leverage (DC) is 44,88%, average share of equity capital (EC) is 55,12%, the average ratio
between financial leverage and average share of equity capital (DC/EC) is 81,42%, that is
0,8142 (44,88 / 55,12 = 0,8142) and the average income tax rate is 35,22%, that is 0,3522
(35,22 / 100 = 0,3522).

For the conversion of levered beta =0,66 to unlevered beta ( ) the following Millers
formula with a tax shield is used (see Formula 5):

Formula 5: [ ( ) ]

Where:

(1-T) is the tax shield, where T is the income tax rate.

Unlevered beta is found with the following formula (see Formula 6) that derives from
Formula 5:

Formula 6:
[ ( ) ]

Based on Formula 6 and provided that the income tax rate is 35,22% the average unlevered
beta for the aforementioned 11 water undertakings is 0,432, because a = 0,66 / [1+(1-
0,3522)*0,8142] = 0,432. If the income tax rate is 0 (in Estonia the tax shield does not come
up) then the undertakings average unlevered beta is 0,364, because a = 0,66 / [1+(1-
0)*0,8142] = 0,364.

By using Formula 4, the capital structure (50% of debt capital and 50% of equity capital) that
is accepted by the CA and the average unlevered beta of 0,364 for the 11 water undertakings

22
Database: Cost of Capital by Industry Sector
12
(with an income tax rate of 0) then the levered beta for water undertakings is 0,73 because
e = 0,364*2 = 0,73.

3. Formation of WACC
For WACC calculation the CA uses the following Formula 1, which was given in the
introduction part of these guidelines:

WACC ke DC k EC
DC EC d DC EC
Where:

k e is the cost of equity capital (%);

k d is the cost of debt capital (also referred to as borrowed capital) (%);
DC is the share of equity capital determined by the regulator (%);
EC is the share of debt capital determined by the regulator (%);
DC + EC is the sum of the shares of equity capital and debt capital determined by regulator
(%).

Resulting WACC values by various sectors which will be used by the CA in 2013 are
presented in Table 4 below.

Table 4 - Formation of WACC in 2013

District heat Electricity Electricity Gas Gas

Water
WACC accounting (in % ) supply transmission distribution transmission distribution
undertakings
undertakings undertaking undertakings undertaking undertakings
Nominal risk-free interest rate of
2,81 2,81 2,81 2,81 2,81 2,81
German 10-year bonds (Rf)
Estonia country risk premium (Rc) 1,51 1,51 1,51 1,51 1,51 1,51
Debt capital risk premium 1,07 1,03 1,07 1,12 1,07 1,07
Cost of debt capital (k d) 5,39 5,35 5,39 5,44 5,39 5,39
Nominal risk-free interest rate of
2,81 2,81 2,81 2,81 2,81 2,81
German 10-year bonds (Rf)
Estonia country risk premium (Rc) 1,51 1,51 1,51 1,51 1,51 1,51
Market risk premium (McKinsey) (Rm) 5 5 5 5 5 5
Levered beta ( e) 1,09 0,76 0,76 0,9 0,86 0,73
Cost of equity capital (k e) 9,77 8,12 8,12 8,82 8,62 7,97
Share of debt capital (wd ) 0,5 0,5 0,5 0,5 0,5 0,5
Share of equity capital (we) 0,5 0,5 0,5 0,5 0,5 0,5
WACC (% ) 7,58 6,74 6,76 7,13 7,01 6,68

13
Appendix 1 - Extract from Professor A. Damodarans database (last update 24 January 2013)

Numb er of Cost of Std Dev Cost of After-tax Cost of

Industry Name Firms Beta Equity E/(D+E) in Stock Deb t Tax Rate Cost of Deb t D/(D+E) Capital
Power 93 1,35 10,03% 40,19% 97,19% 4,87% 8,66% 4,45% 59,81% 6,69%
Source: http://pages.stern.nyu.edu/~adamodar/, Cost of Capital by Industry Sector.

Appendix 2 - Extract from Professor A. Damodarans database (last update 24 January 2013)

Numb er Cost of Std Dev Cost of After-tax Cost of

Industry Name of Firms Beta Equity E/(D+E) in Stock Deb t Tax Rate Cost of Deb t D/(D+E) Capital
Water Utility 11 0,66 5,85% 55,12% 18,89% 2,37% 35,22% 1,54% 44,88% 3,91%
Source: http://pages.stern.nyu.edu/~adamodar/, Cost of Capital by Industry Sector.

14