XI. Interest Rate Increases and Forecast

The forecasted long-term debt and preferred stock costs are based on Sierra's actual, or embedded, costs. However, because we establish the cost of capital on a forecast basis each year, future interest rates must be anticipated to reflect projected changes in Sierra's long-term debt and preferred stock caused by the issuance and retirement of long-term debt and preferred stock during the year.

Sierra's Electric Department assigned debt and preferred stock has fixed contractual estimates. The cost of long-term debt for Sierra reflects a weighted average cost, adjusted to reflect applicable premiums or discounts, and issuance costs. Sierra has forecasted that its test year long-term debt cost for 2001 would be 7.47%.

Sierra estimated its embedded preferred stock by weighting its average embedded cost, adjusted to reflect new issuance costs and any applicable premium or discount. Sierra forecasted that its test-year preferred stock cost for 2001 would be 8.10%.

ORA utilized the same cost of long-term debt and preferred stock in its prepared testimony that Sierra proposed in its application. No other party addressed the reasonableness of Sierra's proposed cost of long-term debt or preferred stock.

Prior cost of capital proceedings generated a considerable debate on the validity of various interest rate forecasts and on the appropriate methodology for equating forecast utility bond rates to other bond ratings. However, in D.90-11-057,⁷ we recognized that actual interest rates do vary and that our task is to determine the "reasonable" cost of debt rather than an actual cost based on an arbitrary selection of a past figure. We concluded that the latest available DRI forecast should be used to determine the embedded debt cost in cost of capital proceedings. Consistent with this conclusion, the assigned Commissioner's Scoping Memo and Ruling instructed all parties that long-term debt and preferred stock costs should be updated to reflect the October 2000, DRI Interest Rate Forecast for 30-year Treasury Bonds.

Sierra appropriately updated its long-term debt and preferred stock costs, but the result of this update did not change its forecasted long-term debt cost or preferred stock cost. No party objected to the updated long-term debt and preferred costs. The recommended 7.47% long-term debt and 8.10% preferred stock costs should be adopted. Having determined the appropriate long-term debt and preferred stock costs we now address the appropriate ROE for Sierra.