Corporate Finance

1

Business Valuation of

Portland General Electric Company Ltd.

As of February 14, 2012

------------------------------------------------------------------------------------------------

Prepared for:

Jonathan James, CEO

Energy Solutions Ltd.

Corporate Finance

Prepared By:

Paul Smith, B. Eng., MBA

Chief Corporate Advisor

Energy Solutions Ltd.

Submitted February 17, 2012

MBA CF_Z0923915 Word Count 3998

2

Table of Contents

Abbreviations .......................................................................................................................................... 4

1.0 Introduction ....................................................................................................................................... 5

2.0 Portland General Electric Company (PGE) ........................................................................................ 6

2.1 PGE Operations ............................................................................................................................. 6

2.2 Company Risks ............................................................................................................................. 7

2.3 Company Financial Performance .................................................................................................. 8

3.0 Calculating the Weighted Average Cost of Capital for PGE .......................................................... 11

3.1 The Capital Asset Pricing Model (CAPM) ................................................................................. 11

3.1.1 CAPM Sensitivity ................................................................................................................ 12

3.1.2 CAPM Limitations ............................................................................................................... 13

3.2 The Dividend Discount Model .................................................................................................... 13

3.2.1 DDM Sensitivity Analysis .................................................................................................... 14

3.2.2 DGM Limitations ................................................................................................................. 15

3.3 Calculating the Cost of Debt ....................................................................................................... 15

3.3.1 Kd Limitations ...................................................................................................................... 16

3.4 Calculating the Weighted Average Cost of Capital .................................................................... 17

3.4.1 WACC Limitations............................................................................................................... 18

4.0 Company Valuation ......................................................................................................................... 18

4.1 Book Value .................................................................................................................................. 18

4.2 Market Value ............................................................................................................................... 18

4.3 Price/Earnings Ratio .................................................................................................................... 19

4.4 Free Cash Flows .......................................................................................................................... 19

4.5 Sensitivity Analysis of PGEDCF Value ......................................................................................... 21

5.0 Value, Synergy and Corporate Governance .................................................................................... 22

5.1 Value Creation Opportunities ...................................................................................................... 22

5.2 Synergy Issues ............................................................................................................................. 23

5.3 Corporate Governance ................................................................................................................. 24

6.0 Recommendations .......................................................................................................................... 25

7. 0 Bibliography ................................................................................................................................... 26

3

Table of Contents Continued

Appendix 1 ............................................................................................................................................ 33

Appendix 2 ............................................................................................................................................ 34

Appendix 3 ............................................................................................................................................ 35

Appendix 4 ............................................................................................................................................ 36

Appendix 5 ............................................................................................................................................ 38

Appendix 6 ............................................................................................................................................ 39

Appendix 7 ............................................................................................................................................ 40

Appendix 8 ............................................................................................................................................ 42

Appendix 9 ............................................................................................................................................ 44

Appendix 10 .......................................................................................................................................... 45

Appendix 11 .......................................................................................................................................... 46

Appendix 12 .......................................................................................................................................... 47

Appendix 13 .......................................................................................................................................... 49

Appendix 14 .......................................................................................................................................... 51

Appendix 15 .......................................................................................................................................... 52

4

Abbreviations

CAPEX Capital Expenditure

CAPM Capital Asset Pricing Model

COV or %COV Coefficient of Variability or Percentage Coefficient of Variability

CWC or WC Change in Working Capital

DCF Discounted Cash Flows

DDM Dividend Discount Model

DGM Dividend Growth Model

DRV Discounted Residual Value

EBIT Earnings Before Interest and Tax

EFP Explicit Forecast Period

ESL Energy Solution Limited

FCF Free Cash Flows

Kd Cost of Debt

Ke Cost of Equity

MRP Market Risk Premium

MW Mega Watts

OPUC Oregon Public Utility Commission

S&P Standard and Poor’s

PGE Portland General Electric Company

TV Terminal Value

WACC Weighted Average Cost of Capital

YTM Yield to Maturity

5

1.0 Introduction

Energy Solutions Limited (ESL) was incorporated in 1967 with headquarters in Maryland

USA. ESL is a vertically integrated power utility supplying energy to the North East USA,

and owns 6000 Megawatt(MW) of installed capacity consisting of nuclear(2500MW),

coal(2850MW), fuel oil (450MW) geothermal(200MW), and solar(50MW). As part of the

growth strategy for ESL, Portland General Electric (PGE) was identified as a potential

horizontal acquisition target. This report aims to provide a fair market valuation of 100%

common stock of PGE as of February 14, 2012. This valuation was performed for the

purpose of determining whether PGE should be acquired and the valuation results are based

on the latest financial information reported by PGE, and current market information from

reputable financial institutions.

This report consists of five main sections – a summary of the operations and financial

performance of PGE; the estimation of the cost of capital of PGE using several proven

models; the estimation of fair value of PGE equity using the book value, market

capitalization, price/earnings ratio, and free cash flow methods; discussion about value

creation opportunities, synergistic and corporate governance factors; and recommendation

details on whether to acquire PGE. The recommendation of this report is NOT to acquire

PGE at this time.

6

2.0 Portland General Electric Company (PGE)

Portland General Electric Company was incorporated in 1930 and is a local based utility with

headquarters in Portland, Oregon. Mr. Jim Piro is the President and CEO since 2009. PGE is

a vertically integrated electric utility involved in the production, transmission, distribution

and retail sale of electricity to customers in the state of Oregon, and the sale of natural gas

and electricity to brokers and energy suppliers on the USA wholesale market.

PGE consists of 2766MW of installed generating capacity utilizing a plant mix of coal

(660MW), natural gas/fuel oil(1200MW), wind(450MW), hydro(500MW) and small scale

photo voltaic(2MW). PGE also own and operated the 1130MW Trojan Nuclear Power

Station which was decommissioned in 1993. The company services an area of 4000 square

miles in Oregon with 824,817 customers.

The corporate mission statement is ‘Safe, reliable power now and for the future,’ and on

September 30, 2011, PGE consisted of 75,345,351 total shares. Operations and retail prices

are regulated by the Oregon Public Utility Commission (OPUC) and the Federal Energy

Regulatory Commission, Global Data (2012), PGE (2010) and PGE (2012a).

2.1 PGE Operations

Table 1 provides a summary of PGE key statistics whilst Appendices 1 and 2 provide details

of key members of management and a breakdown of customer energy requirements. In 2010

PGE purchased 61% of their energy capacity through hedging contracts, and management

estimates an additional 1396MW by 2020 to satisfy the current shortfall and meet future

demand, Appendix 3 provides growth projections. A long term annual load growth rate of

1.9% is projected until 2030 and OPUC allow PGE an annual return on equity of 10% whilst

maintaining a 50/50 debt-equity capital structure.

7

Portland General

Electric Company

Company Data for Third

Quarter 2011,

Total Revenue

Total Assets

Total Equity

Profits after tax

Total Shares

Earnings per share

Dividends per share

Total Energy Delivery

Installed capacity

Total Customers

Coverage Area

Energy sales

Coal

Natural Gas/fuel oil

Hydro

Wind

Purchased

No. of Employees

Main Competitors

$1.33 Billion

$5.61 Billion

$1.66 Billion

$118 Million

75,345,351

$1.57

$0.79

14,320,000 MWhrs

2766 MW

822,975

4,000 sq. miles in Oregon State

16,264 MWhrs

2708 MWhrs (17%)

1058 MWhrs (6%)

1524 MWhrs (10%)

1025 MWhrs (6%)

9,948MWhrs (61%)

2,671

Allegheny Energy – similar utility

Avista Corporation – energy supplier

Avista Utilities – energy distributor

Bonneville Power Corporation

– hydro power sales

Table 1: Portland General Electric Summary Company Data. PGE (2012a)

2.2 Company Risks

PGE is exposed to several industry risks such as reduced energy sales, fluctuating fuel prices

and changes in Government regulations, see Appendix 4. Some company specific risks are;

meeting the Oregon Renewable Portfolio Standards for renewable energy production;

unfavorable climatic conditions and tougher emissions laws on coal plant operation. A

SWOT analysis on PGE is also provided in Appendix 5.

8

2.3 Company Financial Performance

PGE typically funds their expansion programs through the issue of long term bonds, retained

earnings and the sale of common stock, Appendix 6 provides a recent flow of funds analysis

for 2009 to 2010.

Table 2 provides a summary of the financial performance of PGE for the past three years and

shows a fall in sales revenue during 2010; however due to an $80Million reduction in

operating expenses, PGE increased profits from $95Million to $125Million in 2010. From

2008 PGE have made increasing profits and this is reflected by their increasing dividend per

share from 0.970 to 1.035. 2010 profitability ratios of Net Profit Margin 7.0, Return on

Equity 7.8 and Return on assets 2.3 all show increasing profitability from 2008, however

these are below their 2010 industry averages decline is shown 2011, see Graphs 1 and 2, and

Appendix 8. From Graph 1 note the rapid decline in sales growth since 2007, PGE have

performed below the industry in categories of sales, net income and dividend growth.

Liquidity ratio trends measure a company’s ability to generate cash for short term liabilities.

Graph 1 and Appendix 7 and reveal that since 2008 the current and quick ratios of 1.4 and 1.2

respectively have been increasing whilst the cash ratio of 0.18 has shown an increase from

2009 when it was 0.14. Appendix 8 shows PGE’s position of liquidity above the 2010

industry average for current and cash ratios.

Efficiency ratio trends measure a company’s ability to generate revenue relative to capital

expenses, inventory and total assets. Appendix 7 and Graph 3 reveal a decline in the asset

turnover ratio and a general increase in inventory turnover ratio since 2006; both of these are

on par with the industry. The 2010 capital expenditure to sales ratio of 25.2 showed a decline

of 13.4 % from 38.6 in 2009. PGE’s employee efficiencies are lower than the industry

average due to the absence of economies of scale through nuclear power generation.

9

2010 2009 2008

Income Statement Data

Revenue 1783

1804

1745

Operating Expenses 1515

1595

1528

EBIT 284

229

212

Profit before tax 174

125

122

Profit 125

95

87

Balance Sheet Data

Total Current Assets 661

690

768

Total Assets 5491

5172

5023

Long Term Debt 1798

1558

1164

Long Term Debt Capitalisation 52.8%

53.1%

45.6%

Total Liabilities 3892

3629

3669

Senior Secured Debt Rating (S&P/Moody’s) A-/A3

A-/A3

A/Baa1

Share Equity 1592

1542

1354

Share Information

Dividends per share 1.035

1.010

0.970

Earnings per Share 1.66

1.31

1.39

Market Price at Year End 21.70

20.41

19.47

Number of Ordinary Shares (thousands) 75,291

72,852

62,581

Table 2: PGE Key Financial Performance Data for 2008 – 2011, PGE (2012) and PGE (2012c)

Graph 1: PGE Profitability and Liquidity Ratios

Graph 3: PGE Efficiency an


Graph 3: PGE Efficiency an


Graph 3: PGE Efficiency and Growth Ratios


d Growth Ratios

Graph 1: PGE Profitability and Liquidity Ratios Graph 2: Equity and Profitability Ratios

d Growth Ratios

Graph 2: Equity and Profitability Ratios


10


10

11

3.0 Calculating the Weighted Average Cost of Capital for PGE

3.1 The Capital Asset Pricing Model (CAPM)

The Discounted Cash Flow (DCF) valuation method requires the summation of all discounted

future company earnings to determine the total worth of the business minus the book value of

debt. All methods used assume the stock market is efficient, stocks are fairly valued and

updated with the latest information, investors are rational and risk averse believing portfolio

diversity reduces risk, Durham (2012), Mullins (1982) and Verminnen (2010).

The first stage involves the calculation of the Weighted Average Cost of Capital (WACC),

which is the minimum rate of returns each company project must generate to satisfy

investors, and is dependent upon the company’s weighted costs of debt and equity, Hawawini

and Viallet (2007).

The CAPM is used to determine the cost of equity and according to Vernimmen et al (2010)

the model was first developed during the late 1950’s by Markowitz, Sharpe, Lintner and

Treynor. Mullins (1982) states that the risk premium investors’ demand is proportional to the

market beta defined by Equation 1 in Table 4. The market beta is a sensitivity coefficient

based on the variance of expected asset returns to expected market returns, Vernimmen et al

(2010, pp. 348 – 349).

12

3.1.1 CAPM Sensitivity

For the CAPM Appendix 12, Table 12a shows that 2% variations in parameters have little

impact upon Ke, however as variations increase Rf is shown to have the biggest single impact

upon Ke, where a +/-5% variation in Rf causes a 7.5% variation in Ke,. Appendix 12 calculates

a 4.03% Coefficient of Variability(COVKeCAPM) for Ke for +/-5% parameter deviations.

COVKeCAPM is the standard deviation divided by the mean values for Ke stated in percent.

Rqd. Rate of Return = Risk Free Rate (Rf) + Beta(ß) X Market Risk Premium (MRP)

Ke = Rf + ß(Rm-Rf) Equation 1

Beta 0.5

Current Inflation rate 3.20%

10 year Bond rate 2.02%

Risk free rate (10yr Bond rate) + inflation (Rf) 5.22%

Market risk premium rate (Rm - Rf) 5.50%

Ke = Rf + (Rm - Rf) ß

Ke = 5.22 + 5.50 x 0.5 = 7.97% or 0.0797

The risk free rate is based on US ten year government bonds sourced from Yahoo

(2012a).

Beta sourced from Yahoo Finance (2012a)

Market risk premium sourced from CXO (2011)

Table 4: Cost of Equity(Ke) Calculation Using CAPM

13

3.1.2 CAPM Limitations

Bruner et al (1998) felt the risk free rate should be equated to at least the yield of a 10-year

treasury bond, Damodaran (2001) suggested the long term real growth rate of the economy.

Modigliani and Cohn (1979) proposed inflation had a deviation affect on the market

expectation of future equity premiums. For the purpose of this valuation the risk free rate was

the sum of the 10-year treasury bond rate and the current inflation rate. The market risk

premium was determined based on research results from CXO (2011).

Mullins (1982), Brigham et al (1985), Jagannathan and Wang (1996) all believed betas are

were unstable and subject to stock market volatility, therefore basing beta on the past

introduced uncertainty, and regular updates were necessary. Beta for PGE was sourced from

Yahoo Finance (2012a) although the Financial Times (2011) gave the beta as 0.637 which

would have increased Ke by 6.8%. Verminnen (2010) questions the relevancy of beta due to

the falling correlation between market return and return on stocks. However the model

remains popular due to its simplicity.

3.2 The Dividend Discount Model

According to Hawawini and Viallet (2007 pp. 345 - 346) the present share price(P0) is the

discounted sum of all future cash dividends. Details of the DDM are provided in Appendix

10, and the model is simplified by proposing dividend growth is perpetual and at a constant

rate g, as shown in Table 5, Equations 2 and 3.

14

P0 = Div1/(Ke - g) Equation 2

Therefore

Ke = (D1/P0) +g Equation 3

PGE Dividend Growth Rates

Year PGE Dividends ($)

Proportion of

Dividend Change

2005

N/A

2006

0.68

2007

0.93

0.368 2008

0.97

0.043 2009

1.01

0.041 2010

1.04

0.025

2011

1.06

0.024

Growth rate (g)

0.0333

Using growth rates from 2008 to 2011

D1 = 1 year forecasted annual dividend $1.06

P0 = Current PGE stock price $24.60

g = Average PGE dividend growth rate 0.033

Ke = (1.06/24.6) + 0.033 = 0.0766

Data sources: PGE (2012a) and Yahoo Finance (2012a)

Table 5: Cost of Equity(Ke) Calculation Using DDM

3.2.1 DDM Sensitivity Analysis

Appendix 12, Table 12b reveals that no single parameter dominates the sensitivity of Ke.

However for an extreme +/-10% variation in parameters this can cause a +/-15% variation in

Ke.. A COVKeDGM of 4.80% for +/-5% deviations in DDM parameters was calculated and

15

comparison with CAPM reveals the DGM model is 1.2 times more variable and therefore has

a slightly higher degree of uncertainty than the CAPM.

3.2.2 DGM Limitations

Several estimations were made; PGE was a subsidiary of Enron in 2005 and therefore no

individual PGE dividend payment was reported; PGE was acquired during 2007 leading to an

elevated dividend growth rate of 37%, this value was excluded. Growth rates from 2008 to

2011 were used to determine g.

The DDM method assumes constant perpetual growth in dividends and by simplifying the

equation assumes that the growth rate(g) is always less than the company cost of equity(Ke).

According to Hurley and Johnson (1994) and Hawawini and Viallet (2007) the model is

susceptible to unstable dividend payments, the lack of dividend payments, or fast growing

companies. Qfinance (2011) suggests the DDM is suited for mature industries that maintain

steady dividend growth rates and the model should be applied no more than five years due to

dividend policy changes. In an efficient market past history cannot predict the future

performance of a stock, therefore the estimation of the future divided payment D1 is

subjective and prone to uncertainty.

3.3 Calculating the Cost of Debt

For the purpose of this company valuation only corporate bonds were considered and

therefore the cost of debt Kd was equivalent to the weighted average bond interest rate which

was provided in the PGE financial statements, see Table 6 and Appendix 11 for calculation

details.

16

Present values for bonds were calculated using the annuity formula shown in Equation 4

Pbond = Ct(PVDFAYTM, t) + Mt(PVDFYTM, t) Equation 4

Where C is the bond coupon rate, t is the remaining time to maturity, YTM is the interest

yield rate at time t, and M is the bond face value.

Years-to-Maturity - Base year

2011

Semi Annualized Payments

Bond Face value M

($Millions)

Current A3 Corporate

Bond Yield %

Weighted Avg. Bond

Rate %

Present Value of

Bond ($Millions)

1

Y 100

0.46%

5.85

105.37

2

Y 100

1.42%

5.85

108.70

3

Y 63

2.10%

5.85

69.83

4

Y 70

2.32%

5.85

79.39

10

Y 1344

5.01%

5.85

1431.92

$1677

5.85% $1,795.21

Kd = 0.0585 with a present value long term debt calculated at $1795 Million

Table 6: PGE Bond Data, Calculated Present Value of Debt & Weighted Cost of Debt

.

3.3.1 Kd Limitations The main long term debt structure of PGE consists of corporate bonds (see Appendix 11), and

to a smaller degree defined benefit pension plan payments and operating leases; these were

excluded. PGE also utilizes a $600Million revolving credit facility but this is an emergency

fund and was also excluded from the cost of debt calculation.

Limited PGE bond details were available therefore the stated weighted average bond interest

rate was used which meets Financial Accounting Standards FAS157, Ryan (2008). Bond

17

yield rates were sourced from Yahoo (2012a) and the 10-year yield rate was applied to the

reported estimated residual bond value for the period beyond 2015. Using these various

estimates introduced uncertainty in Kd.

3.4 Calculating the Weighted Average Cost of Capital

According to Hawawini and Viallet (2007 pp. 358) the weighted average cost of capital

(WACC) can be calculated using the direct method where WACC utilises the asset beta

calculated from the equity beta and debt/equity ratio - this method works best for unlevered

companies or those with low risk debt. Since PGE has substantial leverage - approximately

50/50, the indirect method was used. Substituting for Ke and Kd in Equation 5, Table 7.

WACC = Kd(1-tc) x D/V +Ke x E/V Equation 5

Cost of Equity (Ke = Avg. from DGM and CAPM) 0.0779

Cost of Debt (Kd) 0.0585

Fair Value of Long term Debt (D) $1795 Million

Outstanding Shares 75,346,000

Market Stock Price $24.60

Equity (E = Outstanding Shares * Market Stock price) $1853 Million

Corporate Tax Rate (tc = 5-year avg.) 31.0%

V = E + D $3648 Million

WACC = Kd(1-tc) x D/V +Ke x E/V

WACC = 0.0585(1- 0.31) x 1795/3648 + 0.0779 x 1853/3648

WACC = 0.0594

Table 7: Indirect Method of Calculating WACC for PGE

18

Appendix 12, Table 12c shows that variations in Ke have the single biggest impact on WACC

followed by Kd. For a +/-5% variation in WACC parameters a maximum deviation of +/-

5.8% occurs and a COVWACC of 2.88% is calculated, this is significantly lower than the

COV of Ke explained by the partial contribution of Ke to WACC.

3.4.1 WACC Limitations

To reduce uncertainty the average Ke from CAPM and DGM was used. Calculations found

the fair value estimate of long term debt to be $1795Million, however PGE Q3 2011 report

gave an estimate of $2028Million which would have reduced the WACC to 0.0583. An

estimate for corporate tax was also used and was based on a five-year average tax rate, since

tax varied according to renewable energy tax credits.

4.0 Company Valuation

Four methods shall be used to assess the worth of PGE – the book value; the market

capitalization value; the price/earnings ratio; and the Discounted Cash Flow value.

4.1 Book Value

According to Hulten and Hao (2008) book values are typically conservative compared to

market values due to the exclusion of intangibles from financial statements. Durham (2012)

proposes the method is backward-looking and misses future earnings potential and therefore

subject to inaccuracy, however the information is easy to access and consistent with most

accounting ratios. The book value for PGE of $1.66Billion provides a starting point in the

valuation process.

4.2 Market Value

Market value or capitalization of PGE is the product of current market share price (MSP) and

the number of outstanding shares. Using a MSP of $24.60 the market value of PGE is

$1.85Billion. According to Durham (2012) this method is considered forward looking,

therefore

stale stock pricing

4.3 Price/Earnings Ratio

According to Anderson and Brooks (2005

used for the measure of company performance based on the ratio of current share price t

previous year’s earnings. The method is a good trending tool, it is forward

current stock price inf

can be manipulated, Durham (2012).

2008, although on 31/12/10 PGE was below the industry standard of 14.8 with 13.1;

presently they ar

Date

31/12/08

31/12/09

31/12/10

30/09/11

24/01/12

Table 3: PGE Rece

Sources Global

4.4 Free Cash Flows

According to Kaplan and Ruback (1995) the DCF method

company

the discounted sum of all future free cash flows generated by the assets.

flow (FCF) i

therefore accounts for future earning potential.

stale stock pricing

since it relies upon market efficiency





current stock price inf



presently they are on par with the industry standard.

Stock

Price

$19.45

$20.41

$21.70

$23.69

$24.60

Table 3: PGE Recent Price/Earnings History

Sources Global

data (2012), Yahoo Finance (2012c) and PGE (2012)

Free Cash Flows


company market value


(FCF) is calculated

for future earning potential.






current stock price information is used, however EPS is backward



e on par with the industry standard.

EPS P/E

1.39 13.99

1.30 15.70

1.66 13.07

1.57 15.09

1.57 15.67

nt Price/Earnings History


Free Cash Flows


ue. The method involves calculating


s calculated using Equation 5

for future earning potential.


According to Anderson and Brooks (2005 pp. 456) the



ormation is used, however EPS is backward

can be manipulated, Durham (2012). Table 3



Industry

13.99

-

15.70

-

13.07

14.80

15.09

N/A

15.67

15.60

nt Price/Earnings History



. The method involves calculating


Equation 5

–

for future earning potential. However it

since it relies upon market efficiency.

pp. 456) the



ormation is used, however EPS is backward

Table 3 and Graph 4 show



Industry

Graph 4: PGE Price/Earnings Trends



. The method involves calculating


However it

is susceptible to investor bias and

pp. 456) the Price/Earnings ratio (P/E) is widely



ormation is used, however EPS is backward-looking and periodic and

and Graph 4 show

an increasing P/E ratio since




According to Kaplan and Ruback (1995) the DCF method provides

. The method involves calculating the present value of a company as



arnings ratio (P/E) is widely


previous year’s earnings. The method is a good trending tool, it is forward-looking since

looking and periodic and





provides reliable

the present value of a company as

the discounted sum of all future free cash flows generated by the assets. Each yearly

19



used for the measure of company performance based on the ratio of current share price to the

looking since





reliable estimate of


yearly free cash

19



o the

looking since




of


free cash

20

Appendix 13 provides details of free cash flow calculations and the estimates used, some

were the EBIT growth projections of no greater than 3% above US long term projected

energy growth rates; a 5-year average corporate tax rate of 31.0%; future Capex based on

2011 Q3 financial report projections and not exceeding 90% of EBIT; the WC was based on

recent historic behavior.

WACC = 0.0594

Base Year = 2011 using Q3 financial information

Book Value of Debt = $1778 Million

Discounted Cash Flows = $479 Million

TerminalValue of Assets (2017) = Expected Cash Flow in 2017 / (WACC – Growth RateTV)

= $113.7 Million / (0.0594 – 0.030)

= $3866.6 Million

Discounted Terminal Value (TV) = $3866.6 Million / (1 + 0.030)5

= $3335.4 Million

PGEDCF Value = Discounted Cash flows + Disc. Terminal Value – Book Value of Debt

= $479 Million + $3335 Million - $1778 Million

= $2036 Million

Market Value = $1850 Million

Table 11: Calculation of the DCF Value of PGE’s Equity

Several advantages of the DCF method are that future developments can be included in cash

flows; the use of WACC reflects the source of funds; dividend policy can be ignored, the

method can be applied to unlisted companies; and the method can accommodate changes in

operations or capital structure. The model is very sensitive and susceptible to inaccurate

estimates and any changes to future outcomes such as variable interest and tax rates; changes

Earnings Before Interest and Tax(EBIT) Equation 5

- Corporate Tax(tc)

+ Depreciation and Amortization(D&A)

- Capital Expenditure(Capex)

- Change in Working Capital( WC = Current assets – Current liabilities)

= Free Cash Flows (FCF)

21

in market conditions; technology impacts; legislation; market trend changes and shocks,

Durham (2012)

4.5 Sensitivity Analysis of PGEDCF Value

Several sensitivity Tables (14a -14f) for the PGEDCF Value are provided in Appendix 14; a

reduction in the EBITEFP forecast by 0.5% across the Explicit Forecast Period (EFP) of 2012 -

2016 or for the terminal value (TV) EBITTV, produces a PGEDCF Value range of $1.64Billion

and $1.62Billion respectively. Whilst a 2% increase in terminal value Capex to $316Millon is

sufficient for the PGEDCF value to fall below the market value. Table 12 provides a summary

of tolerance levels needed for parameters to reduce PGEDCF below the market value (+

denotes increase and – decrease). Appendix 15 provides COV calculations for the WACC, Ke

and PGEDCF for +/-2% variations in their parameters and summary Table 13 reveals the

PGEDCF is 80 times more variable than WACC for a +/-2% change in parameters, the most

sensitive parameter being EBIT growth.

Table 13: Summary of Coefficients of Variation for +/-2% Change in Parameters

Factors Affecting Estimated

PGEDCF

Allowable

Tolerance

EBITEFP < -0.5%

EBITTV < -0.5%

Corporate Tax +1%

CAPEX TV +2%

Working CapitalEFP +150%

Working CapitalTV +5%

WACC +3.6%

+/-2 % Parameter Variation COV (%)

WACC 1.03%

KeCAPM 1.50%

KeDDM 1.95%

PGEDCF 81.79%

Table 12: Allowable Tolerances for Factors Affecting the PGEDCF Value

22

Singh and Uzma (2010) suggest DCF model accuracy is affected by several factors;

inflationary effects on cash flows, the discount rate not considering the diversifiable risk or

one-off/shock effects on share price, the estimation of corporate tax, and attention to all

tangible and intangible incremental costs.

Due to the high degree of variability and estimation Comeau (2009) suggests the use of

uncertainty levels and margins of safety in future cash flow estimations. French and Gabrielli

(2005) also support using uncertainty levels.

The WACC is affected by changes to company Debt/Equity structure, this method assumes

constant. WACC, Hawawini and Viallet (2007) suggest the WACC should be computed

based on the long run target capital structure of the firm.

5.0 Value, Synergy and Corporate Governance

5.1 Value Creation Opportunities

Through the horizontal acquisition of PGE several opportunities for long term value creation

exist. PGE is currently profitable and could add to future shareholder wealth creation

however it is currently performing below the industry standard. There is a potential 30%

increase in customers by 823,000 to 3.5million, increased coverage area to 20,000 sq. miles,

and expansion into North Western USA. Increased economies of scale may provide more

favorable hedging, lower bulk fuel charge and loan interest rate opportunities.

ESL currently operates 4.2% renewable power, the acquisition of PGE immediately enhances

the renewable energy portfolio to 13.7%. This could increase corporate tax credits from 2.5%

to an average 5.0% - a potential tax saving of $25Million per annum. The increased

renewable power diversity also spreads the risk and could attract larger federal grants.

PGE’s expertise in wind power production could aid ESL’s long-term wind power expansion

program of 1000MW. PGE’s experience spans 27 years and 217 turbines. PGE produce 21%

23

of their power from clean natural gas, and expansion plans are in place to increase capacity

by 42% from 1200MW to 1700MW by 2020.

The increased renewable energy capacity will please ESL’s increasing numbers of

environmentally conscious customers and politicians and it should be emphasised that PGE is

non-nuclear, and in light of increased negative publicity due to the Fukojima nuclear power

plant disaster in Japan in 2011, increased public pressure for tighter regulations.

Economies of scale would require higher operations efficiency and profitability, therefore

company restructuring, and management/employee streamlining would be necessary.

5.2 Synergy Issues

Barkema and Schijven (2008) propose that it is not only important to recognise synergistic

potential but the process of tapping this potential is key to value creation. Complex tasks such

as centralizing support activities like HR, R&D and finance, combining and coordinating

business units, dealing with change management issues such as culture and management style

differences; all require considerable time and effort. They suggest the proper assessment of

post-acquisition integrations should be considered over the long-term, and on average

acquisitions decrease the performance of the acquired firm. The process of acquisition should

not be considered a one-time event but a long term integration process likely to require

company restructuring.

Sirower (1997) believed most acquisitions destroy value for shareholders mainly through the

willingness of mangers to overpay for a company in the belief that synergies exist or can be

achieved, and the financial benefits from synergy will offset the premium paid. Careful

exploration of all strategic alternatives should be considered, and the potential of the

acquisition to create future value properly quantified.

Tetenbaum (1999) identified seven practices for integrating people and culture when an

acquisition or merger occurred - Human Resources should be part of the decision making

process; a workable integration plan is necessary; someone is delegated to manage the

restructured staffing needs; awareness and management of employee post-acquisition drift;

good communication throughout the process; identification and inculcation of the new culture

24

that supports the strategic goals; and alignment of appropriate systems and procedures to

attain efficiency.

5.3 Corporate Governance

It is important to mention corporate governance and some of the ethical issues in corporate

finance. According to Verminnen et al (2011 pp. 816 - 817), corporate governance seeks to

promote Agency and discourage Entrenchment Theories. Referring to Jensen and Mekling

(1976) Agency Theory is about manager behavior, the goals of the manager and shareholder

should not be conflicting and there is an understanding about the tolerance for taking risk.

Entrenchment Theory proposes that some managers can become overly powerful, driven by

the need to protect their jobs and eliminate competition.

Linking manager compensation packages to stock options gives an incentive to create value

for the company. Kanniainen (2000) suggests the existence of managerial empire building,

and Roll (1986) refers to the Hubris Hypothesis where the bidding firm incorrectly values a

target above the market price and pays too much.

Hawawini and Viallet (2007) reveal the practice of inflation of company value by lowering

the WACC through increased debt financing, excessive debt however causes financial

distress. Myers (2001) describes Trade-off Theory where firms seek a balance between the

tax advantages of debt and financial distress. Myers (1983) even refers to Pecking Order

Theory where companies set debt/equity targets so that equity investments can be met with

internal funds to avoid passing positive NPV projects and avoid the sale of stock at perceived

low value.

Shleifer and Vishny (2002) proposed Acquisition Theory where some firms resort to

overvaluing equity through earnings manipulation so they can make acquisitions using over-

valued stock. Durham (2012) suggests a balance between corporate social responsibility and

the quest to maximize company wealth and management boards should promote transparency

in all its operations by appointing committees to handle finance, planning, strategy, funding,

ethics etc, and limiting the number of company managers on the board and committees.

These are only some of the ethical issues and clearly strong corporate governance built

around good ethical practice is necessary.

25

6.0 Recommendations

PGE have demonstrated sound liquidity, and have also met most industry averages in

efficiency, however they lack the economies of scale to compete with larger energy providers

but their strength is in renewable energy. PGE have shown consistent profitability, increasing

profits by 43% since 2008, however Q3 indications show 2011 end of year results may show

reduced profitability. PGE’s performance is below the industry average in returns on equity

and on assets, sales, net income and dividend growth. Higher short term sales growth may be

achieved through reduced hedging requirements, necessitated by higher plant availability,

reliability and more efficient operations; in the medium term however additional installed

capacity is necessary and funding sourced.

The P/E shows an increasing trend, PGE is performing at the current industry average of

15.6. The DCF equity value of PGE of $2036Million is an estimated current value of the

equity of the firm, and does not take into account any potential improvement in the way the

firm is managed. This valuation method is very sensitive, and COV calculations reveal a

high degree of uncertainty in the DCF estimate. Numerous assumptions with justification

were made about future cash flows, economic and company growth rates, inflation, risk rates,

debt structure etc. When compared to the market capitalization of $1.85Billion PGE is

undervalued by the market by 10.3%. It must be emphasized during an acquisition a premium

share price would be expected since shareholders anticipate compensation for their loss of

future earnings, Ang and Cheng (2006), when this is considered, combined with synergistic

factors and average profitability it is recommended that ESL DO NOT

proceed with the

acquisition of PGE at this time. However a future review of PGE is recommended.

26

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33

Appendix 1 PGE Company Management

Mr. Jim Piro – President and CEO

Ms. Maria Pope – Senior Vice President of Finance, CFO and Treasurer

Mr. Bill Nicholson – Senior Vice President, Customer Service, Transmission and Distribution

Mr. Jay Dudley – Vice President , General Counsel and Corporate Compliance Officer

Ms. Arleen Barnett – Vice President , Administration

Mr. Bruce Carpenter – Vice President, Distribution

Ms. Carol Dillin – Vice President, Customer Strategies and Business Development

Mr. Cam Henderson – Vice President, Information Technology, Chief Information Officer

Mr. James Lobdell - Vice President, Power Operations and Resource Strategy

Mr. Stephen Quennoz – Vice President, Nuclear and Power Generation

Mr. Dave Roberson – Vice President, Public Policy

Ms. Kristin Stathis – Vice President, Customer Service Operations

Board of Directors

The Board of Directors of PGE consist of executives in utilities, management, finance and

accounting.

Mr. Corbin McNeill Jr. - Chairman of the Board of Directors, Portland General Electric Ltd.

Mr. John Ballantine – Retired Executive Vice President of First Chicago NBD Corp.

Mr. Rodney Brown Jr. - Managing Partner, Cascadia Law Group PLLC.

Mr. David Dietzler – Retired Partner-in-Charge of KPMG LLP, Pacific Northwest.

Mr. Kirby Dyess - Principal, Austin Capital Management LLC.

Ms. Peggy Fowler - Retired CEO and president, Portland General Electric Ltd.

Mr. Mark Ganz - President and CEO, Cambia Health Solutions, Inc.

Mr. Neil Nelon - President and CEO, Siltronic Corp.

Mr. M. Lee Pelton - President, Emerson College.

Mr. Jim Piro - President and CEO, Portland General Electric Ltd.

Mr. Robert Reid - Corporate Director

Source: Eon (2011), PGE (2012a) and PGE (2012b)

34

Appendix 2 PGE Quarter 3, 2011 Energy Delivery Breakdown

PGE total energy delivery was 14,320,000 MWhrs to a total of 822,975 customers

Residential

719809 Total Customers

5,604,000 MWhrs

Commercial

102911 Total Customers

5,560,000 MWhrs

Industrial

255 Total Customers

3,156,000 MWhrs

Wholesale Market

1,848,000 MWhrs

Source: PGE (2012a)

35

Appendix 3 PGE Load Growth Projections

Source: PGE (2011, pp. 8) and PGE (2012a)

36

Appendix 4 Risks

4a. Summary of Energy Industry Risks

1. Weak economy causing reduced energy sales and higher risk of supplier default

2. Fluctuating price for fuels – coal and natural gas – impacting energy price

3. Impact of weather on energy usage and efficiency renewable plant

4. Forced outages affecting plant reliability and availability

5. Change in PGE credit rating impacting on ability to obtain favorable borrowing rates

6. Market conditions affecting borrowing rates

7. Changes in regulations impacting emissions and legal claims

8. Failure of contractual energy supplies

9. Changes in environmental laws

10. Natural disasters

11. Impact of any changes in Oregon regulatory laws on operations and costs

12. Aging work force

4b. Summary of Specific Risks to PGE

1. The Oregon Renewable Energy Act established a Renewable Portfolio Standard

which requires PGE to meet the following renewable energy resource targets – 15%

by 2015, 20% by 2020 and 25% by 2025

2. Decrease in residential deliveries by 5.7% in 2010

3. Reduction in commercial energy deliveries by 3.7% in 2010

4. Changes in Oregon’s economic activity

5. PGE’s generating resources consist of five thermal, seven hydroelectric and a

windfarm: the renewable plant are highly influenced by climatic conditions such as

rainfall and wind conditions

6. PGE is exposed to the risk of interrupted natural gas supplies, they have reduced

through a natural gas storage contract until 2017

7. Based on customer demand projections and plant retirals, PGE are committed to the

installation of 873MW of new plant capacity by 2015 or 1396 MW by 2020.

8. Possibility of the early retirement of the 374 MW Boardman Coal plant due to

emission regulations

37

Appendix 4 Continued

Risks

9. Tighter air emissions regulations in the Clean air Act and Regional Haze Rules will

negatively impacting on coal-fired energy production

10. Changes in the Endangered Species Act could negatively impact the company fish

protection program and their ability to produce hydroelectric power

11. Changes in the Migratory Bird Treaty Act could expose PGE to penalties due to their

operation of transmission lines and wind generation facilities.

12. Coal combustion byproducts are presently exempt but changes in the federal Resource

Conservation and Recovery Act (RCRA) could negatively impact PGE’s operation of

coal plant.

13. Although the Trojan Nuclear Plant was decommissioned in 1993, spent nuclear fuel is

still temporarily housed at the site in an Independent Spent Fuel Storage Installation

controlled by the U.S. Department of Defense. The spent fuel is not expected to be

shipped to a permanent facility before 2020.

Source: PGE (2012a)

38

Appendix 5 PGE SWOT Analysis

Strengths

Efficient use of Resources

Environmental Stewardship

Strong Customer Base of 14 million

Weaknesses

Dependence on Third Parties

Declining Market Share in Sector

Limited Investor Confidence

Limited Liquidity Position

Opportunities

Strong presence throughout mid west

Alternative Energy Resources

Growing Electricity Demand in the US

Threats

Impact of Weather Changes

Fluctuating fuel prices

Tough Environmental Regulations

New competition from renewable energy companies

Table 5a: SWOT analysis for Portland General Electric Company Ltd. Globaldata (2012) and

PGE (2012a)

39

Appendix 6

PGE Flow of Funds Analysis for 2009 to 2010

Source of Funds 2010

2009

Change

Accounts payable 169

187

-18

Risk management current liabilities 188

128

60

Short term debt

19

0

19

Long term debt current payment

10

186

-176

Regulatory liabilities 25

27

-2

Long Term debt 1798

1558

240

Regulatory liabilities

657

654

3

Deferred tax

445

356

89

Pension Plan 140

143

-3

Risk management long term liabilities 188

127

61

Benefit plan liabilities 97

96

1

Other

156

168

-12

Retained earnings & interest

1599

1543

56

Total 5491

5173

318

Use of Funds 2010

2009

Change

Cash & cash equivalents

4

31

27

Accounts receivable

137

159

22

Unbilled revenue 93

95

2

Inventory 56

58

2

Current Regulatory Assets 221

197

-24

Property, Plant & Equipment

4133

3859

-274

Non current Regulatory Assets

544

465

-79

Other 303

309

6

Total 5491

5173

-318

Table 6a: PGE Flow of Funds Analysis for 2009 to 2010, Source: PGE (2012) Main points to note:

1. During 2010 PGE favorably reduced their accounts payables and receivables

2. PGE eroded their end of year cash and cash equivalents by $27 million to $4 million

3. Funds were mainly derived from the issuance of $249 million of long term debt, an

increase in risk management liabilities by $121 million, deferred income taxes of $89

million and an increase in retained earnings by $56 million

4. PGE required an additional $79 million for regulatory asset management, the repayment

of $186 million of matured long term debt, and $274 million for the completion of the

$450 million Biglow Canyon Phase III wind project; smart metering; and the maintenance

and upgrade of the existing generation, distribution and transmission network.

40

Appendix 7

Historical Financial Ratios for PGE and Key Ratio Definitions

November 29, 2011

Portland General Electric Company

KEY RATIOS

Unit/Currency

2010

2009

2008

2007

2006

Equity Ratios

EPS (Earnings per Share) USD 1.66 1.304 1.39 2.319 1.136

Dividend per Share USD 1.035 1.01 0.97 0.93 0.675

Dividend Cover Absolute 1.604 1.291 1.433 2.493 1.683

Book Value per Share USD 21.137 20.502 21.638 21.031 19.583

Cash Value per Share USD 0.053 0.412 0.16 1.167 0.192

Profitability Ratios

Operating Margin % 14.975 11.53 12.436 15.433 10.461

Net Profit Margin % 7.011 5.266 4.986 8.319 4.671

PBT Margin (Profit Before Tax) % 9.759 6.929 6.991 12.565 7.039

Return on Equity % 7.852 6.161 6.425 11.018 5.801

Return on Capital Employed % 5.338 4.569 5.425 7.237 4.961

Return on Assets % 2.276 1.837 1.78 3.53 1.885

Return on Fixed Assets

%

5.528

4.641

5.333

7.535

4.907

Return on Working Capital % 155.233 297.143 182.993

Growth Ratios

Sales Growth

%

-1.164

3.381

0.115

14.671

5.118

Operating Income Growth % 28.365 -4.147 -19.331 69.182 -7.558

EBITDA Growth % 22.619 1.818 -17.5 22.699 -4.118

Net Income Growth

%

31.579

9.195

-40

104.225

10.938

EPS Growth % 27.317 -6.2 -40.045 104.131 10.929

Working Capital Growth % 145.714 -201.449 -146.939 -520 -119.774

Cost Ratios

Operating Costs (% of Sales) % 85.025 88.47 87.564 84.567 89.539

Administration Costs (% of Sales) % 15.423 14.579 15.645 15.146 15.724

Source: Global Data (2012)

41


Historical Financial Ratios for PGE and Key Ratio Definitions

KEY RATIOS Unit/Currency 2010 2009 2008 2007 2006

Liquidity Ratios

Current Ratio

Absolute

1.352

1.113

0.922

1.376

0.938

Quick Ratio Absolute 1.237 1.019 0.843 1.212 0.824

Cash Ratio Absolute 0.178 0.14 0.224 0.258 0.103

Leverage Ratios

Debt to Equity Ratio % 114.761 113.1 111.448 99.772 88.562

Net Debt to Equity % 114.51 111.089 110.709 94.225 87.582

Debt to Capital Ratio

%

36.525

38.313

37.725

35.324

33.822

Asset Turnover Absolute 0.325 0.349 0.357 0.424 0.404

Fixed Asset Turnover Absolute 14.264 4.443 6.144 13.833

Inventory Turnover Absolute 17.911 19.345 14.746 16.078 14.109

Current Asset Turnover Absolute 2.697 2.614 2.128 3.24 2.884

Capital Employed Turnover Absolute 1.12 1.17 1.289 1.324 1.242

Working Capital Turnover Absolute 10.366 25.771 11.857

Revenue per Employee USD 667540.247

Net Income per Employee USD 46798.952

Capex to Sales % 25.238 38.581 21.948 26.104 24.408

Ratio Definitions

Asset turnover = Total Revenue / Total Assets

Inventory turnover = Cost of Goods and services / Average Inventory

Capital Employed = Total Income / Total Assets

Current Ratio = Current Assets / Current Liabilities

Quick Ratio = (Current Assets – Inventory) / Current liabilities

Cash Ratio = Cash and cash equivalents / Current Liabilities

Earnings per share (EPS) = Profit after tax / Total No. of shares

Dividends per share (DPS) = Gross Dividends / Total No. of Shares

Return on Equity = Profit after tax / Total Equity

Return on Assets = Net Income / Total assets

Operating Margin = Operating Income / Total Revenue


42

Appendix 8 PGE versus Industry Ratios in 2011

Growth Rates % PGE Industry S&P

500 Financial Condition

PGE Industry S&P 500

Sales (Qtr vs year ago qtr)

-5.4 13.3 14.2 Debt/Equity Ratio

1.09 1.28 1.06

Net Income (YTD vs YTD)

NA NA NA Current Ratio 1.4 1.1 1.4

Net Income (Qtr vs year ago qtr)

-44.9 6 48.7 Quick Ratio 1.3 0.9 0.9

Sales (5-Year Annual Avg.)

4.28 6.62 8.03 Interest Coverage

2.7 4.3 324.5

Net Income (5-Year Annual Avg.)

14.33

5.83 8.39 Leverage Ratio 3.4 3.4 3.6

Dividends (5-Year Annual Avg.)

3.5 4.65 5.71 Book Value/Share

21.94

24.64 26.49

Table 8a: PGE Growth Rates Verses the Industry Table 8b: PGE Operating Ratios vs the Industry

Price Ratios PGE

Industry S&P 500

Investment Returns %

PGE

Industry

S&P 500

Current P/E Ratio 13.1

14.8 24.6

Return On Equity

8.8

9.4

26.2

P/E Ratio 5-Year High

26.4

7.0 15.9

Return On Assets

2.5

2.8

8.9

P/E Ratio 5-Year Low 7.3

6.4 2.8

Return On Capital

2.7

3.4

11.8

Price/Sales Ratio 1.04

1.85 2.14

Return On Equity (5-Year Avg.)

7.7

11.7

23.5

Price/Book Value 1.13

1.6 4.01

Return On Assets (5-Year Avg.)

2.3

3.5

8.1

Price/Cash Flow Ratio

4.9

8.5 11.6

Return On Capital (5-Year Avg.)

2.6

3.1

10.9

Table 8c: PGE Performance Ratios vs the Industry Table 8d: PGE Profitability Ratios vs the Industry


43


PGE versus Industry Ratios in 2011

Profit Margins % PGE Industry

S&P 500

Management

Efficiency PGE Industry

S&P 500

Gross Margin 46.6 26 39.5 Income/Employee 52,415 139,044 130,202

Pre-Tax Margin 10.9 -7.7 18.1 Revenue/Employee

0.67Mil 2 Mil 1 Mil

Net Profit Margin 7.8 9.2 13.2

Receivable Turnover

13.3 9.1 15.6

5Yr Gross Margin (5-Year Avg.)

NA 3.4 39.6 Inventory Turnover

15.2 15.5 12.5

5Yr PreTax Margin (5-Year Avg.)

8.7 13.4 16.1

Asset Turnover 0.3 0.3 0.8

5Yr Net Profit Margin (5-Year Avg.)

6 9.6 11.5

Table 8e: PGE Profit Ratios vs. the Industry Table 8f: PGE Efficiency Ratios vs. the Industry


Parameter PGE 2010 PGE 2011 Q3

Asset Turnover 0.325 0.238 Inventory Turnover 14.26 10.02 Capex/sales 25.23 16.12 Current Ratio 1.352 1.36 Quick Ratio 1.237 1.31 Cash Ratio 0.178 0.189 EPS 1.66 1.57 DPS 1.035 0.790 ROA 2.27 2.10 ROE 7.85 7.13 Operating Margin 14.97 18.00

Table 8g: Comparison of 2010 and 2011 Q3 Key Ratios for PGE

44

Appendix 9

Financial Highlights from the Portland General Electric 2010

PGE (2010 pp. 2) Financial Highlights from the Portland General Electric 2010 Annual Report

45

Appendix 10 The Dividend Discount Model

Hawawini and Viallet (2007 pp. 345 - 346) explain the Dividend Discount Model (DDM) as

the present share price is the discounted sum of all future cash dividends.

P0 = Div1/(1+Ke) + Div2/(1+Ke)2 +…….Divt/(1+Ke)

t

Simplifying this equation by proposing that dividend growth is perpetual at a constant rate g,

then -

P0 = Div1/(Ke-g)

Therefore, Ke can be determined from the current share price (P0); the expected growth rate

(g) of future dividends calculated from the past growth rate; and the projected dividend

payment (Div1) one year into the future. This is also known as the Dividend Growth Model

(DGM).

Year PGE Dividends ($)

Proportion of Dividend Change

2005

N/A

2006

0.68

2007

0.93

2008

0.97

0.043

2009

1.01

0.041

2010

1.04

0.025

2011

1.06

0.024

Growth rate (g) 0.0333

Table 4: Dividend Growth for PGE 2005–2011, Source: PGE(2011)

D1 = 1 year forecasted annual dividend rate 1.06%

P0 = Current PGE stock price $24.60

g = Average PGE dividend growth rate 0.033

Ke = (1.06/24.6) + 0.033 = 0.076

46

Appendix 11

PGE Long Term Debt details

Bonds Schedule

Company Credit Rating – Moody’s A3, S&P A-

Weighted average interest rate of 5.85%

Maturity 2012, Face Value %100 Million, yield rate 0.46%

Maturity 2013, Face Value $100 Million, yield rate 1.42%



Beyond 2016, Face Value $1344 Million, yield rate 5.01%

Bond Present Values were calculated using the formula-

Pb = C1/(1 + YTM) + C2/(1+ YTM)2 +…….Cn/(1+ YTM)n + M/(1+ YTM)n

Simplified to -

Pb = Ct(PVDFAYTM, t) + Mt(PVDFYTM, t)

1. Where C is the coupon rate

2. YTM is the interest yield rate derived from a current corporate bond yield interest

rate curve

3. t is the outstanding time to maturity

4. M is the bond face value.

Data sources are PGE (2012), PGE (2012a) and Yahoo (2012a), and present value bond

calculator from Lane (2012).

47

Appendix 12

Sensitivity and Coefficients of Deviation of Models Used

CAPM Parameters

Values of Ke for % Parameter

Deviations (Ke = 0.0797)

-2% +2% -5% +5% -10% +10%

Beta 0.079 0.080 0.078 0.081 0.077 0.082 Rm - Rf 0.079 0.080 0.078 0.081 0.077 0.082 Rf 0.079 0.081 0.077 0.082 0.075 0.085 Extreme 0.078 0.082 0.074 0.085 0.069 0.091

Table 12a: Values of Ke for Percentage Variations in CAPM Parameters

DGM Parameters

Values of Ke for % Parameter Deviations (Ke = 0.0766)

-2% +2% -5% +5% -10% +10%

D1

0.075 0.077 0.074 0.079 0.072 0.081 P0

0.077 0.075 0.080 0.074 0.081 0.072 g 0.075 0.077 0.074 0.079 0.073 0.079 Extreme 0.074 0.079 0.070 0.082 0.065 0.089

Table 12b: Values of Ke for Percentage Variations in DGM Parameters

WACC Parameters

Values of WACC for % Parameter Deviations (WACC = 0.0594)

-2% +2% -5% +5% -10% +10% Ke 0.0586 0.0602 0.0574 0.0614 0.0555 0.0634 Kd 0.0590 0.0598 0.0584 0.0604 0.0574 0.0614 tc 0.0596 0.0593 0.0599 0.0590 0.0603 0.0585 D 0.0596 0.0592 0.0599 0.0590 0.0604 0.0585 E 0.0592 0.0597 0.0589 0.0599 0.0584 0.0603 Extreme 0.0581 0.0604 0.0560 0.0629 0.0527 0.0663

Table 12c: Values of WACC for Percentage Variations in Parameters

48


Sensitivity and Coefficients of Deviation of Models Used

CAPM

DDM

+/-5% +/-5%

Ke

(Ke

- x) (Ke - x)2 Ke

(Ke

- x) (Ke

- x)2

0.078 -0.001500

0.000002

0.077 0.000125

0.000000

0.078 -0.001500

0.000002

0.080 0.003125

0.000010 0.077 -0.002500

0.000006

0.074 -0.002875

0.000008 0.074 -0.005500

0.000030

0.070 -0.006875

0.000047 0.081 0.001500

0.000002

0.079 0.002125

0.000005 0.081 0.001500

0.000002

0.074 -0.002875

0.000008

0.082 0.002500

0.000006

0.079 0.002125

0.000005 0.085 0.005500

0.000030

0.082 0.005125

0.000026 0.636 0.000082

0.615 0.000109 n 8

n 8

Mean ( x) 0.080

Mean ( x) 0.077

Var (s2) 0.000010

Var (s2) 0.000014

sd (s)

0.003202

sd (s)

0.003689

Coeff. Dev. 0.040271

or 4.03% Coeff. Dev. 0.047988

or 4.80%

WACC

+/-5%

WACC (WACC - x) (WACC - x)2

0.0574 -0.002025

0.00000410 0.0584 -0.001025

0.00000105 0.0599 0.000475

0.00000023 0.0599 0.000475

0.00000023 0.0589 -0.000525

0.00000028 0.0560 -0.003425

0.00001173 0.0614 0.001975

0.00000390 0.0604 0.000975

0.00000095 0.0590 -0.000425

0.00000018 0.0590 -0.000425

0.00000018 0.0599 0.000475

0.00000023 0.0629 0.003475

0.00001208 0.7131 0.00003512

n 12

Mean ( x) 0.0594

Var (s2) 0.0000029

sd (s)

0.0017108

Coeff. Dev. 0.0287894 or 2.88%

Model COV for +/-5%

(%)

CAPM 4.03%

DDM 4.80%

WACC 2.88%

49

Appendix 13

Free Cash Flow Data and Estimations

Past

2007 2008 2009 2010

Equals EBIT

293.00

212.00

229.00

284.00

tax

(74.00)

(90.00)

(104.00)

(53.00)

Depreciation & Amotisation (D&A) 181.00

208.00

211.00

238.00

Capex

(455.00)

(383.00)

(696.00)

(450.00)

Change in Working capital ( WC)) (183.00)

427.00

(349.00)

(102.00)

Cashflow from Assets (238.00)

374.00

(709.00)

(83.00)

- - - - Table 13a: Past Free Cash Flow Data

Base

Future

2011 2012 2013 2014 2015 2016 2017

Equals EBIT

284.00

292.52

307.15

319.43

329.01

338.89

342.27

-tax

(88.15)

(90.80)

(95.34)

(99.15)

(102.13)

(105.19)

(106.10)

+D&A 238.56

245.72

258.00

268.32

276.37

284.66

287.51

-Capex

(304.00)

(293.00)

(255.00)

(259.00)

(286.00)

(300.00)

(310.00)

-Change in Working capital

(100.00)

(100.00)

(80.00)

(90.00)

(90.00)

(100.00)

(100.00)

( WC)

= Cashflow from assets 30.41

54.44

134.81

139.60

127.26

118.36

113.68

Discounted cash flows

51.39

120.12

117.41

101.03

88.80

Table 13b: Discounted Future Free Cash Flows

Estimations for FCF Calculations

1. Conservative EBIT growth projections of no greater than 3% above US Energy

long term projected growth rates, see Table 13c below.

2. 2017 growth rate was set equal to long term inflation rate.

3. Oregon corporate tax rate is 35%, however PGE corporate tax rate varied due to

renewable energy tax credits. A corporate tax rate of 31.0% was used based on 5-

year historical average; see Table 13d below

4. D&A based on 5-year historical average of 84% of EBIT

5. Future Capex values (2012 – 2015) based on 2011 Q3 financial report projections;

2016 and 2017 values not exceeding 90% of EBIT – consistent with projected

Capex values

6. Future WC not exceeding 35% of Capex and based on 2010 and 2011

behaviour; prior to 2010 WC was erratic

50


Free Cash Flow Data and Estimations

Year US Energy

Growth Rate PGE Growth

Rates

2011 0.0% 1.0% 2012 2.0% 3.0% 2013 2.0% 5.0% 2014 1.0% 4.0% 2015 0.8% 3.0%

2016 1.0% 3.0% 2017 1.0% 3.0%

Table 13c: PGE Projected Growth Rates

Source of US projected energy growth rates, EIA (2010) and PSC (2011)

Year Corporate tax Paid

(%)

2006 33.6 2007 33.7 2008 28.7 2009 28.8 2010 30.4

Avg 31.0%

Table 13d: Corporate Tax Estimation

Source: PGE (2012a)

51

Appendix 14

Sensitivity Tables for Discounted Cash Flow Value for PGE

Table 14h: PGEDCF Value Sensitivity for changes in WACC

EBITEFP

-0.5% +0.5% -1% +1% -1/0% +1.0%

PGEDCF

Value $1.64B $2.44B $1.25B $2.85B $0.50B $3.70B

Table 14a: PGEDCF

Value Sensitivity for changes in EBIT2012-2016

EBIT TV

-0.5% +0.5% -1% +1% -2% +2%

PGEDCF

Value $1.62B $2.62B $1.31B $3.52B $0.89B $8.18B Table 14b: PGEDCF

Value Sensitivity for changes in EBIT2017

Corporate Tax -1% +1% -2% +2% -4% +4%

PGEDCF

Value $2.15B $1.92B $2.26B $1.92B $2.34B $1.70B

WACC 5.97% 5.91% 6.00% 5.91% 6.06% 5.83% Table 14c: PGEDCF Value and WACC Sensitivities for changes in Corporate tax

Capex EFP

-2% +2% -5% +5.0% -10% +10%

PGEDCF

Value $2.06B $2.01B $2.09B $1.974B

$2.15B $1.91B Table 14d: PGEDCF Value Sensitivity for changes in Capex2012 - 2016

CapexTV

-2% +2% -3% +3% -5% +5.0% -10% +10%

PGEDCF

Value $2.21B $1.85B $2.23B $1.76B $2.49B $1.58B $2.94B $1.12B Table 14e: PGEDCF

Value Sensitivity for changes in Capex2017

WCEFP

-2% +2% -5% +5% -10% +10% +150%

PGEDCF

Value $2.10B $2.02B $2.05B $2.01B $2.07B $1.99B $1.84B

Table 14f: PGEDCF

Value Sensitivity for changes in WC2012 -

2016

CWCTV

-2% +2% -5% +5% -10% +10%

PGEDCF

Value $2.09B $1.97B $2.18B $1.89B $2.33B $1.74B Table 14g: PGEDCF

Value Sensitivity for changes in WC2017

WACC -2% +2% -5% +5% -10% +10%

PGEDCF

Value $2.17B $1.90B

$2.41B $1.72B $2.88B $1.46B

52

Appendix 15

+/-2% +/-2% Ke (Ke - x) (Ke - x)2 Ke (Ke - x) (Ke - x)2

0.075 -0.001025 0.000001 0.079 -0.000750 0.000001 0.077 0.000975 0.000001 0.079 -0.000750 0.000001 0.075 -0.001025 0.000001 0.079 -0.000750 0.000001 0.0737 -0.002325 0.000005 0.078 -0.001750 0.000003 0.077 0.000975 0.000001 0.08 0.000250 0.000000 0.075 -0.001025 0.000001 0.08 0.000250 0.000000 0.077 0.000975 0.000001 0.081 0.001250 0.000002 0.0785 0.002475 0.000006 0.082 0.002250 0.000005

0.6082

0.000018

0.638

0.000012

Mean (x) 0.0760

Mean (x) 0.0798

Var (s2) 0.00000219

Var (s2) 0.00000144

sd (s)

0.001480

sd (s)

0.001199

Coeff. Dev. 0.019474

or 1.95% Coeff. Dev. 0.015034

or 1.50%

+/-2%

+/-2%

WACC

(WACC - x) (WACC - x)2 PGEDCF

(PGEDCF

- Y)

(PGEDCF

- Y)2

0.0586 -0.000792 0.00000063 0.50 -1.536000 2.35929600

0.0590 -0.000392 0.00000015 3.70 1.664000 2.76889600

0.0596 0.000208 0.00000004 0.89 -1.146000 1.31331600

0.0596 0.000208 0.00000004 8.18 6.144000 37.74873600

0.0592 -0.000192 0.00000004 2.26 0.224000 0.05017600

0.0581 -0.001292 0.00000167 1.92 -0.116000 0.01345600

0.0602 0.000808 0.00000065

2.06 0.024000 0.00057600

0.0598 0.000408 0.00000017

2.01 -0.026000 0.00067600

0.0593 -0.000092 0.00000001

2.21 0.174000 0.03027600

0.0592 -0.000192 0.00000004

1.85 -0.186000 0.03459600

0.0597 0.000308 0.00000010

2.10 0.064000 0.00409600

0.0604 0.001008 0.00000102

2.02 -0.016000 0.00025600

0.7127

0.00000455

2.09 0.054000 0.00291600

Mean (x) 0.0594

1.97 -0.066000 0.00435600

Var (s2) 0.0000003791

2.17 0.134000 0.01795600

sd (s)

0.0006157

1.90 -0.136000 0.01849600

Coeff. Dev. 0.0103669

or 1.03%

37.83 44.36807600

Mean (x) 2.3644

PGEDCF

(Y) 2.0360

Var (s2) 2.7730048

sd (s)

1.6652341

Coeff. Dev. 0.8178950

or 81.79%

Coefficient of Variability Tables for Key PGE Parameters

Table 15a: DDM +/-2% COV Calculation Table 15b: CAPM +/-2% COV Calculation

Table 15c: WACC +/-2% COV Calculation Table 15d: PGEDCF +/-2% COV Calculation

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