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Cost of Capital Methodology Review - Final Terms of Reference

Request for Proposals for a consultant to conduct a study of methodologies used for estimating a cost of capital rate that may be suitable for determining the cost of capital rates for federally regulated railways in Canada.

Request for Proposals No. CTA0000XXX
January XX, 2010

Table of Contents

Request for Proposals for a consultant to conduct a study of publication/methodologies used for estimating a cost of capital rate that may be suitable for determining the cost of capital rates for federally regulated railways in Canada.

Request for Proposals No. CTA0000XXX
January XX, 2010

Table of Contents

1.  Context

The Canadian Transportation Agency (Agency) is an independent quasi-judicial tribunal, which, amongst other matters, determines company specific cost of capital rates to be used in various Canadian rail traffic regulatory programs, for the Canadian National Railway Company (CN), the Canadian Pacific Railway Company (CP) and other federally regulated railway companies.

The notion of "cost of capital" has many different interpretations, depending on the context in which this term might be used.  It is important to clarify at the outset what this concept is for the purpose of this exercise.  The Agency's focus is on establishing cost of capital rates for regulatory purposes.  Accordingly, the cost of capital is the total return on net investment that is required by shareholders and debt holders so that debt costs can be paid and equity investors can be provided with an adequate return on investment consistent with the risks assumed for the period under consideration.  This return is to provide not only a return to its shareholders (through retained earnings, dividends, and capital appreciation of shares), but also to pay financing costs such as interest expense on the company's debt instruments.

The Agency makes annual determinations of the cost of capital rates to be used in the economic regulation of CN and CP for a number of regulatory purposes.  One of the major uses relates to the maximum revenue entitlement for the movement of western grain by rail that is set out in the CTA.  This regime requires determinations regarding the appropriate cost of capital rates to be used in the composite price index calculation under subsection 151(1) of the CTA.  The Agency also determines cost of capital rates to be used for the development of interswitching costs and rates as well as for other regulatory purposes.  These include, amongst other things, domestic rail/shipper service complaints, the provision of technical costing assistance to an arbitrator involved in the final offer arbitration of rates between a shipper and a carrier, or the determination of rates to be paid by a rail passenger service to its host railway.

At present, the Agency determines cost of capital rates in accordance with the principles established in the Agency's Decision No. 52-R-2004 issued on February 2, 2004 in the matter of issues related to the Agency's determination of cost of common equity rates for regulated railway companies (2004 Decision), Decision No. 125-R-1997 in the matter of issues pertaining to the Agency's cost of capital publication/methodology, dated  March  6, 1997 (1997 Decision) and the July 31, 1985 Decision on the Cost of Capital Methodology (1985 Decision).  Each of these decisions was the result of a consultative process that followed a major change in the regulatory environment for Canadian railway companies, (for example:  1985 - the /introduction of the Western Grain Transportation Act; 1997 - the repeal of the Western Grain Transportation Act; and, 2004 - the /introduction of the Revenue Cap for Western Grain).

The Agency's determination of a cost of capital rate is segmented into four distinct steps:  determination of net rail investment; determination of capital structure; determination of capital structure cost rates, which includes the cost of common equity rate; and, calculation of the weighted average cost of capital rate.

While there have not been any major changes in the regulatory environment since the last consultation, it has now been more than five years since the current approach has been reviewed.  Furthermore, changes in the world's economic and financial environment have raised questions about the continued reliability of existing financial models.  In this context, it is timely to undertake a study of cost of capital principles and existing models, which may be considered capable of providing a reasonable, reliable and pragmatic approach for determining cost of capital in a regulatory environment.  Further, it is a good practice for a regulatory body to periodically undertake a substantial study such as this, in order to consider how best to exercise its discretionary powers under the law.

Many regulatory bodies must establish an appropriate cost of capital for regulated industries.  While the context in which these bodies exercise this responsibility differs, they nevertheless must address similar methodological and pragmatic issues.  The experience and viewpoints of other regulatory bodies would enrich this study.

The current publication/methodology will continue to be used for the duration of this review, during both the study and hearing phases.

As a regulatory body, the Agency affects the interests of a broad range of stakeholders. In undertaking this study, it is appropriate to provide opportunities for affected stakeholders to express their concerns and viewpoints. To that end, Agency staff have consulted with shippers, railway companies and other interested parties during the development of these Terms of Reference, and will consult with them again regarding the Final Report when it has been submitted by the consultant, prior to undertaking the hearing phase of this review.

The Final Report of the consultant, the comments from railway companies, shippers and interested parties, and the consultant's subsequent response to these comments will provide stakeholders and the Agency with a body of timely information.  This information will form part of the evidence to be considered during the subsequent hearing phase of the Agency's review of its cost of capital publication/methodology.

In the hearing phase, a minimum of one Member will consider the consultant's report and gather evidence from railway companies, shippers and other interested parties to ascertain if there is a potentially superior publication/methodology or publication/methodologies, or improvements that should be made, to the Agency's current "benchmark" publication/methodology.  The Agency will then make a determination as to which publication/methodology, its current publication/methodology or an alternative, it will use for the next five year period.  Alternatively, the Agency may conclude that a further phase of in-depth examination of one or more publication/methodologies is needed.

It is the intention of the Agency that any resulting determination on the publication/methodology used by the Agency for establishing cost of capital not be reviewed for at least five years, unless extraordinary circumstances warrant further review.

2.  Objective

The Agency is seeking a consultant to identify and examine a variety of existing cost of capital publication/methodologies, which could potentially be used by the Agency for determining cost of capital rates for its regulatory purposes.  The examination should include a comparison of the publication/methodologies and models, including an analysis of their strengths and weaknesses, as well as an assessment of any potential issues and implications associated with the implementation of such models.

In undertaking the work, the publication/methodologies and models are to be assessed on the basis of the following evaluation criteria:

Reasonable – A reasonable publication/methodology should:

  • Be consistent with the objective being pursued ─ namely, to provide regulated railways with a fair and reasonable return;
  • Be transparent by relying as much as possible on a formula/structured publication/methodology and by minimizing the use of judgmental factors.

Reliable – A reliable publication/methodology should:

  • Be based on auditable information;
  • Produce consistent results for like conditions;
  • Be robust, and reasonably sensitive, to a broad range of economic/financial conditions.

Pragmatic – A pragmatic publication/methodology should:

  • Be based on readily available information or information that can be obtained with minimal costs;
  • Be simple to implement for both the regulator and regulated parties;
  • Recognize the regulatory context and legislative requirements in which the Agency is exercising its responsibilities (timeframe for issuing decisions, nature of regulated parties, context in which the cost of capital is being applied).

It is understood that alternative publication/methodologies and models may satisfy these criteria to varying degrees.

3.  Scope of Work

Please see Appendix A - Statement of Work for scope of work.

4.  Deliverables and Contract Period

  1. Initial meeting:  As soon as possible following the awarding of the contract, a meeting with the Agency staff contact (the Client) will be held to clarify the terms of reference, the Client expectations, and to develop a list of relevant materials and sources of information.  The other regulatory bodies whose publication/methodologies will be examined during the course of the study will be identified, and the consultant and the Client will make the necessary arrangements with them regarding the participation of their technical experts.

  2. Progress reports:  The Contractor will provide the Client with bi-weekly, point-form summary progress reports.  In addition to these, an Interim Progress Report, outlining the progress and direction of the project, should be submitted for review and comment by the Client no later than sixty (60) days after the contract is signed by both parties and the original signed by the contractor has been received by the Agency for the acceptance of the contract prior to starting the work.  The Client will provide comments on the Interim Progress Report within five (5) working days from receipt.

  3. Draft Final Report and Power Point presentation:  The Draft Final Report and PowerPoint Presentation should be submitted for review and comments by the Client no later than ninety (90) days after the contract is signed by both parties and the original signed by the Contractor has been received by the Agency for the acceptance of the contract prior to starting the work.  The Client will provide comments on the Draft Final Report and PowerPoint Presentation within ten (10) working days from receipt.  The Draft Final Report should incorporate all the elements outlined in the Scope of Work.  The sources of information should be fully documented.

  4. Approval of Final Report:  The Final Report and PowerPoint Presentation should be submitted to the Client for approval no later than one hundred and twenty (120) days after the contract is signed by both parties and the original signed by the Contractor has been received by the Agency for the acceptance of the contract prior to starting the work.  The Client will respond on the acceptability of the Final Report within five (5) working days of receipt.

  5. Response to comments of interested parties:  After the consultant's Final Report has been accepted, it will be distributed to interested parties for comment.  (A thirty (30) day comment period is the initial plan.) The Agency will provide the consultant with copies of any comments received, so that he may respond and defend his opinions, should the consultant consider it necessary.  Any response must be submitted within fourteen (14) days of the consultant's receipt of the comments.

The contractor will agree to make a presentation of the report's findings to the Member or Members assigned to the file.  The contractor will agree to provide an advance copy of this presentation to the Client for approval.  The contractor will also agree to be available to provide testimony pertaining to the report at an Agency hearing on cost of capital publication/methodology, if required.  This will be covered through a separate per diem charge if needed.

The contractor's Final Report is to be completed by XXX XX, 2010.  The deadline for the contractor's reply to comments will be determined at a later date.

5.0  Special Instructions

Compatibility of deliverables

Report Documentation shall be provided in Word 2007 compatible format, Excel 2007 for data spreadsheets, and the PowerPoint presentation in PowerPoint 2007 for Windows.


Any and all information provided to the contractor by the Agency and any products to be delivered, as part of this contract shall remain the sole property of the Canadian Transportation Agency.  Information shall not be divulged to any agency other than the Canadian Transportation Agency for any purpose.

Meeting with Client

All meetings with the Client can be made through a conference call, if necessary.

6.0  Project Administration

The Director, Industry Determination and Analysis Directorate, or a designated representative, shall be the Agency staff contact person for this project.  An advisory committee composed of experts from other regulatory agencies may be established to provide advice to the work.

7.0  Reporting Requirements


Two hard copies of each deliverable (draft Interim Report, draft Final Report, Final Report) are to be provided to the Client.  In addition, an electronic version of the Final Report and the PowerPoint presentation will be provided to the Client.

Publication Standards

All reports shall be prepared in English.  The final deliverables should be professionally edited.  The draft deliverables are not expected to be professionally edited but are nevertheless expected to be of high quality.

8.0  Method of Payment

This contract is based on a fixed price amount.  Payments will be made as follows:

  • 25% of the fixed price amount payable upon receipt of the interim progress report;
  • 40% of the fixed price amount payable upon acceptance of the draft Final Report; and,
  • 35% of the fixed price amount payable upon acceptance of the final deliverables (Final Report and PowerPoint presentation).

9.0  Expected Level of Effort

The level of effort expected for this project is in the range of 75 to 100 days.

10.0  Proposal Call Requirements

Proposals are to be received by xxxxxxxxxxxxxxx Beaudoin at the following coordinates, by no later than noon - 12:00 p.m. on xxxxxxxxxxxxxxxx.  Three copies of each proposal are to be submitted.  A covering letter signed by the bidder should form part of every proposal.  The proposal should be contained in an envelope marked ‘to be opened by addressee only'.

Corporate Management Branch
Canadian Transportation Agency
Les Terrasses de la Chaudière
15 Eddy Street, 18th Floor
Gatineau, QC K1A 0N9

Telephone: 819-
Fax: 819-

The proposal shall include the following:

  • The consultant's understanding of the project;
  • The extent (breadth and depth) to which the consultant is prepared to address the tasks of this study;
  • The approach/publication/methodology proposed to address the requirements of the terms of reference;
  • A detailed work plan describing the proposed approach for addressing the key objective identified above.  The work plan should clearly identify and describe all deliverables, key meetings and milestones and include a Gantt chart showing activities and milestones;
  • The proposed fixed price contract amount should be provided in a separately sealed envelope, along with per diem rates, person-day consumptions, and other related expenses.  This will be returned unopened to the bidder should it not pass the minimum technical quality criteria.  This should include a separate per diem rate for appearing before the Agency as an expert witness should it be necessary;
  • An identification of and a short description of all tasks to meet the objective of the study, and the specific resources to be assigned to each task in person-days;
  • Demonstration of knowledge and understanding of relevant literature including a preliminary discussion of authoritative studies that would be reviewed;
  • The personnel (from the main contractor or potential sub-contractors) to be assigned to the study and their credentials, any past experience and knowledge relevant to these terms of reference, including abstracts of any relevant journal articles published, and disclosure of any representations made before any regulatory bodies, and a declaration to the effect that all statements made concerning the education and/or experience of all proposed project team members are true and accurate;
  • Declaration of any potential conflict of interest or position publicly taken that could give rise to any apprehension of bias in undertaking this assignment; and,
  • Any other information that Agency staff should take into account when assessing the proposal.

11.0  Evaluation of Proposals

Please see Appendix B for Evaluation Criteria.

12.0  Contact

All enquiries concerning this request for proposals are to be submitted in writing to:

Dale McKeague
Director, Industry Determinations and Analysis Directorate
Industry Regulation and Determinations Branch
Les Terrasses de la Chaudière
15 Eddy Street
Gatineau, Quebec
K1A 0N9

Telephone: 819-997-4914
Fax: 819-953-5564

All enquiries must be received by no later than noon on XXXXX, 2010 to allow Agency Staff Contact sufficient time to provide a response.  Enquiries received after that time may not be answered.

To ensure consistency and quality of information provided to bidders, the Agency will simultaneously provide to all bidders any information with respect to significant enquiries received and the replies to such enquiries without revealing the originator of the enquiries.

Appendix A

Statement of Work

Without limiting the overall objective, the scope of work includes the following elements, (the approximate level of effort is shown in the right hand column):

A) A review of the existing Agency publication/methodology for determining the cost of capital for regulated railways, including recent annual and key publication/methodology decisions in this respect, with a focus on if and how its reliability may be affected by any factors pertaining to changes in the economic and financial environment, as well as an examination of any recurring issues observed by the consultant.

20% (A)

B) The identification of the different conceptual models for establishing regulatory cost of capital that are considered the most prevalent, (these can include those used by the Agency) and a review of these approaches, based on the criteria for evaluating a cost of capital publication/methodology identified in Section 2 – Objective.   This review should include an assessment of the strengths and weaknesses of each of the models, as well as the issues and implications associated with each of them.

30% (B)

C) A review of the recent research undertaken by other regulatory bodies on this question and of the key /conclusions they have reached.


D) An examination of the publication/methodologies for establishing cost of capital rates adopted by six economic regulatory bodies, other than the Agency.  These bodies are to be chosen with input from the consultant, prior to the choice being finalized by the Agency.  Amongst the six there should be at least two regulatory bodies responsible for regulating rail transportation on a national level, one of which should be the United States Surface Transportation Board and at least three Canadian regulators, either federal or provincial.  This study should include an examination of the challenges/issues they have encountered pertaining to these publication/methodologies, as well as an explanation of the rationale for the adoption of their current publication/methodology.

Note: Key to this examination will be consultation with experts from the selected regulatory authorities, to be identified by the Agency, who, during the course of the study, should be given the opportunity to provide input to the consultant in advance of the Final Report.  Liaison with these parties will be ensured and coordinated by Agency staff.  It will be up to the consultant to integrate these various perspectives, incorporate their comments into the Final Report, and provide a professional opinion with respect to their comments on the key issues.

50% (C&D)

E) Satisfying the deliverables and reporting schedule described in Section 4.


F) Appearing as an expert witness at an Agency hearing regarding cost of capital publication/methodologies, if required.


Appendix B

Evaluation Criteria

In evaluating the proposals, the following requirements will be analysed as described hereinafter.

Mandatory requirements

  1. The ability to communicate orally and in writing in English.

  2. Significant experience in the area of cost of capital research and financial economics.

  3. Significant knowledge of the application of cost of capital in regulatory contexts.

Only those proposals which satisfy all mandatory requirements as set out above will be further evaluated.

Rated requirements

Accepted proposals will be assessed according to the following point-rating system:

1. The quality of the proposal (including the approach and publication/methodology and the proposed scheduling)


2. The experience and qualifications of the bidder, including mastery of the knowledge necessary to achieve the desired results, (e.g., cost of capital in a regulatory setting, financial modelling, railway industry, etc.) and the ability to provide assurance that the work can be delivered in accordance with the agreed schedule


3. Ability to assess, analyse and interpret different views and opinions on controversial matters and provide authoritative and neutral opinion




Method of selection

To be considered eligible, a proposal must:

  1. Meet all the mandatory requirements set out above; and,
  2. Obtain at least 70% for each rated requirements set out above.  The rating scale consists of 100 points.

Proposals not meeting all mandatory requirements or not obtaining at least 70% for each rate requirement will be rejected.

The Agency reserves the right to choose the proposal that will best meet its needs as described above, without any obligation to the other bidders responding to the request for proposals.  Neither the qualifying proposal that scores the highest number of points nor the one containing the lowest estimated cost for the project will necessarily be chosen.  Selection of the proposal will be made in terms of the best overall assessment based on the minimum mandatory requirements and the point rating.

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