compensated for the risks of providing funds to the industry. The allowed rate of return is set with reference to a weighted average cost of capital ( WACC ). The cost of equity component of the WACC reflects returns required by equity investors, while the cost of debt component compensates for efficiently incurred costs of existing and new debt. 76. In its PR24 FD, Ofwat also considered the overall balance of risk and return and sought to calibrate the package so that equity investors in an efficient (notional) company had a reasonable prospect of earning the base allowed return on equity.
Actual returns may vary from the base return during the price control, as cost and service levels may deviate from forecast levels. Allowed return 77. All five Disputing Companies have asked us to consider the allowed return afresh (either in its entirety or some components of it). We have also received third party representations raising issues with the level of the allowed return, including from customer organisations and investors. 78. We intend to carry out an independent assessment of the WACC, taking into account the issues raised by various parties. We will also consider the company- specific issues raised on cost of debt. 79.
We do not propose to deprioritise any of the parameters, given the interlinkages between them and the need to ensure the allowed return as a whole is appropriate. However, we will be mindful of the relative materiality and strength of disagreement in various areas, to ensure our approach is proportionate and efficient. 80. Our chosen approach to estimating each WACC parameter will not be constrained by the approaches proposed by the parties.
However, we are mindful that key methodologies around most parameters are relatively well-established, and it is generally accepted as desirable to have a predictable and consistent approach to estimating the WACC in a regulatory context to create a stable environment for long-term investment. 81. For example, for the cost of equity, we intend to continue to use the Capital Asset Pricing Model ( CAPM ) as our primary model, suitably cross-checked against other evidence.
Similarly, for the cost of debt, while some of the parties have challenged certain aspects of how Ofwat calibrated the allowance, the overall framework for estimating the costs of embedded and new debt in the water sector is relatively well-established. 82. Our estimates will use up-to-date market and other relevant new data where appropriate, for reasons discussed in more detail in paragraphs 96 to 99 below. 21