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XCS(77)2
(C) Financing of Capital Expansion
10
The main sources of finance available for capital expansion without raising tariffs are:
(a) internal sources (depreciation and retained earnings) (b) external sources (borrowings and new capital issues). For the expansion now considered necessary for CLF, the depreciation element in (a) is inadequate because of the way prices for capital equip- ment are inflating. Thus, to the extent that the cost of inflation cannot be met from retained earnings and external sources, a third source,
(c) increased tariffs
will have to be tapped.
11
In other words, the Company must first draw fully on all sources of finance other than increased tariffs (and this would mean striking a balance, consistent with commercial practice, between retained earnings, borrowings and new capital issues). Only if there were still a shortfall should consumers have to contribute through increased tariffs.
12
The machinery for ensuring that this form of financing does not in practice benefit shareholders is the Development Fund. As stated in paragraph 2(c) above, under the present Scheme of Control, this Fund can be used either for capital expansion or for reducing tariffs or avoiding tariff increases. Since the start of the present Scheme of Control, the company has been able to finance expansion from internal and external sources ((a) and (b) in paragraph 10 above), and accordingly the Development Fund has been used only as a means of avoiding tariff increases. But with inflation added to the expansion now envisaged, the Development Fund will be used increasingly to finance capital expansion. This will mean educating the public (and the financial press) to accept the Fund as a major source of finance rather than as a means of avoiding the need to increase tariffs.
13
The growing Development Fund would appear in the company's accounts as a separate figure in the liabilities side of the balance sheet, representing the extent to which consumers have supplemented share- holders funds and on which they receive interest (as described in paragraph 2(d) above, the current rate being 8%). The corresponding entry on the asset side would be within the totals for "Fixed Assets" and "Cash at Bank".
14
F
On the basis of the preceeding paragraphs and other assump- tions listed below, the financial projections at Annex F have been pre- pared. These assumptions are:
(a) a rate of increase of 8% per annum for prices of
capital equipment;
(b) no further investment by ESSO or new capital issues
by CLP;
(c) permitted return at 13% of average net fixed assets;
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