XCC(64)111
5
(a)
(b)
(c)
(d)
(e)
2
The proposed Scheme of Control is basically as follows:
the setting of a new basic tariff within which the companies must work (except to the extent of agreed increases due to changes in the cost of plant, equipment and other local costs. The revenue system will also continue to provide for adjusting charges in respect of changes in the price of fuel);
profits up to 13 1/2% on "average net assets" to accrue to the company. Average net assets are defined as capital investment less depreciation at Inland Revenue agreed rates. This is the normal American basis of control over public utilities. It has the advantage of giving shareholders an interest in the growth of their concern, however financed, and of divorcing the basis for determining profits from the nominal capital structure of the company. (One particular advantage is that the terms of share issues do not affect the return and are therefore of no concern to the regulating authority in this respect).
the surplus after meeting costs including depreciation and taxes and the agreed return on average net assets will be set aside in a "Development Fund" and be utilised for capital expenditure or for rate reductions;
interest to be charged on the Development Fund and utilised to reduce charges to the consumer; the interest to be a charge against the agreed return on average net assets;
restrictions on the distribution of dividends so long as the Development Fund is a significant proportion of total capital investment. This is to provide an incentive to liquidate the Development Fund by way of rate reductions to the consumer when surplus cash is available.
Rate of Return
6
In the USA the return on net fixed assets is usually of the order of 7% to 9% after tax. Utilities there are normally financed to the extent of two-thirds by low interest debentures which, taking into account also the effect of high corporation profits taxes, produces a return on shareholders' equity of 10% to 14% after tax in typical companies. The CLP/ESSC pro- posals are forecast to produce a rate of return after tax of 13% to 14% on shareholders' equity (but see also paragraph 10 below). Because of the low proportion of capital to be provided from borrowing (in the form of the Development Fund) and the low rate of corporation profits tax, this will require a return on average net fixed assets of 13 1/2%. (It must be stressed that the results shown in Appendix II of the proposals (Combined Company Financial Forecasts) are merely forecasts based on certain assumptions, and not firm figures).