C.S. 166
CONFIDENTIAL # 2
XCS(77)2
- 10
(a) other utility companies (e.g. KMB and CMB) enjoy
this higher permitted return;
(b) they expect that the annual cost of capital in major
world markets will increase in the eighties; and
(c) the risk for investors is greater now than it was in
1964.
21
With regard to paragraph 20(a), the Government weighs the individual circumstances of each company and does not believe that all utilities, regardless of such factors as size and type of industry, should be entitled to the same return. For instance, the degree of risk involved
is a relevant factor.
28
Fublic utilities can all probably be classified as "low risk" ventures, although some involve less risk than others. Bus and ferry companies, for instance, face competition from other means of transport; and from time to time factors outside their control can reduce their profitability which cannot be restored even if fares are increased, for to increase fares simply drives travellers to the alternative means of transport. This has happened in the case of the Yaumati Ferry Company. As a result of the opening of the Cross Harbour Tunnel and its use by cross harbour buses the ferry company's profits have fallen to appro- ximately 5% of average net fixed assets.
23
As there is no practical alternative to electricity, however, the power companies, unlike the transport companies, are in a much stronger position to increase tariffs to maintain a permitted level of profits. This reduces the risks to shareholders.
24
Nevertheless, shareholders invest in public utility companies to make money and it is important to ensure that the permitted return enables them to receive a dividend yield comparable to that which they would receive from other similar major undertakings in Hong Kong. The companies must also be able to maintain an adequate dividend cover for purposes of normal expansion. CLP have produced no argument to show that the present permitted return level of 13% on average net fixed assets is inadequate in this respect.
25
With regard to CLP's second point in paragraph 20(b), the increase in cost of capital (based on increases in money interest rates) over 1964 levels was primarily caused by the higher rates of inflation experienced between 1972 and 1974. The rate of inflation and interest rates are presently lower but, for the purposes of forecasting, it seems wiser to assume a rate of inflation of around 8%. But the compound growth of 10% in dividends intended by CLF within the present dividend restriction and included in the financial projections at Annex E, would seem to be sufficient to allow both for inflation and for an increased
CONFIDENTIAL
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