1 / 16

Session Objectives

Session Objectives. Rate-of-return regulation Revenue requirements Rate base Rate of return Expenses Price caps Other cost models. Quality of Service Regulation. The supplier usually exercises initiatives. Acts to recover costs Expands rate-base Avoids public criticism

issac
Download Presentation

Session Objectives

An Image/Link below is provided (as is) to download presentation Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author. Content is provided to you AS IS for your information and personal use only. Download presentation by click this link. While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server. During download, if you can't get a presentation, the file might be deleted by the publisher.

E N D

Presentation Transcript


  1. Session Objectives • Rate-of-return regulation • Revenue requirements • Rate base • Rate of return • Expenses • Price caps • Other cost models TLMN 602.9040 Fall 1999 Session 5

  2. Quality of Service Regulation • The supplier usually exercises initiatives. • Acts to recover costs • Expands rate-base • Avoids public criticism • The regulator usually imposes constraints. • Sets minimum standards • Requires resolution of customer complaints • Requires non-compensatory services (e.g., “lifeline”) TLMN 602.9040 Fall 1999 Session 5

  3. The Unregulated Monopoly Problem • From Session 2: • Prices above competitive levels • Output below competitive levels • Therefore, wealth transferred from consumers to producers • Must impose rate regulation to fix the problem TLMN 602.9040 Fall 1999 Session 5

  4. Goals of Rate Regulation • Emulate competitive mix of price, output, and profits • Fair prices to customers • Price = Money/unit (of quantity or quality) • Avoid destructive competition • Control price inflation • Allow enough earnings to stay in business TLMN 602.9040 Fall 1999 Session 5

  5. Revenue Requirements R = E + B  r, where R = revenue requirement E = operating expense (including depreciation) B = rate base (i.e., capital investment) r = rate of return on investment (i.e., cost of both debt and equity capital) Carriers tend to inflate both E and B. Difficult to set r TLMN 602.9040 Fall 1999 Session 5

  6. Price Mix • For a multi-product firm, also R = pi vi, i = 1,2,…n (subscript i), where p = price of the ith product v = volume of the ith product n = number of products TLMN 602.9040 Fall 1999 Session 5

  7. Rate Base: Method of Valuation • Set by method? • Reproduction cost (best for company) • Original investment, i.e., book value (best for regulator and consumer; ascertainable, at least) • “Fair value” (some combination) • Or by end results? • Maintain financial integrity • Attract capital • Compensate investor risk • Provide acceptable service TLMN 602.9040 Fall 1999 Session 5

  8. Rate Base: Property Included • Assets used for production • Assets under construction (pre- or post- approval) • Construction work in progress (CWIP) • Allowance for funds used during construction (AFUDC) • Cancelled plants and excess capacity • May be disallowed as • Imprudent • Not used and useful • May be allowed in part TLMN 602.9040 Fall 1999 Session 5

  9. Expenses: Depreciation • Proper depreciation rate • Linear? • Accelerated (creates low-tax windfall)? • Effect on tax expense (number games) • Original or reproduction cost? (i.e., may cost $2 million today to replace a $1 million switch bought 15 years ago.) • Charging full depreciation and cost of capital implies “full-cost” pricing, not “marginal-cost” TLMN 602.9040 Fall 1999 Session 5

  10. Rate of Return • Commission mediates between investor interest and consumer interest • No “right” answer-- “zone of reasonableness” • Minimum needed to attract capital • Maximum is what traffic will bear. • Sooner or later, must recover “full cost” instead of short-term marginal cost TLMN 602.9040 Fall 1999 Session 5

  11. Cost of Capital • Whose cost? The firm’s or the industry’s? • Allow incentive for efficiency and innovation • Cost when? Then or now? • Or stock’s earnings/price ratio? • But these are estimated future earnings! • Sensitive to capital mix, because interest is deductible but ROE is taxable • By earnings of non-regulated industry at comparable risk? TLMN 602.9040 Fall 1999 Session 5

  12. Operating Costs • May disallow • Exaggerated costs • Too rapid depreciation • Extravagance • In advertising and public relations • Charities • Large management salaries and expense accounts • Inflated equipment prices from affiliated suppliers • “Gold-plating” • Uniform System of Accounts as basis of expenses TLMN 602.9040 Fall 1999 Session 5

  13. Price Caps: Transition to Competition • Initially set prices to yield fair estimated return on equity, ROE, e.g., 13.5% • Thereafter, cap prices each year for svc “baskets” • Allow economy’s inflation rate • Disallow differential telco prod’vy gain & input drops • Reacts on rates and forces productivity • Allow miscellaneous adjustment(s) • If actual ROE exceeds fair ROE, • Carrier may keep part as incentive • Subscribers may get part as rebate TLMN 602.9040 Fall 1999 Session 5

  14. Price Cap Example PCI(n) = PCI(n-1)(1 + s - p + m) where PCI(n) = price cap index for year n s = percent price inflation p´ = percent telco inflation offset m = percent miscellaneous adjustment Require actual price index PCI(n), for year n Example of values PCI(n) = PCI(n-1)(1 - 3.0%) for s = 2..0%, p = 5.3%, m = 0.3% TLMN 602.9040 Fall 1999 Session 5

  15. GDP Changes in General G = SV = SPF = where G = gross domestic product S = price of “average” product V = volume of “average” product P = V/F = total factor productivity F = total input factors of production d ln G = d ln S + d ln P + d ln F, or dG/G = dS/S + dP/P + dF/F or, as percent increases, g = s + p + f and s = g - p - f TLMN 602.9040 Fall 1999 Session 5

  16. Other Cost Models • Total element long range incremental cost (TELRIC) • Cost of a hypothetical, state-of-the-art local service network • Results in lower cost than actual network • Hybrid Cost Proxy Model • A model based on engineering detail and costs • Know that it exists, but skip details. TLMN 602.9040 Fall 1999 Session 5

More Related