Revised Capital Charge. Improving Return on Capital New Methodology. Business units’ Return on Equity will be used as a measure of performance - Net Income including charge for theoretical debt Total Capital less Theoretical Debt
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Improving Return on CapitalNew Methodology • Business units’ Return on Equity will be used as a measure of performance - Net Income including charge for theoretical debt Total Capital less Theoretical Debt • Total capital will include off-balance sheet activity where business unit capital is at risk. • A theoretical and static debt to equity ratio will be specified for each business unit (see attached). • The capital charge for theoretical debt will be at Enron’s cost of funds. • The Return on Capital measure will not supplant business unit funds flow targets. = Return on Equity
Capital Charge Calculation • Interest will charged at a rate of 7.5% on the theoretical debt and equity structure that has been determined for each business unit. • Interest will be calculated on the Dec. 31, 2000 theoretical debt balance. This debt balance will be calculated by multiplying the sum of equity, 3rd party debt, intercompany balances and off balance sheet obligations by the debt ratio. • Interest will also be charged on the theoretical debt portion of the monthly cash flow. • An adjustment will be made for 3rd party and other intercompany interest.
Example of Calculation of Capital Charge on Beginning Balance Enron Transportation Service Equity (excluding CTA) $ 4,297.9 3rd Party Debt 515.1 Net Intercompany Balance (2,128.4) Total Capital 2,684.6 Debt % 60% Theoretical Debt 1,610.8 Interest Rate 7.5% Capital Charge on 12/31/00 balance $ 120.8
Example of Calculation of Monthly Capital Charge Enron Transportation Service January Cash Flow - cash provided to Corp $ (21.8) Debt % 60% Theoretical Debt Portion of January Cash Flow (13.1) 12/31/00 Theoretical Debt Balance 1,610.8 Total January Theoretical Debt Balance 1,597.7 Interest Rate - annual 7.5% .625% January Capital Charge 10.0 3rd party Interest & I\C interest income (1.4) Capital Charge recorded by Corporate $ 11.4
Mechanics • The capital charge will be calculated by business unit, instead of legal entity. • The capital charge will be recorded in CS by Corporate to the cash services company for each business unit. It will be booked in FI in the following month. • The 2001 Plan will be restated to include the capital charge.
Other Issues • All interest will be included in net income. This will eliminate the distinction between financing and non-financing interest. • This capital charge is solely for meeting management goals regarding allocation of interest. Allocation of interest to meet tax goals should be handled by each business unit. The cash services companies, which are divisions of Corporate, should allocate interest to the legal entities, if this is deemed necessary by the business unit’s tax department.
Theoretical Debt Ratios Enron Transportation Services 60% Enron Americas 50% Enron Europe 50% Enron Global Assets 40% Enron Global Markets 50% Enron Industrial Markets 50% Enron Net Works 50% Enron Energy Services 50% Enron Broadband Services 10% Enron Global E&P 50% Enron Wind 50% Clean Fuels 50%
Example of Calculation of Capital Charge on Beginning Balance Hyperion Line numbers Equity - TOT_SHARE-EQU CTA - 0948 3rd Party Debt - TOT_OTH_LT_DEBT & TOT_NP_OTHER Net Intercompany Balance - 0051, 0052, 0037, 0038, 0218, 0486, 0516, 0517, 0660, 0661, 0878, 0901, 0915, 0936 and 0941