East Indiana Power Company is a private utility regulated by the Indiana Utility Regulatory Commission. It sells electricity to residential users at one rate, P1, and industrial users at another, P2.
The company's power is generated partly by a nuclear power plant, partly by coal-burning plants, and partly by natural gas. The company installed expensive new pollution control equipment at its coal-burning plants last year, in response to new federal regulations. Its CEO earned a bonus of $500,000 last year, as a reward for reducing labor costs by $2,000,000 per year.
The part of Indiana serviced by EIPC is in transition. Much of its old "smokestack industry" has moved to Kentucky or Mexico, but the population is increasing and the service sector is thriving. Nobody knows exactly what is going to happen.
The company is financed with a capital structure consisting of common stock (50% of capitalization) and long-term bonds (the other 50%). The accounting return on equity was 3% last year, and the cost of the bonds was 6%, so the accounting measure of the company's overall cost of capital was 4.5%. The stock issued a dividend equal to 5% of its share price last year, but the share price dropped 10% over the course of the year. The company's beta is 0.34. The average Fortune 500 company's stock price rose 20% the previous year, and over the past 10 years the average company's stock return (dividends and capital gains both) was 8%.
The equation for P=AC for East Indiana Power is
(12.1) P1 Q(P1) + P2*Q(P2) = Expenses + (return on capital)* (rate base)
The company's proposal is to increase P1 and P2 by 10% in order to achieve a return on capital of 7%, which the company says is fair and what is legally required because its return on equity should be 8% in order to match what other companies earn.
Some of you will act as staff of the Indiana Utility Regulatory Commission. Think about your motivations, and what you would recommend to the commissioners.
Some of you will act as employees of the company. Decide how you will present your case to the Indiana Utility Regulatory Commission.
Some of you will act as consultants for a "consumer rights" lobbying group that has hired you to advise it on how to keep electricity prices as low as possible for consumers next year. Make a list of possible angles of attack-- arguments you might make based on equation (12.1) to keep consumer prices low. This might include arguments using facts in this write-up, or questions for your client to investigate (an example, though one not likely to be useful, is: Did the company improperly include its executive's vacation homes in the rate base?).