ML19341C499

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Testimony & Exhibits of Bm Louiselle Re Fair Rate of Return Before Public Svc Commission of State of La
ML19341C499
Person / Time
Site: Waterford Entergy icon.png
Issue date: 10/31/1979
From: Louiselle B
KOSH, LOUISELLE, LURITO & ASSOCIATES, INC.
To:
Shared Package
ML19341C490 List:
References
U-14078, NUDOCS 8103030650
Download: ML19341C499 (86)
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O Before the PUBLIC SEEYICE COMMISSION <

of the STATE OF LOUISIANA Ex Parte LOUISIANA POWER & LIGHT COMPANT (Docket No. U-14078)

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TESTIMONY of EDUCE M. LOUISELLE re EEYEEUR REQUIREMENTS l

October 1979 EOS85 LOUISELLE LORITO A AM50CIATE.

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TABLE OF CONTENTS Page I. Qualifications 1 II. GENERAL PRINCIFLES A. Cost of Service 3 B. Test Year 4 C. Rate 3ase 6 D. Average v. Year End Rate Base 9 III. APPLICATION OF THE PRINCIPLES A. Test Year 12 B. Allocation Factors 12 C. Rate Base . 20 D. Working Capital 21 E. Non-Investor Supplied Capital 23

1. Property Insurance Reserve 24 IV. TEST YEAR ADJUSTED OPERATING INCOME A. Actual Operating Income 25 B. Adjustments to Operating Income 26
1. Interest on Customer Deposits 27
2. Adjustments to Reflect Correct Tax Effect of Wage Increase 27 C. Adjusted Test Year Operating Income - Summary 30 V. CWIP and AFUDC A. Nature of the Problem 30 B. Rate Making Principles and Alternatives 33 l

C. The AFUDC Capitalization Rate 38 D. The AFUDC Issue In the Context of Financial Integrity 40 E. AFUDC - Impact on Revenue Requirements 50 I

VI. DETERMINATION OF REVENUE REQUIREMENTS 50 VII. ATTRITION 51 A. Growth in Revenues 52 i

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  • J Page B. Growth in Expenses 53
1. Power Supply Fuel and Purchased Power 53
2. Depreciation Expense 54

. 3. Wages and Fringe Benefits 54

4. Other Operations and Maintenance Expenses 55
5. Franchise Fees 55
6. Property and Other Taxes 56 C. Growth in Rate Base
1. Gross Plant in Service 56
2. Reserve for Depreciation 57
3. CWIP 57
4. Other Rate Base Items 57
5. Accumulated Deferred Income Taxes 58 D. Measurenent of Attrition 59 E. Attrition - Summary 61 t

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l. I. QUALIFICATIONS
2. Q. Please state your name and occupation.
3. A. My name Bruce M. Louiselle. I am Vice President of Kosh
4. Louiselle Lurito & Associates, Inc., a firm of consultants
5. specializing in the area of public utility economics. My
6. of fice address is 1400 North Uhle Street, Arlington,
7. Virginia. I have been associated with the firm since 1966.

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9. Q. Please describe your education and experience.
10. A. In 1965 I graduated from George Washington University with j 11. a Bachelor of Arts degree majoring in economics. I was l 12. awarded the Juris Doctor degree with honors in 1970 by the
13. National Law Center of George Washington University. I am
14. a member of the Virginia State Bar Association and the Order
15. of the Coif. I was a professorial lecturer at the George
16. Washington University School of Government and Business
17. Administration teaching Public Utility Economics.
18. During my twelve years with the firm, I have been
19. responsible for the preparation of many of the reports,
20. memoranda, direct testimony and exhibits produced by the
21. firm. Among the subjects covered in these diverse studies
22. were: fair rate of return, revenue requirements, rate base
23. dete rmination, cost allocation and separations, valuation,
24. treatment of liberalized depreciation tax savings, etc. ,
25. involving electric, telephone, gas, water, telegraph, i 26. trucking, airline, railroad, and transit companies. I have
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1. also analyzed and assisted in the preparation of the reports
2. on the rates and rate structures of electric and telephone
3. companies as well as for contract carriers. I have testified
4. before the regulatory commissions of the District of Columbia
5. and the States of Louisiana, Maine, Minnesota, Maryland, New
6. Jersey, New York, North Carolina, Ohio, and the Canadian
7. National Energy Board.
8. I have co-authored a paper on rate design presented to
9. the Southern Economic Association and have been one of the
10. lecturers at the NARUC-sponsored Regulatory Studies Program
11. at the Michigan State University.

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  • a II. GENERAL PRINCIPLES
1. A. Cost of Service
2. Q. Would you briefly state the purpose of your testimony?
3. A. I will present testimony concerning the Louisiana Jurisdictional d
4. revenue requirements of the Louisiana Power and Light Company
5. (LP&L).
6. Q. Would you briefly describe the principles and methods
7. generally used to determine revenue requirements for a
8. regulated utility?
9. A. For a regulated utility the revenue requirement equals
10. the total cost of providing service, inclusive of all
11. operating expenses, depreciation, taxes, and f air return.
12. The purpose of regulation is to act as a substitute
13. for competition -- to simulate the working of the com-
14. petitive economy for those industries which for the public 15'. convenience and necessity have effectively been granted
16. monopoly status. The state has thus assumed the responsiblity
17. of ensuring, on the one hand, that a utility does not charge
18. monopolistic prices and earn monopolistic returns, and on
19. the other hand, that the firm has the opportunity of recover-
20. ing all legitimate expenses and earning a fair return. In
21. application, what this responsibility has led to is the l
22. so-called " cost of service" method of determining revenue 1

l 23. requirements. A utility in most respects operates within the 1

24. competitive economy: It contracts labor in competition witn
25. all other firms, it purchases capital equipment, materials, l
26. supplies, fuel, etc., in competition with all other firms.

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1. It finances on the money market at terms which must be
2. competit!ive in the light of all available similar alterna- l
3. tive investment opportunities. Thus, once the regulatory i
4. agency verifies that each element of the utility's cost of
5. service has been obtained in competition and prudently
5. incurred, this cost can be assumed to be at a competitive
7. level. The culmination of this process is the " cost of
8. se rvice " . In summary, regulation attempts to simulate
9. the workings of the competitive economy in determining
10. rates. Through this simulation , revenue requirements for
11. a regulated utility then equal or approximate the total
12. competitive cost of providing the utility service.

13.

14. B. Test Year
15. Q. Will you briefly describe the use and significance of the
16. so-called " test year" approach?
17. A. Rate making is necessarily prospective, that is, tariffs
18. are designed to meet estimated future revenue requirements.
19. One way to estimate future revenue requirements is to
20. estimate future costs. Another way and under most cir-l 21. cumstances the more practical approach, is to select a i
22. recent past period of operations, develop the actual costs
23. during this period, adjust for any known changes which are
24. extraordinary in nature, extraordinary in the sense that l

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25. they would effect significantly the assumed year to year
26. balance between expenses, revenues and plant, and then
1. accept the resulting cost of service as representative
2. of prospective revenue requirements.
3. It is obvious that under actual conditions, a utility's
4. operations in the future will be at a different level from
5. the test year. Usually a utility's service requirements
6. are growing, and its investment, revenues, and expenses
7. can generally be expected to increase as the service grows.
8. But as long as revenues and costs remain in balance, that
9. is, remain in generally the same relative position as in
10. the test year, future costs will still be covered. As
11. new customers and plant are added and additional costs
12. to serve these additional customers are incurred, revenues
13. from the new customers will also be added. Total costs
14. will still be covered, as long as the relative growth in
15. revenues ba'.ances the growth in plant and expenses.
16. In summary, the test year is a recent operating
17. period during which revenue, expenses, and plant require-i
18. ments are either generally in balance, in the sense that the
19. relationship of revenue, expenses and plant in that year l 20. is generally representative of the near term future,
21. or can be adjusted so that such relationships are representa-
22. tive of the near term future. The purpose of a " test year" l
23. is to provide a reasonable basis for estimating the future
24. operating expenses and return requirements, as a guide in
25. determining future revenue requirements and establishine
26. reasonable utility rates. The test year investment, revenues,
27. and expenses properly developed, provide the basis for

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1. determining the total cost of rendering the utility service,
2. the revenue requirement. Tariffs are then designed to
3. produce this total revenue requirement.

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5. Q. You included as a cost of rendering service, " fair return".
6. What do you mean by this term?
7. A.

Obviously in order to finance the plant and property used B.

and useful in providing the utility service, capital must

9. be obtained. A utility company will usually obtain its
10. capital requirements from investors by the issue of debt
11. obligations and equity. Obtaining capital entails a cost.
12. Just as the company must pay a wage to obtain labor, it must 13.

pay an interest cost and a return on equity to obtain capital.

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Thus, the utility's " return" is a cost--the cost of capital

15. invested in the business. The dollar amount of the 16.

" capital cost", or " return" is determined by applying a

17. percentage figure, the fair rate of return, to the
18. utility's rate base. The rate base, where regulation
19. is on an' original cost basis, represents the net capital
20. investment which was required to provide utility service 21.

during the test year and upon which the company must pay

22. a return.

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24. C. Rate Base
25. Q. How is the rate base computed?
26. A.

The rate base is developed by determining the cost of I

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1. plant used and useful in providing the utility service
2. af ter deducting the accumulated reserve for depreciation.

i 3. Certain additional items may be included in the rate base

4. in order to reflect other continuing capital requirements
5. needed for provision of service which must be funded by
6. investors, for example, the investment in working capital.
7. Certain other items may be deducted to reflect that portion
8. of utility plant which has been financed by funds provided
9. by other than investors.

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11. Q. Why may it be necessary to include additional amounts
12. in rate base for working capital?
13. A. In addition to those funds which are invested in fixed
14. plant and property, investors may also provide, on a con-
15. tinual basis, add.'.tional funds for working capital. Such
16. funds may be required to permit the utility to maintain
17. an inventory of materials and supplies, to have the ability
18. to meet certain operating expenses which must be paid, or
19. average, before the revenues associated with these expenses
20. are received, and to keep a certain amount of cash on hand
21. for day to day operations. An allowance for such funds
22. should be included in rate base in order to provide the
23. investors a return on them.
24. In my opinion, the determination of a need for an
25. allowance for working capital should be based on a study
26. of the actual cash requirement of the specific utility in l

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1. view of the relative average elapsed time, or lag,
2. between the provision of service and receipt of revenues
3. on the one hand and the provision of service and payment
4. of expenses or other cash outlays on the other hand.

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6. Q. Why is it proper in determining rate base to deduct amounts
7. of funds which have been provided to the utility by other 8 than investors?
9. A. It will be recalled that the rate base provides the basis
10. for determining the return element included the cost of
11. service. This return element represents the cost of
12. capital, the payment required by investors for the utility's
13. continuing use of investor supplied capital. But this
14. return element is not supposed to include a provision for
15. the payment to the utility and its stockholders of a return
16. for the continuous use of non-investor supplied capital.
17. This would be grossly unfair to the utility's customers,
18. permitting investors to earn a profit on funds which they
19. themselves did not furnish. It must be remembered that the
20. rate base is but a measure of the capital of the company.
21. Capital, by its very nature, includes only that furnished
22. by investors.
23. It seems clear then that to the extent the utility l
24. has been able to finance is utility plant with funds
25. supplied by other than investors, such funds must be
26. excluded from the rate base. LP&L has financed a por-
1. tion of its capital requirements through direct advances
2. by customers, e.g., Customer Deposits and by indirect
3. capital contributions in the form of charges to rate -

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4. payers for expenses which have not been actually incurred,
5. e.g. , Deferred Federal Income Taxes. In determining
6. the appropriate rate base, the cumulative balance of
7. such non-investor supplied capital should be deducted, and
8. I have made such deductions.

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10. D. Average v. Year End Rate Base
11. Q. Should the test year rate base and the test year income
12. statement be for the same period?
13. A. Yes. If a given twelve month period is used as a test year,
14. the revenues, operating expenses, and taxes taken from
15. the income stateraent for that same period, as adjusted are
16. representative of that period's scale or level of operations.
17. Other elements of cost such as depreciation and return sho~u ld
18. be based on the average capital investment which was
19. required during that same twelve month period to pro-
20. duce that test year level of operations. The principle
21. is one of matching both the time and amount of expense
22. with the time and amount of the revenue, again taking
23. into account known changes.

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25. Q. Why do you suggest that the return element ta measured
26. in terms of the average rate base, rather than the year-end '
27. rate base?

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1. A. Ideally speaking, the rate base we are searching for is
2. that which precisely matches revenues and expenses with
3. the amount of capital requi ed to generate such revenues
4. and expenses. Thus, the revenues realized and the expenses
5. incurred on January ',19 79 would be associated with the plant
6. in service on January 1,1978; tne revenues realized and expenses
7. incurred on January 2 would be associated with the plant in service
8. on Juanuary 2, and so on. If we were to carry this matching
9. process through to December 31, 1978, the total revenues realized
10. and the total expenses incurred during the year ending
11. December 31, 1978 would be associated with the daily average of
12. the capital the utility required, that is, the rate base
13. required to produce the revenues and costs incurred during
14. the year. As a practical matter this procedure cannot be
15. implemented. However, the next best approximation to the
16. average daily capital required is the average yearly capital
17. required, which is of course the average rate base.

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19. Q. Is it appropriate in developing test year results to use a
20. year-end rate base along with current year revenues and
21. expenses.
22. A. It is obvious that use of a year-end rate base without any
23. concomitant, adjustment to revenues and expenses to reflect 4
24. the year-end level of operations would violate the test
25. year principle of matching revenues, expenses and rate
26. base. Thus the use of a year-end base would not

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1. be appropriate under such circumstances. The use of a
2. year-end rete base h :s been suggested by some as a way
3. to adjust for what is called " Attrition". While an
4. adjustment for attrition may or may not be necessary,
5. depending on the facts of the individual case, the use
6. of a year-end rate base is not an appropriate procedure.
7. Attrition, which may be defined as an erosion in the
8. earning power of a revenue-producing investment, is a
9. complex phenomenon, the net result of operating expense
10. or plant investment, or both, increasing more rapidly than
11. revenues. In effect attrition results when there is an 12, imbalance in the revenue, expense, rate base relationship.
13. When attrition occurs, the realized rate of return falls
14. below that level which rates were designed to produce.
15. shifting from an average rate base to a year-end
16. rate base simply adds to the rate base an amount. equal to
17. one-half of the net plant additions during the test year.
18. The effect on the rate of earnings would vary according
19. to plant growth in that p6rticular year. It would not
20. compensate for the net effect, if any, of a continuing
21. telative imbalance in investment, revenuss and expenses
22. in the future. In my opinion that is a most imprecise
23. way of compensating for attrition.

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APPLICATION OF THE PRINCIPLE _S 1 A. Test Year 2

3 Q. Turning now to the actual development of the jurisdictional A

revenue requirement for LP&L, could you ex' plain 5

how you applied the principles you have set forth?

6 A. The first step was to select the test year. For this 7

purpose, I will use the data for the year endine December ,31, 6 1978. This test year, selected by the Commission, is the 9

most recent period for which all the necessary data are 10 available and have been available for a sufficient period 11 of time to permit analyses to be made.

12 Since Louisiana Power & Light provides service in two 13 jurisdictions, retail and holesale, it will be necessary la to allocate the test year total company revenue requirement 15 to the Louisiana retail jurisdiction. Thus having selected 16 the test year, the next step would be to select the appropriate 17 allocation factors.

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19 B. Allocation Factors i I

20 1 2i Q. Will you now discuss what allocation factors you propose to 22 use?

23 A. As stated previously the determination of the Louisiana y; retail revenue requirement necessitates the application 25 of allocation factors to certain data for the total 26 company. This process is accomplished in three steps:

7 functionalization, classification and allocation. With

1 respect to the first step, functionalization, the assigu-2 ment of plant costs and expenses to categories according to 3 taeir engineering purpose, I have in nearly all cases relied

, 4 on the Exhibits and workpapers of Mr. Rimes. This was also 5 true with regard to the second step, classification, the 6 assignment of functionalized plant costs'and expenses 7 according to their cost causative characteristics. The 8 third step, allocation, is the process by which functionalized, 9 classified plant costs and expenses are assigned to the 10 various classes of customers through the use of certain 11 factors. It was in this third step where I differed 12 from Mr. Rimes in one important area.

13 Mr. Rimes employed the coincident peak responsibility 14 method to allocate production and transmission, i.e. power 15 supply, related plant and expenses to the retail and 16 wholesale jurisdictions. In applying this method he deter-17 mined the average demand of the wholesale class at the 18 Peak hour ca the four peak days during the test year. The 19 ratio of this average demand to the average demand for the

g Company is the power supply allocation factor for wholesale 21 customers. The same technique was used to determine the 22 Louisiana Company's share of total system power supply 23 construction work in progress.

24 25 Q. Mr. Louiselle, would you recommend that these important items 26 of expense and plant be allocated to classes of users on n the basis of their relative demand at the time the system l

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1. A. .ches its one hour peak demand and even if averaged over l
2. four days? l
3. A. No I would not. An analysis of the Louisiana System hourly
4. load data for the four peak days revealed that while the
5. peak demand of 3826 megawatts was reached at 5:00 P.M. , there
6. was a very broad period of time during which the load was a
7. very high percentage of peak demand. For example, at
8. 1:00 P.M. the average system load was 3561 megawatts, or 94.0%
9. of average peak demand while the load at 9:00 P.M. was 96.2%
10. of system peak demand. Use of a one-hour costing period
11. given these realities is clearly inappropriate because there
12. is a very high probability that the systsm may not reach its
13. peak at 5:00 P.M. in the future. For example an increase of
14. just 3.2% in demand at 1:00 P.M. and a fall of just 3.2% at
15. 5:00 P.M. would cause the Company to reach its peak at 1:00 P.M.
16. instead of at 5:00 P.M.
17. Q. Are there other considerations which lead you to such
18. a recommendation?
19. A. Yes there are. Generally speaking, demand costs should
20. be allocated to those who are and will be responsible for
21. installing an amount of plant which is required to serve
22. them and to make their service firm and reliable. To
23. see what this means, consider the following situation.
24. Suppose a utility has sufficient installed capacity to
25. meet its peak demand whenevet it might occur plus a
26. 25% reserve capacity. Under these circumstasces, the
27. probability of any one customer being denied service
28. as a result of a breakdown in production equipment is l

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1. virtually zero. That is, regardless of when a breakdown
2. may occur, on or off peak, sufficient reserve capacity is
3. available to guarantee service. Thus, the quality of service
4. received by each customer regardless of when he demands it
5. is undifferentiated and homogeneous. In view of this, a
6. proper allocation of demand costs must reflect the fact that
7. those customers who are responsible for use at or near the
8. point of th. utility's peak demand are also responsible for
9. the costs of th ' mount of plant which is required to serve
10. them and to make th. =ervice firm and reliable. In other
11. words, sine:e the quality v. <ervice is equally reliable and
12. firm to all users regardless c1 an ** ;y take service, the
13. cost of such service should be higher to users to the extent
14. that they demand service at or near the time of the system
15. peak demand, since they are the users who are responsible for
16. the installation of the plant necessary to meet the peak level
17. of demand.

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19. Q. Mr. Louiselle, in your example you indicated that users
20. taking service at or near the time of the utility's peak
21. demand are responsible for bearing the demand costs. Why
22. aren't those users taking service only at the time of the
23. peak demand soley responsible for bearing the demand costs;
24. that is, why should users taking service near the time of
25. the peak demand also be asked to bear a portion of the demand
26. costs?
1. A. There are two major reasons why users taking service near
2. the time of the system peak, where peak is narrowly defined
3. as one hour, should bear a portion of the demand cost. In
4. the first place e.s I elready mentioned, where the time of

. 5. the peak demand is narrowly defined and based on historical

6. experience , it is clear that any change in the system load
7. curve could result in a change in the time of peak demand.
8. Since customers are allocated costs based on such historical
9. demands, if the time of the peak were to change even slightly,
10. some of those responsible for the peak demand may not be
11. bearing any of the costs. In 'riew of this, to base cost
12. allocation on a concept of historical peak demand, narrowly
13. defined, consritutes a misapplication of the peak responsi-14, bility method. While Mr. Rimes has averaged the peak demand
15. for four days it must be recognized that he only reflected
16. the demand at a single hour of each day.
17. In the second place, consider a utility identical in
18. every way to the utility in the first example except that
19. it has no reserve capacity. Under these circumstances, the
20. Probability of any one customer being denied service as a
21. lesult of a breakdown in production equipment is not at all
22. near'zero. This probability depends crucially upon when the
23. breakdown occurs. The closer in time that the breakdown occurs
24. to the time of the peak demand, the higher is the probability
25. that service will be denied to a given customer. In fact,
26. if the breakdown occurs at the time of peak demand, the l
1. probability is one that some customers will be deprived of
2. service. Thus, in this example, the quality of service  !
3. received by customers is differentiated and non-homogeneous.
4. That is, the quality of service becomes increasingly undesirable
5. for those customers using power nearer and nearer to the time f 6. of the peak demand. In view of this fact, it would be economically I
7. indefensible for those users taking service near or at the time
8. of the system peak to bear as they did in our previous example
9. all of the demand costs and yet in this case also to bear the
10. highest probability of being deprived of service. In this
11. situation, rates must reflect both supply (cost) and demand
12. (quality of service) conditions, not just supply (cost) conditions
13. as was appropriate in the first example. To this end, then,
14. costs should properly be allocated in such a way as to balance
15. off both suoply and demand conditions. In this second example,

! 16. those users who are or will experience a lower, but yet positive,

17. probability of being deprived of service should bear part of the
18. demand costs along with those users who are or will experience a
19. higher probability of being denied service. What this means, in
20. practical effect is that the period of time during which users
21. taking service should on economic grounds bear demand costs is I
22. of a longer duration under the situation described in the
23. second example than it was under the initial example.
24. There is another way of looking at this allocation problem.
25. Urers responsible for bearing demand costs are those whose use
26. occurs during that period of time when any permanent increase
1. in demand will require additional plant to be installed. Or
2. obversely, users responsible for bearing demand costs are
3. those whose use occurs during that period of time when any l
4. permanent reduction in demand will permit the utility to
5. operate with less productive capacity.
6. Referring again to the first example given above, it
7. was seen that a 25% reserve capacity was required to guarantee
8. service to every user regardless of when service was demanded.
9. In this case, a permanent reduction in demand which would
10. permit the utility to reduce its production capacity could
11. only occur at or very near to the time of peak demand. Thus,
12. a proper allocation of demand costs should make those users 13, whose demands occur at or near the time of the peak demand
14. responsible for bearing the demand costs.
15. In the second example, however, a different conclusion is
16. warranted. If users taking power at or very near the time of
17. the peak demand were to reduce permanently their demand, the
18. utility would not be able to reduce production capacity. In
19. fact, as opposed to the conclusion in the first example, in
20. this recond example it is seen that there is a longer period of
21. time during which any permanent reduction in demand will not
22. permit the utility to reduce its production capacity. Thus it
23. is those users taking power during this longer period of time who
24. are responsible for the demand costs of the utility. l 25.

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1. What the foregoing analysis shows is that the so-called
2. " peak responsibility" method of allocating demand costs among
3. users is the appropriate method of allocating costs from the
4. economic point of view. However, in applying this method, one
5. of the most important f actors to consider is the extent to
6. which a utility has reserve production capacity. As was indi-
7. cated the smaller the reserve capacity, the longer is the
8. period of time during which users taking power are responsible
9. for bearing the demand costs of the utility.
10. LP&L's reserve margin was approximately 16% in 1978 and
11. is expected to be approximately 4% in 1979 and 1980. It is
12. obvious that a company cannot build to maintain a 4% reserve
13. margin and still have reliable service.
14. Q. What power supply allocation factors will ycn1 use?
15. A. I propose to use two sets of allocation factors in the
16. determination of the Louisiana jurisdictional revenue require-
17. ment. I will use those relied on by Mr. Rimes and I will use
18. those which, in my opinion, are more reflective of the actual
19. load patterns and are more reflective of appropriate cost
20. responsibility considerations.
21. In determining the second set of power supply allocation
22. f actors I will rely on tbr peak responsibility method but more
23. broadly defined than has Mr. Rimes. In determining these
24. allocation factors I have averaged the ratio of th? iurisdictional
25. demand to that of the system over the period 12 noon to 11:00 P.M.
26. During this period the System load was always over 90% of peak

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1. demand and averaged 97% of peak demand. I have used this 11-hour
2. period to develop the powir supply allocation factor applicab7 s
3. to Louisiana wholesale-retail customers.

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7. Q. You have stated that you will present your revenue requirement i
8. on two bases. How will you present these data?
9. A. My Exhibit is divided into two main parts. In Part I, I will i 10. develop the jurisdictional revenue requirement based on the
11. use of allocation factors I believe to be appropriate. In
12. Part II, I will develop the jurisdictional revenue requirement
13. based on the use of Mr. Rimes' allocation factors. The

! 14. follow"ing testimony will describe the principles and procedures

15. I have followed and applied consistent with the two bases.
16. These will be discussed primarily with regard to the data
17. presented in Part I of my Exhibit.

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19. C. Rate Base i

20.

21. Q. Will you now discuss your development of the rate base?
22. A. Yes. The rate base is shown on Page 1 of Parts I and II
23. to my Exhibit. As noted there, the rate base is based on
24. average year amounts. On lines 1 through 3 of these pages to
25. my Exhibit, I have developed the net plant in service for the

~

i 26. test year. To this amount, I have added, on line 4, Plant i

1. Held For Future Use, on line 5, Construction Work In Progress
2. (CWIP) and on line 7, LP&L's investment in System Fuels, Inc.
3. I will discuss the issue of CWIP and AFUDC later in my testimony.

. 4.

5. D. Workine Capital 6.
7. Q. Will you now discuss the determination of working capital?
8. A. On line 8 of Page 1, I show LP&L's working capital requirement
9. of S 5,894,000. This amount is developed in deta'sl on Page
10. 2. I have included the average amounts for prepayments, working
11. funds, deferred fuel, and the actual cash needs for operations,
12. maintenance and tax expense.

13.

14. Q. How have you determined the amount of cash working capital
15. required for the payment of operations, maintenance and tax
16. expense?
17. A. In addition to the need for working cash funds, a certain
18. amount of cash is needed so the Company can meet its cash
19. needs for operations and maintenance and tax expense. I
20. previously stated that the actual experience of the Company
21. should be used to properly reflect the need for cash. Accordingly, l 22. I have applied computed lag days to various expense categories.
23. To a certain extent I have relied on Company-provided data.

l

24. For the revenue lag I have used 4 0 days based on an average 30-day
25. billing cycle, 5 days between meter reading and billing and 20
26. days between billing and receipt of revenue. I have used statutory l
1. dates to compute the lag applicable to taxes. For the purchase
2. power expense I have used 30 days based on the terms of its
3. Agreement with MSU. Analysis of the payment terms of the
4. various suppliers of fuel resulted in the lag days shown.
5. In reference 'to "other" operation and maintenance expenses,
6. I have reviewed numerous working capital studies wherein the
7. typical lag for this type of expense is 25 days. Such a lag
8. can be rationally verified. The average service lag is 15
9. days, the mid-point of a month. The bill is received and
10. paid by the loth of the following month for a total lag of 25
11. days. I will use 25 days.
12. Finally, it should be noted that the cash advanced
13. portion of the working capital is most likely an overestimate
14. since it does not reflect the net disbursement lag. The pay-
15. ment of expenses becones a drain on working capital only af ter
16. the money has left LP&L's bank account. This occurs sometime
17. after the check is written, most likely 3 or 4 days later.
18. Likewise revenues become a source of working capital only
19. af ter the money has been deposited in the bank account which
20. occurs about one day after LP&L receives it. Reflection of
21. these lags would reduce the net lag.

22.

23.

24.

25.

26.

~~

6

1. E. Non-Investor Supplied Capital 2.
3. Q. In your determination of rate base, you have deducted
4. non-investor supplied capital. Will you explain why you S. have made these deductions?
6. A. Yes. I have deducted the following items: customer
7. deposits, deferred income taxes, accumulated unamortized
8. investment tax credits, and the operating insurance reserves
9. as shown on lines 9 to 12. These amounts represent funds
10. which have been obtained from customers through charges for
11. utility service or required advance payments; as such they
12. are available to the Company for general purposes. Clearly
13. then, these funds represent cost free customer contributions
14. upon which the Company is not entitled to earn a return.
15. As I stated earlier, the sole purpose of developing a
16. rate base is to determine the investment upon which the
17. Company is to earn a fair return. The rate base provides the
18. basis for determining the return element to be included in 19, cost of service, i.e., the rate base times the fair rate of
20. return produces the return. The return element reflects the 21, cost of capital, i.e., the payment which must be made to investors
22. to compensate them for the Company's continuing use of investor-
23. supplied capital in the provision of electric service. But
24. clearly the return must not include payment to the utility and
25. its stockholders for the continuous use of cost-free espital
26. supplied by other than investors. There is no possible reason
1. for the utility and its investors to be perndtted to earn
2. a return on capital which is customer supplied.
3. This is most clearly evident in the case of customer
4. deposits. These amounts were paid directly by customers to

. 5. the Company. The Commission has consistently deducted these

6. balances as well as the reserve for deferred income taxes.
7. ,
8. 1. Property Insurance Reserve 9.
10. O. You have also deducted the property insurance reserve. Will
11. you discuss that deduction?
12. A. The property insurance reserve can be compared to the reserve
13. for deferred taxes. In the caso of deferred taxes an amount
14. of taxes is charged to expense larger than that in fact paid.
15. The difference between the expense charged and the actual
16. liability is the amount deferred. In the case of property
17. insurance reserve, the Company has charged as an expense an
18. amount large- than that actually incurred as a loss. The
19. difference has been accumulated in the property insurance
20. reserve. This amount represents customer-supplied funds avail-j 21. able for general corporate purposes and should be deducted
22. from the rate base.

23.

24.
  • 25, 26.

l

{

1. IV. TEST YEAR ADJUSTi 'PERATING INCOME 2.
3. A. Actual operating Income 4.
5. Q. Having developed the rate base, what was the next step?
6. h. The next step was to develop the revenue requirement. I have
7. reviewed and analyzed the revenues and expenses that the
8. Company realized in the test year. Further I have reviewed
9. and analyzed the adjustments proposed by Mr. Rimes to
10. these actual results of operations in the test year. With
11. certain exceptions which I will discuss later, these adjustments
12. appear proper and reasonable.
13. I say "most" adjustments because the results shown on
14. Page 5 do reflect the proforma wage adjustment proposal by
15. the Company. It was not possible to remove this adjustment
16. given the data presented by the Company. This does not mean
17. that I consider the adjustment inappropriate. In principle,
18. I do not. It is my opinion that the amount of this adjustment
19. has been improperly computed. I will discuss this matter in
20. connection with the determination of adjusted operating income.
21. The second adjustment reflected in actual results is the
22. reflection of deferred fuel cost accounting. This was recently
23. approved by this Commission and is properly reflected.
24. Third, I have not reflected in operating expenses the amorti-i
25. zation of the property loss booked in 1978. This loss will have

! 26. been fully amorti:ed via charges to ratepayers prior to the date

27. rates resultant f rom this proceeding are ef fective. Consequently,
28. it should not be included in test year results.

i

d i

1. In developing the "other revenues" appearing on Page 4, I

i 2. I have departed from the procedure employed by Mr. Rimes.

3. He treated these revenues as an offset to expenses and
4. allocated them to Louisiana Jurisdictional operations via the
5. expense allocations. I have allocated them directly to
6. Louisiana Jurisdictional operations on what I consider to be
7. an atppropriate basis that reflects the source of these
8. revenues.
9. The final aspect of the actual results that bears
10. discussion relates to deferred income taxus. I have not
11. reflected as an expense. deferred state income taxes. I
12. discussed this matter at length in Docket No. U-13220.
13. In thet proceeding the Commission did not allow deferred
14. state income taxes as an expense. The results shown on Page 4
15. are consistent with that decision.

16.

17. B. Adjustments to operating Income 18.
19. Q. Will you now discuss the adjustments to operating income you
20. believe to be appropriate?  ;
21. A. Yes. These are depicted on Page 5 to Parts I and II. I 22< have reviewed the adjustments proposed by Mr. Rimes and have
23. included all of them on Page 5. Specifically, I have included 24 the effect on net operating income of the:
25. o Rate changes, and,
26. o Elimination of the income resulting from the coal strike.

1

1. The amount for each of these adjustments shown on Page 5
2. of Part I is identical to that proposed by Mr. Rimes.
3. In addition I have reflected three additional adjustments
4. one of which was also proposed by Company witnesses although

. 5. in a different amount.

6.

7 1. Interest on Customer Deoosits 8.

9. Q. Why have y6u included interert on customer deposits?
10. A. Since I have deducted the customer deposits from the rate
11. base, it is anly appropriate that the interest on such
12. deposits be reflected as an operating expense. The amount
13. shown does not reflect any reduction for income taxes since
14. the interest on customer deposits was included in the interest
15. deduction used to obtain the current taxes shown on Page 4.

16.

17 2. . Adjustment to Reflect Correct Tax Ef fect of Nage Increase 18.

19. Q. Will you now discuss your next adjustment?
20. A. Yes I will. While I have reflected the wage expense change
21. testified to by Mr. Rimes I have not relied on his computation l 22. of the ef fect of these expense changes on income taxes.
23. Specifically, Mr. Rimes has understated the change in income
24. taxes resulting from these adjustments.
25. Proforma adjustments are adjustments to net operating
26. income. This means that the income tax effect of a change in l

l l

1

1 l

1. expenses has been reflected. For example, if an expense
2. increases, taxes decrease, and the sum of these two changes,
3. one positive and one negative, produces the adjustment to
4. net operating income. Mr. Rimes has in effect done the same

. 5. thing except he shows the effect on income taxes separately.

6. With regard to certain expenses Mr. Rimes has used two 7 different methods to compute the tax effect. He has used
8. one method when he computed the tax effect of booked expenses
9. and another method to compute the tax effect of a proforma
10. adjustment to that very same expense item. This can be seen
11. ,

by analyzing and comparing the computations used to compute

12. book income taxes to the computations used to derive the tax
13. effect of proforma adjustments.
14. A review of the computation to produce book income taxes
15. as well as Mr. Rimes' cross-examination shows that the tax
16. effect of fringe benefits is equal to the tax rate times the
17. total amount of such items expensed and capitalized in the year.
18. Thus .LP&L flows through to customers the tax effect
19. of deducting currently these capitalized expenses. LP&L
20. does not provide for any deferred taxes relating to these t

l 21. items. In sum, in reference to test year income taxes, LP&L

22. takes the capitalized portion of these expenses as a tax
23. deduction and flows the effect of that through rates to
24. consumers.

l 25.

26.

1. Now to be considered, and contrasted, is the way Mr. Rimes
2. computes the tax effect of proforma adjustments to these same
3. items. A review of his workpapers shows that in computing the
4. tax effect, he reflected only that portion that he has expensed.
5. In other words he has not reflected the total current year's
6. tax effect of the adjustments he has proposed.

7 The effect of dhis procedure is to retain for the Company

8. and its stockholder the additional tax deductions he has failed
9. to reflect. Thus, this procedure used by Mr. Rimes is not a
10. form of tax normalization. Tax normalization means that tax
11. benefits earned currently will some day be flowed back to
12. consumers. Since LP&L does not use ' tax normalization for
13. these items it cannot and will not flow these amounts back to
14. consumers.
15. Thus, not only is the method Mr. Rimes used to compute the
16. tax effect of adjustments to relief and pensions and payroll
17. taxes inconsistent with the method used to . compete per books
18. taxes, it is improper since it permanently denies the benefits
19. of these tax deductions to consumers. Thus, it must be stressed
20. this issue is not one of flow-through versus normalization.
21. I have recomputed the tax effect of the adjustments by
22. computing the tax effect in the same manner as used by Mr. Rimes
23. to compute per books taxes. The adjustment shown on line 5 of
24. Page 5 is the additional reduction in tax that should be reflected.

25.

26.

t I

1. C. Adjusted operating Income-Summary 2.
3. Q. Will you now discuss your adjusted operating income?
4. A. Yes. After reflecting an adjustment to AFUDC, which I will
5. discuss subsequently, the test year adjusted net operating
6. income is S 97,332,000 which when compared to the rate base
7. produces a rate of return of 8.5%.

8.

9. V. CONSTRUCTION WORK IN PROGRESS AND THE ALLOWANCE FOR FUNDS USED DUR-
10. ING CONSTRUCTION 11.
12. Q. You previously indicated that you would discuss construction
13. work in progress (CWIP) and the allowance for funds used
14. during construction (AFUDC). Will you summarize your analyses
15. and recommendations?
16. A. I will recommend that LP&L be required to continue to
17. capitalize AFUDC at an AFUDC rate of 5%. I propose to analyze 3
18. this issue in terms of the nature of the problem, the rate-
19. making principles and alternatives, and the resultant financial
20. inplications given the Company's ten (10) year construction
21. program.

22.

23. A. CWIP and AFUDC-The Nature of the Problem 24.
25. Q. Why is there this continual concern over CWIP and AFUDC7
26. A. The simplest answer to that question is: "Because of accounting
27. convention". A complete explanation will require a discussion 1
1. of certain relevant facts. At this time LP&L capitalizes
2. AFUDC on its books of account at a rate lower than the cost
3. of capital. Thus, it recovers its capital costs associated 4, with CWIP partially as the plant is being used and partially
5. when it is being built. The effect of this treatment would
6. be to allow the Company to recover a portion of its capital 7 costs associated with CWIP from consumers prior to the time
8. those consumers receive service from that plant.
9. For a clear understanding of this issue certain basic
10. facts are relevant. In order to build plant, the Company
11. must incur costs: wages must be paid, materials must be
12. purchas ed , contractors must be paid and all other costs
13. associated with construction must be paid. However, none
14. of these costs is included in expenses; rather they are
15. capitalized. Consequently, these costs are not passed on to
16. current customers in the year incurred but are recouped from
17. future customers through depreciation charges. Thus, they
18. are pro-rated over the useful life of plant. For example,
19. during the 19 78 test year more than 30% of all labor costs
20. were not reflected as an expense in the test year but were
21. capitalized so that they will be recovered from future
22. ratepayers.

l 23.  ;

24, 25.

26.

1. Since the cost of this plant is not recovered immediately
2. from customers, the Company must raise capital to finance the
3. plant. During the period of time the plant is providing
4. service, everyone agrees that the customers receiving that

. 5. service should pay the associated capital costs. During

6. the period of time the plant is under construction and
7. not providing service, the Company has to incur capital
8. costs. These capital costs are no different than the cost
9. of labor or equipment I have just discussed. They must be
10. paid for when incurred. However, for the same reason that
11. the labor and equipment costs associated with construction
12. are capitalized, capital costs should be capitalized.
13. Only by capitalizing such costs will customers who receive
14. service pay for the service they receive--and not for someone
15. else's service.
16. Since labor cost, material cost, contractors' cost
17. and all other construction costs, except construction-related
18. capital costs, are not shown as expenses in the income
19. statement there is no question but that they are proper 20 costs to be recovered over the useful life of the plant.

21 . Unlike these other expenses, construction-related capital

22. costs are treated in the income statement. Where these
23. costs are capitalized, they have been treated, by virtue of
24. accounting convention, as "other income" in the income
25. statement. Rather than treating AFUDC as "other income",
26. a more descriptive and meaningful way would be to
1. treat it as a negative expense item inasmuch as such treatment
2. reflects the true economic nature of what AFUDC is all about.
3. Indeed, recent accounting changes partially reflect this
4. reality. In its Order No. 561 dated February 2, 1977, the
5. then [.P.C. stated at page 4:
6. "Since there is little conceptual difference between capitalization of the cost of borrowed
7. funds used for construction purposes and other costs of construction such as labor and materials,
8. we believe that the readers of financial statements will be better informed if such construction interest
9. is shown as an allocation of cost by a reduction in the Interest Charges Section of the income statement
10. rather than as an incone item."
11. In other words, had the construction-related capital
12. costs like all other construction costs been charged
13. directly to construction where they belong and not
14. included in the income statement, this issue would never
15. have risen. If this were done, since the interest
16. expense and other capital ccats associated with CWIP
17. would not be reflected as a current expense, AFUDC would
18. not be needed to adjust these costs to their proper levels.

19.

20. B. The Rate-Making Principles and Alternatives 21.
22. Q. Is it necessary to collect construction-related capital
23. costs from current customers as the Company is now proposing i

! 24, in order to compensate the investor for the use of his funds?

f 25.

26.

1 l

1. A. No, it is not. There are three alternative ways of treat-
2. ing plant under construction so as to give the investor
3. the opportunity of earning a given fair rate of return
4. on his investment. However, only two of these alternatives,
5. as I will show later, meet the requirement that expenses
6. and revenues be properly matched. An example showing these
7. three alternatives is provided on Page 1 of the Appendix
8. to my Exhibit. In each case I have assumed that $1,000
9. of plant is under construction for one year and then is
10. placed in service for two years, and that the cost of
11. capital is 8 %.
12. In Section I of that page I show the situation where
13. for the first year (1977) CWIP is excluded from rate base
14. and therefore the AFUDC while capitalized, is not reflected
15. *he cost of service for regulatory purposes.

As can be

16. ,en , the cost of capital that was incurred in the first
17. year while the plant was under construction, S80 in my
18. example, is included in the arte base in 1978, the first i
19. year the plant is in service. It will be noted that the i

l

20. example assumed that the depreciation was accrued on the

, 21. last day of the year and thus the rate base in equal to the

22. beginning of the year amount. This was done to simplify 23.

~

24.

25, 26.

m. __ .
1. the presentation and in no way affects the conclusions. In
2. 1978 and 1979 the total return of and on capital includes
3. $540 of depreciation plus 8% of the rate base. Thus it can
4. be seen that the investor will receive the return on his
5. capital which includes his $1,000 initial outlay and S80
6. of earnings not received in the first year plus the return
7. of his capital.
8. The second alternative, shown in Section II, shows the
9. results where plant under construction is included in rate
10. base, the AFUDC is capitalized and included in income,
11. As can b6 seen the results in terms of total return of
12. and on capital are identical to those shown in Section I
13. under the first alternative.
14. The third possibility is where the plant under
15. construction is included in rate base but there is no
16. capitalizing of AFUDC. Thus for regulatory purposes there
17. is no AFUDC to include in the cost of service. As can be
18. seen the rate base in 1978 is only S1,000 as compared to
19. the S1,000 under the first two alternatives. The reason
20. for this is that under the third alternative, the S80 of
21. capital cost were expensed in the first year hnd hence
22. have already been recovered in rates. The problem with
23. this of cours is that customers were made to provide l

l 24. S80 in revenue to the utility prior to the rendition

25. . of service. Consequently, expenses and revenues have
26. been mismatched.

27 As can be seen the total dollar return of and on 1

1. capital in this third alternative is, in absolute terms,
2. less than in the first two, i.e., S1,029 versus $1,200.60.
3. It will be recalled that the initial requirement I 4.

established was that each alternative was to provide

5. the investor the opportunity to earn his full return.
6. It can be shown that the present value of the return 7.

requirements at January 1, 1977 is identical under each

8. of the three alternatives. In each case the present value
9. of the return discounted at the 8% cost of capital is
10. 51,000, i.e.,

the exact amount of the initial investment.

11. Therefore, while there is a difference in the total
12. dollar amount of the return of and on capital, Alternative
13. III versus Alternatives I and II, in each case the
14. investor has received the same compensation for the use
15. of his funds, since the present values are identical. Thus,
16. leaving aside the issue of " quality of earnings" the
17. investor is indifferent as among the various methods.

18.

The example shown on Appendix Page 1, while accurately

19. setting forth the relevant principles, does not represent
20. reality in two respects. First, the example ignores the l
21. income tax consequences. To be specific, while the
22. capitalized AFUDC is depreciated for book purposes, that
23. portion of depreciation representing AFUDC is not a tax
24. deductible expense. On Appendix Page 2 I show a hypothet4 cal
25. example which takes the income tax effects into account.
26. This example assumes that in the first year there is a l l
27. .

51,000 construction program, and S1,000 of plant in l

l l

l l

1. service (land). The cost of capital is assumed to be 8%
2. consisting of 50% equity at a 10% cost rate and 50% debt at
3. 6%. It is further assumed that the plant construction in
4. year 1 has a 10 year life and that it is placed in service
5. in year 2.
6. The purpose of these assumpticas is to isolate the
7. ef fect of alternative treatments of construction-related
8. capital costs. On lines lA through llA I show the results
9. were the construction-related capital costs recovered from
10. customers in the year incurred. On lines 1B through llB
11. I show the resu'to were these construction costs capitalized
12. and recovered over the life of the plant. On lines 1C
13. through llc, Column J, I show the difference in the revenue
14. requirements. These values reflect, year-by-year, the
15. isolated ef fect of the alternative treatments. In Column
16. L, I show the present value of these differences based on
17. an 8% discount rate, the cost rate of capital. As can be
18. seen the sum of the present values is positive indicating
19. that it is in the consumers ' interest to have these
20. construction-related capital costs capitalized at no
21. disadvantage to the investor. The second simplification
22. contained on both Appendix Page 1 and 2, is that it
23. assumes a single piece of plant and traces the effects
24. over the life of that single piece of plant. In fact,
25. CWIP is nearly always growing. Typically, under conditions
26. of a growing plant, it can be shown that while the present
27. values of the returns earned by investors are again the

l l

i l i

1. same under the threc 31ternative methods, the p. resent
2. values of the revenues paid by consumers under Alternatives
3. I and II will always be less than under Alternative III,
4. The fact is that while the investor is equally well off
5. under either of the three methods, the consumer is better
6. off under Alternatives I and II.
7. This can also be looked at from the point of view of
8. individual consumers. When CWIP is continually growing,
9. it is clear that consumers under Alternative III (inclusion
10. of CNIP in rate base with no AFUDC) would be paying now
11. for some plant they will never use. On Appendix Page 3,
12. I show such an example based on assumptions similar to
13. those on Appendix Page 2 except that construction work in
14. progress is assumed to be growing at a 10% annual rate.
15. The data shown are for years 12 through 24. It is in the
16. twelfth and following years that the equilibrium situation
17. obtains. This is so since given a 10-year life beginning
18. in year 2 it is in the twelf th year that plant in service
19. and CWIP are growing at 10% annually. As can be seen,
20. the difference in the revenue requirement is always posi-
21. tive indicating that consumers are better off when the
22. construction-related capital costs are capitalized at no
23. disadvantage to investors.
24. C. THE AFUDC CAPITALIZATION RATE
25. Q. You have previously indicated that in principle AFUDC
26. represents the cost of construction related capital. Does
27. that mean that the AFUDC rate should be equal to the cost i
28. '

rate of capital?

i I

t l

1. A. As a matter of principle the AF]DC rate should be equal i
2. to the fair rate of return. Use of a rate for AFUDC less
3. than the fair rate of return has the effect of shif ting
4. the burden ,for this portion of the CWIP from the futr.re
5. customers to the current customers. A simple example
6. will make this clear. Assume the fair rate of return is
7. 9.0%, the AFUDC rate is 7.0% and the rate base is equal
8. to S1,000 of construction work in progress. Using these
9. values the following result would be obtained.
10. Fair Rate of Return at 9% $90.00
11. AFUDC at 7.0% 70.00
12. Current Return Deficiency $20.00 13.

Thus current ratcs would have to be set so that an additional

14. 520.00 of return would be earned by the company. This
15. 520.00 which is associated with CWIP would have to be
16. recovered from current customers. In my opinion this is
17. inappropriate since current customers are receiving no
18. service from this plant. Therefore , as a matter of principle
19. AFUDC should be based on tne fair rate of return, except in

( 20. extraordinary circumstances.

21.

22. O. What are the tax implications of that recommendation?
23. A. Were the Commission to require LP&L to capitalize i
24. AFUDC at 10.4%, the fair rate of return, the ef fect would
25. be to flow through to the ratepayer the effect on income
26. taxes of the construction-related interest deductions
27. in the year incurred. It is my opinion that generally it is
1. preferable to flow these benefits through to the consumer in~
2. the year incurred. Conceptually, tax deductions have value i
3. only if there is revenue against which they can be offset.

i l

i

4. Since it is current customers who provide that revenue, it
5. is current consumers who give rise to the value of these
6. interest deductions; therefore, they should receive the 7 benefit. When the tax benefits are not flowed through,
8. and thus deferred, such benefits would continue to accumulate
9. in increasing amounts assuming that CWIP continues to
10. increase. Under such conditions of deferral the consumer
11. would never realize fully these tax benefits.

12.

13. D. The AFUDC Issue In the Context of Financial Integrity 14.

15.'O. How do you propose tu analyze the relationship of AFUDC to

16. financial integrity?
17. A. A proper starting point in this analysis is what might be f 18. called the three part test set forth in the Hooe decision.
19. These three tests are:
20. 1. The return to the equity owner is to be commensurate
21. with the returns earned on investments , i.e. , market
22. prices, in companies of corresponding risks;
23. 2. The return should be sufficient to assure confidence
24. in the financial' integrity of the company, and;
25. 3. The return should be sufficient to maintain the
26. company's credit and allow it to attract capital.

I

1. While these three tests provide three alternative ways to
2. view this matter, they are but one test in the sense that
3. if one is met all are met. Thus, if the company's stock-
4. holders are able to earn a return comparable to the returns
5. available on other investments having corresptnding risks,
6. the company will indeed be able to attract additional equity
7. capital. Or, looking at it from the opposite point of view,
8. if a company's stock is attractive to investors, it is
9. because the return available to investors is commensurate with
10. returns available to those investors on alternative investments
11. considered by them to be of corresponding risk. Finally, if the
12. company is able to obtain additional capital and maintain 13, its credit the return earned is sufficient to meet the other tests.
14. Q. How does the AFUDC issue impact on the return regt J by
15. the equity owner, the first of the three Hope tests?
16. A. As is well known, the investor's required rate of return
17. on equity or indeed any type of capital, is equal to the
18. compensation he requires for
19. 1. Inflation,
20. 2. Productivity of capital or pure interest, and
21. 3. Risk.
22. There can be no doubt that the level of AFUDC cannot and

(

, 23. does not affect either the rate of inflation or pure i

24. interest. Consequently, if AFUDC has an impact on the f
25. investor's required rate of return, the cost of equity, it l
26. is because it affects the level of risk. Since there are a
27. priori theoretical nasons to believe that the existence
1. of AFUDC could have both positive and negative impacts on the
2. level of risk, empirical evidence is necessary to determine
3. how these offsetting impacts are ultimately reflected in the
4. cost of equity capital. )

5.

6. O. Would you explain how AFUDC could have both an upward and a
7. downward effect on the level of risk perceived by investors?
8. A. Consider first the cause of a possible downward effect on
9. the level of risk. Where a company is capitalizing AFUDC,
10. the cost of construction-related capital is returned to
11. the investor 'ria depreciation expense. There can be Jittle
12. doubt that the certainty of its receipt is far greater than
13. - where AFUDC is not capitalized. Under that approach the 14, investor earns his return on his construction-related
15. investment only if the company earns at least the fair rate
16. of return. Considering only the construction-related capital
17. costs, in those yearrahen the company earns less than a fair
18. return, the investor loses forever his trportunity of earning
19. a fair return unless the capital costs are capitalized.
20. Next to be considered is the cause of a possible up-
21. ward effect on the level of risk. Here, the a priori
22. theoretical consideration is very much. a function of the
23. level of the AFUDC. In this context, it must be stressed
24. that it is not the level of AFUDC per se which constitutes
25. the essential cause of increased risk, but rather the impact
26. of that level of AFUDC on the company's financial integrity
27. and hence its ability to attract capit.al. In other words
28. a company with 100% of its earnings accounted for by AFUDC
29. would obviously not be able to meet standard indenture

._- m

1 l

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1. requirements and therefore coald not obtain additional
2. secured debt. In that case, a company could well have
3. difficulty moating its statutory mandates. Investors
4. would consider this as a factor increasing the risk of an
5. investment in that company.
6. While no: a theoretical consideration, there is a
7. practical aspect of AFUDC that may result in an increased
8. level of risk. This practical aspect arises from accounting
9. convention and the investment community's interpretation of
10. this convention. I am referring to the fact that accounting
11. convention separates construction costs into two components,
12. capital costs and all other, i.e., labor and material. Due
13. to accounting convention, the capital-related construction 14, costs are reflected in the income statement, necessitating
15. AFUDC, while the other construction costs are capitalized
16. directly. To my knowledge the investment community has not
17. objected to the capitalizing of the labor and material costs
18. even though they must be paid for today. The investor
19. receives return of and on such capital over the life of the
20. plant. The investment community has objected to treat-
21. ing the construction-related capital costs in a similar
22. fashion. Frequent objections are voiced in the financial
23. community relating to the quality of earnings
24. associated with an increase of non-cash AFUDC income. Ic
25. should be noted however that expenses such as depreciation,
26. deferred taxes and investment credits are non-cash expenses.
27. Hence the quality of earnings improves the larger are

l l

1. these items. Thus in order to properly ascertain the 2, quality of earnings all cash and non-cash items should be
3. considered.
4. It may very well be that whatever adverse impact AFUDC
5. has on the cost of equity, it is the result of the irvestment
6. community's constant declaration of AFUDC's deficiencies
7. rather than the result of any deficiencies in fact. The
8. investment community's use of such expressions as " phantom"
9. or " psychedelic" earnings hardly leads to an informed response
10. by investors. In any event, whatever impact the real or
11. imaginary deficiencies of AFUDC has on the cost of equity
12. should be evident in the market prices investors are willing
13. to pay.
14. In sum AFUDC could theoretically have either a positive
15. or negative impact on the cost of equity.
16. Q. How does AFUDC impact on the confidence in the financial
17. integrity of a company?
18. A. The degree of investors' confidence in the financial
19. integrity depends on a myriad of factors. No one factor
20. can be considered in isolation except in the most unusual
21. circumstances. A rational investor, in appraising the
22. financial integrity of the company, is ultimately concerned
23. with how these factors impact on one primary question: Does the 24.

company have a reasonable expectation of earning its cost of l l 25. capital and can it obtain the capital needed to build the plant

26. necessary to meet demand for service. If a company can be l
27. expected to earn its cost of capital and obtain needed capital, i

t

1. the equity investor will have confidence in the com9any.

2.

3.

4. In the case of equity capital, reasonable terms means

. 5. without dilution. By this I do not mean that the existence

6. of a market to book ratio of less than unity is always
7. prima facie evidence of a lack of financial integrity.

8 Short term or spot market aberrations can 1 sd to depressed

9. market prices. Those aberrations are often unrelated to
10. earnings levels and underlying risk parameters. For example,
11. Consolidated Edison's passing of a dividend had a significant
12. depressing effect on other utilities' market prices
13. irrespective of their earnings performance or any change 14, in their underlying risk parameters.
15. Lack of AFUDC accounting can be a significant contributor
16. to a company's inability to earn its authorized rate of
17. return. This is so because plant while under construction
18. produces no revenues or earnings even though the capital
19. financing such plant is reflected in the demoninator of the
20. fraction producing the rate of return earned. Where AFUDC
21. accounting - followed, the increase in plant under con-
22. struction dres not produce a decline in the rate of return
23. earned.
24. Obviously, the impact of a change in any one of the
25. myriad of factors affecting the financial integrity of a 26, company is a function of the level of that factor as well l

l 27. as the level of the other factors.

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1. For example, the impact of increasing a company's
2. AFUDC from 5% to 15% of its income available for equity
3. must be appraised in light of first, that level of AFUDC,
4. and second, the level of the others factors.

Thus a 15%

5. level of AFUDC in the context of a company that is earning
6. its cost of capital could have little, if any, impact on
7. the company's financial integrity. However, the impact of
8. such a level of AFUDC on a company earning substantially
9. below its cost of capital could well be interpreted as a
10. further sign of financial weakness. Likewise, moving from
11. an AFUDC percentage of equity earnings of 50% to 60% could
12. be similarly interpreted even though the company was
13. earning near its cost of capital.
14. The point is clear: the impact on a company's integrity
15. of a change in AFUDC must be considered in light of the
16. amount of change, the ending level and soundness of the
17. company's other financial characteristics. Consequently, 18, the fact that a company's AFUDC will double is not r.ui
19. generis cood or bad. This judgment can only be made
20. Intelligently within the scope of a company's overall
21. firancial health. The best evidence to consider would be
22. an indicator of the company's financial integrity over the
23. near term future. Such analyses have been presented to
24. the Commission in recent cases and by Dr. Lurito in this case.

25.

26. O. The third section of the Hope test you cited was the
27. ability to attract capital and maintain the company's i

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1. credit. How does AFUDC relate to this third criterion?
2. A. I am sure it is quite obvious that the third criterion
1. is inextricably linked to the first two. Hence, if a
4. company is allowed a reasonable opportunity to earn its
5. cost of capital and if this cost of capital is con-
6. sistent with financial integrity, then the company will be
7. able to maintain its credit and attract capital. Accordingly,
8. a level of AFUDC that will 'llow a company to maintain
9. its financial integrity will also allow it to maintain
10. its credit and attract capital.
11. One of the critical indicators of credit worthiness
12. is a company's bond rating. It is well known that there
13. are many factors that are considered in assigning a
14. company a bond rating. While the bond rating agencies
15. are not definitive it is generally believed tnat debt
16. ratio and coverage are the primary considerations in
17. establishing a particular rating. While AFUDC impacts
18. on cash coverage, so do many other factors such as
19. whether a company normalizes for the tax effects of
20. accelerated depreciation and the investment tax credits.
21. In addition, the level of AFUDC typically impacts on
22. indenture coverage and therefore on a company's ability
23. to sell additional debt capital.

, 24.

! 25. Q. You have indicated that LP&L should be required to continu

26. capitalizing AFUDC. Have you analyzed this proposal in

! 27. terms of financial integrity?

1

1. A. As I will develop later, my proposal will result in a level
2. of AFUDC equal to approximately 17% of af ter-tax operating
3. income and 40% of equity income. These relationships reflect
4. test year levels of CWIP and operating income from LP&L's
5. jurisdictional operations and the use of a 5% AFUDC rate.
6. As shown by Dr. Lurito for total company operations , the 7 level of AFUDC, consistent with a 10.4% rate will prohibit
8. the Company from obtaining additional debt capital until 1983
9. even if it earns a rising overall fair rate of return. Furthe r-
10. more, the level of AFUDC, when compared to equity income, shows
11. that in 1980 and 1981, AFUDC is in excess of equit: earnings.
12. Consequently, it is obvious that LP&L could not obtain the
13. capital it needs to meet its construction program. Consequently,
14. given the principles I have set forth above, it is necessary
15. to determine what level of AFUDC will allow LP&L to obtain
16. sufficient capital to meet its construction program. Such an
17. analysis will result in the lowest cost to consumers over the
18. future period when the plant under construction will be used.
19. Consistent with the procedures used by Dr. Lurito, I have l I 20. developed financial indicators based on the use of a 5% AFUDC '
21. rate. Were that rate used and were LP&L to earn a fair rate
22. of return, it would have indenture coverages in 1981, 1982, and
23. 1983 sufficient to raise the needed capital. Given the fact
24. that indenture coverage is based on historical earnings and not
25. prospective earnings,1980 coverages will reflect 1979 earnings l
26. ,

until the end of that year.

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1. The results of the analysis are summarized below.

2.

3. Financial Indicator 1980 1981 1982 1983 (A) T (C) (D) T 4.
5. Interest Cov. : Earnings (BFIT) 2.24 2.22 2.46 2.36 Interest Cov.: Cash (BFIT) 2.26 2.37 3.20 2.93
6. Internal Funds as % of Const. 22% 35% 81% 30%

AFUDC as % of Eq. Earnings 54% 60% 9% 22%

7. Indenture Coverage 2.45 2.04 2.21 2.27
8. The 2.45 times indenture coverage shown is based on the
9. level of earnings that would be experienced in 1980 were
10. LP&L to earn a 10.4% fair rate of return. The values shown
11. for the years 1981-1983 reflect the level of earnings produced
12. ' in the prior year.

13.

14. O. Why will. the use of a 5% AFUDC rate result in the lowest
15. cost to consumers?
16. A. The only alternative to a reduction in the AFUDC rate is a
17. significant increase in the return on equity used to determine
18. the fair rate of return. Indeed, to accomplish the job a
19. rate of 18.7% on equity and an overall rate of return of 12.3%
20. would have to be used. Such a procedure would cost the
21. consumers more than the use of a 5% AFUDC rate, since rate -
22. payers would have to pay for a higher rate of return now and
23. then pay again in the future for the higher capitalized AFUDC.

i

24. In sum, the lowest cost to consumers consistent with the main-l 25. tenance of financial integrity is to capitalize AFUDC at a 5%
26. rate through 1982. At that point in time, a return to an AFUDC i

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9

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1

1. rate more reflective of the cost of capital would be appropriate.
2. It must also be stressed that LP&L must be required to
3. capitalize AFUDC on its books at a 5% rate beginning when
4. rates resultant from this proceeding become effective. This
5. is necessary to prohibit over compensation of the construction-
6. related capital costs.

7.

8. E. AFUDC - Impact on Revenue Requirements 9.
10. Q. You have recommended that LP&L be required to capitalize AFUDC
11. at a 5% rate. Have you quantified the impact of this recom-
12. mendation on adjusted operating income?
13. A. Yes, I have. On line 6 to Page 5 of my Exhibit I show an AFUDC
14. Adjustment. The amount shown is the reduction in AFUDC necessary
15. to move from the 6.75% AFUDC rate booked in the test year to
16. the 5% rate I recommend.

17.

18. VI. DETERMINATION OF REVENUE REQUIREMENTS 19.
20. Q. Will you now derive the increase in rates necessary to produce
21. the fair rate of return?
22. A. Yes. As shown on Page 5 I have determined the needed increase ,
23. in rates based on the 10.4% and 10.5% range in rates of return  ;

i

24. testified to by Dr. Lurito. On line 9 is shown the required l
25. operating income, on line 10 the return deficiency and on line
26. 11, the revenue deficiency. The amounts shown on line 11 are l
1. before consideration of attrition . Based on a 10.4%
2. rate of return, the rate increase is S 42,404,000 and 3.

based on a 10.5% rate of return the increase is S 44,638,000, 4.

. 5. VII. ATTRITION 6.

7 Q. You indicated previously that you had a study of attrition.

8. Will you now describe your analyses?
9. A.- Yes.

It will be recalled that attrition is the result of a

10. change in the relationship among revenues, expenses, and
11. rate base. Such changes can come about for various reasons.
12. Perhaps the simplest explanation is that ehen inflation exceeds
13. productivity, attrition will most likely result. Consider
14. wages as an example. If wage rates rise by 6% (inflacion)
15. and productivity of the employees rises by 6% then there
16. would be no attrition caused by rising wage rates. This is
17. obvious since unit wage costs under those conditions will not
18. rise at all.
19. It can be seen that what is important in analyzing and
20. estimating future attrition is to properly consider changes in
21. real costs and real revenues. Consideration of revenues will
22. make this clear. Revenues increase for basically two reasons,
23. growth in demand and increases in rates. In estimating future
24. attrition one must be careful to consider only growth in demand
25. and to exclude from consideration growth due to rate increases.
26. Such an analysis will thus consider the growth in real revenues.

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1. With these general observations in mind I will now discuss
2. how I analyzed the question of future estimated attrition.
3. Basically, I have analyzed past growth in revenues , expenses
4. and rate base and based on that analysis of past growth, as
5. well as consideration of events that are known to take place
6. in the future, estimated what the earnings of the Company
7. would be one year after the rate increase becomes effective.
8. The first step of my study was to analyze the past
9. trends in the three major components : revenues, expenses,
10. and rats base, 11.
12. A. Growth in Revenues 13.
14. Q. How did you estimate revenue growth?
15. A. The Company was requested to furnish a 1968-1978 historical
16. review of kilowatt hour sales. These data are shown on Page 6
17. (All of the data used to analyze attrition is contained in
18. Part I to my Exhibit. ) . As can be seen the impact of the
19. oil embargo, conservation, and the recession appear rather
20. dramatically with 1973-74 growth in the 3% to 5% area and
21. growth before and af ter that in the above 10% area.

l

22. The second step of my analysis was to analyze the rela-
23. tionship between KWh growth and base revenue growth. Based
24. on the limited data available, it appears that base revenue
25. growth is equal to approximately 80% of KWh growth.

26.

1. Given these data I estimate a growth in revenues
2. through December 31, 1980 of 8%.

3.

4. B. Growth in Expenses 5.
6. Q. How did you analyze expenses?

7 A. The first step was to divide expenses into certain categories.

8. The categories I used were power supply, fuel and purchased
9. power, depreciation, wages and benefits, other operating and
10. maintenance expense, Franchise fees, property and other taxes,
11. state income taxes, and federal income taxes.

12.

13. 1. Power Supplv, Fuel, and Purchased Power 14.
15. I have increased these expenses by an annual growth rate
16. of 10% or by a rate some 25% greater than the growth in revenues.
17. Generally, due to the workings of the fuel adjustment clause
18. the growth rate that should be applied to fuel and the energy
19. portion of purchased power should be the same as the growth in
20. revenues. This is so because were the Company fuel costs to
21. grow due to increases in the cost of fuel, this increase would
22. automatically be reflected in increased fuel adjustment clause
23. revenues. In this case, I have used the higher growth rate to
24. reflect increases in the capacity portion of purchased power.

l

25. Given LP&L's load projections, it will be responsible for l
26. increased capacity charges under the power supply agreement with
27. MSU.
1. 2. Depreciation Expense 2.
3. The next category of expense analyzed was depreciation
4. expense. The change in depreciation expense is a function of
5. the growth in depreciable plant and any change in the deprecia-
6. tion rate. I will assume no change in depreciation rates.
7. On Page 7 I show the depreciation expense in each year
8. 1972-1978 [ Column (B) ] as well as the year-to-year percent
9. changes (Column (C)] and the trend rates of growth (Column (J)].
10. Comparing these data to that shown on Page 8, Columns (I) and
11. (M) indicates that absent changes in depreciation rates the
12. growth in depreciation expense parallels growth in gross plant.
13. I will use the estimated rate of growth in gross plant as the
14. rate of growth in depreciation expense. This rate, which will
15. be discussed subsequently is 8%.

16.

17. 3. Wages and Fringe Benefits 18.
19. The next category of expense analyzed was wages and
20. fringe benefits. The relevant data are shown in Columns (D),
21. (E), and (K) on Page 7. The data shown reflect wages only and
22. thus exclude fringe benefits. These data also incorporate the
23. impact of changes in the number of employees. As can be seen,
24. the year-to-year percent changes fluctuate between 7.4% and 15.4%.
25. The trend rates of growth are all above 10% and are
26. centered in the 11% to 13% area. It would appear that based on
1. these data and current inflation expectations that an increase
2. of approximately 12% in wages is a reasonable estimate for the j
3. future.

4.

5.

~

4. Other Operations and Maintenance Expense 6.
7. Q. How did you analyze other operations and maintenance expense?
8. A. Other operations and maintenance expense for each year 1972-1978 .
9. was first determined. This is cqual to "O & M" expense less
10. fuel, purchased power, wages and fringe benefits. The amounts
11. of other "O & M" so determined is set forth in Column, (F) on
12. Page 7 to my Exhibit. Also shown are the year-to-year percentage
13. changes and the trend rates of growth, Columns (G) and (L),
14. respectively.
15. As can, be seen the year-to-year percentage change varies from
16. 7.3% to 35.3%. Based on these data it would appear that an
17. estimated annual rate of increase in this expense of 14% is
18. reasonable. I will use 14% in my analysis of attrition.

19.

20. 5. Franchise Fees 21.
22. Q. How did you analyze Franchise fees?
23. A. I have assumed that the level of Franchise fees is related
24. to the level of revenues. I will grow the Franchise fee at
25. the 8% annual rate that I determined reasonable for revenues.

26.

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1. 6. Prooerty and Other Taxes 2.
3. O. How did you estimate the growth in property and other taxes?
4. A. The data I relied on is shown on Page 7, Column (H). Shown
5. there is the property tax expense in each year 1972-1978.
6. Property taxes account for over 95% of the property and other 7 tax category. As can be seen property taxes declined by 8.5%
8. in 1978 whereas the increases prior to the 1978 decline had
9. been in the 4 %-7% area. I will use 5% as the annual rate of
10. growth to apply to this expense in my analysis of attrition.

11.

12. C. Growth in Rate Base 13.
14. 1. Gross Plant In Service 15.
16. Q. Having discussed your estimated rate of growth in revenues and
17. expenses, will you now discuss how you analyzed the components
18. of the rate base?
19. A. I have sub-divided the rate base into five components, the
20. first of which is gross plant. On Page 8 I show the gross 21, plant in service by function for each year 1972-1978. ,

1

22. As can be seen, while the growth in the components varies
23. year by year, the growth in total gross plant has been reasonably !

i '

24. s table . No major additions to gross plant are anticipated until
25. Waterford comes on line in 1981. Based on the data shown on Page
26. 8 and particularly the trend rates of growth an 8% annual rata
27. of growth appears reasonable.
1. 2. Reserve For Depreci.stion 2.
3. The second component analyzed was the reserve for
4. depreciation. The relevant data are shown on Page 9. As
5. can be seen, the reserve for depreciation has been growing
6. f aster than either gross plant or depreciation expense.
7. Based on these data it appears that an annual rate of growth P. of 10% is reasonable.

9.

10. 3. CWIP 11.
12. The estimated future average CWIP was determined
13. directly from the data furnished by LP&L. Since those data
14. were for the total company it had to be allocated to juris-
15. dictional operations. This was accomplisher' by using the
16. weighted CWIP allocation factor used in the test year.

17.

18. 4. Other Rate Base Items 19.
20. The fourth category of rate base consists of tina
21. remaining elements of rate base exlcuding deferred federal
22. income taxes. Thus, included are:
23. o Materials and Supplies l o Investment in System Fuels
24. o Working Capital o Plant Held For Future Use
25. o Customer Deposits o Pre- 1971 Tax Credits, and
26. o Operating Reserves.

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l

1. Data is available for three of these items for
2. the period 1972-1978. These data are shown on Page 10 to
3. my Exhibit. As can be seen the year-to-year percent changes
4. fluctuate considerably as ,do the trend rates of growth. I
5. will use St as the annual rate of growth for the "other
6. rate base items" . It can be seen that while this is consid-
7. erably below the 1978 growth it is well within the range in
8. the trend rates of growth.

9.

10. 5. Accumulated Deferred Income Taxes 11.
12. On Page 9 I show the accumulated deferred income taxes

, 13. for each of the years 19 72-1978. As can be seen these amounts

14. have been increasing at a decreasing rate. The most recent
15. year shows a 7.5% rate. Comparing these year-to-year percent
16. changes to the percent changes in gross plant on Page 8 shows
17. that deferred taxes have consistently grown at a rate f aster
18. than gross plant. This is also true with regard to a comparison
19. of deferred taxes to depreciation expense.
20. Given the use of an 8% annual growth rate in gross plant
21. and depreciation expense use of an 8% rate for deferred taxes i
22. would be conservative. I will use 8% as the anticipated annual
23. rate of growth in deferred taxes in my analysis of attrition.
24. -

l 25.

26.

. . l i

1. D. Measurement of Attrition 2.
3. Q. Will you now summari=e how you propose to measure anticipated
4. attrition? ,
5. A. It will be recalled that I have previously determined the
6. revenue requirement af ter making various proforma adjustments.

7 Thus I have already adjusted expenses and revenues in specific

8. quantifiable amounts. For example, I have adjusted wage
9. expenses for increases that occur in the test year and through
10. June of 19 79. This means that the wage and fringe benefit
11. expenses I have included reflect wage rates and fringe benefits
12. that will exist until approximately June 30, 1979 on average.
13. Based on the growth rates just discussed, I wil) project
14. the rate of return to be earned in the first year rates
15. resultant from this proceeding are in effect. For the purpose
16. of this analysis I will assume new rates are effective January
17. 1, 1980. Consequently, I will project the rate to be earned
18. in the_ twelve months ending December 31, 1980,
19. The first step in this process was to analyze the
20. adjusted test year expenses in terms of what specific adjustments
21. have already been made. For example, in projecting wage expense
22. it must be recognized that I have already adjusted that item
23. to, on avet r, the June 30, 1979 level. Thus, in projecting
24. wage exp to the year ending December 31, 1980, I am only
25. concerne. 4 the period July 1,1979 through December 31, 1980.

26.

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1. The study of attrition is shown on Page 11 of my Exhibit.
2. As shown there on lines 3 through 10 I have divided expenses into
3. eight categories. This was done so that individually applicable
4. growth rates could be applied to the specific time periods.
5. In Column (D) I show the date to which the revenue,
6. expense or rate base item has been proformed. In (C), I show
7. the proformed test year amounts. In Column (E) is shown the
8. estimated growth rates which I have discussed previously. Based
9. on the growth rates and the information contained in Column (D)
10. the compound adjustment f actors shown in Column (P) were
11. computed. These factors when applied to the data in Column (C)
12. will produce the amount of the respective item for the year

, 13. ending December 31, 1980.

14.

15. Q. How have you determined the change in income taxes?
16. A. I have compared the test year net operating income before taxes
17. to the net operating income estimated for the year ending
18. December 31, 1980. Also reflected was an increase in interest
19. expense consistent with the growth in the rate base and consis-
20. tent with the cost of debt and debt ratio testified to by Dr.
21. Lurito. I then applied the tax rate to the difference to obtain i
22. the change in income taxes.
23. As shown on line 13 net operating income will rise from j
24. S119,064,000 to S156,049c000. The net rate base (line 20) will riso
25. from S1,114,844,0wo to S 1,600,588,000 producing a decrease
26. in the rate of return (line 21) from 10.4% to 9.75%. Based on
1. this study a rate of attrition of .65% is indicated. In other
2. words, based on this study, the Company is expected to experience
3. earnings attrition. Consequently, I recommend that an attrition
4. allowance of .65% be allowed. Based on a rate base of S1,144,844,00C
5. the attrition allowance would be S 14,520,000 of additional revenues.
6. The need for such a large attrition allowance results from two
7. unrelated factors. First, LP&L has not suggested any proforma
8. adjustments extending beyond June 30, 1979. There fore , this
9. attrition allowance is partially in lieu of what is normally 10, considered as proforma adjustments. The second factor is the
11. significant increase in CWIP. Between 1978 and 19 80 CWIP will 12, increase by 80%. Given a 5% AFUDC rate, it can be seen that
13. this alone will cause attrition.

14.

15. E. Attrition - Summarv 16.
17. In sum, an allowance for attrition to be rational, must
18. be based on an anticipation of future events. In the context
19. of rate-making, an attrition allowance is an ex ante concept,
20. since rate-making is by its nature prospective. The fact that a
21. company has experienced attrition in the past should not be
22. controlling. Past history is useful only as a guide to estimating
23. the future. Certainly past events such as the oil embargo, the
24. recession, etc. , should not be automatically projected to occur in
25. the f uture. However, based on my analysis, it is my opinion that i 26. it is reasonable to conclude that LP&L's jurisdictional operations l

(

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1. will experience attrition in the first year the rates resultant
2. from this proceeding are in effect. Consequently, an allowance
3. for attrition should be made.

4.

, 6.

7.

8.

9.

10.

11.

12.

13.

14.

15.

16.

17.

18.

19.

20.

21.

22.

. 23.

24. -

25.

l l 26.

i Before the PUBLIC SERVICE COMMISSION of the STATE OF LOUISIANA i

Ex Parte LOUISIANA F0WER & LIGHT COMPART (Docket No. U-14078)

EIRIBIT of BRUCE M. LOUISELLE re REVENUE REQUIREMENTS l

October 1979 l

MOSM LOURNELLE LURITO & ASSOCI ATES. INC.

Artnoton, Vagrue I

Part 1 Page 1 t

LOUISIANA PO'a'ER AND LIGHT COMPANY LOUISIANA JURISDICTIONAL OPERATIONS RATE BASE AVERAGE FOR YEAR ENDING DECEMBER 31. 1978

($1,000)

Line Item Amount (A) (B) (C)

1. Plant In Service S 1,040,588
2. Less: Accumulated Depreciation 272.358
3. Net Plant In Service S 768,230
4. Plant Held For Future Use 4,081
5. Construction Work in Progress 438,391
6. Materials And Supplies 5,994
7. Investment In System Fuels 21,305
8. Working Capital (Developed on Page 2) 5,894 Less: Non-Investor Supplied Capital

. 9. Customer Deposits S 11,054

10. Accumulated Deferred Income Taxes 79,349
11. Pre 1971 investment Tax Credits 4,358
12. Operating Reserves 4.290
13. Total Non-Investor Supplied Capital ($ 99.051) l
14. Rate Base S 1.144.844 l

Part I Page 2 e LOUISIANA POWER AND LIGHT COMPANY LOUISIANA JURISDICTIONAL OPERATIONS WORKING CAPITAL REQUIREMENT YEAR ENDING DECEMBER 31, 1978 Line Item Amount (A) (B) (C)

1. Average Prepayments S 1,242
2. Average Working Funds 236
3. Cash Advanced Portion Operating Expenses 1,906 (Developed Page 3)
4. Deferrse Fuel 2,510
5. Total $ 5.894 l

l e

l

LOUISIANA POWER AND LIGilT COMPANY .

LOUISLANA JURISDLCTIONAL OPERATIONS DETERMINATION OF CASil ADVANCED PORTION OF WORKING CAPITAL _

YEAR ENDING DECEMBER 31, 1978

($1,000)

Lcuisiana Retail Dollar Weighted Lina item Amount Lag Days Lag Days Lag Days (A) (R) (C) (D) (E) (F)

1. Fuel $ 143,171 25.5 $ 3,650,861
2. Purchased Power ' Net 7,872 30.0 236,160
3. Franchise Fees 3,536 .9 3,182
4. Property Tax 8,254 182.5 1,506,355
5. Payroli 30,631 12.6 385,951
6. Other Operating Expenses 39,644 25.0 991,100
7. State Income Tax 3,145 136.9 430,550
8. Federal Income Tax 3L,094 90.0 2,798,460
9. Miscellaneous Tax .,

165 (45.0) (7,425)

10. Total $ 267,512 $ 9,995,194
11. Total Expense Lag Days 37.4
12. Revenue Lag Days 40.0
13. Het Lag Days 2.6
14. Average Daily Expenses ($267,512 4 365) $ 733 Cash Advanced Portion of Working Capital - $ 1,906 15.

(L.13 x L.14) yy w>

ba H

Part I Page 4

_ LOUISIANA POWER AND LIGHT COMPANY LOUISIANA JURISDICTIONAL OPERATIONS ACTUAL OPERATING INCOME YEAR ENDING DECEMBER 31. 1978

($1,000)

Line Item Amou?t (A) (B) (C)

Revenues:

1. Electric Operating Revenues $ 359.548
2. Other Operating Revenues 5,494
3. Total Revenues S 365,042 Expenses:
4. Operation Expense S 188,049
5. Maintenance Expense 33,269
6. Depreciation 35,118
7. Taxes Other Than Incone 11,645 Income Taxes
8. Current Federal $ 11,835

. 9. Current State 1,179

10. Deferred Federal ,

8,914

11. ITC Adjustment- Net (1,089)
12. Total Income Taxes S 20,839
13. Total Expenses S 288,920
14. AFUDC $ 27,577
15. Net Operating Income S 103,699 l

I t . - . -

I Part I Page 5 LOUISIANA POWER AND LIGHT COMPANY LOUISIANA JURISDICTIONAL OPERATIONS DETERMINATION OF REVENUE REQUIREMENTS YEAR ENDING DECEMBER 31, 1978

($1,000)

Line Item Amount (A) (B) (C)

1. Actual Net Operating Income $ 103,699 (Developed Page 4)

ADJUSTMENTS TO NET OPERATING INCOME

2. To Reflect Rate Increase Effective In 1978 S 3,400
3. To Eliminate Extraordinary Income Resulting (2,438)

From Coal Strike

4. Interest On Customer De; -its (262)
5. To Reflect Correct Taxes on Wage Increases 83
6. AFUDC Adjustaent (7,150)
7. TOTAL ADJUSTMENTS S 6,367
8. Adjusted Net Operating Income S 97,332 At A Rate Of Return Of:

10.4% 10.5%

9. Required Net Operating Income S 119,064 ~ S 120,209
10. Return Deficiency (L.9 - L.8) $ 21,732 S 22,877
11. Revenue Deficiency (L.10 + .5125) S 42,404 $ 44,638 l

l l

l

LOUISIANA POWER AND LICHT COMPANY ATTRITION _

ANALYSIS OF HECAWATT HOUR SALES 1968 - 1978 Hegawatt Hour Sales To H.S.U. Sys4em Hegawatt Hour Sales Jo Other Customers Total Megawatt Hour Sales Year-to-Year Yea r-to-Yea r Year-to-Year Year Amount I Change Amount  % Change Amount  % Change (A) (5) (C) (D) (E) _

(F) (G) 1968 2,158,680 7,490,381 9,649,061 1969 4,772,388 121.08% 8,505,242 13.55% 13,277,630 37.61%

1970 3,806,304 (20.24) 9,260,529 8.88 13,066,833 (1.59) 1971 3,039,780 (20.14) 10,410,512 12.42 13,450,292 2.93 1972 4,024,042 32.38 11,899,580 1( in 15,923,622 18.39 1973 5,375,481 33.58 12,621,291 6.07 17,996,772 13.02 1974 5,540,342 3.07 13,008,330 3.07 18,548,672 3.07 1975 5,029,293 (9.22) 14,128,135 3.61 19,157,428 3.28 1976 5,379,795 6.97 16,170,851 14.46 21,550,646 12.49 1977 2.455,516 (54.36) 18,496,885 14.38 20,952,401 (2.78)

,1978 1,990,082 (18.95) 20,721,582 12.03 22,711,664 8.40 YEAR TO FINAL YEAR TREND RAYE OF GROWfH (H) (I) [ (J) 1968-78 (.63)I 10.08% 8.00%

1969-78 (4.38) 9.92 6.94 1970-78 (4.43) 9.91 7.27 1971-78 (6.37) 9.80 6.91 1972-78 (12.41) 9.91 5.58 1973-78 (18.92) 11.06 4.82 1974-78 (24.15) 12.76 5.07 1975-78 (29.99) 13.69 4.94 -

1976-78 (39.18) 13.20 2.66 y, 1977-78 (18.95) 12.03 8.40 gg e a, Os .-4

ATTRITION _

ANALT515 0F DEFRECIATION EXPENSE: WACE AND FATROLL EXPENSEl OTHER 0 & H EKFENSE AND F MPERTT TAX EXFENSE LOUISI ANA F0WER AND LICHT COMPANT_

1972-1978

_0THER O & H EXFENSE , FROFERTT TAE E1FENSE

_ DEPRECIATION EXPENSE WAGE AND FATROLL E1FENSE YEAR-TO-TF.AR TEAR-10-TEAR TEAR-ithYEAR YEA h-To-V tA R I CHANGE ANDUNT I OIANGE APR)UNT I GANCE I DIANCF. AM1UNT TEAR AMolNy (C) (N)

~ 0ii (C) (D) (E) (F) (I)

~(I)

$ 13.222 $ 20.832 $ T 881 1972 $ 20.467 14.219 7.542 22.442 7.732 7.770 (1.41)!

1973 22.120 9.032 7.4 12 25.607 14.101 8.304 6.872 1974 24.447 9.532 15.275 15.352 27.528 7.502 8.692 4.672 1975 27.837 13.873 17.620 14.741 29.546 7.312 9.295 6.943 1976 33.866 21.661 20.218 8.45% 34.952 18.301 9.9 71 7.272 1977 35.999 6.301 21.926 24.985 13.951 47.303 35.342 9.123 (8.50)!

1978 38.389 6.641 TEAR TO FINAL TEAR TREND RATE OF CROWTH (R) (L) (N)

(J) 11.531 13.271 3.822 1072-78 11.982 12.241 14.481 4.141 1971-78 12.331 12.7R2 14.791 3. 31 1 1974-78 12.)02 11.951 19.63% 2.182 1975-78 10.80%

6.471 11.173 26.531 (.91)E 1976-78 6.642 13.953 35. 541 (8.50)!

1977-78

?5 23 u .4

ATTRITI(W ANALYSIS OF FLANT IN SERVICE LOUISIANA F0WER AND LIQlf CDMFANT 1972-1978 FRODUCTION FI. ANT TRANSNISSION PLANT DISTRIBUTION & CENERAL FIANT TOTAL FIJWIT IN SERVICE 1 EAR-TU-1 EAR YEAR-TO-YEAR YEAR-To-YEAR YEAR YEAR-YD-YEAR A.1OUNT I CHANGE AMOUNT I CllANCE ANDUNT I CIIANCE (4 (B) AMOUNT I OIANCE (C) (D) (E) (F) (C) (H) (I) 1972 $209.204 $134.84 7 $ 350. 785 $ 694.836 1973 283.103 35.323 $136.624 1.322 371.858 6.011 791.585 11.921 1974 306.008 8.09% $142.257 4.122 397.223 6.82% 845.488 6.812 11; 7 5 428.790 4'O.122 $14 8.650 4.492 424.769 6.932 1.002.209 18.541 197a 435.754 1.622 $154.427 3.892 454.479 6.991 1.044.660 4.242

  • 1377 462.789 6.208 $159.314 3.162 488.540 7.491 1.110.643 6.321 1978 485.131 4.832 $159.96 7 412 542.075 10.962 1.187.173 6.891 YEAR TO FtIIAL YEAR TRFJID IN CROWTN RATE

_ (J) (R) (L) (n) 1972-78 14.78% 3. 2 71 7.353 9.322 1973-78  !!.958 3.392 7.6 31 8.601 1974-78 10.492 3.091 T.911 8.1 32 1975-78 4.40t 2.541 8. 372 5.862 1*J 71- 78 5.512 1.781 S.211 6.602 1977-78 4.83% .412 10.962 6.892 E?

w 5

1 Part 1 Page 9

, LOUISIANA POWER AND LIGHT COMPANY

~

TTRITION ANALYSIS OF ACCUMULATED DEPRECIATION AND DFIT 1972 - 1978 ACCUMULATED DEPRECIATION DEF. INCOME TAXES Year-to-Year Year-to-Year Year Amount  % Change Amount ,

% Change E (B) (C) (D) (E) 1972 S 143,991 S 44,319 1973 162,151 12.61% 50,856 14.75:

1974 184,914 14.04 56,910 11.90 1975 209,288 13.18 72,298 27.04 1976 240,691 15.00 79,199 9.55 1977 280,559 16.56 85,742 8.26 1978 317,583 13.20 92,180 7.51 YEAR TO FINAL YEAR TREND RATE OF GROWTH (F) (G) 1972-78 14.26% 13.61 1973-78 14.54 13.05 1974-78 14.74 12.02 1975-78 15.08 8.42 1976-78 14.87 7.88 1977-78 . 13.20 7.51

ATTRITION ANALYSIS OF FLANT HELD FOR FUTURE USE t NATERIAL. SL7 FLIES. AMD PREPAftfMTS LESS OFERATING RESERVES LOUIS 1 AMA POWER AND LICHT CaprANY 1972-1978 PLANT HELD FOR FUTURE USE MATERIALS, SUrrLIES & PREPAYMENTS OPERATING RESERVES TOTAL YEAR-To-YEAR Y EAR-TO-Y F.AR Y EA R-TO-Y EAR YEAR-10-YEAR TEAR AMOUNT I OIANCE AMDtWT 2 OIANCE AMOUNT 2 OIAMCE AMOLMT I OIANCE (A) (t) (C) (D) (E) (F) (C) (H) (1) 1972 $ 4.284 $ 10,476 $ 4,750 $13,004 1973 4,549 6.192 10,667 1.821 4,824 1.43% 10.392 1.881 1974 4,528 (.46 2) 9.128 (6.932) 4.813 (.23t) 9.643 (7.21 2) 1975 4 .5 99 1.57% 7.311 (26.36 2) 4,653 7,257 (3.322) (24.741) 1976 4.599 0 8,601 17.641 4,909 5.502 8,29 1 14.251 --

1977 4,599 0 7 905 (8.091) 4.565 (7.012) 7,9 39 (4.251) 1978 4.599 0 9,263 17.181 4.855 6.151 9,007 13.452 YEAR TO FINAL YEAR TREND RATE OF C80WTH 1972-78 (J) (R) (L) (N) 1072-78 .901 (3.892) (.102) (3.522) 1973-78 .292 (3.442) (.212) ( 3.2 72) 1974-78 .311 (.602) ( 022) (.4?!)

1975-78 0 6.462 .552 6.232 1976-78 0 3.782 (.551) 4. 322 1977-78 0 17.181 6.352 13.451

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Part II Page 1 14UISTANA PO'MR AND LIGHT COMPANY 14.u,1,S.1,AN,A, ,.l.0 R 1,S D,1,C,T,1 ON_A,L ,U PE RATlO,N,[S, VT.E, B,QE

@?.R' ACE ,F,t)ri ,YE,A,R, E,ND,1,NG, Uf.C).*jBER ,3,1, 19,78,

( S,12 00,0,),

1.i ne item , , , App,u n,t,, , ,

( A.), , ,, ,,,,, , , ,. (5)

.. ,,,,,,,,,,,,,,,,,,, ( )

, , .. . ,,C , , , , ,

1. Plant in Service $ 1,038,450
2. I.e s s : Accumulated Depreci;stion 271.833
3. Net Plant in Service S 766,617

- 4. Pl .a n t lield For Tuture lise 4,066

5. Const ruction k'ork In Progress 436,817
6. Mat erials And Supplies 5,988
7. I vestment in System Fucis 21,305
8. kbrking Capital (Developed on Page 2) 5,964 Le55:_ ..Mn. .I_nv_e a.t.o r_ .S,unitsd, C,a,pj_t,a_1
9. Custo:ncr Deposits S 11,054
10. Accumulated Deferred income Taxes 78,469
11. Pre 1971 Investment Tax credits 4,350
12. Operating Reserves 4.282
13. Total Non-Invest or Suppl,f ed Capital ($ 98.155)
14. Rate Base S 1,142,602

Part II Page 2 4

4

, LOUISTANA POWER AND LIGH1 COMPANY LOUISIANA JURISDICTIONAL OPERATIONS h

WOR _KI,NG CAP,1_TAL REQUIREMENT i YEAR ENDING DECEMBER 31, 1978

.L.!".* . _ . . . _ . . Item Amount J^) _ .... _.. 18.)._ _____.- . . . . . _ . _ _ . (C). . ..

1. Average Prepayments S 1,242 1
2. Average Working Funds 236
3. Cash Advanced Portion Operating Expenses 1,976 (Developed Page 3)
4. Deferred Fuel 2.510

! 5. Total S 5.964 1

i I

LOUISIANA POWER AND LIGilT COMPANY LOUISIANA JURLSDICTIONAL OPERATIONS DETERMINATION OF CASil ADVANCED PORTION OF WORKING CAPITAL YEAR ENDING DECEMBER 31, 1978 .

($1,000)

Imulslana Retail Dollar Weighted s int Item Amount Lag Days Lag Days Lag Days JA) (B) (C) ,

(D) (E) (F)

1. Fuel $ 143,171 25.5 $ 3,650,861
2. Purcissied Power- Net . 7,877 30.0 236,310
3. Franchise Fees 3,531 .9 3,178
4. Property Tax 8,177 182.5 1,492,302
5. Payroli 30,561 12.6 385,069
6. Other Operating EM eises 39,605 25.0 990,125
7. State Income Tax 3,144 136.9 430,414
8. Federal Income Tax 31,091 90.0 2,798,190 9 Miscellaneous Tax 165 ( 4.5.0) (7.425)
10. Total $ 267,322 $ 9,979,024
11. Total Expense Lag Days 37.3
12. Revenue 1.ag Days 40.0
13. Het Lag Days 2.7
14. Average Daily Expenses ($ 267.322 ,*r 365) $ 732
15. Cash Advanced Portion of Working Capital $ 1,976 (L.13 x L.14) .o .o N

E. n

Part II !

Page 4 LOUISIANA POWER AND LIGHT COMPANY LOUISIANA JURISDICTIONAL OPERATIONS ACTUAL OPERATING INCOME YEAR ENDING DECEMBER 31, 1978

($1,000)

Line Item Amour.t (A) (B)

(C)

Revenues:

1. Electric Operating Revenues S 359,548
2. Other Operating Revenues 5.494
3. Total Revenues S 365,042 Expenses:
4. Operation Expense S 188,020
5. Maintenance Expense 33,194
6. Depreciation 35,055
7. Taxes Other Than Income 11.566 Income Taxes
8. Current Federal $ 12,015
9. Current Sta6e 1,197
10. Deferred Federal 8,905
11. ITC Adjustment- Net (1 ,087)
12. Total Income Taxes S 21.030
13. Total Expenses ,

S 288,865

14. AFUDC $ 27,478
15. Net Operating Income S 103,655 l

l

_-. - _ . . . =_ .- - .

Part II Page 5 1,0UISIANA POWER AND LIGHT COMPANY LOUISIANA JURISDICTIONAL OPERATIONS DETERMINATION OF REVENUE REQUIREMENTS YEAR ENDING_DEC, EMBER ,31. 1978 (51,000)

Line Iten Amount (A) (B) (C)

1. Actual Net Operating Income S 103,655 (Developed Page 4)

ADJUSTMENTS TO NET OPERATING INOOME

2. To Reflect Rate Increase Effective In 1978 S 3,400
3. To Eliminate Extraordinary Income Resulting (2,438)

From Coal Strike

4. Interest On Customer Deposits (262)
5. To Reflect Correct Taxes On Wage Increases 83
6. AFUDC Adjustment (721?4)
7. TOTAL ADJUSTMENTS ($ b,141)
8. Adjusted Net Operating Income $ 97,314 At A Rate Of Return Of:

lu.4% 10.5%

9. Required Net Operating Income $ 118,831 $ 119,973
10. Return Deficiency (L.9 - L.8) S 21,517 S 22,659
11. Revenue Deficiency (L.10 + .5125) S 41.984 $ 44.213 i

i

l APPENDIX

Appendix Page 1 THREE ALTERNATIVE TRZATMENTS OF CONSTRUCTION WORK IN PROGR.ESS AND A1.LOVANCE FOR FUNDS USED DURING CONSTRUCTION I. Exclude Construction Work In Progress From Rate Base Do Not Include AFUDC In Income Capitalize AFUDC 1977 1978 1979 Total A. Rate Base - $1,080.00 5540.00 -

B. Return -

S 86.40 43.20 $ 129.60 C. Depreciatier. -

540.00 540.00 1,080.00 D. AFUDC - - - -

E. Return Requirement S 626.40 3583.20 $1,209.60 II. Include Co.struction Work In Progress In Rate Base Include AFUDC In Income Capitalize AFUDC 1977 1978 1979 Total A. Rate Base $1,000.00 $1,080.00 $540.00 -

B. Return S 80.00 $ 86.40 S 43.20 S 209.60 C. Depreciation -

540.00 540.00 1,080.00 D. AFUDC (80.00) - -

(80.00)

E. Return Requirement 5 S 626.40 3583.20 $1,209.60 III. Include Constructice Work In Progress In Rate Base Do Not Include AFUDC In Income Do Not Capitalize AFUDC 1977 1978 1979 Total l

A. Rate Base $1,000.00 $1,000,00 5500.00 -

B. Return S 80.00 $ 80.00 $ 40.00 $ 200.00 C. Depreciatien -

500.00 500.00 1,000.00 D. AFUDC - - - -

E. Return Requirement 5 80.00 S 580.00 5540.00 $1,200.00

App 3ndix Page 2

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s. mal l is is si is is is i:i in ic gi gi in fa i$ !!! E55 !!! EEE !!! EEE !!! 815 !!! !!! !!! 555 liX D m m,D
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