6

# Box 1: The Cash-flow approach used by Offer in the NGC price review

The table reports the calculation of transmission revenues (severe case) to be earned by the National Grid Company in Britain, made by the regulator in his 4th Consultation Paper. The regulator eventually based his price control on a slightly more lenient revenue allowance.

# Calculation of transmission business revenues<sup>4</sup>

||_.1997/8_|_.1998/_|_.1999/0_|_200/1_|_*. Total_|
|---|---|---|---|---|---|
|....................................................<br>Operating Costs|............<br>. 350|.342|323|........................<br>304|....................<br>_.|
|Capital Expenditure|194|155|154|213||
|Total|544|497|477|517||
|PV of outlays at 6.5%|527|452|408|414|1801|
|PV of asset values<br>...............................................|.400<br>........ .......................|....... ...... ................|.......................|2971<br>..................|1069<br>........i..|
|<br>PV of costs|||||,, ,,,,<br>2870|
|Unregulated Revenue|128|116|118|108||
|PVat6.5%|124|106|101|87|418<br>|
|..<br>..........................................................<br>Regulated Revenue<br>|..............................<br>735<br>|.............................<br>705<br>---|............................<br>677<br>--<br>|........**.**...........................<br>650<br>**-**!------|............................<br>............**............**<br>;<br>...<br>--'---'-'--"-''-"-'-t''''--'--"''''''-'-'-''--|
|.....................................<br>PV of regulated revenue<br>|.............................<br>712|... .......................<br>641<br>-|......<br>.....................<br>578<br>-<br>-<br>-<br>--i-|...... ............<br>521<br>-----------------|........<br>2452<br>--------i----------|
|..................<br>,. ..............<br>PVofrevenues|. .......... .. ..........|....... . ............|.|....|.......<br>2870|

The derivation of the closing value is shown below. The opening asset base of £4040m is rolled forward by expected capital expenditure less the allowed depreciation to obtain a closing value of f3823m. This is discounted back to the present by dividing by _(1+r) 4_ where r is the regulator's estimate of the cost of capital (6.5%) and raising to the fourth power reflects the fact that the control lasts for four years. The discounted closing value is therefore 3823/1.2865=2971.

# Derivation of the asset value

||_i19997/8_|_1998/9_|_1999/2000_|_2000/1_|
|---|---|---|---|---|
|Opening Value<br>...................<br>.................................|4040<br>.........**.......**..................|4007<br>.........**.....**...................|3930<br>..................**.....**<br>I<br>...........|3849<br>........................................|
|Depreciation<br>...........<br>i .....<br>I.....<br>....|227<br> I..............I.......I...........|232<br>......................................|235<br>......<br>.... I............|-239<br>..................|
|<br> <br><br>Capital Expenditure|<br>194|<br>155|<br> <br>154|213|
|Closing Value<br>............................................................|4007<br>I......<br>.............<br>.|3930<br>.........<br>..........................|I 3849<br>......<br>...........|3823<br>.................|
|PV of Closing Value|<br> <br> <br>4007|<br>|<br>|2971|

4 The Transmission Price Control Review of the National Grid Company. Offer 4th Consultation Paper. Offer: UK