Fig. 4.14 Typical Patterns of Costs and Revenue Requirements where: Rn = revenue requirements in year n, D = discount rate (weighted average cost of capital), and B = book life. A discount rate consistent with financial assumptions is needed for the present worth and levelizing calculations. Most electric utilities use their own weighted average cost of capital as the discount rate for making these calculations. The weighted average cost of capital is composed of the appropriate fractions of preferred stock, common stock, and bonds multiplied by the corresponding rates of return required in the marketplace. In general, observed market rates of return reflect the investor’s expectation of future general inflation plus some premium known as a "real” rate of return. The GNP deflator was used to estimate the historic inflation and to adjust the current-dollar rates of return to obtain real rates of return. In the comparative analyses, annual and levelized revenue requirements were calculated in inflation-free or "constant" dollars. A 1978 dollar value was used as the constant-dollar basis. Hence, only the "real" part of the discount rate should be used. Future prices of goods were expressed in the 1978 values, and increases higher than general inflation were added to these prices. Base capital structure and economic assumptions typical of privately- owned utilities are used in the analysis and are summarized in Table 4.13.
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