How the Regulator Overpays Investor? A Simple Exposition of the Principles of Tariff Setting

11 Pages Posted: 5 Aug 2007

See all articles by Ignacio Velez-Pareja

Ignacio Velez-Pareja

Grupo Consultor CAV Capital Advisory & Valuation

Rauf Ibragimov

Russian Presidential Academy of National Economy and Public Administration

Joseph Tham

Duke University - Duke Center for International Development in the Sanford School of Public Policy

Daniel Toro González

Universidad Tecnológica de Bolívar (UTB); WSU

Date Written: August 2, 2007

Abstract

In this teaching note, we discuss the basic principles for tariff setting. Tariff setting is very important for regulated industries, such as water and power. The tariff should provide an appropriate risk-adjusted return to the investor. If the tariff were too low, then the investors would not be willing to invest. On the other hand, if the tariff were too high, then it would reduce the consumers' welfare.

We examine the Rate of Return method for calculating the tariff in a regulated firm. In the rate of return method, the tariff compensates the investor for all the costs that the investor incurs, including a fair return. We use the discounted cash flow approach to value the return that the investor receives. The results of both calculations must be consistent.

In particular, using simple examples, we show that in the presence of a positive expected inflation rate, the typical tariff calculation, Rate of return method, is an overestimation of the required payment to the equity holder.

Keywords: WACC, taxes, regulation, tariff regulation

JEL Classification: D61, G31, H43

Suggested Citation

Velez-Pareja, Ignacio and Ibragimov, Rauf and Tham, Joseph and Toro González, Daniel, How the Regulator Overpays Investor? A Simple Exposition of the Principles of Tariff Setting (August 2, 2007). Available at SSRN: https://ssrn.com/abstract=1004578 or http://dx.doi.org/10.2139/ssrn.1004578

Ignacio Velez-Pareja (Contact Author)

Grupo Consultor CAV Capital Advisory & Valuation ( email )

Ave Miramar # 18-93 Apt 6A
Cartagena
Colombia
+573112333074 (Phone)

HOME PAGE: http://cashflow88.com/decisiones/decisiones.html

Rauf Ibragimov

Russian Presidential Academy of National Economy and Public Administration ( email )

Vernadskogo Avenue,82
Moscow, Moscow region 119571
Russia
007 495 4347103 (Phone)
007 495 4349027 (Fax)

HOME PAGE: http://www.ranepa.ru/eng/

Joseph Tham

Duke University - Duke Center for International Development in the Sanford School of Public Policy ( email )

Box 90312
302, Towerview Dr, Rubenstein Hall, Room 272
Durham, NC 27708
United States
919-613-9234 (Phone)
919-681-0831 (Fax)

HOME PAGE: http://fds.duke.edu/db/Sanford/faculty/thamjx

Daniel Toro González

Universidad Tecnológica de Bolívar (UTB) ( email )

Manga Calle del Bouquet
Campus de Ternera, Parque Industrial y Tecnológico
Cartagena, Bolívar
Colombia

WSU

Pullman, WA 99164
United States

HOME PAGE: http://cahnrs-cms.wsu.edu/ses/Pages/default.aspx

Register to save articles to
your library

Register

Paper statistics

Downloads
195
rank
146,360
Abstract Views
1,680
PlumX Metrics