Question

1. A regulated investor-owned electric utility currently generates 12 million Mwh per year with a total rate base, including transmission and distribution assets, of $10 billion. Its operating costs are $200 million annually. If the regulatory agency allows a 10 percent rate of return on the rate base, what is the regulated price of electricity, and the utility's annual earnings?

2. The utility projects its annual electricity demand to grow by an additional 7 million Mwh to 19 Mwh per year, and its peak load to grow by 1,000 Mw. Its management is considering whether to install a nuclear power plant or several gas-fired turbines. The table below summarizes the capital and operating costs of the two options.

Fuel source	Capacity (Mw)	Capital cost ($millions)	Operating cost ($/Mwh)
Nuclear	1,000	$5,000	$5.00
Natural gas	1,000	$500	$50.00

a. Assuming that the utility's rate base would be increased by the amount of the capital cost for whichever option the management selects, what would be the earnings and regulated price of electricity under each generation alternative? Assume that the old capacity continues to generate 12 million Mwh per year, and that all the demand growth is met from the new plant.

b. Suppose the utility were expand its capacity by 1,000 Mw, but demand growth turns out to be only 4 million Mwh instead of 7. What would be the earnings and regulated price of electricity under each alternative in this case, still assuming that the old capacity continues to generate 12 million Mwh per year, and that all the demand growth is met from the new plant? Who ends up paying how much for the forecasting error?

Answer 1