UMC Finance and Ratemaking 2 — Questions and Answers
Question 1: In utility ratemaking, which component of the revenue requirement compensates investors for the use of their capital?
- Depreciation expense
- Operating and maintenance costs
- Return on rate base (Correct answer)
- Income taxes
Correct answer: Return on rate base
Return on rate base provides investors (both debt and equity holders) with compensation for the capital they have invested in utility plant.
Question 2: A utility's test year shows $500,000 in fuel costs. Regulators apply a fuel adjustment clause (FAC). The primary purpose of the FAC is to:
- Reduce the utility's rate base
- Allow automatic pass-through of fuel cost changes between rate cases (Correct answer)
- Eliminate the need for depreciation accounting
- Cap fuel spending at test year levels
Correct answer: Allow automatic pass-through of fuel cost changes between rate cases
A fuel adjustment clause (FAC) lets utilities automatically recover changes in fuel costs from customers without filing a full rate case each time.
Question 3: The 'used and useful' standard in utility regulation means that plant is included in rate base only if it:
- Was built within the last 10 years
- Is currently providing service to ratepayers and is needed for that service (Correct answer)
- Has been fully depreciated
- Received state legislative approval
Correct answer: Is currently providing service to ratepayers and is needed for that service
Regulators include plant in rate base only when it is both in service (used) and necessary to serve customers (useful), protecting ratepayers from paying for idle assets.
Question 4: Which rate design approach charges customers a flat monthly fee regardless of consumption volume?
- Inverted block rate
- Declining block rate
- Fixed customer charge (Correct answer)
- Time-of-use rate
Correct answer: Fixed customer charge
A fixed customer charge is a set monthly fee that recovers costs associated with serving a customer (metering, billing) independent of how much they use.
Question 5: When a utility commissions a cost-of-service study, the primary goal is to:
- Determine the total debt capacity of the utility
- Allocate total costs among customer classes to set equitable rates (Correct answer)
- Calculate depreciation schedules for new plant
- Measure employee productivity benchmarks
Correct answer: Allocate total costs among customer classes to set equitable rates
A cost-of-service study allocates the utility's total costs (production, distribution, customer) to each rate class so rates can be set that reflect the cost to serve each group.
Question 6: In utility finance, 'working capital allowance' in the rate base represents:
- Cash reserves set aside for major capital projects
- The amount of money utilities need to operate between billing and collection (Correct answer)
- Long-term debt outstanding at year-end
- Accumulated depreciation on plant assets
Correct answer: The amount of money utilities need to operate between billing and collection
Working capital allowance recognizes that utilities must pay operating expenses before collecting revenues from customers, and investors deserve a return on this cash need.
Question 7: A utility files for a rate increase using a 'future test year.' This means the revenue requirement is based on:
- Actual costs from the most recently completed 12-month period
- Projected costs for a future 12-month period after the rate case concludes (Correct answer)
- An average of the past five years of costs
- Historical costs adjusted only for inflation
Correct answer: Projected costs for a future 12-month period after the rate case concludes
A future test year uses forecasted costs and revenues for a future period, so rates reflect what costs will be when the new rates take effect rather than past costs that may already be outdated.
UMC Finance and Ratemaking 2
In utility ratemaking, which component of the revenue requirement compensates investors for the use of their capital?