Residuos de construcción

In our methodology paper, we highlighted that equity injections, including the issuance of new equity and retained earnings are viable options to ease a financing constraint. We do not regulate dividends as part of our regulatory framework. It is for management and investors to decide a company’s dividend policy. Nevertheless, we need to make some assumptions about dividends for the purposes of modelling cash flows.

We have used a dividend yield of 5% (about 70% of the cost of equity). This implies dividend growth of 2.1% given the cost of equity. The dividend yield is consistent with the view of the industry as an income stock. The dividend yield is lower than for the 2004 price review as we consider equity retention to be an important part of the way forward necessary to ease a financing constraint. The growth assumption for the period 2010-15 is broadly consistent with the GDP growth calculated from the average of independent forecasts of GDP (published by HM Treasury) for the period until the end of 2013 and the Government’s forecasts of long-term growth beyond then.

We remain of the view that equity injections or rights issues are legitimate means of easing the financing constraint brought about by continuing large capital programmes. This is particularly the case where new equity supports RCV growth for a company operating under a stable regulatory regime. Three companies (Thames, Bristol and South East) had weaker financial ratios in our financeability assessment at our cost of capital. These companies have the largest RCV growth assumption in 2010-15 and as a result, weaker financial ratios arise. Accordingly, in our financial modelling for Thames, Bristol and South East we have assumed equity injections amounting to 20%, 10% and 7.5% of opening notional equity respectively to relieve the financing constraint.

For these three companies, we also included an allowance to recognise the transaction costs associated with the cost of new equity issuance, calculated as 5% of equity raised. NERA, in its advice to Water UK, suggests transaction costs associated with equity issuance are estimated to be about 5%. This is consistent with evidence elsewhere, including for example, Smithers’ report for Ofgem.

Ultimately, it is for the companies and their investors to determine how best to finance the investment programme in reaction to the overall price limit package. It is possible that the debt markets could recover such that companies will be able to issue index- linked debt either directly or through swap arrangements. This would be an alternative means of easing the financing constraint. If these companies are able to issue more index-linked debt, consumers will not be disadvantaged. This is because we will recover the costs we have assumed for the issuance of new equity at the next price review in the event that the company does not issue equity in the period 2010-15 to finance the

investment programme,

The dividend yield we have assumed for the issuance of new equity is consistent with that on existing equity. This is consistent with the view that the purpose of the new equity is to fund growth of the RCV.

5.7 Taxation

Profits need to be sufficient to remunerate investors and lenders, but they also need to cover business taxes. The financial projections show effective current tax rates of about 16% for the industry. This reflects the relatively high gearing of the industry as a whole and its capital intensive nature. For most companies, the impact of tax payments on customers’ bills is lower over the period 2010-15 than in 2005-10. This is primarily because of a reduction in the allowed rate of return and hence our projections of operating profit and a lower corporation tax rate (28%) than at the last price review.

We set out our approach to calculating tax in respect of the tax shield on interest payments in our methodology paper. In summary, for companies with actual gearing above the level underpinning the cost of capital, we have calculated tax based on the companies’ actual gearing projections in their business plans. For companies whose business plan gearing projections are below 57.5%, we have calculated their tax calculated on the basis that they had geared up to 57.5%.

Companies with relatively low levels of gearing raised concerns that our policy would disadvantage them as it would prevent them from recovering sufficient revenue to finance their functions in circumstances where the company is not able to match the assumed gearing level.

We interpret our duty to ensure companies can finance their functions to mean that price limits will allow an efficiently financed company to deliver its services to consumers and earn a return on capital, on average, at least equivalent to the cost of capital.

Our policy on the approach to tax brings it into line with our assumption on gearing. It is just one policy within the price setting package. It is for the companies, their

shareholders and management to determine the most efficient financing structure to meet their circumstances within the price setting package. In addition, our approach to tax is consistent with other regulators, for example the approach adopted by Ofgem for its 2004 and 2009 electricity distribution reviews.

We have tempered the impact through our assumption of lower notional gearing for the small companies. In reality, this has affected just one water only company for our final determinations.