Split cost of capital

In effect

The split cost of capital refers to splitting the cost of capital into different allowed rates of return to reflect the contrasting risks for various aspects of a regulated business.

Current practice is to allow a regulated firm to earn a single weighted average cost of capital (WACC) on both new capital expenditure and the firm’s existing regulatory asset base (RAB).

In contrast, the split cost of capital specifies distinct rates of return to reflect different allowances for risk for:

  • the RAB
  • different forms of capital expenditure.

We released the information paper on the split cost of capital  on 4 February 2014.

This information paper explains the ‘split’ cost of capital concept, its rationale and its potential for application in the Australian regulatory context. The paper was prepared taking account of submissions received on the Discussion Paper published on 3 April 2013.

The QCA proposes to conduct further investigation of the split cost of capital concept in the course of ongoing price determinations.

On 26 April 2013 we released the discussion paper on the split cost of capital for public comment.

This discussion paper explores the concept of split cost of capital in more detail and assesses its potential application in the Australian regulatory context. By identifying the cost of capital for the different components of the business, it is expected that the paper will better inform our understanding of the revenue requirement for regulated firms.

Five submissions were received.

Investors need assurance that they can expect to recover their investment and earn a normal commercial return on their investment recognising the relevant risks that they face. There is evidence that certain regulated businesses face relatively low risks on investments that have already been made but may face higher risks on their business operations and future investments.

On the basis of these different risk profiles, a ‘split’ cost of capital concept has been proposed by Professor Dieter Helm of Oxford University.

The QCA is examining the split cost of capital concept.