Financial Management & Corporate Finance Case Study

Analyzing Impact of Regulatory Environment Changes: Case of a Power Sector Project in India

OR

Abstract:
Power sector regulator, CERC, announced its power tariff regulations for the regulatory period 2009-14. These regulations were to govern the power sector tariffs in India and consequently, the revenues for the power generation firms in that region. It mandated that the power generation units could now earn an ROE of up to 16%. This disappointed almost all the industry players but interestingly for quite opposing reasons. While firms in the business of electricity generation wanted an even higher ROE, others, including the power distribution public sector undertakings, wanted a lowering of rates. The insistence on reducing the tariff was to such that consumer interest groups lobbied for an even lower ROE than the just concluded regulation period’s (2004-09) level of 14%. On the other hand, the CERC stressed the necessity of a higher return to power sector players so that more equity investment could be attracted in this sector which was not able to meet the growing power demands in the country. The interesting aspect was that most of the major reports in the media debating on the impact of the ROE hike concluded by forecasting a better future for power generating companies. However, they did not go into much of an examination of other aspects of regulations which might have made it difficult to achieve such levels of revised efficiency, a precondition to gain from the upwardly revised tariff rates. VAI which was entrusted with the task of estimating the correct value of a new coal-based thermal power project, THE, going in for an IPO, contended that the value occurring to a power project under the new regulations would depend, to quite an extent, on the project’s efficiency and performance. The question under examination therefore investigates the regulatory environment after announcement of CERC’s 2009-14 tariff regulations with a view to estimate its impact on HTE’s valuation.

Pedagogical Objectives:

• Familiarize with Industry analysis under regulated industrial environment.
• Legal environment of business and the evaluation of its impact on industry structure and returns.
• Valuation of projects in regulated sectors.
• Costing procedure and pricing of a public utility under a regulated tariff environment.
• Implications of different proportions of domestic and foreign debt and their suitability for a project.
• Iterative calculation procedures and interdependent values in the application of loop, table, and Goal Seek functions of Microsoft Excel for valuation.
• Real Options.

Keywords : Business Environment, Capital Budgeting, Capital Structure, Central Electricity Regulatory Commission (CERC), CERC (Terms and Conditions of Tariff) Regulations (2009), Coal-Based Thermal Power Project, Industry Analysis, Infrastructure finance, Microsoft Excel, Power Sector, Project appraisal, Project Finance, Project Management, Project Valuation, Power Sector Reforms in India, Regulatory Environment, Real Options, Strategic Finance