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Saturday, January 8, 2011

Financial Management & Power Sector Series_ROE v/s ROCE

Debates still range on which is the better metric to use for performance evaluation-ROE or ROCE. Those proposing ROE take the narrow shareholder perspective but those wanting ROCE maintain that ROE may lead to too much 'leveraging' and risk taking. Notionally, the policy does permit  the CERC to adopt either approach but The National Tariff Policy and the various State policies I have seen so far seem to favour ROE as the basis for tariff determination. The D/E ratio is optimal at 70:30 for the project so focus does seem ROE.

The reason may be that the intent is to ensure that resources flow into the power sector. So the risk capital rate should be ROE. Also, interest costs are allowed as 'pass through' so the producer can earn only on his equity infusion considering that consumers pay his debt service costs.

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