How do you determine the revenue requirement?

Rate of return needs to be fair to investors and reasonable from the customer’s perspective. There are different methods to establish a reasonable rate of return – a commonly applied litmus test is to determine if the rate of return allows the utility to attract additional capital to pay for its investment needs, without reaching levels of return that are expected by speculative, high-risk investors. A utility with a simple funding structure (equity plus debt) will have a cost of capital that is equal to the weighted average cost of both sources of funding (i.e., the weighted average cost of capital, or “WACC”).

Operating expenses comprise of costs related to labor, materials, depreciation, and tax, among others. In order to be included in the revenue requirement, these expenses must be necessary and prudent.