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In addition, Mitchell uses the most pessimistic extant statistical study to project subscriber demand in the top 100 markets. This study predicts that only 22 to 45 percent of homes passed in these

largest markets will eventually subscribe. The NCTA's own projections, obtained from a survey of its members, place mature penetration at 65 percent of homes passed, a statistic which we accept as the best informed estimate of cable potential in these markets.

In the analysis described below, we have reestimated the prospective profitability of cable television, and we reach much more optimistic conclusions. While we utilize Mitchell's cost parameters throughout with only minor modifications, we are confident that these estimates are accurate only for systems of approximately 10,000 subscribers at maturity. For smaller systems, Mitchell's cost estimates are too high and for larger systems they are too low. Minor modifications have been made in the extent of underground construction mandated by local communities and in the temporal pattern of investment. Otherwise, our only adjustments in the basic assumptions employed by Mitchell involve projections of mature subscriber levels in the top 100 markets and the rate of growth of revenues per subscriber. When the cable industry's own projections of these magnitudes is substituted for Mitchell's unrealistically low estimates, profitability is increased substantially. The difference between our estimates, based upon a conservative 2 percent growth in revenues per subscriber, and Mitchell's are presented in Table A-1.

'Don Andersson, The CATV Industry - Current Subscriber Penetration, Projected Subscriber Growth, Capitalization, by 5 Year Periods 1972-1992. With Special Emphasis on Existing and Potential Cable Systems Within 35 - Mile Zones on the Top-100 Television Markets.

B. KEY VARIABLES IN CALCULATING CABLE SYSTEM PROFITABILITY

This section describes the calculations performed in determining cable system profitability and introduces the most important variables that affect these calculations.

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Critical to Mitchell's study and our calculations is the internal rate of return--a fundament al measure of the profitability of capital investments. The internal rate of return on any investment project is that discount rate which equates total future discounted revenues to total discounted future costs. Since the discounted value of any revenue or expense item is directly proportional to its absolute magnitude and inversely proportional to its temporal distance from the present, both the timing and the magnitude of revenue or expenditure items play a critical role in the final calculations. This is not an idle point, as we shall see, for Mitchell has made some very important implicit assumptions about the timing of both revenues and costs.

The precise method for calculating the value of the rate of return is easily described. If we call p (t) the average revenue per subscriber at time t and S (t) the average number of subscribers at time t, the present value of all future revenues is:

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Defining operating costs in each period as OC (t) and capital outlays as
K(t), we may express the present value of all future outlays as:

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That cable television is not courting bankruptcy is obvious from a perus al of these estimates for a typical 10,000 subscriber system. The empirical details and analytical techniques which compel such a conclusion are contained in the five principal sections of this paper which follow and in a comprehensive statistical appendix,

Section B details the important parameters involved in calculating the rate of return on cable-system investment. Section C reviews the NCT A report's crucial assumptions, suggesting more reasonable alternatives in several instances. Section D reviews the terms obtained by system owners in recent mergers, deriving from these price estimates imputed expected future growth of revenues and profits. Section E contains the results of our calculations, including an examination of the effects of alternative copyright fee schedules. Finally, Section F is a full statement of our conclusions. The Appendi of the report, a separate volume, contains the voluminous computer printouts which define the detailed calculations of the results obtained.

B. KEY VARIABLES IN CALCULATING CABLE SYSTEM PROFITABILITY

This section describes the calculations performed in determining cable system profitability and introduces the most important variables that affect these calculations.

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Critical to Mitchell's study and our calculations is the internal rate of return--a fundamental measure of the profitability of capital investments. The internal rate of return on any investment project is that discount rate which equates total future discounted revenues to total discounted future costs. Since the discounted value of

any revenue or expense item is directly proportional to its absolute magnitude and inversely proportional to its temporal distance from the present, both the timing and the magnitude of revenue or expenditure items play a critical role in the final calculations. This is not an idle point, as we shall see, for Mitchell has made some very important implicit assumptions about the timing of both revenues and costs.

The precise method for calculating the value of the rate of return is easily described. If we call p (t) the average revenue per subscriber at time t and S (t) the average number of subscribers at time t, the present value of all future revenues is:

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Defining operating costs in each period as OC (t) and capital outlays as
K(t), we may express the present value of all future outlays as:

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Combining these two formulas gives us the equation to be solved for r once all revenue and cost data are entered:

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As the formula for calculating the internal rate of return implies, revenues per subscriber, p(t), must be computed for all future time periods. These revenues are obtained from subscribers' monthly fees, the charge for second or third connections within the subscribing home, installation fees, advertising revenues, and revenues from leasing channels to independent suppliers of entertainment fare. Data on monthly fees currently realized by cable systems are easily obtained, but the future pattern of these fees is not so easily ascertained since changes in the monthly fee must typically be approved by municipal licensing authorities. In addition, there are only indirect data on the extent of "secondary' fees from households electing to connect more than one receiver to the cable.

More speculative is the magnitude and rate of development of "ancillary revenues"--from such sources as advertising, pay-cable, and other services provided in addition to retransmissions. Most of these sources are only beginning to develop at present, but most participants in the industry expect these revenues to grow substantially in the near future.

Mitchell's approach to estimating the future pattern of revenues per subscriber is quite simple. He assumes that the monthly fee is $5 and that 20 percent of all subscribers elect to connect a second set at $1 per month. Advertising revenues are projected at $2. 20 per subscriber per year. All of these estimates are projected to grow at an annual rate of zero percent per annum. Other ancillary revenues are ignored.

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