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How, then would cable systems' profits be affected by a 16.5%

copyright payment and a concommitant rise in subscriber rates?

Revenues would be unchanged, while operating costs would increase

sharply by the amount of the copyright payments.

There would

be some small offsetting changes in other incremental costs,

resulting from the saving achieved by not serving the subscribers who

do not purchase service at the higher price.

For typical systems,

there are rather small costs of installing additional drop lines,

additional maintenance and billing expenses and slightly higher

taxes and dues related to numbers of subscribers.

In consequence, the net effect of allowing higher subscriber

rates in conjunction with 16.5% copyright fee payments would be to

reduce rates of return to nearly the same levels as would be

achieved by holding subscriber rates unchanged with the same 16.5%

copyright fees.

In addition, penetration would be lower, providing

a narrower base for future leased-channel services capable of

generating additional payments from cable systems to program suppliers.

We remind the reader that the discussion in the preceeding

several paragraphs assumed a degree of upward price adjustment which

has not been observed.

In the remainder of this study we adhere

to a fixed monthly price of $5.00 1 for maximum cable broadcast

service allowed by the Fcc rules. 8/

An analysis of the profitability of systems under the alternative

assumption of higher rates and consequently reduced penetration

would yield approximately the same findings.

7 Plus $1.00 for second television sets in 20% of households. 8 One other reminder may be in order. Since we are considering all

prices and costs in 1972 terms, increases in the monthly subscription rate at about the rate of increase of consumer prices generally will not contradict our observation that real subscription rates cannot be adjusted.

MEASUREMENT OF CABLE SYSTEM PROFITABILITY

To summarize the profitability of the typical cable systems

of this study we will calculate the (pre-tax) financial rate of

return on total capital invested in each system.

The financial

(or internal) rate of returng/is the single comprehensive measure

of investment in a cable system.

Unlike ratio measures for a

particular year (e.g. net revenues divided by total capital) it

correctly recognizes the opportunity cost of front-end financing,

i.e. that several years are required before systems achieve full

penetration, during which time invested funds are needed.

Using

the financial rate of return permits us to compare the profitabil

ity of funds invested in CATV systems with other types of invest

ments, and thus the likelihood of cable systems being constructed.

The rate of return required to induce investment in a cable

system will depend on the proportion of total capital which can be

obtained through debt instruments and the associated borrowing

rates, and the minimum return demanded by equity investors.

Be

cause the cable industry more closely resembles a high-risk growth

industry than a public utility, at least at the present time, both

lenders and investors demand higher rates of return than for

seasoned investments.

9 The internal rate of return is that discount rate which equates

the present value of revenues and costs over the lifetime of the system. For further discussion, see Comanor and Mitchell, "Cable Television and the Impact of Regulation," p. 184.

For this study we have held both revenues and cost at 1970

price levels over the full life of the cable system.

Financial

measures are consequently in real (constant dollar) terms.

The

corresponding rate of return concept is the financial return

which would occur if prices did not rise throughout the economy :

whereas in an inflationary period, investors expect price increases

and demand higher returns in money terms to compensate them for

the otherwise reduced value of their funds when their investment

is recovered.

Thus if investors expect a 4% rate of inflation

to continue indefinitely and will invest in enterprises comparable

to cable television only when they return 15% on average, the

required rate of return in constant prices would be 11%.

A detailed investment survey 10 of the CATV industry in late

1971 reports that mature cable companies with demonstrated earnings

have found long-term credit expensive, and that institutional

investors are looking for a 15% return as a combination of interest

and equity appreciation.

As a standard of minimum profitability

necessary to generate investment in new cable systems, we will use

a 10% constant-dollar financial rate of return on total capital.

This is on the low side of recent financing experience of established

CATV companies, and would therefore apply to new systems constructed

by the larger multiple system owners today.

New CATV firms lacking a

track record will face higher costs of capital and will require

somehwat higher rates of return to justify their construction.

10/

& Stieglitz, Inc., "The Cable Television Industry."

RESULTS--AN EXAMPLE

We are now prepared to analyze the financial results for typical

systems in the several market situations discussed earlier.

For

each system, the computer simulates the complete revenue and cost

experience to be expected, using the parameters supplied by the

analyst.

The detailed cost and revenue schedules have been built

into the Comanor-Mitchell computer program, modified to include

the changes in FCC rules, penetration and costs discussed earlier

and in the appendix of this study.

As an example, consider the abstract of the computer output

reproduced in Table 3

Part A indicates that this example is

representative of a 25,000 subscriber system located near the middle

of a top 50 market. Density is assumed to be 200 homes per mile, and

family income $12,200.

Annual subscriber rates are $62.40, correspond

ing to $5.00 per month plus a small additional amount for second

sets.

Since this is a central urban location, 20% of the cable

miles are underground, and standard local origination equipment

has been budgeted.

Revenue from advertising on the cablecasting

channel has been estimated at $2.20 per subscriber annually.

The

table of signals carried shows that 3 VHF networks plus one viewing

test network are available off-the-air.

In addition there is one

UHF independent and a VHF educational station.

In addition to these

broadcast signals, the cable system imports two independents and

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