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1.4 Projection of Operation and Maintenance Expenses Operation and maintenance (O &M) expenses are incurred by the City to collect and convey wastewater. O &M expenses are expensed during the current year and are not capitalized or amortized over an extended period of years. In general, operation and maintenance expenses are grouped into a number of different functional categories, planning, collection, etc. To begin the process of projecting O &M expenses over the planning horizon, escalation factors were developed, generally ranging from 3% to 3.5 HDR began with the City's projected expenses for the operating and maintenance expenses for the early years of the planning horizon. HDR then escalated the O &M expenses based upon the escalation factors. Total operation and maintenance expenses for the City are projected to be approximately $2.7 million in FY 2010. O &M expenses are projected to increase to approximately $3.3 million by FY 2017, primarily as a result of the assumed inflation over that time period. 1.5 Projection of Sewer Capital Improvement Projects Funded from Rate Revenues The City has a significant amount of local sewer capital improvement projects planned over the planning horizon. More importantly, in looking beyond the next eight years, the number and size of the replacement sewer projects is anticipated to ramp up significantly. The City and its engineering firm are in the process of developing a Water and Wastewater Asset Management Study, which includes an analysis of the local sewer collection and pumping system. The value of the Asset Management Study to this rate study is that it provided a road map of where the City should probably be positioned in eight years, as it relates to capital improvement funding from rates and capital reserve fund balances. This aspect is discussed in more detail below. There are a number of different methods that may be used to fund the projected capital improvement projects. Among the methods that may be used to finance these capital improvement projects are long -term debt, capital reserves and rates. It is through the use of a combination of these financing resources that the City can minimize their rates through time. A general financial guideline that can be used to determine proper funding levels for capital improvements from rates is that, at a minimum, a utility should fund an amount equal to or greater than annual depreciation expenses. Annual depreciation expense reflects the current investment in plant that is being depreciated or "losing" its useful life. Therefore, this portion of plant investment needs to be replaced to maintain the existing level of infrastructure. It must be kept in mind that, in theory, annual depreciation expense reflects an investment in infrastructure an average of fifteen (15) years ago, assuming a 30 -year useful (depreciable) life. Simply funding an amount equal to annual depreciation expense will not be sufficient to replace the existing or Development of the Revenue Requirement City of Pleasanton Local Sewer Rate Study "A general financial guideline that can be used to determine proper funding levels for capital improvements from rates k that, at a minimum, a utility should fund an amount equal to or greater than annual depreciation expenses. 1-4