We found a match
Your institution may have access to this item. Find your institution then sign in to continue.
- Title
Required Rate of Return for Equity Capital Under Conditions of Growth and Consideration of Regulatory Lag.
- Authors
Thompson, Howard E.; Thatcher, Lionel W.
- Abstract
This paper shows the development of a method for estimating the required rate of return on equity capital for public utilities tinder conditions of growth. The distinguishing feature of the method is the calculation of the required rate of return by making the proper adjustments (for flotation costs and the appropriate market-to-book ratio) to the market-determined investor capitalization rate. If the investor capitalization rate is not adjusted upward but used as the allowed rate of return, the market price of the security will tend toward the book value.8 This fact has long plagued the advocates of the discounted-cash-flow method and caused them either to make an arbitrary upward adjustment to get the allowed rate of return or to make no adjustment and simply recommend an unreasonably low value for the rate of return. The inclusion of a sufficiently high market-to-book ratio to protect against adverse changes in the investor capitalization rate adds the missing link to the discounted-cash-flow method.9 We would hasten to state that the miss- ing link which we have added is theoretical in nature. Our method, on the other hand, is by all means pragmatic. The model presented in this paper does not pretend to eliminate the need for the reconciling role of the American system of regulation. Reasonable men will still differ. But since the assumptions and calculations are laid bare for all to see when a mathematical model is used, it is possible to assess the effects of different assumptions about parameters. This is the role of sensitivity analysis. It can only be of benefit to the regulatory process.
- Subjects
RATE of return; CAPITAL; STOCKS (Finance); INVESTMENTS; REGULATED industries; RATIO analysis; CAPITAL investments
- Publication
Land Economics, 1973, Vol 49, Issue 2, p148
- ISSN
0023-7639
- Publication type
Article
- DOI
10.2307/3145279