The Lake Woebegone Power Company is a regulated electric utility which has equit

Question

The Lake Woebegone Power Company is a regulated electric utility which has equity with a market value of $ 1.5 billion and debt outstanding of $ 3 billion. An outside business consultant notes that this is a high debt ratio relative to the average across all firms, which is 27%, and suggests that the firm is overlevered. a. Why would you expect a electric utility to be able to maintain a higher debt ratio than the average company? b. Does the fact that the company is a regulated monopoly affect its capacity to carry debt?

Explanation / Answer

a) electric utilities are able to maintain such high debt ratios because of the nature of service offered and the cash inflows to the firm. Demand for electric utilities are more or less likely to be stable even in case of bad economic conditions as electric utilities are necessities and not luxury, thus causing these firms to have relatively stable cash inflows.

b) Yes, being a monopoly means it is not facing any market competition and doesnot face risk of eroding market share. Also being regulated means it is subject to more stringent rules and obligations making them unlikely to make discretionary expenditures as they are answerable to regulatory authorities.

Related Questions

Navigate

• Browse (All)
• Browse T
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.