New approach to estimating the cost of common equity capital for public utilities |
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Authors: | Pauline M Ahern Frank J Hanley Richard A Michelfelder |
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Institution: | 1.AUS Consultants,Mt. Laurel,USA;2.School of Business, Rutgers University,Camden,USA |
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Abstract: | The regulatory process for setting public utilities’ allowed rate of return on common equity has generally used the Gordon
DCF, CAPM and Risk Premium specifications to estimate the cost of common equity. Despite the widely known problems with these
models, there has been little movement to adopt more recently developed asset pricing models to provide additional evidence
for estimating the cost of capital. This paper presents, validates empirically and applies a general yet simple consumption-based
asset pricing specification to model the risk-return relationship for stocks and estimate the cost of common equity for public
utilities. The model is not necessarily superior to other models in its practical results, yet these results do indicate that
it should be used to provide additional estimates of the cost of common equity. Additionally, the model raises doubts as to
whether assets such as utility stocks are a consumption (business cycle) hedge. |
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