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DIVERSIFICATION, DOUBLE LEVERAGE, AND THE COST OF CAPITAL
Author(s) -
Pettway Richard H.,
Jordan Bradford D.
Publication year - 1983
Publication title -
journal of financial research
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.319
H-Index - 49
eISSN - 1475-6803
pISSN - 0270-2592
DOI - 10.1111/j.1475-6803.1983.tb00339.x
Subject(s) - subsidiary , debt , diversification (marketing strategy) , leverage (statistics) , rate of return , cost of capital , capital structure , business , weighted average cost of capital , return on capital employed , economics , return on capital , monetary economics , finance , microeconomics , economic capital , financial capital , marketing , capital formation , multinational corporation , profit (economics) , computer science , individual capital , machine learning
Public utility regulators choose between “double leverage” and “independent company” approaches to determine the cost of equity capital for electric utility holding companies that have diversified and telephone holding companies that have diversified and issued parent debt. Dissimilarities between these two approaches result in significant differences in cost of capital estimates, in allowed rates of return, and in prices of utility services. No valid support for the “double leverage” approach is found after an analysis of descriptive examples and a general theoretical examination of the two approaches compared against established goals of rate of return regulation. The “independent company” approach is shown to be universally correct. The authors suggest, therefore, that only the “independent company” approach should be employed in rate of return cases of regulated public utilities whose parents own subsidiaries with unequal risk and/or whose parent has its own debt.