You have been retained as an analyst to evaluate a proposal by your citys privately-owned water company
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Question:
You have been retained as an analyst to evaluate a proposal by your city’s privately-owned water company to increase its rates by 100 percent. The company has argued that at the present rate level, the firm is earning only a 2 percent rate of return on invested equity capital. The company believes a 16 percent rate of return is required in today’s capital markets.
Assume that you agree with the 16 percent rate of return proposed by the company.
- What factors need to be considered when setting rates designed to achieve this objective?
- Would your analysis differ if you knew that individuals were prohibited by law from drilling their own wells? What impact would this have on the price elasticity of demand?
- Water companies have a large proportion of fixed costs as compared with variable costs. How does this fact influence your analysis?
- Do you believe this firm (a monopolist) can earn its required 16 percent rate of return even if the public utility commission agrees this is a reasonable rate of return?
Related Book For
Entrepreneurial Finance
ISBN: 978-0538478151
4th edition
Authors: J . chris leach, Ronald w. melicher
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