A utility company is allowed to charge prices high enough to cover all costs, in

Question

A utility company is allowed to charge prices high enough to cover all costs, including its cost of capital. Public service commissions are supposed to take actions to stimulate companies to operate as efficiently as possible in order to keep costs, hence prices, as low as possible. Some time ago, AT&T's debt ratio was about 33 percent. Some people (Myron J. Gordon in particular) argued that a higher debt ratio would lower AT&T's cost of capital and permit it to charge lower rates for telephone service. Gordon thought an optimal debt ratio for AT&T was about 50 percent. Do you agree with this and why?

Explanation / Answer

yes i agree. Gordon thought an optimal debt ratio for AT&T as it is now 50%, then theoretically, its cost of equity increases as well since its equity becomes more risky. Thus, the decrease in the cost of debt would be more than offset by the increase in cost of equity.

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