prices. The drawback is that this method could lead to overcapitalization. For example, if the rate of return is set at five percent, then the firm can charge A public utility company (usually just utility) is an organization that maintains the infrastructure for a public service (often also providing a service using that infrastructure). Public utilities are subject to forms of public control and regulation ranging from local community-based groups to statewide government monopolies. Public utilities are meant to supply goods and services that are cons Ensuring services are of the highest quality and responsive to… E… Average production costs: the utility calculates the break-even point and then sets the prices equal to average costs. The equity issue is basically overcome since most of the market is being served. As a defect regulated firms do not have incentives to minimize costs. Rate of return regulation: regulators let the firms set and charge any price, as long as the rate of return on invested capital does not exceed a certain rate. This method is flexible and allows for pricing freedom, forcing regulators to monitor prices. The drawback is that this method could lead to overcapitalization. For example, if the rate of return is set at five percent, then the firm can charge a higher price simply by investing more in capital than what is actually needed (i.e., 5% of $10 million is greater than 5% of $6 million). Price cap regulation: regulators directly set a limit on the maximum price. This method can result in a loss of service area. One benefit of this method is that it gives firms an incentive to seek cost-reducing technologies as a strategy to increase utility profits. Utility stocks are considered stable investments because they typically provide regular dividends to shareholders and have more stable demand. Even in periods of economic downturns characterized by low interest rates, such stocks are attractive because dividend yields are usually greater than those of other stocks, so the utility sector is often part of a long-term buy-and-hold strategy. Utilities require expensive critical infrastructure which needs regular maintenance and replacement. Consequently, the industry is capital intensive, requiring regular access to the capital markets for external financing. A utility's capital structure may have a significant debt component, which exposes the company to interest rate risk. Should rates rise, the company must offer higher yields to attract bond investors, driving up the utility's interest expenses. If the company's debt load and interest expense become too large, its credit rating will deteriorate, further increasing the cost of capital and potentially limiting access to the capital markets.