The Commissioners are also of the view that the interests of the ratepayers should be safeguarded. The ratepayers should not be penalized for any change in circumstances (e. G. Excess liquid cash due to change of technological needs) resulting in inefficiency at Combat. Such risk should be borne by the Shareholders alone. The Judgment covers the fair rate of return awarded to Combat (commensurate to Its risks), the rate base and the price structure to be followed by Combat.
At the onset, we concur with Combat’s argument that their risk profile cannot be compared to that of AT due to the following: . Even though AT is in the same business of providing communication channels, yet the equipment used is vastly different I. E. Satellites versus data cables. 2. AT is a well-established utility while Combat is a new venture. Their risk profiles are not similar. 3. Considering the testimony of DRP. Myers, the beta found for AT and Combat are different thus Implying that the Investors view the Inherent risk of the companies differently.
Next, we look into the various risk factors discussed before us in order to reasonably estimate the risk inherent in Combat. Operating Risks 1 . Technological Risk: The trial staff established low technological risk by considering in hindsight the fact that Combat’s evolution was relatively trouble-free. In our opinion, this Is unjustifiable as when the company was started there was no way of knowing this and the technological risks were Immense. 2. Business Risk: There was no government guarantee for Combat. Also, considering associated with the business. . Demand Risk: The arguments put forward by the trial staff in this case are sound but do not present a case for comparison with AT&T. 4. Competitive Risk: We think that competitive risk is medium, thus deviating from both the trial staff and Combat’s stand. This is because although high risk was created due to Combat’s competitors being its customers, it was also mitigated to some extent by PC’s support. 5. Regulatory Uncertainty: Again this uncertainty of prospective regulation is reduced by expected support from FCC. . Political/alienation Risk: We agree here with the trial staffs response. The risk faced by Combat is probably Just a little greater than that faced by other international organizations operating in those countries during that time. From the above discussion, we conclude that the company faces more operational risk than that touted by the trial staff albeit it is not as high as Combat claims. Financial Risk The trial staff wants to impute the implications of a 45% debt structure to calculate the cost of capital.
This is incorrect since firstly, there were no assets that could be used as security till 1972 and secondly, this is a hypothetical situation of which there can be many. However, we are of the opinion that the debt should be imputed at a rate of 45% post-1972 as a miscalculation on part of the management should not exult in unjustified price structure for the ratepayers. Rate Base The appropriate rate base should now be calculated based on the above decision to impute debt post-1972. Pre-1972, the rate base will be the entire capital of the company.
Evaluation of Cost of Capital We disagree with the first two witnesses, namely DRP Brigham and DRP Carleton and their estimation of Combat’s cost of capital. DRP Abraham’s method takes into account 602 industrial firms and 56 utilities. These two categories of companies are not comparable for the purposes of this analysis. Also, the Andersen study using four utilities and its results is not worth considering since these utilities had a different capital structure and consequently, a completely different risk profile from that of Combat. Justification or methodology followed for calculating this. Also, we have no indication whatsoever about the nature of this premium, whether it is the risk premium for Combat or the utilities sector or the market or the country as a whole. We concur with DRP Myers’ methodology of using the CAMP for calculating the risk premium. This study further simplifies matters as the cost of equity and the cost of UAPITA is the same for this firm pre-1972 and incorporate the cost of debt post-1972.
Also that the beta in this case would be calculated on the basis of market data. Assuming the markets to be efficient implies that the appropriate risks have been implicitly factored into the prices and the beta. Based upon these estimates we will state the cost of capital to be 14%, which is the mid point found for the various risk estimates over time, taking into account a beta range from 1. 4 – 1. 7 as recommended by DRP. Myers. Pricing Structure The commissioners are of the view that Combat was injudicious in charging the axiom rates the markets could bear.
Instead, Combat should have charged rate of return that is sufficient for it to maintain: a) to cover cost of capital already committed to the enterprise over and above the operating expenses incurred; and b) to attract additional capital as needed in competitive money markets at reasonable costs. We instruct FCC and Combat to calculate the appropriate revenues for Combat in line with the preceding Judgment. Combat should be penalized 50% of the excess revenue, if any, and FCC should use this money to further infrastructure development in Communication systems.
