The Regulated Firm and the DCF Model: Some Lessons from Financial Theory.

This paper explores lessons from established financial theory for allowed rate of return calculations within the constant-growth dividend (DCF) framework. Analysts using this model have been wedded to the conventional cost-of-equity formula. The authors set forth equivalent alternatives which make the analysts' task easier, more precise, and more confident. What is even more important, they derive a set of consistency conditions that must be observed for the appropriate use of the model. A basic capital-market principle is used to determine an alternative, flotation-cost adjusted, rate of return, an expression which provides useful insights for regulatory participants. Copyright 1990 by Kluwer Academic Publishers