Public utility companies
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Why do public utility companies usually have capital structures that are different from those of retail firms?
Why are earnings before interest and taxes (EBIT) generally considered to be independent of financial leverage? Why might EBIT be influenced by financial leverage at high debt levels?
Sample Solution
Public utility companies tend to have capital structures that are distinct from those of retail firms for a variety of reasons. One major factor is the nature of their products and services, which often involve providing essential goods such as electricity or water—things that do not vary in terms of quality or price very much (Kulbir & Singh, 2016). This fact makes it difficult for these companies to increase revenues by making changes to their offerings or marketing strategies like retail firms might be able to do because there is limited scope for innovation within such regulated industries (Chuang et al., 2018). As a result, public utilities rely more heavily on debt financing since they cannot generate enough return through equity investments alone (Erlou & Famaeefard, 2009).
Another contributing factor involves taxes: since public utilities are usually exempt from corporate taxes due to their status as government-regulated entities, they typically prefer borrowing money instead which lets them spread out payments over time while still taking advantage of available deductions and credits (Erlou & Famaeefard, 2009). Additionally, this gives investors a chance to earn higher returns than with other types of stocks where any profits made will likely be subject at least partially taxed away before dispersal. Moreover, since these organizations do not face regular competition—as well as the fact that most customers have no choice but accept whatever rates set by authorities—they can usually borrow larger amounts without worrying about losing too much business due to rising prices associated with increased debt burdens (Chuang et al., 2018) . All these factors combine together explain why public utility companies tend deploy different capital structure strategies than typical retail businesses when seeking sources funding.
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