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In this paper Dr. Jeff D. Makholm responds to the 15 February 2003 edition of Public Utilities Fortnightly, in which Jonathan Lesser admonished regulators to rethink the traditional discounted cash flow (DCF) method for finding the cost of capital. Dr. Makholm refutes Mr. Lesser—and defends the use of the DCF method in ratemaking proceedings in the US. In outlining his defense, Dr. Makholm provides a broad overview of the regulatory process and the evolution of rate of return analysis. With this overview, he provides context for the role and adequacy of particular rate of return techniques within the unique administrative environment of rate cases in the US.

Dr. Makholm proposes that the DCF has endured for nearly two decades for three basic reasons: it rests on a straightforward theoretical base; it capitalizes on the depth of the US capital markets; and it employs directly the analysis of disinterested stock industry analysts. He states that these key attributes are unique to the DCF, and the methods mentioned by Mr. Lesser all have various debilitating attributes. Ultimately, Dr. Makholm states that the search to streamline rate cases lies not in Mr. Lesser’s search to replace the DCR model but instead in instituting performance-based regulation complemented by continued unbundling and deregulation.

This article is provided here with permission from Public Utilities Fortnightly, May 15, 2003, Copyright © 2003 PUR Inc., http://www.pur.com. All rights reserved.