A utility company is allowed to charge prices high enough to cover all costs, including its cost of capital. Public service commissions are supposed to take actions to stimulate companies to operate as efficiently as possible in order to keep costs, hence prices, as low as possible. Some time ago, AT&T's debt ratio was about 33 percent. Some people (Myron J. Gordon in particular) argued that a higher debt ratio would lower AT&T's cost of capital and permit it to charge lower rates for telephone service. Gordon thought an optimal debt ratio for AT&T was about 50 percent.
Do the theories presented in Chapters 14 and 15 or Corporate Finance 2nd edition by Roos, Westerrfield, Jaffe and Jordon support or refute Gordon's position?
First, according to the text, the optimal capital structure of the company is the mix of debt and equity financing that maximizes the value of the company. This value is directly related to the stock price of the company's stocks. Hence, the optimal capital structure is the debt and equity mix that maximizes the price of AT&T's common stock. ...
The solution is given in paragraph form with 233 words in total. As the concepts in the book are explained within, the solution can be used without the textbook.