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Considerations When Evaluating the Effects of Regulation

Considerations When Evaluating the Effects of Regulation

The laws and regulations in a market can take different structures. Further, the laws can affect industries and individual companies differently. Consequently, regulation analysts need to understand and predict the impact of proposed new regulations. Similarly, they should analyze varying regulations and project their impact on future expectations of the companies and industries. This assessment of the impact of regulations on the expectations of industries and companies assists analysts to utilize appropriate valuation tools to come up with fair values for business and investment recommendations.

Steps of Evaluating the Effects of Regulation

1. Assessment of the Possibility of Regulatory Change

A regulatory analyst would need to evaluate the probability of the proposed regulation being implemented. To do this, an analyst will have to comprehend the regulator’s objectives, the cost-benefit analysis utilized by the regulator, and the level of participation of the regulated companies. The analyst might also want to include public and political pressure.

2. Assessment of the Effect of Regulatory Change on a Sector

The analysis incorporates an analyst’s or an investor’s judgment on the effect of regulations on:

i. Revenues

The regulations in a market might induce limits on the prices, rents, tariffs, and the charged fees to protect consumers. Moreover, certain rules might ban some products or services. Therefore, an analyst would need to approximate the impact of such regulatory interventions on the companies’ income, if all entities in the market will be affected uniformly.

ii. Cost Effect

Submitting to specific regulations results in an additional cost for the companies. For instance, these costs could increase operating expenses for a manufacturing company if the regulation needs the incorporation of new safety traits or new equipment. Therefore, an analyst would need to approximate such costs and include their effect on the anticipations of a company’s profitability.

iii. Business Risk

Regulations can involve fines, compensation to customers, or banning some business activities. Such occurrences are difficult to anticipate. Moreover, the impact of these regulations is hard to quantify. Therefore, an analyst should include such incidents when approximating their probabilities or determining the risk in the discount rate used to determine a company’s value.

Question

The regulatory authority in a country has proposed new regulations on the logistic procedures, limitation of age, and pollution caused by industrial trucks. An equity analyst wants to evaluate the effects of these new regulations on a specific manufacturing company. What would most likely be the significant factor to be considered by the analyst?

  1. The methods and techniques utilized by the regulator in cost-benefit analysis of the regulations.
  2. Variation of costs associated with the purchase, operation, and maintenance of the trucks.
  3. The positive effect of decreased pollution on public health and resulting healthcare expenses saving in the broad society.

Solution

The correct answer is B.

The analyst would need to comprehend and analyze the effect of the proposed new rules on the performance of the company.

A and C are incorrect. are associated with cost-benefit analysis, which is carried out by the regulatory institution.

Reading 8: Economics of Regulation

LOS 8 (i) Describe the considerations when evaluating the effects of regulation on an industry.

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