Question

List two advantages and disadvantages both rate of return and incentive regulations and enumerate tge alternatives to these two

Answer 1

Advantages of Internal Rate of return

• Simple to interpret. If IRR is more than project capital cost then the project is chosen, else it is rejected.
• The internal rate of return is a rough estimate and can be compared with the required rate to conclude whether to choose a project or not.

Disadvantages of Internal Rate of return

• Impractical assumptions are made while we evaluate a project using internal rate of return. Positive clash flows throughout the lifetime of the project is one such example.
• Evaluation of dependent projects is not viable using internal rate of return. For example, project A is completed only when project B is promptly done.

Investors these days use MARR, i.e. Minimum Acceptable Rate of Return to evaluate a project. It accounts for both positive and negative cash flows as well.

Advantages of incentive regulations

• Creates opportunities for firms to maximize their earnings by enhancing internal efficiency measures. This is done by reducing both capital and operating expenditures.
• From a regulatory point of view, the firms now reveal their true costs, thereby increasing the transparency

Disadvantages in incentive regulations are:

• There isn't any incentives for good service quality, reliability, or impactful social programs under pure price caps. Basically the company doesn't have no incentive to continue with the same.
• Firms tend to exaggerate costs in order to gain advantage at next review for incentives. They try to rig this system and make the most of it.

Alternative for incentive regulations could be taxation, subsidies, covering up for liabilities (paying for the damages in a firm), grants, etc. In this way, the misusing tendency of firms reduce.

Hope this helps. Do hit the thumbs up. Cheers!