Globalizing the Cost of Capital and Capital Budgeting at AES - Case Solution
This case study "Globalizing the Cost of Capital and Capital Budgeting at AES" grants the students the opportunity to calculate the cost of capital for 15 different projects around the world. AES Corp suffered heavy losses from currency devaluations in South America and regulatory changes in other countries. Its director for corporate planning comes up with a method to take into account the various risks associated with the project and other factors in every country. This method is designed to compute the cost of capital for the corporation's projects which varies from case to case.
Case Questions Answered
- How would you evaluate the capital budgeting method used historically by AES? What's good and bad about it?
- If Venerus implements the suggested methodology, what would be the range of discount rates that AES would use around the world?
- Does this make sense as a way to do capital budgeting?
- What is the value of the Pakistan project using the cost of capital derived from the new methodology? If this project was located in the U.S., what would its value be?
This case solution includes an Excel file with calculations that will be available after purchase.
This case solution includes an Excel file with calculations.
1. How would you evaluate the capital budgeting method used historically
by AES? What’s good and bad about it?
The capital budgeting method of AES was fairly simple and straightforward. Because they only had domestic contract generation projects at the beginning, in which the price of output and input did not fluctuate much, the method only had three assumptions.
First, all dividend cash flow was equally risky.
Second, the equity discount rate for the dividends from the project was a 12% discount rate for all projects.
Third, use a project finance framework for financing the project, and it has a non-recourse debt term.
The following table summarizes the advantages and disadvantages of the model:
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