Aes Case Solution
1. How would you evaluate the capital budgeting method used historically by AES? What’s good and bad about it?
“When AES undertook primarily domestic contract generation projects where the risk of changes to input and output prices was minimal, a project finance framework was employed.”
Usually, project finance framework is used when the project has predictable cash flows, which can easily represent operating targets through explicit contract. When cash flows are certainty, the company can have higher level of leverage and it is easier to separate project assets from the parent company.
Advantages and Disadvantages: 1) Advantages a. Maximize Leverage b. Off-Balance Sheet Treatment c. Agency Cost d. Multilateral Financial Institutions 2) Disadvantages a. Projects V/S Division b. Complexity c. Macroeconomic Risk d. Political Risk:
2. If Venerus implements the suggested methodology, what would be the range of discount rates that AES would use around the world?
If Venerus and AES implement the suggested methodology, the projects would change while WACC changes.
To find WACC we must first calculate the leveraged bets for each the US Red Oak and Lal Plr Pakistan projects, using the equation unleveled beta/(1-D/V). It is easy to find debt to capital ratios, which are 39.5% for U.S and 35.1% for Pakistan, and the unleveled beta, which are both 0.25, in Exhibit 7a and 7b. Then we can obtain a leveraged beta for the U.S., 0.41, and for Pakistan, 0.3852.
Second we should find the risk free and risk premium rates. Because all debts are finance in U.S. dollar, we use the risk free rate, which is equal to U.S. T-bill, and risk premium rate, which is equal to U.S. risk premium, to calculate the cost of capital for all countries. Using equation cost of capital = Risk Free Rate + levered beta * Risk Premium, we can get the cost of capital for U.S. project, 7.27%, and for Pakistan project, 7.2%.
After that we should find the
“When AES undertook primarily domestic contract generation projects where the risk of changes to input and output prices was minimal, a project finance framework was employed.”
Usually, project finance framework is used when the project has predictable cash flows, which can easily represent operating targets through explicit contract. When cash flows are certainty, the company can have higher level of leverage and it is easier to separate project assets from the parent company.
Advantages and Disadvantages: 1) Advantages a. Maximize Leverage b. Off-Balance Sheet Treatment c. Agency Cost d. Multilateral Financial Institutions 2) Disadvantages a. Projects V/S Division b. Complexity c. Macroeconomic Risk d. Political Risk:
2. If Venerus implements the suggested methodology, what would be the range of discount rates that AES would use around the world?
If Venerus and AES implement the suggested methodology, the projects would change while WACC changes.
To find WACC we must first calculate the leveraged bets for each the US Red Oak and Lal Plr Pakistan projects, using the equation unleveled beta/(1-D/V). It is easy to find debt to capital ratios, which are 39.5% for U.S and 35.1% for Pakistan, and the unleveled beta, which are both 0.25, in Exhibit 7a and 7b. Then we can obtain a leveraged beta for the U.S., 0.41, and for Pakistan, 0.3852.
Second we should find the risk free and risk premium rates. Because all debts are finance in U.S. dollar, we use the risk free rate, which is equal to U.S. T-bill, and risk premium rate, which is equal to U.S. risk premium, to calculate the cost of capital for all countries. Using equation cost of capital = Risk Free Rate + levered beta * Risk Premium, we can get the cost of capital for U.S. project, 7.27%, and for Pakistan project, 7.2%.
After that we should find the