Brian Baker A35020136 FI 451 S.

1 3/19/2007

Case 3: Globalizing the Cost of Capital and Capital Budgeting at AES

Question 1 Explain and commen on !e capi al "#d$e in$ me !od #%ed !i% oricall& "& AES. I% !ere a need 'or c!an$e( Explain. Question 2 I' )ener#% implemen % !e %#$$e% ed me !odolo$&* +!a +ill "e !e ad,#% ed di%co#n ra e 'or !e -ed .ak pro,ec /0SA1 and !e 2al 3lr pro,ec /3aki% an1( Question 3 4alc#la e !e e''ec !a a re5i%ion o' i % co% o' capi al +ill !a5e on !e 2al 3lr pro,ec 6% 73). 4ommen on !e re%#l %.

Case 3: Globalizing the Cost of Capital and Capital Budgeting at AES

Q.1 A !e AES corpora ion capi al "#d$e in$ +a% !i% oricall& a 5er& %imple me !od* !a +a% #%ed 'or all pro,ec % "ein$ examined* re$ardle%% o' $eo$rap!ical loca ion. 8!i% me !od en ailed 4 r#le% +!ic! +ere9 all reco#r%e de" +a% deemed $ood* !e economic% o' a $i5en pro,ec +ere e5al#a ed a an e:#i & di%co#n ra e 'or !e di5idend% 'rom !e pro,ec * all di5idend 'lo+% +ere con%idered e:#all& ri%k&* and a 12; di%co#n ra e +a% #%ed 'or all pro,ec %. 8!i% me !od +orked 'la+le%%l& +!en implemen ed in !e 0.S.* "# +!en i "e$an "ein$ applied o in erna ional pro,ec %* i +a% $i5in$ !e compan& #nreali% ic 73) 5al#e%. <!ile %ome concern exi% ed* !a5in$ no al erna i5e* !e& con in#ed o #%e !e ori$inal me !od. B& 'ailin$ o ake in o acco#n increa%ed <A44* c#rrenc& ri%k* poli ical ri%k* and %o5erei$n ri%k* !e compan& !ad de5eloped pro,ec % !a "e$an 'ailin$ in !e earl& 20006%. 8!e mi% ake "& !e compan& de% ro&ed i % % ock price and marke capi ali=a ion* lo%in$ million% o' % ock!older% e:#i & in !e proce%%. 8!e de" % r#c #re ca#%ed %i$ni'ican c#rrenc& ri%k 'or "o ! !e paren AES and i % %#"%idiarie%. A% %!o+n in ex!i"i 6* de" +a% denomina ed in 0S> 'or !e %#"%idiarie%* +!ile !e& +ere "rin$in$ in re5en#e% in 'orei$n c#rrencie%. 8!e paren companie% al%o lo% ca%! 'lo+% +!en deprecia ion occ#rred %ince !e mone& made "& %#"%idiarie% +a% +or ! %#"% an iall& le%%* a' er de5al#a ion% o' 'orei$n c#rrencie%. .ne %#c! example i% !e Ar$en inean pe%o* +!en i lo% 40; o' i % 5al#e on i % 'ir% da& o' radin$ a% a 'loa . <i ! %#c! enormo#% o5er%i$! % "& mana$emen * and drama ic reali=a ion% o' di''erin$ ri%k le5el% acro%% marke %* i 6% :#i e apparen AES m#% make a c!an$e o i % capi al "#d$e in$ % r#c #re* i' i i% o %#r5i5e.

Brian Baker A35020136 FI 451 S. 1 3/19/2007 Q.2 I' )ener#% and AES implemen !e %#$$e% ed me !odolo$&* !e pro,ec % +o#ld c!an$e dra% icall& d#e o a c!an$e in <A44. 8o 'ind <A44 +e m#% 'ir% calc#la e !e le5era$ed "e a% 'or eac! !e 0S -ed .ak and 2al 3lr 3aki% an pro,ec %* !e e:#a ion #nle5eled "e a/1?/de" o capi al1 +ill "e #%ed. 8!e #nle5eled "e a can "e 'o#nd in ex!i"i 7"* and i% .25 'or "o ! pro,ec %. 8!e de" o capi al ra io% can "e 'o#nd in ex!i"i 7a* 'or !e 0.S. i i% 39.5;* and 'or 3aki% an i i% 35.1;. B& pl#$$in$ !e n#m"er% in o !e e:#a ion a le5era$ed "e a can "e 'o#nd 'or !e 0.S. i i% .41* and 'or 3aki% an i i% .3@52. 8!e nex % ep +o#ld "e o 'ind !e co% o' capi al +!ic! i% #l ima el& di''eren 'or eac! co#n r&* "# #%e% !e 0.S. ri%k 'ree and ri%k premi#m ra e%* "eca#%e all de" i% 'inanced in 0S>. 8!e co% o' capi al i% e:#al o 0.S. 8?"illA le5era$ed "e a /0.S. ri%k premi#m1. For !e 0.S. pro,ec i i% 4.5;A.41/7;1 +!ic! i% e:#al o 7.37;. For !e 3aki% an pro,ec i i% 4.5; A.3@52/7;1 +!ic! i% e:#al o 7.2;. 7o+ !e co% o' de" m#% "e 'o#nd* "& #%in$ !e 'orm#la 0.S. ?"illA de'a#l %pread. Bo ! !e 0.S. and 3aki% an pro,ec % !a5e e:#al %pread% o' 3.47;* !ere'ore "o ! &ield !e %ame co% o' de" . 3l#$$in$ in !e n#m"er% &o# !a5e* 4.5;A3.47; +!ic! i% e:#al o @.07;. 8!i% clearl& doe% no make %en%e $i5en !e 5a% di''erence% in !e marke % % r#c #re o' eac! co#n r&* !e poli ical ri%k in5ol5ed. 8o ad,#% 'or !e%e 'ac or% !e %o5erei$n ri%k m#% "e aken in o acco#n * +!ic! can "e 'o#nd in ex!i"i 7a. 8!e %o5erei$n ri%k 'or !e 0.S. i% a% expec ed 0;* "# 'or 3aki% an i% a % a$$erin$ 9.9;. 8o ree5al#a e !e co% o' capi al and co% o' de" !e %o5erei$n ri%k i% added o !em. 8!i% re%#l % in !e 0.S.6% "ein$ con% an and 3aki% an6% co% o' capi al ri%in$ o 17.1; and i % co% o' de" ri%in$ o 17.97;. Finall& +i ! e5er& !in$ el%e calc#la ed i 6% po%%i"le o calc#la e !e <A44* #%in$ !e 'orm#la $i5en on pa$e 7. I con%i% % o' le5era$ed "e a /co% o' capi al1 A >e" o capi al /co% o' de" 1 /1? ax ra e1. For !e 0.S. <A44B 6.4@;* and 'or 3aki% an <A44B 15.93;. /E:#a ion +i ! n#m"er% %!o+n on a ac!ed pa$e1 8!e 'inal % ep i% o a$ain '#r !er ad,#% !e <A44 accordin$ o i % ri%k %core* 'o#nd on pa$e 9 and ex!i"i 7a. 0%in$ !e %#mma ion o' !e %core% m#l iplied "& !e $i5en +ei$! % !e ri%k %core i% calc#la ed. /S!o+n on pa$e 9 o' !e ca%e1. 8!e 0.S. ri%k %core i% a%%#med o "e 0* %ince e5er& !in$ i% in 0S> and !e 0.S. pro,ec % <A44 i% alread& acco#n in$ 'or !e ri%k. 8!e 3aki% an ri%k premi#m i% calc#la ed o "e 1.425* and +i ! eac! poin e:#alin$ 500 "a%i% poin %* 1.425C500B 705"pB 7.05;. 8!i% n#m"er i% direc l& acked on o !e exi% in$ 3aki% an <A44 o come o# +i ! 15.96;A7.05;B 23;* +!ic! i% !e 'inal <A44 calc#la ion 'or !e pro,ec . B& akin$ in o man& more 'ac or% !an pre5io#% model% allo+ed i i% clear !a !e <A44 'or "o ! !e 0.S. and 3aki% an pro,ec % $rea l& di''er 'rom !e 12; % andard #%ed !i% oricall&. 8!e 0.S. pro,ec %#ddenl& look% m#c! more 'a5ora"le* +!ile !e 3aki% an pro,ec i% #nlikel& o "e accep ed +i ! %#c! a !i$! +ei$! ed a5era$e co% o' capi al a ac!ed o i . Q.3 0%in$ !e ca%! 'lo+% $i5en in ex!i"i 12 i i% po%%i"le o calc#la e !e 73) 'or !e pro,ec %* and c!an$e !e co% o' capi al in !e 3aki% an pro,ec o explore !e e''ec %. 0%in$ excel

Brian Baker A35020136 FI 451 S. 1 3/19/2007 o calc#la e !e ca%! 'lo+% /%!o+n on %epara e %!ee 1 a !e ori$inal 12; di%co#n ra e* !e 23.1; 'or 3aki% an* and 6.45; 'or !e 0.S. i i% ea%& o compare !e di''erence% in 73). 8!e ori$inal 12; di%co#n +o#ld &ield a 73) o' D505.51 million* !e 3aki% an 23.1; di%co#n ra e +o#ld &ield a D290.@3 million 73)* and !e 6.45; 0.S. di%co#n ra e +o#ld &ield a D744.0@ million 73). I i% :#i e apparen !a !e 3aki% an pro,ec 6% 73) %#''er% $rea l& 'rom i % !i$! <A44* comin$ in D214 million le%% !an +i ! !i% orical model* and D453 million le%% !an +i ! !e 0.S. di%co#n ra e. <i ! %#c! lo+ 73) comin$ 'rom !e 2al 3lr pro,ec i % 5al#e co#ld "e reac!ed "& !e 0.S. pro,ec +i !in a"o# 6 &ear%. 8!i% i% like %a&in$ !a d#e o %#c! ri%k& 'ac or%* incl#din$ poli ical ri%k* i i% #nrea%ona"le o a%%#me !a !e pro,ec +o#ld opera e lon$er !an 6 &ear% in 3aki% an "e'ore i 6% #na"le o con in#e* #na"le o recei5e an& '#r !er ca%! 'lo+%* and #na"le o reclaim a%%e %. >#e o %#c! !i$! di%co#n in$* and implied ri%k* i i% pro"a"l& no in !e compan&6% "e% in ere% o p#r%#e pro,ec % in 3aki% an* and o look 'or pro,ec % +i ! le%% ri%k and lo+er <A446%.