Aes Case

(5 points) How would you evaluate the capital budgeting method (12% rule) used historically by AES? Discuss your thoughts in light of the past business situation and the current business situation of AES.

2. (10 points) Given AES's pyramid ownership structure, does the 12% discount rate (applied to dividends at the parent company level) properly reflect the overall group leverage? In particular, does the 12% discount rate result in the projects' hurdle rates (at the subsidiary level) that are likely too high or too low? Explain briefly.

HINT: Keep in mind that the parent company own equity stake in the subsidiaries, and therefore the return on asset for the parent is the return on equity for the subsidiaries. The return on asset of the subsidiaries can then be calculated by mixing the return on equity and the return on debt together, just as in WACC. This process then trickles down as some subsidiaries own other subsidiaries and so on down the chain.

3. (10 points) If Venerus implements the suggested methodology, what would be the range of discount rates that AES would use around the world?

Note the following steps: (i) adjust the costs of debt and the costs of equity to reflect country risk, (ii) calculate WACC using the adjusted costs of debt and costs of equity from (i), and (iii) add additional idiosyncratic risk adders to obtain adjusted WACC.

4. (5 points) Conceptually, does the suggested methodology make sense as a way to incorporate country and political risks into capital budgeting? Does this methodology double or triple count some of the risks? From AES (or any MNC for that matter)'s perspective, should idiosyncratic risk be compensated for?

5. (10 points) What is the value of the Pakistani project using the cost of capital derived from the new methodology? If this project were located in the U.S., what would its value be? What explains the difference? Please use the unlevered cash flows with TV given in Exhibit 12 as the free cash flows.

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