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Aes Approach

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AES Case study approach

Cost of Capital for Lal Pir Project
Levered Beta
Cost of Equity Calculation
Cost of Debt Calculation
Weighted Average Cost of Capital Calculation
Discount Rate Calculation
Calculating the Range of Discount Rates for AES
Cost of Equity Calculation
Cost of Debt Calculation
Weighted Average Cost of Capital Calculation
Discount Rate Calculation
If the project was in USA,
PV of Cash Flows
Project Value*

Abstract:
AES has been using a single discount rate for all of its operations – an equity discount rate of 12% based on US data. This discount rate was quite appropriate in the past when most of the operations were based in US. However, the recent expansion of AES into different geographical areas has exposed the diverse operations of the company to varied amounts of risk. The company is now contemplating the use of different discount rates for each of its projects. It is suggested that the costs of equity and debt are adjusted for sovereign spread – the difference in the riskfree rates of the local country and the US. The WACC is later adjusted for the project-specific risks based on a broad range of seven categories including exchange rates, regulatory environment, and operational complexities. It is determined that the new methodology results in a broad range of discounts rates – ranging from around 10% to 30%. However, the use of different discount rates for projects with varied risk in consistent with the theoretical basis of capital budgeting. The valuation of the Lal Pir project reveals the stark difference between the old and the new method of capital budgeting. Moreover, it is believed that the adjustments of sovereign spread and project-specific risk are consistent with the circumstances of AES. The amount of the adjustments may be disputed but any errors could be best addressed on the basis of empirical

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