Aes Case

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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?

Venerus framework consisted of fairly simple set of rules in which a 12% discount rate was used for all the projects and he felt that this model worked fairly well in a world of domestic contract-generation projects. After AES’s international business expansion the model become increasingly strained with the expansions in Brazil and Argentina because hedging key exposures such as regulatory or currency risk was not feasible. Based on the facts of 15 sample projects in different countries in the world, in order to calculate the range of discount rates around the world, we should find the highest and lowest WACC in 15 samples, which should be the WACC of USA and WACC of Argentina, because USA has the highest credit rating and Argentina has the lowest credit rating in 15 sample projects.
First, we identified unlevered beta for USA and Argentina from Exhibit 7b are 0.25 for USA because its contract generation project and 0.5 for Argentina because of competitive supply project.
We found the Debit to Capital Ratio for USA and Argentina in Exhibit 7a are 39.5% and 40.8% respectively. By substituting those values we calculated leverages bête for USA and Argentina.
Second, we calculated Cost of Equity by using Risk Free (10 years US Treasury bond), Risk Premium (US Risk premium) and Leveraged beta.
Third, we calculated Cost of Debt by using Default Spread and Sovereign Yield given in Exhibit 7a.
Finally, the discount rate (WACC) is calculated by substituting Cost of Equity, Equity value, Cost of Debt, Debt value and Tax rate, and the range of the discount rates are 6.5%(lowest) to 22.2% (max).
Taking consideration of default risk and sovereign risks into accounting makes sense, as these…...

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