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AES CASE STUDY

Date: April 26, 2011

To: Dr. David Hemley

From: Tim Castorena

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Subject: AES Case Study

Introduction

An analysis of AES Company case has been performed, which consists of assessments of the case, evaluating AES’s standard WACC, evaluating Venerus’s adjusted WACC, and determining if Venerus should present his adjusted WACC to the board and use the Venerus’s adjusted WACC.

AES brought Rob Venerus in June 2003 to direct the newly created Corporate Analysis & Planning. A combination of factors including the devaluation of key South American currencies, adverse changes in energy regulatory environments, and declines in energy commodity prices conspired to weaken cash flow at AES subsidiaries and hinder the company’s ability to service subsidiary and parent-level debt. As earnings and cash distribution to the parent started to deteriorate, AES stock collapsed and its market capitalization fell nearly 95% from $28 billion in December 2000 to 1.6 billion just two years later. Venerus reviewed the company’s existing assets, which required creating a new method of calculating the cost of capital for AES business. In 2002, AES was organized around four separate lines of business: Contract Generation, Competitive Supply, Large Utilities, and Growth Distribution.

Evaluation of Standard WACC

Capital budgeting for AES was simple while using the standard WACC formula because AES mainly did domestic contract generation projects where the risk of changes to input and output prices was minimal. All dividend flows were considered equally risky, and a 12% discount rate was used for all projects. However, the current model had become strained because of the expansions in Brazil and Argentina where hedging key exposures such as regulatory or currency risk was not feasible. Venerus did not believe that the World CAPM was sufficient for AES use, because World CAPM was not ideal for developing countries....