Case Study Aes

Umer Khan

NSU ID: N01173174

Case Study: AES

There are many factors to take into account when setting up international business across different boundaries and countries. Global business always involves risks and regulations that can affect growth and prosperity. In the case of AES, the complexities of finding consistency in capital budgeting proved to be an obstacle that caused significant damage and needed to be fixed in order to prosper. In the past, AES used the same cost of capital for all of its capital budgeting, but the company’s international expansion raised questions whether a single cost of capital adequately accounts for the different risks AES faces in its diverse businesses and diverse environments. Regulatory changes and currency devaluations ended up being the source of heavy losses for AES businesses in South America and abroad. The company was forced to develop a methodology to calculate the different costs of capital for its different global projects. This case study examines how a global firm can account for different risks in evaluating its international operations and in investing overseas and determine how the adjusted cost of capital derived from the new methodology affects the value of a particular project.

When starting the company, AES failed to develop proper strategy to take into account global expansion and international regulation. Perhaps the main issue was the assumption that the financial risks involved in these foreign countries could be assessed using the same model that they were applying here in the United States. Historically, AES capital budgeting methodology primarily used the following assumptions: 1.) all nonrecourse debt was regarded as good. 2.) Dividend cash flow were considered equally risky. 3.) Project was evaluated by the equity discount rate for the dividends from the project. 4.) A 12% discount rate was applied to all projects.

This method is overly simplistic and flawed in terms of project evaluation as...