Aes Project Wacc

Globalizing the Cost of Capital and Capital Budgeting at AES

The impressive growth of AES since going public in 1991 highlights how the capital budgeting function plays an integral part in AES’s financial success. The AES Corporation is a global energy company with generation and distribution businesses. Much of AES’s growth has come from developing nations, in which AES must analyze and manage risks that are not present in domestic operations. The growth in international operations reveals the current capital budgeting function may be inadequate to incorporate the array of risks that international operations will be exposed to. As a result, AES will need to update the capital budgeting methodology by revising the financial techniques and developing a system to quantify specific project risk.

AES Current Capital Budgeting Methodology

AES’s current capital budgeting process is very straightforward. Cash flows from each project are discounted at the corporate rate of 12%. AES uses project finance for most of its operations in which non-recourse loans are acquired to finance the project. Securing these loans is based on the assumption that the cash flows from the project are adequate to repay the loans. AES considered each cash flow equally risky, and applies a 12% equity discount rate. This simplified methodology is appropriate for domestic operations where business and financial risks are uniform. In addition, AES could hedge prices to further mitigate financial risk. So, for domestic operations, a “generic” corporate discount rate may be appropriate.

The main advantage of the current capital budgeting methodology is that it provides comparability between projects. This allows management an easy and quick way to value and compare capital investments. The current methodology works well with AES domestic investments, where the similar capital structures of utilities and shared business risks allows a universal discount rate to be used. However, as AES...