GLOBALIZING THE COST OF CAPITAL

Globalizing the cost of capital and capital budgeting at AES



Table of Content

CHAPTER 1 INTRODUCTION TO THE CASE STUDY1

1.1Background of the Study1

1.2Statement of the problem2

1.3Research Aims and Objectives2

1.4Structure of the rest of the Report3

CHAPTER 2 DESCRIPTION OF THE CASE STUDY4

2.1Business Segment4

2.2Case detail Analysis5

CHAPTER 3- PROBLEM STATEMENT PLAN AND ANALYSIS8

3.1Statements of problems in the case8

3.2Literature Review9

3.2.1.Cost of Capital and Evaluation of the Investment10

3.2.2.Valuation of share capital11

3.2.3.Risk Affecting Investment decision13

3.2.4.CAPM15

3.2.5.Arbitrage pricing theory17

3.2.6.Macro-Economic Factors and Investment18

3.3Plan of Analysis18

3.4Source of data19

CHAPTER 4- ANALYSIS AND FINDING20

a.Additions made ??to the model of Modigliani and Miller26

CHAPTER 5- PROPOSED SOLUTIONS TO PROBLEM28

5.1Integrated assessment of the analysis28

5.2Recommendation38

5.2.1.Hedging38

5.2.2.Arbitrage pricing theory38

5.3Propose Plan Action40

5.4Limitation of the study40

CHAPTER 6 - APPLICATION OF LEARNING IN OTHER INDUSTRY41

6.1Hedging Risk by Royal Dutch Shell43

REFERENCES47

APPENDIX50

Globalizing the Cost of Capital and Capital Budgeting At AES

Chapter 1 Introduction to the Case Study

Background of the Study

This case is of company who has been involved in the generating electricity business across the world. The base of this case is the development of the Cost of capital for their various business and potential projects.

In this case, the importance of Cost of Capital will be clear as the financial decisions of the company are reflected in their financial statements. It also seen that financing scheme used in investment; where investment is the asset, and debt financing as liabilities and equity contribution gives rise to equity. 100% of the investment (asset) is fully funded (liabilities plus equity). An equilibrium to finance an investment, it could be 50% debt and 50% equity, but this relationship depends on the economic sector, the type of business, the nature of investors and creditors. For this reason, an investment that is carried out with funding of 33% debt and 67% of equity, i.e. a debt / equity ratio of 1 to 3, does not necessarily indicate that the owners (investors) rely more in his business creditors, but simply that the goodness of the business at a particular time and / or the bargaining power of investors and creditors made ??it possible that ratio.

During late 2000AES has suffered a lot due to the devaluation of the South American currency against U.S. dollar which had made their investment almost zero, as their loans were dominated in Argentina Peso which reduced almost 50% against the U.S. dollars. Beside this, the regulatory changes in countries which were initially in favors for the new generation assets in their countries but after seeing that their own domestic companies are de-motivating the regulatory started supporting their won domestic companies which made AES to pay an additional cost (exchange rate). Lastly, the decline in commodity prices in UK which made wholesale price up to 30% down. Moreover, AES was forced to take considerable charges of impairment on discontinued and unprofitable business.

Statement of the problem

The problem in this case was to adopt a method to calculate the cost of capital which would be in favor for the various business and potential projects of ...