Globalizing the Cost of Capital and Capital Budgeting at Aes

Globalizing the Require of Main and Main Budgeting at AES In June 2003, Rob Venerus, leader of the newly composed Corposcold Anatomy & Planning clump at The AES Corporation, thumbed through the five-inch stack of financial ends from subsidiaries and considered the variation and flake of AES. In the 12 years bybygone it had bybygone generally-known, AES had grace a adventitious defiant supplier of electricity in the globe delay balance than $33 billion in possessions smart athwart 30 countries and 5 continents.Venerus now faced the daunting drudgery of creating a regularityology for careful requires of main for valuation and main budgeting at AES attentiones in clear subsidences environing the globe. He would deficiency balance than his extensive daily dose of caffeine to apex himself in the equitable discourse. Much of AES’s dilution had charmed locate in developing chaffers where the unmet require for life far exceeded that of balance familiar countries. By 2000, the bulk of AES revenues came from balanceseas operations; closely one-third came from South America nondescript.Once a ticklish component in its arrange for achievement, the audience’s intergregarious peril afflict AES during the global economic downturn that began in past 2000. A concourse of retaliateers including the devaluation of key South American currencies, alien modifys in life regulatory environments, and disengages in life staple consumes conspired to dilute coin issue at AES subsidiaries and balance the audience’s faculty to employment favourable and cause-flatten tripure.As corrects and coin divisions to the cause established to spoil, AES hoard furled and its chaffer mainization cut closely 95% from $28 billion in December 2000 to $1. 6 billion upcorrect two years pastr. As one deal-out of its apology to the financial emergency, AES start composed the Corposcold Anatomy & Planning clump in arrange to discourse ordinary and forthcoming strategic and financial endowigates. To prepare the manage, the CEO and consequence of leaders asked Venerus, as leader of the new clump, to reesteem the audience’s tangible possessions, which required creating a new regularity of careful the require of main for AES attentiones.Central to the doubts oppositeness Venerus was the intergregarious design of AES, as he explained: “As a global audience delay operations in countries that are hugely unanalogous from the U. S. , we deficiency a balance rugged way to gard environing surrender and our require of main environing the globe. And, frankly, the finance textbooks aren’t that beneficial on this theme. ” The edict from the consequence of AES to compose a new regularityology offered an sensational but irrefragable endowigate. As he disposed his materials for the consequence, Venerus wondered if his new mode would counteract the closeities of the rare attention situations environing the globe delay ____________________________________________________________ ____________________________________________________ Professor Mihir Desai and Research Associate Doug Schillinger disposed this plaint. HBS plaints are familiar merely as the basis for arrange discourse. Cases are not proportiond to assist as endorsements, springs of leading facts, or illustrations of able or inable synod.Copyequitable © 2004 President and Fellows of Harvard College. To arrange copies or solicit license to propagate materials, fawn 1-800-545-7685, transcribe Harvard Attention School Publishing, Boston, MA 02163, or go to http://www. hbsp. harvard. edu. No deal-out of this generally-knownation may be propagated, stored in a rectification classification, used in a distributesheet, or infections in any mould or by any means—electronic, spontaneous, photocopying, recording, or otherwise—outside the license of Harvard Attention School. 204-109 Globalizing the Require of Main and Main Budgeting at AES he deficiency for a unblended, sincere manage that could be implemented correspondently and acceptably throughout the edifice. AES Corporation1 Roger Sant (MBA ’60, HBS) and Dennis Bakke (MBA ’70, HBS) established AES Corporation (originally Applied Life Services) in 1981 soon succeeding the gathering of federal congress that became disclosed as the Generally-disclosed Usefulness Regulatory Policy Act (PURPA). The congress was deal-out of the United States synod’s reaction to developing regret balance American belief on extraneous oil.The act sought to shorten this belief by requiring that electric utilities spring some of their new faculty deficiencys through adapted cogenerators and inferior defiant faculty endrs, granted that the faculty breedd by defiants require close than if the suitedness were to end the faculty itself. Sant and Bakke reexoteric that in shielding inferior defiant faculty endrs from requirely set-forth and federal decision, PURPA explicitly composed a chaffer for a new secret sector faculty chaffer. In exercise, the act closely ensured that defiant faculty endrs could subordinatecut a suitedness’s require of arrangeation. The audience judiciously struggled to discipcord financing but succeeding the edifice of its earliest coepoch quickness in Houston, Texas, in 1983 and the forthcoming fruit of a beneficial coepoch quickness in Pittsburgh, Pennsylvania, in 1985, AES practiced flying enlargement. By the promise the audience went generally-disclosed in 1991, revenues had aged to $330 darling and net allowance had soared to $42. darling from $1. 6 darling upcorrect three years prior. In the coming 1990s, AES began to transfer its convergence balanceseas where there were balance liberal opportunities for the audience to adduce its nonrecourse, scheme finance type to the fruit of straightened generating facilities. In restoration, extraneous synods frequently granted incentives to fascinate extraneous plain bombardment in infrafabrication schemes affect faculty fixs. The readiness of intergregarious fruit banks to endow furtherbalance AES in gay deal-outs of the globe succored lenify the surrender of expropriation, and the increased variation of the global financial chaffers granted main adit to main. AES trained its intergregarious dilution in 1991–1992 delay the escheatment of two fixs in Northern Ireland. The forthcoming year, AES began what would grace a huge dilution into Latin America delay the wages of the San Nicolas epoch quickness in Buenos Aires, Argentina.A year pastr, AES composed a indivisiblely listed favourable, AES China Generating Co. , to place Chinese fruit schemes. As the step of dedecision quickened environing the globe, AES was offered delay an liberal furnish of main and a opulence of opportunities for bombardments in life-cognate attentiones, some of which were balance close than AES’ portfolio of arrange epoch schemes. In restoration to expanding its cord of attention continuity, it continued its geographic dilution and among 1996 and 1998 the audience uncongenial unconnected wide suitedness companies in Brazil, El Salvador, and Argentina. By this promise the audience was spending an deemd 80%–85% of its main bombardment balanceseas in locates as clear as Australia, Bangladesh, Canada, Cameroon, The Dominican Republic, Georgia, Hungary, India, Kazakhstan, the Netherlands, Mexico, Pakistan, Panama, Puerto Rico, Ukraine, The United Kingdom, and Venezuela. 2 1 Much of this balanceview comes from Paula Kepos, ed. , Intergregarious Directories of Audience Histories, Competency 10 (Detroit: St. James Press, 1995), pp. 25–27. 2 Paula Kepos, ed. , Intergregarious Directories of Audience Histories, Competency 53. (Detroit: St. James Press, 1995), p. 17. 2Globalizing the Require of Main and Main Budgeting at AES 204-109 AES in 2002 By 2002, AES was one of the widest defiant faculty endrs in the globe. (See Exhibits 1, 2, and 3 for AES one financial set-forthments. ) The audience was arranged environing impure unconnected cords of attention: Arrange Generation, Competitive Supply, Wide Utilities, and Enlargement Distribution. 3 Arrange epoch In 2002, AES’s Arrange Epoch attention resemblanceed for closely 29% of AES revenues and consisted of epoch facilities, which sold electricity subordinate long-promise (five years or longer) arranges. The promise of the arranges recognized AES to word its peril to vaporousness in electricity consumes. The ending unwavering arrangeation requirements enabled AES to correspondently foreshadow furnish deficiencys and penetscold into concordantly long-promise agreements for coal, congruous gas, and fuel oil, thereby wording its peril to fuel consume vaporousness. Facilities varied considerably in extent, delay fixs as inferior as the 26 MW Xiangci-Cili hydro fix in China to the vast 10-fix 2,650 MW Tiete hydro close in Brazil. Competitive furnish Accounting for 21% of AES revenues, the Competitive Furnish cord of attention old electricity plainly to tradeable and vend customers in competitive chaffers using shorter-promise arranges or daily discoloration consumes. Competitive Furnish attentiones, rarely fawned “merchant fixs,” were very-much capable to modifys in the consume of electricity, congruous gas, coal, oil and other raw materials. AES’s loophole in U. S. dollars was influenced by a multitude of retaliateers including air stipulations, emulation, modifys in chaffer decisions, attention scold and extraneous modify fluctuations, and availfaculty and consume of emissions credits.Such consume vaporousness had of-delayed damaged unconnected Competitive Furnish attentiones including the Drax fix in the U. K. , the widest fix in AES’s Competitive Furnish alert. 4 Wide utilities By the end of 2002, the Wide Usefulness attention middle solely three main utilities, each in a unanalogous province: Indiana Faculty and Light Audience in the U. S. (IPALCO), Eletropaulo Metropolitana Electricidade de Sao Paulo S. A. in Brazil (Eletropaulo), and C. A. La Electricidad de Caracas in Venezuela (EDC). These utilities wholly epoch, transmission and division capabilities and were theme to persomal synod decision and consume elucidation.All three enjoyed regional monopolies and in completion resemblanceed for 36% of AES revenues. U. S. life decisions had required AES to vend a impureth such audience, Central Indiana Light and Faculty (CILCORP), when AES escheatmentd IPALCO, a sale that was consummated neighboring the end of 2002. Enlargement division Enlargement Division attentiones offered AES suggestive implicit enlargement due to their subsidence in developing chaffers where the require for electricity was expected to develop at considerably faster scolds than in familiar countries.However, these attentiones too faced glorious surrenders cognate to exempt obscureies, close unwavering synods, and regulatory regimes, and differing cultural norms touching basic causes such as reimbursement conventions and defendion decisions. Two new Enlargement Division attentiones in Ukraine (Kievoblenergo and Rivoblenergo) and one in Cameroon (SONEL) were uncongenial as of-delayed as 2001. 3 The description for these cords of attentiones comes widely from AES’s annual reports; see AES Corporation, 2001 Annual Report (Arlington: AES Corporation, 2002) and AES Corporation, 2002 Annual Report (Arlington: AES Corporation, 2003). Life companies ordinaryly assign to epoch companies not as members of a “portfolio” but members of a “fleet. ” 3 204-109 Globalizing the Require of Main and Main Budgeting at AES Recent Difficulties AES’s locatement in extraneous chaffers as courteous-mannered-mannered as inadapted execution at unconnected new U. S. attentiones closely tottering the audience during the global economic slowdown that began in 2001. AES’s chaffer esteem established to droop reluctantly in 2001 but cut precipitously in 2002. Having traded for balance than $70 per divide in October 2000, AES hoard hovered environing $1 per divide in the selfselfsimilar month of 2002 (see Exhibit 4).Wall Street began to doubt the audience’s faculty to air the blow, and one analyst wrote, “It is serene that AES’s ordinary hoard consume is imageing the scenario that the audience obtain not outlast. ”5 The subjection of the hoard consume and the forthcoming $3. 5 billion dropping that middle a stout transcribe-off in 2002 were brought on by unconnected retaliateers, the property of which was amplified by AES’s main fabrication. Among these retaliateers were alien transfers in extraneous modify chaffers, regulatory policies, and staple consumes; sundry of these were retaliateers AES could not extensively defend itself opposing.Currency Devaluations During 2001, a gregarious and economic emergency in Argentina brought environing a suggestive devaluation of most South American currencies opposing the U. S. dollar. In December, the newly elected synod rash the province’s unwandering dollar-to-Argentine-peso modify scold (1:1) and converted U. S. dollar-denominated loans into pesos. On its earliest day of trading as a natant circulation, the peso lost 40% of its esteem opposing the U. S. dollar. 6 By the end of the year, the peso was trading at a scold of 3. 32 pesos to the U. S. dollar and had been as proud as 3. pesos. 7 The currencies in Brazil and Venezuela—equal main chaffers for AES—followed succor, delay the Brazilian Existent and the Venezuelan Bolivar each depreciating closely 50% opposing the U. S. dollar during the selfselfsimilar limit (see Exhibit 5). As a end, AES recorded extraneous circulation action droppinges of $456 darling in 2002. Unconnected of AES’s subsidiaries in South America tripureed on their tripure and were obscure to restructure. The tripure was nonapplication to the cause, AES Corporation, so AES was not obligated to employment the favourable tripure.However, the cause audience did beneathgo from coin issue shortfalls as a end of inferior-than-expected dividends tail from the subsidiaries. The impression of devaluation was increased when extraneous attentiones were hired in persomal circulation but had obligations to reimburse tripure denominated in U. S. dollars. Alien Regulatory Changes During the past 1990s, the regulatory agencies in Brazil had triped to end a chaffer fabrication adaptedly fascinateive to submit private edifice of new epoch possessions. Require exceeded furnish, causing shortages. The bulk of Brazil’s epoch faculty was hydroelectric, and life deficiencies were exacerbated in 2001 and 2002 by below-mediocre rainfall. In apology, the Brazilian regulatory authorities began homogeneityning life expenditure in June 2001. 8 In restoration to the dropping of sales competency, the deccord of the Brazilian existent opposing the dollar triggered a regulatory 5 Ali Agha and Ed Yuen, Banc of America Securities, “AES Corporation, Anatomy of Sales and Earnings,” October 25, 2002, serviceable from The Investext Group, http://www. nvestext. com, adited July 15, 2003. 6 “Argentina’s Peso I Expected to Face Exigency This Week,” The Wall Street Journal, January 14, 2002, serviceable from Factiva, http://www. factiva. com, adited July 7, 2003. 7 AES Corporation, 2002 Annual Report (Arlington: AES Corporation, 2003), p. 38. 8 Ibid. , p. 20. 4 Globalizing the Require of Main and Main Budgeting at AES 204-109 contest regreting the conducive modify scold for the existent-to-dollar life-require pass-through stipulations in AES’s arrange. In property, the synod of Brazil required AES to escheatment life in dollars occasion reimbursing the requires using an prior limit modify scold, which lagged the deflation. In the impureth pity of 2002, AES took a pretax want commit of closely $756 darling on Eletropaulo, one of its main Brazilian attentiones. Staple Prices Deccord A 2001 modify in the regulatory regime in the U. K. too alienly impressioned AES by increasing emulation and reducing consumes in its epoch chaffers. That, along delay an unusually zealous plaining in the U. K. brought tradeable electricity consumes down closely 30%. 9 These exigencys caused unconnected matchies to tripure on their long-promise escheatment agreements. This counterdeal-out surrender, coupled delay modifys in the staple chaffers, enhanced the financial exigency on AES facilities, and those that could not vend electricity balance their loopholeal requires were charmed off-cord or curtail down. Balance and balance the circulation and regulatory obscureies at AES, the audience was obscure to use suggestive want commits on unbeneficial or discontinued attentiones.In 2002, the audience took succeeding-tax commits of $465 darling on fruit and edifice schemes, $301 darling on discontinued operations, and a huge $2. 3 billion in asset wants associated delay unconnected wide suitedness and epoch attentiones. 10 AES Reaction In apology to the financial emergency, AES achievementlargely refinanced $2. 1 billion of bank loans and tripure securities. The refinancing preparation came through the day precedently AES was to pay down $380 darling of its ungathered tripure. A clump of 63 banks and bombardment funds agreed to add $1. billion in new loans, and AES trustworthy a two-year extension on another $500 darling in notes due in 2002. 11 AES too trustworthy agreements to vend a compute of its possessions. Completion proceeds from the sales were expected to be closely $819 darling. Proceeds from sales in 2003 were expected to be closely $310 darling. 12 Main Budgeting at AES Historically, main budgeting at AES was fairly sincere. When AES subordinatetook principally private arrange epoch schemes where the surrender of modifys to input and output consumes was minimal, a scheme finance framework was employed.Venerus explained that this framework consisted of a fairly unblended set of rules—all nonapplication tripure was deemed good-tempered, the economics of a fond scheme were evaluated at an equity remittance scold for the dividends from the scheme, all 9 AES Corporation, 2002 Annual Report, p. 21. 10 Ibid. , p. 37. Eletropaulo. The $2. 3 billion in asset want commits middle the $706 darling succeeding tax want commit at 11 “AES Hoard Shoots Up as Refinancing Keeps Bankruptcy at Bay,” The Washington Post, December 17, 2002, serviceable from Factiva, http://www. factiva. om, adited July 17, 2003. 12 AES Corporation, 2002 Annual Report, p. 36. 5 204-109 Globalizing the Require of Main and Main Budgeting at AES dividend issues were considered equal surrendery, and a 12% remittance scold was used for all schemes. In a globe of private arrange-epoch schemes where most surrenders could be hedged and attentiones had concordant main fabrications, Venerus felt that this type worked fairly courteous-mannered. Beginning in the coming 1990s, delay AES’s intergregarious dilutions, this type of main budgeting was normal to schemes balanceseas.Early on, the type worked courteous-mannered-mannered (as it had delay the judicious dilution in Northern Ireland), owing this scheme had sundry of the characteristics of private opportunities. Venerus explained that the type became increasingly strained delay the dilutions in Brazil and Argentina owing hedging key perils such as regulatory or circulation surrender was not manageable. In restoration, the financial fabrication of a going-regret attention affect a suitedness is notably unanalogous than that of a worded-lifep asset affect a generating quickness. Nonetheless, in the deficiency of an academic or other opinion, the basic regularityology remained sacred. Another retaliateer that composed indispensable obscureies for transporting this type to balanceseas elucidations was the ever-increasing closeity in the financing of intergregarious operations. As one illustration of this, Venerus picturesquely how intergregarious operations would be evaluated and financed. Exhibit 6 illustrates the ordinary fabrication: favourable A and B were financed delay tripure that was nonapplication to the cause. The subsidiaries’ creditors had claims on the unfeeling possessions at the faculty fixs but not on any other AES incorpoblame or favourable.The persomal office audience, which frequently represented multiple subsidiaries, too pretended to finance edifice or wagess and accepted equity in the multitudinous subsidiaries it held. In restoration, the office audience had tripure that was nonapplication to the cause, trustworthy by dividends from the exempt audience. Finally, AES pretended unintermittently frequently at the cause flatten in arrange to add equity dollars into office companies and favourable schemes. At the end of 2002, AES had $5. 8 billion in cause audience (recourse) tripure and $14. 2 billion in nonapplication tripure.Using this favourable fabrication, the cause audience accepted coin issues in the mould of dividends from each favourable (some of which were office companies) and, owing the fabrication of whole bombardment opening was essentially the selfsame, all dividend issues were evaluated at the selfselfsimilar 12% remittance scold. This had the avail of making concordant schemes seemingly approximate. However, when subsidiaries’ persomal circulation existent modify scolds depreciated, leverage at the favourable and office audience flatten ablely increased, and the subsidiaries struggled to employment their extraneous circulation tripure.Venerus redetermined how the type established to pulverize in coming intergregarious bombardments: Imagine a existent devaluation of 50%. That cuts EBITDA in dollar promises by 50% and coverage homogeneitys spoil by balance than 50%. The persomal office audience cannot employment its borrowing, and dividends to the cause are slashed. Ultimately the one leverage was courteous-mannered-mannered balance 80% delayout any hedging of extraneous modify for any meaningful duration; this is where the type broke down. Venerus’s reresolution to the whole had to be congruous, limpid, and aditible. He knew his olution would feel to resemblance for modifys in required profits due to leverage, incorposcold some subordinatestanding of a scheme’s surrender continuity, implicitly embody province surrenders, and quiescent add esteems that were congruous delay chaffer deportment, including trading multiples. Globalizing the Require of Main To balancehaul the main budgeting manage and evaluate each bombardment as a clear opening delay rare surrenders, Venerus knew he would feel to calcupast a require of main for each of the sundry clear AES attentiones. As a starting apex, he considered the 15 figurative schemes shown in 6Globalizing the Require of Main and Main Budgeting at AES 204-109 Exhibit 7a and, using the financial facts in Exhibit 7b, he endeavored to follow a ponderosityed mediocre require of main (WACC) for each scheme using a test regularityology: WACC = E D re + rd (1 ? ? ) V V In arrange to calcupast each WACC, Venerus knew he would feel to gauge all of the retaliateer deal-outs for the 15 schemes: the require of tripure, the target main fabrication, the persomal province tax scolds, and an mismisdivert require of equity. In arrange to coalesce the require of equity, he would earliest feel to deem a abstemious equity beta.Venerus doubted whether the transmitted CAPM type could succor him calcupast all of the requisite ingredients for AES attentiones in emerging chaffers. He did not supporter the use of a “World CAPM” where beta gauged the covariance of a scheme’s retaliate to the globe chaffer portfolio of equities. AES owned attentiones in insufficiently integrated main chaffers, so Venerus feared the use of a Globe CAPM dominion succumb artificially low requires of main due to the low (or in some plaints disclaiming) interrelation of developing economies delay the globe chaffer.For illustration, a globe CAPM dominion genescold the unabstemious end of a WACC inferior than the U. S. surrender-free scold due to its disclaiming interrelation delay the globe chaffer portfolio. Similarly, Venerus did not supporter the use of a “Local CAPM” where beta gauged the covariance of a scheme’s profits delay a portfolio of persomal equities. Countries such as Tanzania or Georgia, where AES had schemes, did not feel any meaningful equity chaffers or persomal benchmarks. Still, he knew he had to coalesce a way to apprehend the province-persomal surrenders in extraneous chaffers.At a proud flatten, Venerus familiar an mode delay two deal-outs. First, he proportiond a require of tripure and require of equity for each of the 15 schemes using U. S. chaffer facts. Second, he ascititious the dissimilitude among the succumb on persomal synod obligations and the succumb on similar U. S. Treasury obligations to twain the require of tripure and the require of equity. Venerus believed that this dissimilitude or “unfailing distribute” approximated the incremental borrowing requires (and chaffer surrender) in the persomal province. Exhibit 8 summarizes Venerus’s mode.Calculating the Require of Equity and the Require of Failure To deem an equity beta for each scheme, Venerus earliest had the Corposcold Anatomy & Planning clump use unlevered equity betas from approximate U. S. companies. They mediocred the betas to succumb one unlevered beta for each of the impure cords of attention. Bygone the equity betas imageed not solely the chaffer surrender associated delay each audience, but too the unanalogousial propertys of leverage, the clump relevered the equity betas at telling main fabrications for each of the 15 schemes using the forthcoming equation: levered = ? unlevered E V Using the relevered equity betas, Venerus had the clump calcupast the require of equity for each scheme using the transmitted CAPM equation: Require of Equity = r f + ? rm ? r f ( ) 7 204-109 Globalizing the Require of Main and Main Budgeting at AES Finally, an mismisdivert require of tripure deficiencyed to be proportiond. Fond the suggestive regulatory and chaffer modifys impressioning AES balance the former two years, Venerus ruled not to use the unadorned require of tripure which dominion image chaffer stipulations that no longer existed.Instead, he attempted to deem the retaliate on tripure requireed by endowors fond the coin issue surrenders of a fond scheme. To do so, he applied the forthcoming equation: Require of Failure = r f + Failure Distribute The type of “failure distribute” was based upon the observed relation among EBIT coverage homogeneitys for approximate life companies and their require of tripure (shown in Exhibits 9a and 9b). The clump deemd the mismisdivert EBIT coverage homogeneity for each scheme fond its vaporousness of coin issues and leverage. Then, using the observed relation, they assigned the commensuscold require of tripure.For illustration, a scheme delay a target EBIT coverage homogeneity of 3. 0x was assigned a tripure distribute of closely 300 bp. Adding the Unfailing Spread13 Precedently plugging the require of equity and require of tripure into the WACC equation, Venerus wanted to resemblance for province-persomal chaffer surrender. He believed that surrender could be apprehendd in the dissimilitude among persomal synod obligation succumbs and the similar U. S. Treasury succumbs, or the “unfailing distribute. ” Thus, he ascititious the distributes establish in Exhibit 10 to twain the require of equity and require of tripure and used those esteems to genescold a WACC for each scheme.WACC Adjustments for Ununiform Surrender Venerus knew the balance CAPM-based unfailing distribute mode could add AES delay a suited WACC imageing the classificationatic surrender associated delay each scheme according to its persomal chaffer. However, was the mode abstemious in developing chaffers where adit to main was worded and notice was close than full? Venerus believed that audience-persomal surrender could not be easily medley detached in such chaffers. Moreover, AES—as an “investor” looking for implicit schemes—could not alter in the selfselfsimilar way a portfolio superintendent dominion alter.Perhaps most mainly, Venerus was regreted that careful expected coin issues by a probability-weighted mediocre of multitudinous outcomes would be very-much obscure, if not unusable, to do correspondently or acceptably athwart the whole AES portfolio, plain delayout the crisis of his offer drudgery. He felt budgeted coin issues would be balance early serviceable. Thus, he believed the mismisdivert remittance scold for AES attentiones should resemblance for some flatten of scheme-persomal surrender. Plain if expected coin issues were serviceable, Venerus felt that some place of scheme-persomal surrender just consequence.Venerus artistic his apex delay an illustration: Consider two hydro fixs in Brazil that are particular in whole i-elation bar the hydrological surrender of the large streams that gratify them. Twain fixs feel the selfselfsimilar probability-weighted expected esteem coin issues. The hydrology of fix #1 ends coin issues that can alter by plus or minus 50% in a fond year. The hydrology of fix #2 ends coin issues that can alter by plus or minus 10% in a fond year. If twain these fixs are financed delay 100% equity and pay no taxes, CAPM tells us that these fixs are rebuke the selfselfsimilar totality.That, to me, is easy. 13 Too assignred to as the “province distribute type” or the “Goldman Model. ” See Jorge O. Mariscal and Rafaelina M. Lee, Goldman Sachs, “The Valuation of Mexican Stocks: An Extension of the Main Asset Pricing Model,” 1993. 8 Globalizing the Require of Main and Main Budgeting at AES 204-109 In arrange to requite for this “undiversifiable scheme-persomal surrender,” the Corposcold Anatomy & Planning clump composed a surrender scoring classification planned to conjunction the judicious require of main. First, splain categories of scheme-flatten surrender were verified.Each sort was arrangeed and ponderosityed according to AES’s faculty to obviate and lenify unfailing surrenders. For illustration, owing AES was incapable to hedge modifys in currencies in unfailing chaffers, “circulation surrender” accepted a proud ponderosity and arrange. In contrariety, AES felt it could coerce for most technical or fix-cognate wholes and, as such, “operational surrenders” accepted a relatively low ponderosity. See Exhibit 11 for the splain surrenders and illustrations for each. Second, schemes were actiond on their flatten of peril to the splain categories of scheme surrender.For each sort, a scheme was assigned a action among 0 (meanest peril) and 3 (foremost peril). Next, the actions were varied by the i-elationive ponderositys and the splain categories ascititious concertedly to succumb a unmarried attention-persomal surrender jaw. For illustration, Table A shows how the Lal Pir scheme, a arrange epoch attention in Pakistan, dominion be assigned actions that translated into a attentionpersomal surrender jaw of 1. 41. Table A Surrender Jaw Calculation for Lal Pir Scheme Action for Lal Pir 1 1 2 0 1 2 2 Surrender Scores (action x ponderosity) 0. 035 0. 070 0. 210 0. 00 0. 180 0. 430 0. 500 1. 425 Categories of Surrender Operational/Technical Counterparty Credit/Performance Regulatory Edifice Staple Circulation Contrexplicit Enforcement/Legal Sum of indivisible jaws = attention-persomal surrender jaw Source: Audience instrument (explicit assessments hidden). Ponderosity 3. 5% 7. 0% 10. 5% 14. 5% 18. 0% 21. 5% 25. 0% Finally, the attention-persomal surrender jaws were used to calcupast an compromise to the judicious require of main. The meanest attention-persomal surrender jaws (jaw = 0) accepted no compromise to the proportiond require of main.For schemes delay the proudest attention-persomal surrender jaws (jaw = 3), the require of main was increased by 1500 bp. The relations among attention-persomal surrender jaws and compromises to the require of main were cordar. Thus, a attention-persomal surrender jaw of 2 would succumb an compromise to WACC of 1000 bp, and a attention-persomal surrender jaw of 1 would succumb an compromise of 500 bp. 14 Preparing for the Consequence Venerus reviewed his regularityology and considered the edict he had accepted from the consequence. In arrange to make-glossy the main budgeting manage at AES, he ad to bequeath a logical and skilled way to designate require of main in all of AES’s intergregarious chaffers. In his own opinion, he went balance the steps 14 AES too considered a balance involved non-lineighboring algorithm to genescold the WACC compromise from the attention-persomal surrender jaw. 9 204-109 Globalizing the Require of Main and Main Budgeting at AES in his manage: calcupast the require of equity and the require of tripure using U. S. chaffer facts, add the unfailing distribute to each, calcupast WACC using a target main fabrication, and finally, add a attention- persomal surrender compromise to WACC. Still, doubts lingered in his opinion. He reviewed the scheme coin issues for the AES Lal Pir arrange epoch fix in Pakistan offered in Exhibit 12 as a way of gauging the property of his new regularityology. In doing so, he considered the dissimilitudes in esteem composed by each of the compromises to the remittance scold. Was his remittance scold an explicit resemblance of the surrender associated delay the scheme? Did it succumb the punish esteem? Balance generally, did the unfailing distributes correspondently apprehend the chaffer surrender persomal to a fond province?Had he used the mismisdivert surrender categories and succorable ponderositys to image AES’s disposition for surrender? It was promise for him to career. Should he stir confident delay the restoration of the attention-persomal surrender jaw or should he solely use the transmitted unfailing distribute type? The consequence’s reaction was unusable to foreshadow. What if the ends were incongruous delay obvious trading multiples? Would they commit him of creating an balance-involved regularity, or would they laud the new technique as a pragmatic way to calcupast the require of main in an intergregarious composition? 0 Globalizing the Require of Main and Main Budgeting at AES 204-109 Exhibit 1 AES One Allowance Statement 2002 $4,317 4,315 8,632 (3,627) (3,086) (6,713) (112) (2,031) 312 219 (87) (1,600) (612) (456) (203) (2,651) (27) (34) (2,590) (573) (3,163) (346) $(3,509) 2001 $3,255 4,390 7,645 (2,416) (3,052) (5,468) (120) (131) (1,575) 189 116 (65) 18 (30) 176 755 206 103 446 (173) 273 $273 2000 $2,661 3,545 6,206 (2,093) (2,210) (4,303) (82) (79) (1,262) 201 51 (52) 143 (4) 475 1,294 368 120 806 (11) 795 $795Amounts in darlings bar per divide figures Revenues Regulated Non-regulated Completion revenues Require of sales Regulated Non-regulated Completion require of sales SG&A payments Severance and action requires Attention payment Attention allowance Other allowance Other payment (Loss) form on sale of bombardments and asset want payment Goodobtain want payment Extraneous circulation action dropping Equity in pre-tax (loss) corrects of cements (Loss) allowance precedently allowance taxes and boy attention Allowance tax (benefit) payment Boy attention (allowance payment) (Loss) allowance from constant operations Dropping from operations of dicontinued attentiones (net of allowance tax avail of $90, $10 and $5, i-elationively) (Loss) allowance precedently cumulative property of resemblanceing modify Cumulative property of modify in resemblanceing cause (net of allowance tax avail of $72) Net (loss) allowance BASIC (LOSS) EARNINGS PER SHARE (Loss) allowance from constant operations Discontinued operations Cumulative property of resemblanceing modify Basic (loss) corrects per divide Source: $(4. 81) $(1. 05) $(0. 65) $(6. 51) $0. 84 $(0. 32) $$0. 52 $1. 67 $(0. 01) $$1. 66 AES Corporation, 2002 Annual Report (Arlington: AES Corporation, 2003). 11 204-109 Globalizing the Require of Main and Main Budgeting at AES Exhibit 2 AES One Counteract Sheet 002 $780 211 1,264 384 218 1,492 4,349 194 23,050 (4,204) 18,846 1,403 8,984 33,776 2001 $802 215 1,137 468 215 1,855 4,692 3,031 21,127 (3,015) 18,112 2,433 8,544 36,812 2000 $950 1,297 1,566 569 1,193 209 5,784 3,122 21,874 (2,632) 19,242 2,248 2,642 33,038 1999 $669 164 936 307 327 184 2,587 1,575 14,210 (763) 13,447 1,904 1,367 20,880 1998 $491 35 383 119 155 71 1,254 1,933 6,029 (525) 5,504 1,490 600 10,781 Amounts in darlings, as of December 31 ASSETS Coin & Equivalents Other Short-Term Investments Accounts Receivable Inventory Prepayments & Advances Other Ordinary Possessions Completion Ordinary Possessions Long-Term Investments Property Fix & Equipment Accum Depr. & Amort. Property Fix & Equipment, Net Goodwill/Intangibles Other Long-Term Possessions Completion Possessions LIABILITIES & SHAREHOLDERS’ EQUITY Accounts Payable Short-Term Failure Curr.Long-Term Failure and CLOs Other Ordinary Liabilities Completion Ordinary Liabilities Long-Term Failure Completion Long-Term Failure Deferred Taxes Other Long-Term Liabilities Completion Liabilities Stockholder’s Equity Common Hoard Affixed Hired in Main Retained Rights Treasury Hoard Other Equity Completion Shareholders’ Equity Completion Liabilities + Shareholders’ Equity Shares Ungathered Source: “AES Annual Counteract Sheet,” http://www. onesource. com. December 1,139 3,341 2,031 6,511 17,684 17,684 981 8,941 34,117 727 2,449 1,752 4,928 17,406 17,406 627 8,312 31,273 743 2,462 1,834 5,039 17,382 17,382 1,863 3,212 27,496 381 1,216 973 2,570 12,136 12,136 1,787 1,750 18,243 215 1,413 348 1,976 5,791 5,791 268 952 8,987 6 5,312 (700) (4,959) (341) 33,776 558 2003, 5 5,225 2,809 (2,500) 5,539 36,812 533 serviceable from 5 5,172 2,551 (507) (1,679) 5,542 33,038 509 OneSource 4 2,615 1,120 (1,102) 2,637 20,880 414 1,243 892 (343) 1,794 10,781 361 Services, Notice 12 Globalizing the Require of Main and Main Budgeting at AES 204-109 Exhibit 3 AES 2002 Revenues by Cord of Attention and Geographic Region Cord of Attention $1,180 $3,137 Wide Utilities $1,837 Arrange Epoch Competitive Faculty Furnish Enlargement Division $2,478 Geographic Region $1,568 $2,783 South America North America Europe/Africa $1,739 Carribean $2,091 Source: AES Corporation, 2002 Annual Report. 13 204-109 Globalizing the Require of Main and Main Budgeting at AES Exhibit 4 AES Hoard Consume History, March 1996 through December 2002 $80. 00 $70. 00 $60. 00 $50. 00 $40. 00 $30. 00 20. 00 $10. 00 $12/1/96 12/1/97 12/1/98 12/1/99 12/1/00 12/1/01 12/1/02 3/1/96 6/1/96 9/1/96 3/1/97 6/1/97 9/1/97 3/1/98 6/1/98 9/1/98 3/1/99 6/1/99 9/1/99 3/1/00 6/1/00 9/1/00 3/1/01 6/1/01 9/1/01 3/1/02 6/1/02 9/1/02 Source: Note: Created by plaintwriter. Hoard consumes regulateed for splits. 14 Globalizing the Require of Main and Main Budgeting at AES 204-109 Exhibit 5 Selected South American Modify Rates (2001–2002) (persomal circulation per U. S. dollar) 4. 0 3. 5 3. 0 2. 5 2. 0 1. 5 1. 0 0. 5 Jan-01 May-01 Brazilian Existent (left) Source: Bloomberg LP. 1,600 1,400 1,200 1,000 800 600 400 200 Sep-01 Jan-02 May-02 Sep-02 Venezuelan Bolivar (right)Argentine Peso (left) 15 204-109 -16- Exhibit 6 Ordinary Fabrication of an AES Bombardment AES Cause Corporation Possessions Liabilities US Bank Failure Equity favourable Equity office co. Corposcold Failure Persomal AES Office Audience Possessions Liabilities $-denominated tripure Equity favourable (non-application to cause) AES Favourable A Possessions Liabilities Fossil fuel faculty fix $-denominated tripure (non-application to cause) AES Favourable B Possessions Liabilities Hyrdo faculty fix $-denominated tripure (non-application to cause) Source: Audience instruments and plaintwriter anatomy. 204-109 -17- Exhibit 7a Surrender Scores AES Scheme Facts Cord of Scheme Description Distribute 3. 57% 8. 3% 3 3 Distribute 300 MW gas fired wholly cycle fix ordinaryly subordinate edifice 30 km east of Santo Domingo 123 MW hydroelectric faculty fix located on the San Juan large stream in western Argentina Largest coal-fired faculty place in western Europe. It can end plenty electricity - environing 4000 MW- to coalesce the deficiencys of closely impure darling persons Division audience that assists a population of 14 darling in Sao Paulo 277 MW fossil fuel fix located in Tocopilla, 1500 km north of Santiago 360 MW gas turbine quickness located 25 kilometers southeast of Dhaka, main of Bangladesh 600 MW coal fired faculty fix 337 MW coal fired faculty fix 210 MW Oil-fired quickness furnishing the main city of Santo Domingo Joint Venture delay the Synod of Orissa. Two 210 MW P. C. oal-fired units Oil fired 140 MW coepoch quickness - subordinate arranges of up to 10 years, electricity, fume, housed air, dematerialized inspire and nitrogen to three chemical facilities adjacent to the fix 832 MW congruous gas-fired fix Division Audience serving 380,000 customers Division Audience serving Tbilisi, the main of Georgia. 600 MW gas-fired wholly cycle faculty fix 7. 9% 25. 0% 23% 35. 1% 28. 7% 25% 32. 9% 0. 0% 33. 3% 2. 5x 17. 0% 35. 2% 2. 5x 4. 34% 34. 0% 30. 0% 3. 5x 2. 89% 0. 0% 29. 5% 3. 0x 3. 57% 0. 00% 35. 0% 40. 8% 3. 0x 3. 57% 16. 25% 3 25. 0% 35. 1% 3. 0x Tax Scold Failure to Cap. Coverage EBIT Failure Unfailing Edifice Operation/ Technical Regulatory Circulation Counterparty Arrange enf. / Legal 3 3 3 3 2 2 2 2 2 2 3 3 1 3 1 1 1 1 1 1 2 2 1 2 2 1 2 3 3 3 3 3 2 3 2 1 3 3 1 2 1 3 3 3 3 3 3 2 3 Andres Dominican Regenerally-disclosed CG Caracoles Argentina CS 2 DraxUnited Kingdom CS - 2 Eletropaulo Brazil LU 8. 93% - 1 Gener Chile CG 1. 73% - - Haripur Bangladesh CG 4. 34% 5. 23% 2 - Kelvin South Africa CG 2. 5x 3. 0x 4. 0x 4. 34% 3. 57% 1. 85% 3. 14% 9. 90% 8. 93% 1 - 1 3 Lal Pir Pakistan CG Los Mina Dominican Regenerally-disclosed CG OPGC India CG 30. 4% 3. 0x 3. 57% 3. 60% - 1 Ottana Italy CS 35. 0% 42. 5% 2. 5x 4. 34% 0. 14% - - Red Oak USA CG 37. 5% 30. 0% 20. 0% 34. 0% 39. 5% 36. 5% 26. 1% 32. 2% 3. 0x 2. 5x 4. 0x 4. 0x 3. 57% 3. 57% 1. 85% 1. 85% 0. 00% 9. 98% 9. 98% 8. 93% - 2 2 - Rivnoblenergo Ukraine GD Telasi Georgia GD Uruguaiana Brazil CG Source: Audience instrument. Scheme descriptions charmed from http://www. aes. om/businesses/default. asp. Staple 3 1 3 2 2 1 1 3 2 3 2 Attention / Scheme Province Attention 204-109 Globalizing the Require of Main and Main Budgeting at AES Exhibit 7b AES Selected Financial Facts Select Financial Notice 10-Year U. S. Treasury Obligation U. S. Surrender Recompense Unlevered Equity Betas by Cord of Attention Arrange Epoch Wide Usefulness Enlargement Division Competitive Furnish 4. 5% 7. 00% 0. 25 0. 25 0. 25 0. 50 Source: Audience instrument. Exhibit 8 Summary of WACC Calculations for AES Step 1. Calcupast unlevered equity beta. 2. Relever equity betas at target main fabrication. 3. Calcupast require of equity for each AES attention.Required Notice • • • • • Betas at approximate U. S. companies Target mainization homogeneitys Risk-free scold Equity surrender recompense Relevered equity beta Risk-free scold Failure distribute Mode Unlever and mediocre equity betas for approximates in each AES cord of attention Estimated by scheme using coin issues to calcupast desired EBIT coverage 10-Year U. S. Treasury Note Long-promise avg. dissimilitude among S&P 500 and U. S. Treasuries 10-Year U. S. Treasury Note Observed relation among EBIT coverage homogeneitys for approximate companies and their requires of tripure The dissimilitude among persomal synod dollardenominated obligation succumbs and the similar U. S.Treasury Note 4. Calcupast the require of tripure. • • 5. Add province persomal surrender to the require of tripure and require of equity. • Persomal unfailing distribute Source: Audience instrument and plaintwriter anatomy. 18 Globalizing the Require of Main and Main Budgeting at AES 204-109 Exhibit 9a EBIT Coverage Ratios and Failure Spreads 25. 0x 12. 0% 20. 0x 10. 0% 8. 0% 15. 0x 6. 0% 10. 0x 4. 0% 5. 0x 2. 0% Baa1 Baa2 Baa3 Caa1 Caa2 Caa3 Ba1 Ba2 Ba3 B1 B2 Aa1 Aa2 Aa3 A1 A2 Aaa A3 B3 - EBIT Coverage Homogeneity Source: Audience instruments. Failure Distribute 19 204-109 Globalizing the Require of Main and Main Budgeting at AES Exhibit 9b EBIT Coverage Ratios and Failure SpreadsCredit Rating Aaa Aa1 Aa2 Aa3 A1 A2 A3 Baa1 Baa2 Baa3 Ba1 Ba2 Ba3 B1 B2 B3 Caa1 Caa2 Caa3 EBIT Coverage Homogeneity 21. 1x 15. 1x 10. 9x 8. 1x 6. 3x 5. 2x 4. 6x 4. 2x 3. 9x 3. 6x 3. 2x 2. 6x 1. 9x 1. 0x 0. 8x 0. 6x 0. 4x 0. 1x 0. 1x Failure Distribute 0. 2% 0. 3% 0. 4% 0. 6% 0. 7% 0. 9% 1. 2% 1. 5% 1. 9% 2. 3% 2. 9% 3. 6% 4. 3% 5. 2% 6. 2% 7. 4% 8. 6% 10. 0% 11. 4% Source: Audience instruments. 20 Globalizing the Require of Main and Main Budgeting at AES 204-109 Exhibit 10 Credit Ratings and Unfailing Spreads Used by AES US (AAA) Australia (AAA) Bahamas (n/a) Canada (AAA) UK (AAA) Italy (AAA) Spain (AAA) Netherlands (AAA) Hungary (A-) Chile (A-) Qatar (A-)Czech Regenerally-disclosed (A-) Mexico (BBB) China (BBB) Oman (BBB) South Africa (BBB-) India (BB) Bangladesh (n/a) Sri Lanka (n/a) El Salvador (BB+) Kazakhstan (BB) Panama (BB) Brazil (BB) Dominican Regenerally-disclosed (BB-) Bolivia (B) Georgia (n/a) Pakistan (B) Ukraine (B) Venezuela (CCC+) Argentina (D) Cameroon (n/a) Nigeria (n/a) Tanzania (n/a) Uganda (n/a) 0% 2% 4% 6% 8% 10% 12% 14% 16% 18% Source: Audience instrument; Test and Poor’s and Lehman Brothers. 21 204-109 Globalizing the Require of Main and Main Budgeting at AES Exhibit 11 Scheme Persomal Surrender Categories and Weightings Surrender Sort Operational Illustration An AES fix may trip to opescold at faculty or trip to end adapted electricity to coalesce arrangeual obligations. AES has offuse agreements that—affect forthcomings and other derivative instruments—require credit; the matchy may either trip to shaft restorational parallel as required or trip to pay. Arrange residuum managees in a extraneous province may modify succeeding AES has made bombardments in a epoch quickness. Regulatory agencies may appropriate not to adupcorrect scolds for a suitedness succeeding inflation goes up or other chaffer dynamics modify. Edifice of a persomal fix is consummate but the fix may not permould they way it is deemed to (the excitement scold is too proud, the output too low, the availfaculty too low, etc. ). Prices of coal, oil, or other fuels may spike.