1. (3 points) "...the company's international exposure hurt AES during the global economic downturn that began in late 2000. A confluence of factors including the devaluation of key South American currencies...weaken[ed] cash flow at AES"

Explain why the devaluation of the South American currencies adversely affected AES.

2. (3 points) "...brought wholesale electricity prices down approximately 30%. These pressures caused several counterparties to default on their long term purchase agreements."

In what way are long term price agreements similar to forward contracts? Was AES's long term price contracts equivalent to going long or short a forward contract on electricity? What may be an alternative to using long term price contracts to hedge AES's exposure to fluctuations in electricity prices? Is this alternative viable?

3. (2 points) Why is it difficult to hedge regulatory risk?

4. (2 points) Why may it have been difficult for AES to hedge certain currency risks associated with its subsidiaries in Brazil and Argentina?

5. (2.5 points) Venerus argues against using a Global CAPM to estimate the cost of capital. What are his arguments against? Are his arguments convincing? What are some arguments in favor of AES using the Global CAPM to estimate the cost of capital?

6. (2.5 points) Venerus argues against using a Local CAPM to estimate the cost of capital. What are his arguments? Are his arguments convincing? What are some arguments in favor of AES using the Local CAPM to estimate the cost of capital?

7. (5 points) Calculate the cost of capital for the AES La Pir contract generation project in Pakistan using AES's proposed methodology as described in the case. Follow the steps outlined below (see also Exhibit 8):

(a) Calculate the levered beta (equity beta) for La Pir.Refer to the information in Exhibits 7.A and 7.B.

Note! Levered beta (equity beta)is the beta estimated for the firm with debt and equity in its capital structure (i.e., the covariance between the firms actual stock returns and the returns on the market portfolio). Unlevered beta (asset beta)is the beta estimated for the firm assuming it has no debt.

Note! Debt to cap. = Debt to capital where capital is the amount invested in the project.

The unlevered beta in Exhibit 7.B is based on similar US firms. Does this seem reasonable?

(b) Calculate the cost of equity. Refer to Exhibit 7.A and 7.B and your answers to (a).

Note! First use the CAPM and then add the sovereign spread as discussed in the case. The sovereign spread is the difference between the Pakistani and US risk-free rates (i.e., the return on short term government debt in the respective countries).

(c)Calculate the cost of debt

Note! You need to consider both the default spread and the sovereign spread. The former adjusts for the riskiness of the project; the latter adjusts for the fact that the project is located in Pakistan and not the US.

(d) Calculate the WACC

(e) Calculate the adjusted WACC

Note! You need to add the Idiosyncratic Risk Measure as discussed in the case. Also recall that 100 basis points (bp)=1 %.