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 7.8. Notel Levered beta (equity beta) is the beta estimated for the firm with debt and equity in its capital structure (Le., the covariance between the firms actual stock returns and the returns on the market portfolilo). Unlevered beta (asset beta) is the beta estimated for the firm assuming it has no debt. Notel Debt to cap, Debt to capital where capital is the amount invested in the project. The unlevered beta in Exhibit 7.8 is based on similar US firms. Does this seem reasonable? (b) Calculate the cost of equity. Refer to Exhibit 7.A and 7.8 and your answers to (a). Notel 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 (Le, the return on short term government debt in the respective countries) (c) Calculate the cost of debt Notel 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 Notel You need to add the ldiosyncratic Risk Measure as discussed in the case. Also recall that 100 basis points (bp)-1 % . A- A- AT AaibCcDdfe AaoCDdfe AabCcDc AaBbCcDdf AaBb AasbCcDdE AbCeDdEe Styles Pane Subtitie Heading 1 Heading 2 Tide Susdla Emph. No Spacing Narmal EBIT Delat Soveneign Line of Project Desolption Spad Busines Covenge Spred Country Tax Rate Debt to Cap. Business/Project TIT a9% 3 3 3.57% Dominican Republic 300 MW gas fired combinad cycle piant curmrantly under oonstuction 30 km east of Santo Daminge 25.0% 351% Andres 1625% 3 2 2 1 3.0x 3.57% 123 MW hydroelectric power plant located on the San Juan rver in westem Arpentina 35.0% 408% Caracoles Agentina 2 2 2 3 30 3.57% 0.00% Largest coal-red power station in wetem Europe. t can produce anough electriaity about 4O00 MW-o meet the needs of approsmately four mon people 00% 295% Drax United Kingdom 3 3 8.93% 3 Eletropaul 34.0% 30.0% 289% Braz LU Disibution compary that serves a popuadon of 14 mlon in Sao Paulo 2 17.0% 352% 2.5 434% 173% Chie 277 MW fossi tuel plent located in Tocopita, 1500 km nonth of Santage Gener 25 434% 23% 300 MW gas tubine taoty ocaed 25 omaters southeast of Ohaka capal of Bangiadesh 0.0% Haripur angladesh 25% 32% 25 4.34% 314% South Arica Kalvn co 00 MW coal fred power plant 23% 2 3.0 ass 90% Pakistan La Pir CO a37 MW coal red power plart 210 MW O1e olty spplying the capal cty of Sant Domingo 25 0% 4O A93 CO Dominican Repubic Los Mina 7.9% 304% 30 35P% 30% 2 Joint Ventue with the Govemert of Orissa. Two 210 MW PC 0oal-fed unts OPGC Inda CG 42 5% 2.5 O fred 140 Mw cogeneration facity under conracts of up to 10 yean, alectricky, ateam, compressed ar, demalerialzed water and ntgen to tree chemical facilten adacent to the 35.0% 434% 014% CS Otana Haly piant 0.00% 37.5% 35% 30 357% uSA 832 MW natural gas-red plant Red Oak Disributon Company serving 380.000 oustomers 30.0% 36 5% 2.5 357% 9.3% GO Rivnoblenergo Ukraine 20 0% 261S 40 tass a98% Distributon Company serving Tbilei the capial of Ceorgia Telas Georgia GD 32 2 833% 34 0% 4.0 Braz 600 MW ges-red combined cycle power plart Ungun CO rp pecy edame ogade EBIT Default Severeign Tax Rate Debt to Cap. Coverage Spread Spread 25.0% 35 1% 30x 357% 8 93% 22 35.0% 40.8% 30x 3.57% 16.25% 1 0.0% 29.5% 30x 3.57% 0.00% 3 34.0 % 30.0% 3.5x 8.93% 2.89% 35 2% 17.0% 2.5x 4.34% 1.73% 0.0 % 333% 2.5x 4.34% 523% 25% 329% 2.5x 4.34% 3.14% 1 2 2 23% 35.1% 3.0x 357% 9.90% 2 1 2 1 25.0% 28.7% 4.0x 1.85% a.93% 3 3 30.4 % 7.9% 3.0x 3.57% 360% 35.0 % 42.5% 25x 4.34% 0.14% 37.5% 39.5% 3.0x 357% 0.00% 2 300% 36.5% 2.5x 357% 9.98% 20.0 % 26.1% 4.0x 1.85% 9.98% 3 3 34.0 % 32 2% 4.0x 1.85% 8.93% 2 2 Construction Operation Technical Regulatory Currency en kuedaaquno Contract enf Commodity AES Selected Financial Data Exhibit 7b Select Financial Information 4.5% 10-Year U.S. Treasury Bond U.S. Risk Premium 7.00% Unlevered Equity Betas by Line of Business Contract Generation 0.25 Large Utility Growth Distribution 0.25 0.25 Competitive Supply 0.50 Exhibit 8 Summary of WACC Calculations for AES Step Required Information Approach 1. Calculate unlevered equity beta Betas at comparable U.S. companies Unlever and average equity betas for comparables in each AES line of business Target capitalization ratios 2. Relever equity betas at target capital structure. Estimated by project using cash flows to calculate desired EBIT coverage 3. Calculate cost of equity for each AES business Risk-free rate 10-Year U.S. Treasury Note Equity risk premium Long-term avg. difference between S&P 500 and U.S. Treasuries Relevered equity beta Risk-free rate 4. Calculate the cost of 10-Year U.S. Treasury Note debt. Default spread Observed relationship between EBIT coverage ratios for comparable companies and their costs of debt The difference between local govemment dollar- denominated bond yields and the corresponding U.S. Treasury Note 5. Add country specific risk to the cost of debt and cost of equity. Local sovereign spread 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 7.8. Notel Levered beta (equity beta) is the beta estimated for the firm with debt and equity in its capital structure (Le., the covariance between the firms actual stock returns and the returns on the market portfolilo). Unlevered beta (asset beta) is the beta estimated for the firm assuming it has no debt. Notel Debt to cap, Debt to capital where capital is the amount invested in the project. The unlevered beta in Exhibit 7.8 is based on similar US firms. Does this seem reasonable? (b) Calculate the cost of equity. Refer to Exhibit 7.A and 7.8 and your answers to (a). Notel 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 (Le, the return on short term government debt in the respective countries) (c) Calculate the cost of debt Notel 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 Notel You need to add the ldiosyncratic Risk Measure as discussed in the case. Also recall that 100 basis points (bp)-1 % . A- A- AT AaibCcDdfe AaoCDdfe AabCcDc AaBbCcDdf AaBb AasbCcDdE AbCeDdEe Styles Pane Subtitie Heading 1 Heading 2 Tide Susdla Emph. No Spacing Narmal EBIT Delat Soveneign Line of Project Desolption Spad Busines Covenge Spred Country Tax Rate Debt to Cap. Business/Project TIT a9% 3 3 3.57% Dominican Republic 300 MW gas fired combinad cycle piant curmrantly under oonstuction 30 km east of Santo Daminge 25.0% 351% Andres 1625% 3 2 2 1 3.0x 3.57% 123 MW hydroelectric power plant located on the San Juan rver in westem Arpentina 35.0% 408% Caracoles Agentina 2 2 2 3 30 3.57% 0.00% Largest coal-red power station in wetem Europe. t can produce anough electriaity about 4O00 MW-o meet the needs of approsmately four mon people 00% 295% Drax United Kingdom 3 3 8.93% 3 Eletropaul 34.0% 30.0% 289% Braz LU Disibution compary that serves a popuadon of 14 mlon in Sao Paulo 2 17.0% 352% 2.5 434% 173% Chie 277 MW fossi tuel plent located in Tocopita, 1500 km nonth of Santage Gener 25 434% 23% 300 MW gas tubine taoty ocaed 25 omaters southeast of Ohaka capal of Bangiadesh 0.0% Haripur angladesh 25% 32% 25 4.34% 314% South Arica Kalvn co 00 MW coal fred power plant 23% 2 3.0 ass 90% Pakistan La Pir CO a37 MW coal red power plart 210 MW O1e olty spplying the capal cty of Sant Domingo 25 0% 4O A93 CO Dominican Repubic Los Mina 7.9% 304% 30 35P% 30% 2 Joint Ventue with the Govemert of Orissa. Two 210 MW PC 0oal-fed unts OPGC Inda CG 42 5% 2.5 O fred 140 Mw cogeneration facity under conracts of up to 10 yean, alectricky, ateam, compressed ar, demalerialzed water and ntgen to tree chemical facilten adacent to the 35.0% 434% 014% CS Otana Haly piant 0.00% 37.5% 35% 30 357% uSA 832 MW natural gas-red plant Red Oak Disributon Company serving 380.000 oustomers 30.0% 36 5% 2.5 357% 9.3% GO Rivnoblenergo Ukraine 20 0% 261S 40 tass a98% Distributon Company serving Tbilei the capial of Ceorgia Telas Georgia GD 32 2 833% 34 0% 4.0 Braz 600 MW ges-red combined cycle power plart Ungun CO rp pecy edame ogade EBIT Default Severeign Tax Rate Debt to Cap. Coverage Spread Spread 25.0% 35 1% 30x 357% 8 93% 22 35.0% 40.8% 30x 3.57% 16.25% 1 0.0% 29.5% 30x 3.57% 0.00% 3 34.0 % 30.0% 3.5x 8.93% 2.89% 35 2% 17.0% 2.5x 4.34% 1.73% 0.0 % 333% 2.5x 4.34% 523% 25% 329% 2.5x 4.34% 3.14% 1 2 2 23% 35.1% 3.0x 357% 9.90% 2 1 2 1 25.0% 28.7% 4.0x 1.85% a.93% 3 3 30.4 % 7.9% 3.0x 3.57% 360% 35.0 % 42.5% 25x 4.34% 0.14% 37.5% 39.5% 3.0x 357% 0.00% 2 300% 36.5% 2.5x 357% 9.98% 20.0 % 26.1% 4.0x 1.85% 9.98% 3 3 34.0 % 32 2% 4.0x 1.85% 8.93% 2 2 Construction Operation Technical Regulatory Currency en kuedaaquno Contract enf Commodity AES Selected Financial Data Exhibit 7b Select Financial Information 4.5% 10-Year U.S. Treasury Bond U.S. Risk Premium 7.00% Unlevered Equity Betas by Line of Business Contract Generation 0.25 Large Utility Growth Distribution 0.25 0.25 Competitive Supply 0.50 Exhibit 8 Summary of WACC Calculations for AES Step Required Information Approach 1. Calculate unlevered equity beta Betas at comparable U.S. companies Unlever and average equity betas for comparables in each AES line of business Target capitalization ratios 2. Relever equity betas at target capital structure. Estimated by project using cash flows to calculate desired EBIT coverage 3. Calculate cost of equity for each AES business Risk-free rate 10-Year U.S. Treasury Note Equity risk premium Long-term avg. difference between S&P 500 and U.S. Treasuries Relevered equity beta Risk-free rate 4. Calculate the cost of 10-Year U.S. Treasury Note debt. Default spread Observed relationship between EBIT coverage ratios for comparable companies and their costs of debt The difference between local govemment dollar- denominated bond yields and the corresponding U.S. Treasury Note 5. Add country specific risk to the cost of debt and cost of equity. Local sovereign spread