“When AES undertook primarily domestic contract generation projects where the risk of changes to input and output prices was minimal, a project finance framework was employed.”
Usually, project finance framework is used when the project has predictable cash flows, which can easily represent operating targets through explicit contract. When cash flows are certainty, the company can have higher level of leverage and it is easier to separate project assets from the parent company.
Advantages and Disadvantages: 1) Advantages a. Maximize Leverage b. Off-Balance Sheet Treatment c. Agency Cost d. Multilateral …show more content…
Hence we see that the geographical diversification of business made project financing less recommendable as a symmetrical risk becomes more manifest.
4. What is the value of the Pakistan project using the cost of capital derived from the new methodology? If this project was located in the U.S., what would its value be?
In order to calculate the value of project for the Lal Pir project in Pakistan, we first need to calculate the Weighted Average Cost of Capital (WACC) using the new proposed methodology. The first step is to calculate the value of levered β. The value of the levered β comes out to be 38.52%, which essentially means that our project is not very highly correlated to the market return. Using this value of β we now calculate the cost of Equity. We have used the return on U.S. Treasury Bond, which is 4.5%, as the risk free return. The cost of equity comes out to be 7.2% and similarly, using the risk free return and the default spread we calculate the cost of debt which comes out to be 8.07%. It is important to note that the cost of debt and the cost of equity also need to be adjusted for the sovereign spread. Once we have the adjusted costs of equity and capital, the WACC comes out to be 15.93%. However, now we need to adjust this WACC for the risks associated with doing the project in Pakistan. As mentioned in part 2, we get final WACC