* 12% discount rate was used for all projects
* Venerus felt that this model worked fairly well
* In 1990s this model of capital budgeting was exported to projects overseas * model became increasingly strained with the expansions in Brazil and Argentina * because hedging key exposures such as regulatory or currency risk was not feasible * the ever-increasing complexity in the financing of international operations is another problem * when subsidiaries’ local currency real exchange rates depreciated, leverage at the subsidiary and holding company level effectively increased, and the subsidiaries struggled to service their foreign currency debt * Venerus’s solution to the problem had to be consistent, transparent, and accessible
* As a starting point, he considered the 15 representative projects shown in Exhibit 7a and, using the financial data in Exhibit 7b * he endeavored to derive a weighted average cost of capital (WACC) for each project using a standard methodology: * he endeavored to derive a weighted average cost of capital (WACC) for each project using a standard methodology:
In order to calculate each WACC, Venerus knew he would have to measure all of the constituent parts for the 15 projects: * the cost of debt
* the target capital structure
* the local country tax rates
* an appropriate cost of equity
Venerus feared the use of a World CAPM might yield artificially low costs of capital. Similarly, Venerus did not advocate the use of a “Local CAPM” where beta measured the covariance of a project’s returns with a portfolio of local equities. Countries such as Tanzania or Georgia, where AES had projects, did not have any meaningful equity markets or local benchmarks.
Still, he knew he had to find a way to capture the country-specific...