Title of Assignment: Case – Globalizing the Cost of Capital and Capital Budgeting at AES
1. What is the problem with using a constant discount rate for all projects? Explain in the context of
both all-domestics and international company?
The problem with using a constant discount rate for all projects is that it is assuming too much
about future cash ows. The future will inevitably be unlike the past. Constant discount rates
also assume that that the total risk level of a business will never change, which as we can see
with AES and the advent of the global economic crisis at the turn of the century is not factual.
Risk levels uctuate greatly and can ul”mately hinder a company’s ability to hedge itself from
losses incurred in one country by the gains in another. For example, the issue cropped up for
AES in South America when they had a large amount of capital “ed up with Argen”na,
Venezuela and Brazil. In the late 1990s, Brazil began to see shortages of energy because
demand began to exceed supply, and was exacerbated by an expansive drought. This caused
the Brazilian authori”es to regulate energy consump”on, which ul”mately caused a decline in
the real against the dollar. AES leveraged obliga”ons had to be paid in U.S. dollars while their
customers in Brazil were paying them in reals that were worth a frac”on of those dollars. This
caused their losses to mount. In conclusion, the devalua”on of the real caused more losses for
AES than it could an“cipate through analyzing their future cash ows with a constant discount
rate. This was because the discount rate was directly impacted by the government response to
