CAPITAL BUDGETING AT AES CORPORATION

50 Pages   |   14,050 Words
AES Corporation is a major US corporation which is active in the production and distribution of electricity. The company operates production and distribution of electricity in 29 countries and employs 27,000 people. A large share of capital investment allocated by AES was in third world countries like Bangladesh, Cameroon, The Dominican Republic, Georgia, India, Kazakhstan and Pakistan. AES Corporation is facing a convergence of several problems which emanate from the issue of rapid devaluation of South American currencies. The culmination of the above mentioned problems has resulted in an almost devastating fall in AES stock prices within a time span of two years. The objective of the paper is to develop a sophisticated set of measures for AES Corporation to make provision for business risks and evaluating the cost of capital around the world.
Capital budgeting model is adopted for AES Corporation to evaluate the cost of capital of the company. The analysis shows that the added riskiness was not gauged at the appropriate level. Evaluation of the financial statements showed that profitability of the organization is high as long as interest expenses are not taken into account. This directly implied that the leverage of the company is very high. Evaluation of the operational components of Balanced Scorecard Analysis exhibits that the production systems owned by AES Corporation were performing well. The human resource of the company exhibits high regards towards the values of the company and shared the commitment of the organization towards its mission.
The recommendation for AES Corporation is to change the financial model which is currently in place in the organization. The company should adopt a project specific assessment of beta coefficient to measure the required rate of return. AES Corporation should create local holding companies to secure financing for the projects. The debt for expansionary projects in distant developing economies must be secured either in local currency or hedged against devaluation.
Findings and recommendations of AES Corporation were applied on AES Corporation. The usefulness of this section is high because Motorola is heading down the same path as AES Corporation. The strategic level issues faced by both businesses originate from the leverage. The recommended that the required rate of return for Motorola should either be set high or the business should reduce its leverage.

Table of Contents

Executive Summary. 1
Chapter 1 – Introduction. 4
Background of the Company. 5
Power Generation Industry. 5
Problem Statement 6
Research Questions. 6
Aims of the Research. 6
Objectives of the Research. 7
Chapter 2 – Case Brief 8
Chapter 3 – Plan of Analysis. 11
Problem Statement 11
Relevant Literature Review.. 11
Capital Budgeting Model 13
Weighted Average Cost of Capital 14
Morphological Analysis. 14
Balanced Score Card Model 15
Proposed Plan of Action. 16
Sources of Data. 16
Chapter 4 – Analysis & Findings. 18
Financial Analysis & Management 18
Capital Budgeting Model for AES Corporation. 18
Weighted Average Cost of Capital 18
Ratio Analysis. 20
Strategic Management 22
Porter Five Forces Model Analysis. 22
Threats of Substitute Products or Services. 23
Bargaining Powers of Buyers. 23
Bargaining Powers of suppliers. 23
Intensity of Competitive Rivalry. 24
SWOT Analysis. 25
Balanced Score Card Model 26
Managing Human Capital 29
Competency Model Analysis 29
Job Analysis & Job Design. 31
Chapter 5 – Analysis & Findings. 33
Integrated Assessment of the Analysis. 33
Recommendations 35
Proposed Plan of Action. 36
Limitations of the Study. 36
Chapter 6 – Application of the Findings To Another Company. 38
Company Background. 38
Semiconductor Business. 39
Problems Faced by Motorola. 40
Application of the Findings of AES Corporation’s Analysis on Motorola. 41
Conclusion. 42
References. 44
Appendices. 46
Appendix 1 – Income Statements AES Corporation. 46
Appendix 2 – Balance Sheets AES Corporation. 47
Appendix 3 – Cashflow Statements AES Corporation. 48 Figure 1 - Porter's Five Forces Model Analysis (self-drawn) 24
Figure 2 - SWOT Analysis for AES Corporation (self-drawn) 24
Figure 3 - Balanced Scorecard Analysis for AES Corporation (self-drawn) 27
Figure 4 - Top Hierarchical Structure at AES Corporation (self-drawn) 29
Figure 5 - Human Resource Matrix at AES Corporation (self-drawn) 30

Chapter 1 – Introduction

Background of the Company AES Corporation is a major US corporation which is active in the production and distribution of electricity, particularly in Latin America, United States and Europe. AES Corporation was founded by two former high officials of US Government – namely, Roger Sant, a former Federal Energy Administration, and Dennis Bakke from the Office of Management and Budget (Trent, 1992). The company was formed in the year 1981 under the name Applied Energy Services and its head office is located in Arlington in Virginia State.
 

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AES Corporation is a leading player in the utilities sector. The company operates production and distribution of electricity in 29 countries and employs 27,000 people. The scale of operations of the company is huge and the company is ranked among Fortune 500 companies and its shares are an important component of Dow Jones Utility Average. In 2008, AES Corporation achieved a turnover of 14.1 billion dollars. Its power plants have a total installed capacity of about 40,300 megawatts and the company has sought growth through building additional power stations in six countries. Its electricity distribution networks account for 55 percent of its turnover (Official Website AES Corporation, 2012). AES serves in territories while serving a total population of 11 million people. In April 2010, AES Wind Generation, a wholly owned subsidiary of AES acquired the UK wind developer Your Energy Limited (YEL). This acquisition enabled AES to add over 700 megawatts to its generating capacity and most importantly strengthen its position in alternative energy sector.
Power Generation Industry Power generation industry is a highly important industry for every economy for in every economy production of electricity is essential for both consumers and industry. Electricity is used in the production of almost all goods and services, while in large quantities it is directly consumed by households. The U.S. for power comprises of annual sales exceeding $200 billion, and the electricity industry account for about 3.2 percent of GDP of United States (Kalraath, 2009). In addition, the electricity sector has experienced a growth rate of almost four percent annually. The projections give an annual growth of 2 to 2.6 per cent until 2020, which implies companies like AES need to plan both financially and operationally to expand their operations.
Over the past decade, the regulatory framework within which the electricity industry has begun to transform. A few countries, especially in Europe, have implemented new regulations to boost competition through liberalization of the industry by striving especially to reorganize functions that are not natural monopoly (Bordigoni, Hita and Blanc, 2012). Some countries have adopted legislation introducing competition in the production and the retail market and to do that have separated these functions, which allows new entrants access to existing networks. Therefore, existing companies need to prepare for emerging competition by increasing their efficiency and being careful with the financing costs of their business.
Problem Statement The problem statement of the research is that AES corporation is facing a convergence of several problems which emanate from the issue of rapid devaluation of South American currencies. In addition, energy industry is being increasingly regulated round the globe which implies that adverse impacts are felt on pricing of AES Corporation due to stringent regulatory environments. Also, measures by several governments to promote competition in this sector have reduced the prices charged by energy companies which have weakened their bottom line.  The culmination of the above mentioned problems has resulted in an almost devastating fall in AES stock prices within a time span of two years. The problem statement of the report is to find a new method for managing financials of the company and to revive its profitability.
Research Questions The problem statement gives way to a number of research questions for investigation:
  1. What are the internal contributory factors to the worsening financial situation of AES Corporation?
  2. What are the external contributory factors to the worsening financial situation of AES Corporation?
  3. What are the options available for calculating the cost of capital at AES Corporation?
  4. What would be the impact on marketing, human resource and operations functions of AES Corporation for changing its cost of capital calculation methods?
Aims of the Research The aim of the research is to address current and future strategic and financial challenges of AES Corporation. The aims of the report include investigating alternative methods for budgeting of the company and formation of new methods for calculating the cost of capital for AES businesses.
Objectives of the Research The objective of the paper is to develop a sophisticated set of measures for AES Corporation to make provision for business risks and evaluating the cost of capital around the world. The company needs to balance the complexities of the problems faced by the changes in its external environment and to devise solutions based on finance, marketing, human resource and strategic management disciplines.  The case relates to AES Corporation which is in the industry of generation and distribution of power. The foremost power generation of the company was created in Houston, Texas and after the initial success, the organization grew very rapidly. Initial growth of the organization was funded through retained earnings of the profits generated by the business and through debt. Eventually, the growth requirements of the business grew to the extent that the shares of the organization were offered to public. Majority of the growth after initial public offering came from overseas operations of the business. The organizational focus was shifted on overseas markets and foreign capital was attracted through direct investment into the business by international development banks. This helped the business to mitigate the risks of expropriation and increased access to capital markets for AES Corporation to finance organizational expansion. 
The financing requirements of capital for AES Corporation included capital needed for the purchase two plants in Northern Ireland and massive acquisition of power generation facilities in Latin America. For Chinese operations, AES chose to create a separately listed subsidiary – AES China Generating Company. A very positive trend which was happening during this expansion phase round the globe was a rapid deregulation of the energy sector around the world and monopolies were breaking up due to measures taken by government for elimination monopoly powers. AES Corporation fared well during this phase because it contained a steady supply of capital from its public shareholders and at the same time, there was exponential growth in the energy sector. A number of projects undertaken by AES Corporation during this important phase of its operations comprised of contract power generation projects. Growth came from all directions, and it was not long after that when the company acquired numerous big utility companies in Brazil, El Salvador, and Argentina.
Allocation of company’s finances is also an important consideration for any conglomerate similar to AES Corporation. A large share – almost 80% - of capital investment allocated by AES was in third world countries like Bangladesh, Cameroon, The Dominican Republic, Georgia, India, Kazakhstan and Pakistan. Contract generation of electricity was financially more attractive because the terms of typical a five-year contract limited the exposure to volatility in electricity prices. The production systems owned by AES Corporation were also diversified, for instance, they comprised of coal, natural gas, and fuel oil, which in effect reduced the exposure of AED Corporation to fuel price volatility.
In contrast with long-term contractual project, the other form of project in which AES got involved were merchant plants, which were exceedingly susceptible to changes in the price of its out of electricity, as well as, the inputs of natural gas, coal and oil. The margins for this second form of business operations also varied significantly which meant that financial riskiness involved with contractual projects was much lesser than merchant plants. Interest rate and foreign exchange rate fluctuations accounted for a significant proportion of volatility in the operations of AES Corporation.
This growth period of AES Corporation came to an abrupt end in the year 2001 when global economies slowed down. The market value of AES Corporation’s shared plummeted very steadily during this phase and during the year 2001-02 share price fell from $70 per share to $1 per share. The impact of this drastic loss in value of capitalization of the firm, of course, led the financial experts to question the stability of the bottom line and cash flows of this company which was once considered the prime choice of investors. Some of the investors pointed out that the financing of the growth of the company was based on poor choices, and it was genuinely feared that the company will go bankrupt. Given the size of the total equity of the corporation at the time, the net total loss in the valuation of the company amounted to $3.5 billion which was brought on by several factors. The net effect of this change was amplified by AES's capital structure which was heavily based on leverage from external borrowing. Shareholders of the company are paid in accordance with the decisions of the top management of the company while debtors are needed to be paid irrespective of profitability.
The changes taking place in the external environment were adverse for AES through a number of ways. Devaluation in the currencies of those countries was taking place in the countries from which cash inflows of AES were generated. This devaluation was most prominent in Venezuela and Argentina. Regulatory changes added up to the problems of AES Corporation. This problem was encountered with greatest intensity in Brazil where domestic construction of new generation assets was adopted by the government. The supply of electricity outpaced the demand spelling trouble for AES due to falling prices of energy. Commodity prices fell internationally following the year 2001, which brought down electricity prices. In addition, unusually warm weather in England reduced electricity demand.
The response of the company to this crisis situation was mostly based on financial measures. The company’s management refinanced a large proportion of its loan and secured extension on repayment of a large proportion of loan. AES Corporation also resorted to sell a number of its fixed assets to meet its immediate obligations to its creditors comprises of a consortium of forty-seven banks. The case pertains to this phase of AES Corporation in which it needs to find a way to resolve the immediate crisis while balancing both short-term and long-term needs of the business. Problem Statement The problem encountered by AES Corporation in the given scenario relates to financial difficulties faced by the organization due to the high cost at which capital has been acquired at the company during the expansionary phase of the business. These problems have been exacerbated by devaluations in the exchange rate of the currencies in which AES Corporation receives majority of their cash inflows. Rapid devaluation of South American currencies like Argentina is a major shock where the organization had invested large amounts of funds for growth in production capacity. The secondary problems faced by the organization are that energy industry is being increasingly regulated in the world. Brazil in particular is th region where the supply of energy has even surpassed the demand by consumers and industry.
This directly implies that negative impacts on pricing of AES Corporation occurs reducing the profitability of operations. In addition, measures by several governments are taken to enhance degree of competition in energy production and distribution sector which has weakened the bottom line of these companies. The profitability if much lower than the figures which were projected and on the basis of capital financing was acquired by the corporation. The shareholders had invested readily in the equity of the company in anticipation of high profitability which never occurred.  The combination of the above mentioned issues has is a rapid decrease in the share price of AES Corporation’s stock. The problem is to find internal and external contributory factors to the worsening financial situation of AES Corporation, as well as, to find possible options available to AES Corporation to address strategic and financial challenges.
Relevant Literature Review there is various concepts, theories, models and secondary researches which are relevant to the case of AES Corporation. Sandahl and Sjögren (2003) state investment decisions and financing are among the largest of any business as they undertake the long term. These decisions are to a large part of the Finance Department. The company's goal is to create value, in other words, to increase its own value and therefore that of shareholder wealth. To create value, it must identify, on the resources available, a rate of return at least equal to that required of its investors (Sandahl and Sjögren, 2003). Slagmulder, Bruggeman and Wassenhove (1995) analyze the different aspects of the investment decision, including the concept of investment and financing, the factors to be taken into account in investment decisions and also evaluate the criteria for investment decisions.
According to Bragg (2007) the main selection criteria are based on discounting. The Finance Department must determine the rate to be used. This rate is the opportunity cost of risk related to the project and, more broadly, to the enterprise. Thus, having analyzed the logic of investment choices on one hand and the funding sources and their distribution on the other hand, every organization must focus on capital budgeting.
In the opinion of Gordon, Loeb and Stark (2003), active management imposes limits on investment managers regarding the level of risk they can take to obtain yields. They must be as concerned about the risk of loss as potential returns.  The risk budget is presented annually to members of the Board of Directors of the company, which review and approve investment decisions and their financing (Gordon, Loeb and Stark, 2003). Board members also review and approve policy asset mix. Strong risk management systems we provide a coordinated view of risks to the fund and its components. They include an asset-liability model used to examine and compare a wide range of long-term economic forecasts, scenarios and capitalization of investment strategies, and a system of risk management which is based on statistical results to measure market risk and credit risk (Gordon, Loeb and Stark, 2003).
Budgeting involves the planned allocation of funds to various departments of a business organization. Budgeting is often done by companies on a periodic basis. In simpler terms, this means that planning and estimating the financial position of an organization in a given period.
The budgeting process is very basic. A budget can keep track of the health of a company, large or small. A person with a basic income can also plan a budget. Expenses can be captured on a day-to-day basis, these expenses can be clubbed under one subcategory. The usefulness of a budget depends on the reliability of the information used to create it (Bragg, 2007). Unrealistic estimates of prices, yields, or input quantities would decrease the accuracy of the budget and could possibly lead to a bad financial decision.
Slagmulder, Bruggeman and Wassenhove (1995) mentions budgeting process can help corporations make good management decisions in any organization, if the information used to make the statement is reliable. If the process is undertaken on a one-year cycle, one must plan the next budget at least three months before the end of the current. If the budget is for much shorter periods, such as a month, these organizations should begin preparing the budget next month, in one to two weeks before the start date.
According to Slagmulder, Bruggeman and Wassenhove (1995), there are six main types of budgets made by companies, namely, sales budget, production budget, equipment purchasing budget, the budget staff, overhead budgeting, and budget for capital expenditures. Most organizations use structured planning to give maximum results in key areas, including return on sales, revenue growth, asset management and equity. Many companies carry out the process on an almost daily basis, and include the majority of activities associated with planning activities, such as growth areas, competitors, cash flow and profits. One advantage of the first year annual business planning is that it gives organizations the ability to understand performance, and also helps to realize the factors affecting it. It also helps to make continuous improvements and anticipate problems and offers reliable financial information on which to base decisions, improve clarity and focus (Sandahl and Sjögren, 2003).
In view of the problem faced by AES Corporation and literature review given above, the following models of financial management, accounting methods and strategic management are relevant to the analysis:
Capital Budgeting Model Capital Budgeting Model toolkit provides information on how to develop and follow a budget. This will allows the organization to form a general budget for the organization, as well as, a budget for a specific project. The model also gives tools to help the business to estimate the costs of different modes of financing. Budgeting is the key to financial management. Application of this model can help an organization to identify financing methods which increases the capacity of the organization to manage its finances efficiently (Helfert, 2001). Application of this model will tell whether AES Corporation should have opted for debt financing, issued bonds or sought some other forms of financing to expand its operations.
The two main techniques for budgeting is that of incremental budgeting and the zero-based budgeting. Incremental budgets are budgets in which the figures are based on those spending the previous year, adding a percentage due to the increase in inflation for the subsequent year. This budgeting technique is only suitable for organizations in which every year is very similar to each other in terms of activities (Alkhafaji, 2003). AES Corporation was in expansionary phase; therefore, zero based budgets are used for analysis of AES Corporation’s financing decisions. In zero based budgets, numbers of previous years are not used as starting points. The process begins from "zero" with activities proposed for the year. The result is a more detailed budget and more accurate, but this method requires more time and energy.
Weighted Average Cost of Capital The weighted average cost of capital is the rate of return average annual expected, by shareholders and creditors, in return for their investment. 
AES Corporation is facing the problem that the rate of return generated by its operations is much lower than the expectations of its shareholders (Helfert, 2001). The WACC measures what the company owes to all who contributed capital. For the company, this is a help in choosing the method of financing. In case of AES Corporation, there were three possible sources of funding: 
- Equity capital by issuing shares in exchange for dilution of ownership 
- Third parties (banks, financial institutions, various lenders) that provide external capital in the form of loans and debts that the company will have to repay; 
- Retained earnings of its past activity (profits from previous years).
The first two represent a source of capital often more interesting than the third, limited in amount and available so uncertain, since it depends on the results of the activity. One question that arises in case of AES Corporation is to compare the cost of funding sources to appeal to the cheapest source. The WACC will serve as the benchmark. The cost of equity is often likened to the return expected by the owners (the partners in the case of a company whose capital is divided into shares) is expressed as a percentage. This model is, therefore, related to the opportunity cost which the performance of similar investments can do.
Morphological Analysis is a method to systematically explore possible futures from the study of all possible combinations of a system. The purpose of morphological analysis is the demonstration of new processes or products in both technological forecasting and scenario building. AES Corporation’s financing choices were not in line with other functions of the organization and not all possibilities were explored (Sadler, 2003). This method of analysis involves breaking down the system or function under study into subsystems or components. In this system, the choice of components is critical and requires considerable thought, for example from the results of structural analysis. It is first necessary to have components as independent as possible. They must also account for all the studied system. 
Each organizational component of AES Corporation can take on several configurations. In the example of the global scenarios for expansion of AES Corporation, a given scenario was characterized by the choice of different combinations of entry into a foreign country and different choices of financing methods (Kotler, 2009). All these combinations represent the range of possibilities, also called morphological space. The objective of the analysis is to reduce the space in an initial morphological useful subspace by introducing constraints of exclusion, selection criteria from which the relevant combinations can be examined.
Although mainly used in technological forecasting, this method lends itself more and more frequently in the construction of scenarios, the dimensions (components) demographic, economic, technical or social can be characterized by a number of possible states (configurations or assumptions). This is the reason for selection of this model for analysis because AES Corporation didn’t take into account all potential possibilities when making international expansion decisions.  To avoid being swamped by the combinations, the analysis will define key criteria and variables during the first phase.  The potential limitation of this analysis is that the combinations can quickly overwhelm the user. One solution is to introduce selection criteria, constraints, exclusion or preference and exploit the useful morphological subspace.
Balanced Score Card Model will be used for higher-level analysis of AES Corporation’s case. Balanced Scorecard is a method to measure the activities of a company into four main perspectives: learning processes, customers and finances. Before application of this model, vision, values ​​and mission of the organization should be explained, to gain a comprehensive understanding of their organization. The usefulness of this method is that it focuses not only on financial results but also on the human issues that bring results, so that organizations focus on the future and act in their best interest long term. The system of strategic management is forcing managers to focus on metrics that lead to success (Bragg, 2007). It balances the financial perspective with the perspectives of customer, process and employees. These measures are often indicators of future performance. There is no evidence from the case that the top management of AES Corporation had a relevant strategy during the growth phase of the business, and it is not always certain that the establishment of such a device allows anticipating problems.
To develop a balanced scorecard includes three processes:
  • translating the vision into operational goals;
  • communicate the vision and the decline in individual performance;
  • feedback and learning, then adjusting the strategy accordingly
The most sensitive part is the strategic capabilities, or learning of the organization. It is indeed the responsibility of the top management to adapt the organization with new learning so that it is enriched by new knowledge by the effects of interaction between decision makers, operational staff, customers and other stakeholders. Application of this model to the case of AES Corporation will evaluate whether the financing choices of top management were in line with other functional aspects of the business.
Proposed Plan of Action Plan of analysis adopted for this case analysis report is methodical and holistic. Financial and operational data for AES Corporation is evaluated under the strategic management and financial management models given above. Both qualitative and quantitative data for AES Corporation is analyzed under the relevant theoretical models to identify whether the financing methods adopted for financing business growth were justified given the external circumstances of the company or not. In addition, role of support functions of the organization like Human Resource Management and Marketing Management will be assessed to gauge their effectiveness is supporting growth initiatives of the top management. This plan of action will lead to the root cause of the immediate financial problems which are being faced by AES Corporation and strategic decisions to deal with the issues will also be identified through this approach.
Sources of Data The predominant proportion of analysis in this report relates to secondary data. The exhibit of the case study already contains a sizeable amount of company-specific information. The information given within the exhibits of the case study relates to the cost structure of the company, and distribution of the revenues in terms of the ‘Line of the Business’ and ‘Geographical Region’. Summarized data about Weighted Average Cost of the Capital of AES Corporation and qualitative information about risk categories is also given. Secondary data provided in the case is utilized for financial analysis models followed in the analysis section. These sources of secondary data are highly reliable because they belong to the audited financial reports of AED Corporation as given in the published financial reports of the company. The information provided in the annual reports is verified by the independent auditors of the company.
Financial information of AED Corporation are accessed from the official website of the company since all public limited companies are required by SECP regulation to publish their audited financial statements on the official website of the company. Consolidated financial statements for the years 2000, 2001 and 2002 are already given within the ‘Exhibit 1’ of the case study provided. Use of primary information for this report is both costly and less reliable. The analysis methods used in the report contains both qualitative and quantitative analysis of information. The advantage of using a combination of the two methods is that findings are both rich in information and also objective. Industry reports pertaining to operational performance of the power generation plants of the company are also a valuable source of data for the purpose of the report. Capital Budgeting Model for AES Corporation Capital budgeting model is adopted for AES Corporation to evaluate the cost of capital of the company and to compare it with the financing cost which was adopted by the organization for its expansion. If the cost of acquired finances is higher than the potential rate of return of the capital, then it can be presumed that the top management of the company made erroneous decisions pertaining to financing decisions of the company. To evaluate financing decisions for AES Corporation, Weighted Average Cost of Capital model has been utilized to evaluate financial decisions of the management. The figures for the model are derived from the financial statements of the company for the financial years 2000-03 (see Appendix) and industry reports. The year 2000-03 is chosen for financial statement’s analysis because these years correspond to the settings of the case.
Weighted Average Cost of Capital for AES Corporation is calculated below utilizing data from the financial statements of the company and data for beta is derived from industry reports.
AES Corporation - Weighted Average Cost of Capital
    millions $    
DATA Amount of equity     8,507      
  Amount of debt   20,608      
  Tax rate 40%      
  Equity beta       1.10  * taken from market reports
           
RESULT 1+ (1-T)D/E       2.45      
  Unlevered equity beta       0.45      
           
           
  Project or Acquisition      
           
DATA % Debt 40%      
  % Equity 60%      
  Tax rate 40%      
           
RESULT 1+ (1-T)D/E       1.40      
  Unlevered project beta       1.10    = average of unlevered equity betas of comparable firms
  Project equity beta       1.54      
           
DATA Risk-free rate 6.00%   = yield on long-term Treasury bonds
  Market risk premium 7.40%   = historical average excess return of S&P 500
           
RESULT Project equity beta       1.54      
  Market risk premium 7.40%      
  Equity risk premium 11.40%      
  Plus risk-free rate 6.00%      
  Cost of equity 17.40%      
           
Note:  The estimate of the market risk premium is the arithmetic average from 1999-2003
           
DATA Cost of debt 9.0%      
           
RESULT       Weighted  
      Weights Cost  
           
  After-tax cost of debt 5.4% 40.0% 2.2%  
  Cost of equity 17.4% 60.0% 10.4%  
  Weighted average cost of capital 12.6%  
             
During the calculations for the weighted average cost of capital for AES Corporation, a highly important observation which is made is that riskiness of the projects has increased by quantum leaps during expansionary phase of the company. The initial expansion of the company’s operations raised the beta value by a marginal level because those countries to which AES Corporation expanded its operations during the initial period were very similar in terms of regulatory mechanisms of the governments and macro-economic environment. For this reason, the consequent cost of capital and required rate of return for the company remained low. However, when the top management of the company decided to expand its operations to countries with very low economic and political stabilities in the regions, then it was essential that the rate of return must justify the added riskiness which was taken by the company. The analysis shows that the added riskiness was not gauged at the appropriate level, which implied that even those risky investments were justified by beta calculations that would have been possible with a very low cost of capital. A 12% discount rate was adopted for calculating feasibility of all projects. This discount rate was very similar to the one adopted for calculation of domestic contract-generation projects where risks were only marginal in comparison to international expansion projects.
Key Financial Ratios AES Corporation
Gross Profit Margin 31.10%
EBIT Margin 22.20%
EBITDA Margin 29.00%
Pre-Tax Profit Margin 12.80%
Current Ratio 1.2
Quick Ratio 0.6
Leverage Ratio 7
Receivables Turnover 6.8
Inventory Turnover 17.1
Asset Turnover 0.4
Revenue to Assets 0.4
ROE from Total Operations 24.10%
Return on Invested Capital 5.90%
Return on Assets 3.40%
Debt/Common Equity Ratio 3.09
Ratio Analysis Key financial ratios are calculated for AES Corporation to identify the problem areas for the company. Evaluation of the financial statements through liquidity, profitability and pay-out ratios of the company shows that profitability of the organization is high as long as interest expenses are not taken into account. The table shows that Gross Profit Margin, EBIT Margin and EBITDA Margin of the company have sizeable value, however, the Pre-Tax Profit Margin is a mere 12%, showing a drop of almost 17% from EBITDA margin. This directly implies that the leverage of the company is very high in comparison to the size of operation of the company or the profitability which generated by this financing option is very low. The Current Ratio of the company can be termed unnecessarily high because considerable resources of the company are invested in cash and cash equivalents, while they should have been invested in the fixed or long-term assets for increasing generation capacity. Leverage ratio confirms the above mentioned diagnosis that the leverage on the company is too in comparison to its size, since the figure of 7 times shows a degree of leverage which is above industry standards.
 The value of receivables ratio of the company are also too low, which indicates potential problem with management of liquid resources at the company. This impact of inefficient financial management of the business is being felt on the entire operations of the organization. Return on Assets and Return on Invested Capital are too low for any industry. At a return of 5% on invested capital, the shareholders of the company would be highly unhappy since it is only marginally better than the return on government treasury securities. 
  A highly interesting observation of the trend analysis of the Revenues and Earnings before Tax of the company exhibits that they show opposite trends from one another. While, the revenues of the company continue to rise after 2001, the profitability of the company gets low. This shows that excessive leverage of the company has been nullifying the positive impact of revenue growth. The operations and marketing personnel appear to be functioning well, since they seem to have contributed towards top-line growth of the company, yet the bottom line continue to perform poorly due to finance function of the business.
Another interesting observation of the trend analysis is the contrasting movements of the Total Equity and Earning before Tax trends lines. Despite low profitability of the business, the equity of the corporation rises sharply indicating a possibility of issue of new capital. If such a path is taken, the existing shareholders of the business would be disgruntled because the profitability of the company is already low and the issue of new shares will dilute the ownership of shareholders even further. Since, the job of the finance manager of any public limited company is to maximize the shareholder value; the above mentioned findings indicate poor financial management at AES Corporation. Strategic management analysis of AES Corporation employs various strategic models to holistically study the strategic positioning of AES Corporation in memory chip industry with respect to the surrounding environment.
Porter Five Forces Model Analysis Porter’s Five Forces model analysis evaluates the power generation industry rather than the organization is question.
Barriers to Entry Power generation industry is characterized by significantly high level of barriers to entry for a new producer in the industry because the capital requirements are extremely high for setting up an energy production unit. Also, getting government approval for entering this industry is essential and difficult to obtain since it is one of the highest regulated industries in almost all economies worldwide. For instance, governments of developing countries have a high level of protection on power generation because it is a fundamental utility and consumers must be able to afford it. Pricing is, hence, highly regulated by businesses. Also, there are several restrictions with respect to control of raw materials – like coal, natural gas, petroleum, etc – because input requirements for production of electricity are huge and also scarce mineral resources. Another key qualifying requirement for entry into memory chip production industry is having access to financial resources to set up production units. The case mentions that markets of emerging economies like Brazil, Indonesia and India are receiving huge capital influx from foreign direct investments into the industry; therefore, barriers to entry appear to get lower in the light of international capital movements. No brand loyalty or even brand differentiation exists in the market to restrict entry of new producers in the segment (Sadler, 2003). Economies of scale does tend to act as a barrier to entry, however, for certain developing economies, this hardly serves as a viable barrier to entry because they represents a very large customer base in the form of a large population (Sadler, 2003). There are no switching costs for a customer of utilities to deter switching to another supplier of electricity. Therefore, the component of Five Forces’ model which pertains to barriers to entry renders memory chip industry is a moderately attractive industry to operate in.
Threats of Substitute Products or Services There are no viable substitutes for power for consumers to serve their need for electricity in everyday life. Only memory chips can be used in computers, programmable devices, handheld devices, e-book readers and tablets to save information (Alkhafaji, 2003). There is no other product which can be used to perform the same function. This is an attractive feature of power generation industry for an individual firm operating in the industry. 
Bargaining Powers of Buyers Evaluation of the case shows that bargaining powers of buyers is high in the industry for a number of reasons. Firstly, customers in contemporary deregulated environment are free to choose the supplier of electricity in developed countries. In developing countries, consumers of electricity are protected by government intervention. Buyers are not restricted by their geography of their operations because transportation cost associated with memory chips in almost negligible. The customers in this industry are also sensitive to price changes because the cost of electricity is almost five to fifteen percent of the total cost of living in several emerging economies. There are no switching costs of buyers, as well. This component of the industry is also weak for firms operating in the industry.
Bargaining Powers of suppliers is very low because they lack any differentiable advantage for the supplier other than the cost. Industry specifications are almost uniform and power generation companies are free to choose their supplier of petroleum and other raw materials. The only binding for factors for power generation firms like AES Corporation is that they need to enter into exclusive contract with some of the suppliers of raw materials like formation of gas pipeline for electricity generators or may need to create a rail track for with coal mine (that are generally owned by governments). Strength of distribution channel is sometimes a differentiating factor between suppliers because large quantities of raw materials need to be moved for power generation. This means that in certain situation suppliers may possess monopoly powers over electricity generation companies. Labor unions also tend to have significant say in the affairs of the industry. For the above mentioned reason, the bargaining power of suppliers is also low in the industry which is a strong feature for this industry.
Intensity of Competitive Rivalry in the industry is high. The cumulative supply the industry exceeds cumulative demand. The increased capacity within the industry drives intense competition between firms operating in the industry. In the past, AES Corporation was able to gain competitive advantage over its rivals in the past due to its excellence in power production and cost advantages, but it is gradually losing this advantage because of its high cost of capital (Ericka, 2011). For power generation industry, the intensity of competitive rivalry is the key determinant of the competitiveness of the industry. The problem with the industry is that innovation is not a sustainable competitive advantage for an individual player because the firm is not able to secure its competitive positioning (Alkhafaji, 2003). Organizational culture and human resource can potentially become a sustainable advantage for key firms because these features cannot be so readily imitated by firms. 
Figure 1 - Porter's Five Forces Model Analysis (self-drawn)

SWOT Analysis the SWOT analysis for AES Corporation serves as an important strategic management tool to cross-check strengths and weaknesses of the organization with the changes taking place in the external environment. This will help to device strategic alternatives for the organization which cross-checks with trends in the industry.
Strengths Global presence
Large financial resources
Diversified investments
Vertically integrated operations
Weaknesses Suppliers & Customers are concentrated
Limited presence in value chain
High financial leverage
Legal proceedings
Opportunities Increasing electricity demand in some markets including US
Emerging alternative energy sector
Rising electricity prices
Threats Rising fuel prices
Foreign currency fluctuations
Environmental regulations
Growing competition
Figure 2 - SWOT Analysis for AES Corporation (self-drawn)
 
The SWOT analysis for AES Corporation indicates that the key strengths of the organization is not the equity associated with the name of the organization, rather it is the global presence of the organization which cushions the organization against any risk of reduction in demand or political instability in a single region. Diversified investments of the business and vertically integrated operations ensure economics of scale that helps to provide low-cost energy to its markets. The financial resources of the business conglomerate are very huge which implies that the business can enter into any sector which seems profitable and can fully utilize any opportunity which carries potential.
The major weakness of the business conglomerate is the huge cost of capital – mainly in the form of debt – carried by it. This cost of debt reduces the profitability of operations and leaves little gain for the paid-up shareholders of the company. Due to disgruntled shareholders, AES Corporation has lost share price value in the market. Also, suppliers of the business are limited which leaves business with very little choice in shifting suppliers to gain any meaningful cost advantage. The organization is also weak in backward integration, which has been sought by other power generation companies.
SWOT analysis also shows that the strength of containing huge financial resources of the company correlates very closely with the opportunity of growing demand in several developing countries. A number of developing countries like Indian and China have engaged in a rapid industrialization process which requires large supply of energy for sustainability. This opportunity for business growth is supplemented by emerging alternative energy sector which is still in its nascent stages. While power generation in traditional manner offers only marginal rate of return for power generation companies due to limited capacity, alternative energy can prove to be the segment with extraordinary high rate of return. Some industry experts have pointed out that alternative energy will provide a cushion against increasingly unstable raw material costs, since alternative energy power generation is based more on technology rather than on raw material fuels.
The above mentioned opportunity is also linked to a key threat to power generation industry of volatile raw material costs. Petroleum prices are highly erratic around the world due to political instability in oil producing countries like Iraq and Libya. This threat is exacerbated by foreign currency fluctuations in the market which makes the cash inflow for the parent company instable. On the other hand, in the developed world environmental regulations are becoming stringent pertaining to carbon dioxide emissions by the industry. It won’t be long that power generation companies will find their production costs soaring. Hence, SWOT analysis shows that devising a strategy for AES Corporation needs careful attention to be paid for correlation of strengths and weaknesses against external environment’s changes. 
Balanced Score Card Model analysis of AES Corporation takes into account all functional areas of business. Certain areas of AES Corporation have been identified to be weaker than the others. The area of business with greatest level of problems within AES Corporation is found to be finances at the company. It has been found from Balanced Score Card Analysis that financing requirements of capital for AES Corporation has not been met adequately. The corporation needed finances for investing in purchasing or setting up power plants for the regions in which it was expanding its operations. The financing requirements in some regions was met through long-term debt financing, while for some regions a separation incorporation of a sister concern was carried out.
Evaluation of financials within Balance Score Card Model also confirms that AES Corporation obtained a steady supply of capital from its public shareholders.  Financials of contract power generation projects is also found to be financed from equity rather than some short-term means of financing of the project which was based on seasonal demand rather than consistent demand. A large share – almost 80% - of capital investment allocated by AES was in third world countries. Financial analysis of the company also took into account the margins for the business. The net and gross margin for business operations also varied significantly which meant that financial riskiness involved with AES Corporation’s operations was considerably high. Interest rate and foreign exchange rate fluctuations are also part of financial analysis of AES Corporation for they accounted for a significant proportion of volatility in the operations of AES Corporation.
The evaluation of the financial components of Balanced Scorecard of AES Corporation’s shows plummeting share price of the company. During the year 2001-02 share price of AES Corporation fell from $70 per share to $1 per share.

Figure 3 - Balanced Scorecard Analysis for AES Corporation (self-drawn)
The net impact of this significant loss in the value of the share price of the corporation is a negative factor of the financial performance of the company. The stability of the bottom line and cash flows of AES Corporation is also low which indicates negative performance of the finance division of the company.
The financing of the growth of the company was based on poor choices, and it was genuinely feared that the company will go bankrupt. Given the size of the total equity of the corporation at the time, the net total loss in the valuation of the company amounted to $3.5 billion which was brought on by several factors. The net effect of this change was amplified by AES's capital structure which was heavily based on leverage from external borrowing. Shareholders of the company are paid in accordance with the decisions of the top management of the company while debtors are needed to be paid irrespective of profitability.
Evaluation of the operational components of Balanced Scorecard Analysis exhibits that the production systems owned by AES Corporation were diversified, yet their production efficiency was high. Coal, natural gas, and fuel oil production system of electricity were all controlled through six-sigma and other process control methods. The technology used for contractual project also comprised of coal, natural gas, and fuel oil production systems and each one of these systems contributed to operational excellence of the company. The other form of project in which AES got involved were merchant plants. These types of plants are characterized by significant level of threats in operations control because they are exceedingly susceptible to changes in the supply of the inputs of natural gas, coal and oil.
The Learning and Growth component of Balanced Scorecard at AES Corporation shows that the human resource of the company exhibited high regards towards the values of the company and shared the commitment of the organization in its myriad operating policies. However, no formal learning and development program had been initiated at the organization for the human resources of the company, rather it was only the top management of the company which was being trained and developed for growth initiatives. This contributes towards a negative score in the Learning and Growth component because learning should be initiated throughout the organization and it is essential for the business to continuously improve skill-set of its human resource. The company's plants operated without shift supervisors and the subsidiaries of AES Corporation were made responsible for keeping a check on human resources of the company. Despite, low investment in human resource development and learning, it was a positive factor that every AES employee was forthcoming to participate in the company’s strategic planning and design initiatives for the plant. Also, the human resources of the company were organized into multi-skilled teams to complement each other’s functional knowledge and to carry out specialized tasks.  
The Internal Business Processes components of Balance Scorecard of the company show that the plants of AES organization were organized into three levels of operations. The electrical production process in the facilities was operated continuously, which was managed through provisions for shift work. Also, employees of the business worked on three twelve-hour shifts, following which, they used to have three days off. The internal business processes of the company were also consistent with the principles of corporate social responsibility.  Even though the majority of the plants of the company operated in third world countries, yet the organization ensured that it didn’t contribute towards external costs to the environment. The management of the company adopted all measures to encourage respect for the physical environment and cleanliness among its personnel.
Figure 4 - Top Hierarchical Structure at AES Corporation (self-drawn)
 Competency Model Analysis The competency model approach to human resource analyzes performance of an organization in terms of knowledge, skills and attributes of human resources. Competency of the human resource of an organization is an outcome of te recruitment strategy of the organization, the incentive plan offered to the employees and the investment on their learning and development. The recruitment strategy at AES Corporation is driven by five key values of the company which the human resource managers of the organization seek in potential candidates. As a part of recruitment strategy, recruiters at AES Corporation seek candidates who possess pride and passion to contribute to the vision of a company, to care about others and they are motivated and committed to work together to share innovative ideas to make a difference in the lives of their consumers. Further, at the time of recruitment, it is measured whether a candidate is open to change and willing to work in a complex environment (Fisher, 2011).
In addition to recruitment strategy, the hierarchy of human resource at AES Corporation is designed in a traditional reporting structure. A sample of the hierarchical structure at top management of the organization has been drawn to depict the reporting structure at AES Corporation. This design of human resource reporting structure is quite outdated and it stifles intrinsic motivation and creativity at workplace. The above drawn reporting structure is gradually being replaced in contemporary organization by an flat organizational structure to instill a sense of ownership of work rather than mere accountability. For this organizational structure to work effectively, it is considered essential to impose strict controls at different levels and functions of the organization. Also, stringent performance targets are assigned to the human resource of the organization to ensure maximum compliance to organizational mission and vision. The evidence from the case supports that control at human resources are termed as highly important at AES Corporation.
Evidence for communication barriers have been found at AES Corporation between various hierarchical layers. Often times, employees have reported that their observations and opinions never reaches higher level of organizational hierarchy due to various filtering layers of management. Also, no system has been created in the organization for rapid communication between different organizational functions. For instance, communication between finance and operations functions takes place only at the respective managerial levels, rather than at the lower level of hierarchies. Analysis suggests that this hindrance of communication – both vertically and horizontally – is responsible for inadequate assessment of region-specific risks for the organization and for such delayed realization of expansionary problems faced by the business. The initial signs of expansionary problems, which were felt at the regional level, could not make it to the headquarters in time. 
Job Analysis & Job Design
Figure 5 - Human Resource Matrix at AES Corporation (self-drawn)
  At AES Corporation, the human resource management system comprises of a methodical approach towards job analysis and job design. Every job within the organizational setup is disintegrated into individual components to isolate key traits and skills required for a human resource to carry out the job. AES Corporation is a company which invests significant resources in training and development of human resources.  Employee retention is highly important in such firms because a high turnover of employees depict wastage of resources which has been spent by the company on development of human resource. Employee retention rate of AES Corporation is not available in any public document.
HR philosophy of AES Corporation is that the management of the company believes in creating an environment that maintains a sustainable commitment of its employees to the company. AES Corporation also believes that the key factor which binds the employee to the company is based on shared values (Surhone, Timpledon and Marseken, 2010). To attain the objective of high retention rate of employees within the company, AES Corporation ensures that employees enjoy working for his company and they want to maintain the relationship with their organization. There is evidence to support that employees at AES are encouraged to knowingly invest their skills, time and effort in the service of the company. This practice creates a binding effect to the employees toward the company. In addition, the management of the company provides skills development and the response to the requirements of the employee, in return for its ownership of the objectives and willingness to maintain its relationship with the company. 
In other words, employee loyalty is not something which is demanded at AES from the employees rather it is something which is the responsibility of the management to create. Management at AES Corporation has established a retention policy is to fulfill expectations of the employee as the central concern of the company, to ensure job satisfaction of employees and to establish other relationships shared of confidence. In this stable relationship, the employee remains in the company by an individual will result in both a reflection of free choice and a step back.  This section describes the implications of the analysis for AES Corporation’s strategy and utilizes the findings to create a strategic path for the organization. Even though analysis has been performed of several functional areas within the company, the major anomalies during the analysis have been found in the financial analysis. The capital budgeting at AES Corporation was followed by a few simple rules even though the complexity of the organizational ventures was very high. AES Corporation was not simply expanding its operations in the same country with similar risk factors associated with previous investments, rather risk and required rate of return for every international expansion was different. Since, the socio-economic settings, the uncertainty associated with political situation and pattern of electricity demand are all different, the beta co-efficient to calculate the required rate of return for the shareholders of the company should have been radically different. In actuality, the management of AES Corporation considered all cashflows to be equally risky and discounted them at a uniform discount rate of 12%, which was a fundamental flaw in the financial evaluation of any project.
The model for financial assessment at AES Corporation should have been much more complex and it must have included at the base minimum the components of (i) currency risk and (ii) regulatory risk for each country. Financial evaluation also shows that the debt structure utilized for financing expansion was not appropriate for the type of expansion in which the organization was involved. AES should have chosen to localize the risk of default by securing credit against the assets of the regional power plants’ assets and taken credit from the regional office rather than head office. If this measure was adopted, then AES Corporation would have been able to localize the risk of default because in case of non-repayment of loan, the creditors would only be able to secure assets of the regional power plant. For instance, when the revenues from Brazilian operations were low, then only the Brazilian entity of AES Corporation would have been under the threat of insolvency and being taken to court by creditors rather than the AES Corporation as a whole. This was a strategic level oversight since the business was growing at such a rapid pace that the top management failed to even take into account the probability of default.
Financial assessment of AES Corporation also brought to notice the fact that the debt which was secured at the regional level was to be repaid in foreign currency rather than local currency. For instance, a power plant of AES Corporation operating in Pakistan was leveraged against a debt which was to be repaid in dollars. This inadequately exposed AES Corporation to the risk of changes in foreign currency exchange rate. When Pakistani Rupee was devalued, the liabilities of the entity were to be paid in USD, while the revenues of the organization decreased by a very huge margin. By attempting to keep simplicity in financial modeling, the top management of AES Corporation, in effect, managed to build expansion of operations of the organization on very weak fundamentals.
This inadequacy was hidden due to the incorrect choice of the financial models utilized to project profitability. Country specific risks was not captured adequately by the financial models used by the top management of AES Corporation perhaps out of fear of not being able to secure finances for growth or due to urgency of making most of opportunities found in foreign markets. Currencies of economies like Argentina plummeted at an unprecedented pace; nevertheless, this possibility was not as distant to be completely missed. The financial analysis shows that there was not systematic attempt to assess riskiness of an individual country. Rather, the assumption which was maintained at the headquarters was that AES’s operations are becoming more secure through this expansion due to diversification. This diversification, in fact, multiplied the risk of a chain default in case the macro-economic situation of world becomes adverse towards developing economies, which in fact happened.
Findings of both CAPM model and ratio analysis of AES Corporation converge on the finding that the cause of the strategic level issues faced by the corporation originates from the leverage of the company.  Leverage ratio indicated that the leverage on the company is too large in comparison to its size, which amounts to a figure of 7 times the size of company’s equity. When the amount owed to creditors of the company is seven times the size of the equity of the company, this show heightened riskiness to all forms of external shocks to the organization. This degree of leverage is by far above industry standards. Analysis using Weighted Average Cost of Capital shows that the riskiness of the projects has increased by quantum leaps during expansionary phase of the company. The value of receivables ratio of the company are also too low, which indicates potential problem with management of liquid resources at the company. Interestingly, while the revenues of the company continue to rise after 2001, the profitability of the company gets low. This shows that excessive leverage of the company has been nullifying the positive impact of revenue growth.
The positive aspects of the analysis are that the problems of AES Corporation are restricted to the financials of the company. The fundamentals of the power production industry remains strong due to high barriers to entry, low threat of substitute products and only medium bargaining power of suppliers. Also, the human resource function of AES Corporation continues to serve as a competitive edge for the organization which is a very positive element. The implication is that if the human resource system of the organization is strong and industry fundamentals continue to be in favor of AES Corporation, then the company will be able to recover very rapidly from the temporary problems being faced by it. The recommendations for AES Corporation is to change the financial model which is currently in place in the organization with a project specific assessment of beta coefficient to measure the required rate of return for the investors of the company.  The required rate of return for AES Corporation should be determined through a different method, whereby beta coefficient is measured through a formula which contains various individual components of risk. Required rate of return should not even be same for two projects in the same region unless all variables pertaining to resource endowment and external environmental variables are same.
Second recommendation for AES Corporation is to create local holding companies to secure financing for the projects. The financing should be secured at the regional level, so that if liquidity or solvency problems are faced at a specific region, the parent company is cushioned against region specific risk. Of course, the risk to the parent company cannot be eliminated completely; the objective would be to at least minimize the direct impact on the parent company. The loans would be secured, in case of implementation of this recommendation, at the assets of the local power generation unit.
Thirdly, the debt for expansionary projects in distant developing economies must be secured either in local currency, or hedged against currency devaluation risk. This will save the organization from the risk of a rapid devaluation in a country’s currency against repayment of debt. The immediate course of action for AES Corporation is to reschedule debt repayment with the creditors of the company. The company should come clean with the creditors and reveal them that the liquidity problems of the company are entirely due to adverse changes in external circumstances, rather than selfish interests of the management. This will prevent the creditors of the company forming a consortium and taking hold of operations of the company. The company can also sell its power generation facility in some specific region to a competitor to secure funds to repay immediate pressing debt payments.  
The proposed plan of action for medium term is to create a dynamic and detailed risk assessment mechanism based on weighted average method. This risk assessment method will include variables of Regulatory Risks, Technological Risks, Credit Default Risk, Commodity Price Risks, Currency Risks and Legal Risks. This model should be proposed to the board of directors of the company and then implemented organization wide till the regional levels. Next, the regional entities of AES Corporation are to be given autonomy in carrying out assessment of their region’s project and to secure financing against these projects – both from the headquarters and third parties.
For the long term of the business, it is recommended that the business should create a model to qualify its international expansion decisions. Rather than rushing to take advantage of opportunities in external market, the business should assess whether the strategic implications of the expansion matches with the vision and mission of the company. All international expansion decisions must be based on the qualifying system. The limitation of the study and the analysis created on the basis of the study is that it takes into account only company specific information and does not utilize country specific information. For instance, data about per capita GDP, energy consumption rate and regulatory framework for individual countries – like Argentina, Brazil, Pakistan, etc – is not taken into account. The reason for not utilizing this information is time and space constraint for the analysis. Another limitation of the study is that not all functions of the organization are evaluated, rather only those functions are analyzed which are most pertinent to the nature of the study. Motorola Corporation has been chosen as the organization to apply findings of the previous section. The rationale for selection of Motorola Corporation for this section is that Motorola has been found to be engaged in similar problems of estimation of cost of capital during global expansion. Motorola Corporation is a company based in Schaumburg in Illinois.  Motorola is an international manufacturer of electronic systems and components with a focus on mobile communications, networking and embedded systems (Motorolla , 2012). Motorola Corporation has started in 1930, with the launch of the first commercially successful car radios in the world. The radio was named "Motorola" because of its heavy and bulky design. The word was derived from motor (motion) and ola (sound wave). The initial product success of Motorola was so great that it soon became synonymous in the U.S. for the manufacturer of car radios. The company also gained success with equipment of consumer electronics and radio equipment for use by the police and military (Motorolla , 2012). In the development of mobile phones Motorola took a leading position. Many of the early missions US -American space flight had radio equipment on board, developed by Motorola. 
The business of the company also succeeded in manufacturing technology, semiconductors, including integrated circuits used in computers and microprocessors that were used for families Atari ST , Commodore Amiga , Apple Macintosh and Power Macintosh (actually equips Most opponents of the IBM PC and compatibles).
In the late 1960s, Motorola began working on the development of mobile telephony. Fifteen years and 150 million dollars later, the group launched Motorola DynaTAC, first cell phone in the world (Motorolla, 2012). Since then the company is on par with Nokia as one of the market leaders. It also sold equipment to the infrastructure of communications networks. Motorola also participated in the launch of the constellation of satellites Iridium.
Motorola built the first mobile phone in the year 1983. In 1989 Motorola introduced MicroTAC the smallest and lightest phone of the time.  In United States, Motorola used to be a market leader in the mobile phone market. Motorola produced the first flip phone and the first dual-band device (Olesiafx, 2012). Motorola was also the first company to introduce the production-ready UMTS mobile phones. Particularly flat clamshell Motorola RAZR could be landed a top seller; sold over 50 million units.
The success of mobile phones in the early 1990s led Motorola in Europe for many more of a shadowy existence. This was because mobile phones designed by Motorola for the U.S. market were incompatible in Europe. Wireless communications standards followed in United States and the frequencies followed were not compatible with European GSM frequencies. 
The name of Motorola became associated with quality production. In the early eighties, Motorola launched an aggressive pursuit to improve the quality of its products, at first by ten times, and then by a hundred times. The company set a precept of quality of "six sigma ". This statistical term means "six standard deviations from an average statistical performance." This implies that Motorola is proposed to reduce defects in their products to less than 3.4 per million in each of its processes: 99.9997% defect-free. "Six Sigma" became the rallying cry of Motorola (Motorolla , 2012).
However, the mobile division of Motorola came under crisis. In 2008, sales fell by 39 percent. In global sales, Motorola which used to be in second place behind Nokia fell below third place behind Samsung. Motorola was considering a sale of the temporary mobile phone division, following its first quarter 2008 loss of 418 million USD and has a share of total sales of 44.3 percent. The smartphone based on Google's operating system Android 2.0, and was a direct competitor to the Apple iPhone 3G, however, the phone never took off in sales.
Semiconductor Business The semiconductor sector of Motorola was launched with two product offerings of Semiconductor Components Group (SCG), which was mainly discrete components and standard products, and ON Semiconductors in the year 2000. The computer maker Apple used semi-conductors manufactured by Motorola for several years. The first step of the PowerPC and several other brands used semiconductors made by Motorola. The business was gradually taken away by Intel processors.  
In July 2010, announced that Nokia Siemens Networks and Motorola announced an agreement that Nokia Siemens Networks will own majority of the assets in the financial sector take over mobile network infrastructure from Motorola. Because of a dispute, this step was completed in April 2011, at a purchase price of 975 million. The problems faced by Motorola are mostly financial in nature. Financial problems of Motorola Corporation, following reduction in market share, continued to grow. In the first quarter of 2009, the company incurred a loss of $ 190 million, and spent U.S. $ 1,300 million from its reserves because he could not raise capital markets. Motorola announced in 2011 after its massive loss of market share and financial problems to split into two separate companies Motorola Mobility and Motorola Solutions. Motorola Mobility Solutions contains the business of Motorola cell phone business and the business customer unit.
On August 15, 2011, Google announced the purchase of Motorola Mobility, the company born from the division of Motorola, Inc. for 12,500 million dollars, as part of its strategy to enhance the use of Android. Motorola Mobility is owned by a significant margin by Google and Motorola Solutions is listed on the stock exchange.
The financial ratios of the company in comparison with industry standards are given below:
Company Title Price Debt Levered Debt Beta Equity Capital Equity Capital Tax % Beta Unlevered
Motorola Mobility $39 1.85 9,234 11,739 11,739 12.00% 0.00% 25.00% 1.85
Nokia $2 1.56 9,560 8,876 18,436 107.70% 51.90% 20.00% 0.84
Cisco $16 1.18 16,855 88,061 104,916 19.10% 16.10% 20.60% 1.02
Alcatel-Lucent $1 2.41 5,366 2,630 7,996 204.10% 67.10% 0.00% 0.79
Qualcomm $60 0.97 1,015 101,866 102,881 1.00% 1.00% 18.00% 0.96
Research In Motion $7 1.69 5,785 3,663 3,663 10.00% 0.00% 27.20% 1.69
LM Ericsson $10 1.04 33,186 210,879 244,065 15.70% 13.60% 31.30% 0.94
Microsoft $30 1 11,921 249,632 261,553 4.80% 4.60% 26.00% 0.97
Siemens $90 1.58 24,910 78,481 103,391 31.70% 24.10% 30.90% 1.3
Median    1.56 9,560 78,481 102,881 15.70% 13.60% 25.00%  
Table 1 - Comparative Analysis of Weighted Average Cost of Capital (source: Google Finance)
Comparison of the financials of the company with other players in the industry gives key insights about the sources of financial problems faced by Motorola Corporation. Motorola is highly debt levered organization ranking second after Alcatel-Lucent. Therefore, Motorola and AES Corporations are similar with respect to business debt being a major source of problems within the organization. Inordinately high level of business leverage at Motorola implies that the organization has failed to secure adequate source of financing for its business which has increased riskiness of operations significantly, as was the case for AES Corporation. By taking up large amounts of debt, AES Corporation had created a situation whereby any form of disruption in the cash stream of the company will create major problems for financing. In other words, Motorola is heading down the path of AES Corporation of imminent insolvency. The share price of the company will fall by a huge margin similar to AES Corporation, if Motorola fails to pay any of its short-term liability in due time.
Even though no immediate problems with the method of capital budgeting has been found at Motorola Corporation as was found at AES Corporation, the financial profile of both companies match by a considerable margin; even though the two organizations operate in entirely different industries. The complexity of the organizational ventures is also comparatively low at Motorola Corporation in comparison to AES Corporation because Motorola has not expanded as much aggressively in developing markets as AES Corporation. Nevertheless, the unlevered beta of the two corporations is very high in comparison to industry competitors indicating that both organizations have made financing choices which had impacted their operations negatively.  
Findings of the comparison of key financial ratios with industry averages and other competitors in the market has indicated that for both organizations, the causes of the strategic level issues faced by the businesses originates from the leverage.  Leverage ratio indicated that the leverage on the company is too large in comparison to its size. The net outcome is the heightened riskiness to all forms of external shocks to the organizations. The value of receivables ratio of the companies are also too low, which indicates potential problems with management of liquid resources at the company. Since, it has been established that the nature of the underlying problems at Motorola are identical at AES Corporation and Motorola Corporation. The recommendations for Motorola Corporation is to learn from the mistakes of AES Corporation and rectify the financial model which has been used by the top management of the organization to assessment of business risks and determining the beta coefficient to evaluate the required rate of return for the investors of the company.  Since, the riskiness of the business is high (as expressed by the beta co-efficient of the company), the required rate of return for Motorola should either be set high, or the business should reduce its leverage. If this step is not taken, then the share price of the company will fall in the similar manner as it has occurred for AES Corporation. In addition, the beta coefficient for Motorola should be measured through a formula which contains various individual components of risk rather than being overly simplistic. Simplistic models for calculations for beta only hides true riskiness and required rate of return, as exhibited from the case of AES Corporation. Motorola should also seek alternative means of financing its ventures rather than relying heavily on debt financing.
Second recommendation for Motorola pertains to global expansionary projects. When entering into new territories and expanding its business geographically, Motorola should create local holding companies and then secure financing for its projects. The benefit of this approach will be that risk and leverage will not be centralized. The financing for Motorola Corporation should be secured at the regional level of the organization, so that if liquidity or solvency problems are faced at a specific region, the parent company is cushioned against region specific risk. This recommendation will prevent Motorola from facing the crisis which has been faced by AES Corporation. Motorola should also create a dynamic and detailed risk assessment mechanism which is based on weighted average method. The regional entities of Motorola should be given autonomy to look after their own financial health rather than relying entirely on headquarters which are distant from regional happenings. In this section, Motorola Corporation was chosen as the organization to apply findings frame state as later. The usefulness of this section is high because Motorola is heading down the same path as AES Corporation. By application of the recommendations from AES Corporation on Motorola Corporation, the former can be saved from reaching the same problems of insolvency and a low share price value.  It is concluded that Motorola and AES Corporations are similar with respect to business debt being a major source of problems within the organization. It is also found from the findings of the comparison of key financial ratios with industry averages and other competitors in the market that strategic level issues faced by both businesses originates from the leverage. It is recommended that the required rate of return for Motorola should either be set high, or the business should reduce its leverage. When entering into new territories and expanding its business geographically, Motorola should create local holding companies and then secure financing for its projects. Alkhafaji, A. (2003) Strategic management: formulation, implementation, and control in a dynamic environment, New York: Haworth Press.
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Currency in
Millions of US Dollars
  Dec 31
2000


 
Dec 31
2001


 
Dec 31
2002


 
Dec 31
2003
Revenues 15,197.0 13,110.0 15,828.0 17,274.0
TOTAL REVENUES 15,197.0 13,110.0 15,828.0 17,274.0
Cost Of Goods Sold 11,596.0 9,753.0 11,892.0 13,124.0
GROSS PROFIT 3,601.0 3,357.0 3,936.0 4,150.0
Selling General & Admin Expenses, Total 368.0 339.0 392.0 391.0
Other Operating Expenses 11,596.0 9,753.0 11,892.0 13,124.0
OTHER OPERATING EXPENSES, TOTAL 11,964.0 10,092.0 12,284.0 13,515.0
OPERATING INCOME 3,233.0 3,018.0 3,544.0 3,759.0
Interest Expense -1,770.0 -1,461.0 -1,503.0 -1,603.0
Interest And Investment Income 519.0 344.0 408.0 400.0
NET INTEREST EXPENSE -1,251.0 -1,117.0 -1,095.0 -1,203.0
Income (Loss) On Equity Investments 33.0 93.0 184.0 -2.0
Currency Exchange Gains (Loss) -184.0 35.0 -33.0 -38.0
Other Non-Operating Income (Expenses) 64.0 77.0 -87.0 25.0
Merger & Restructuring Charges 18.0 -- -- -16.0
Impairment Of Goodwill -- -122.0 -21.0 -17.0
Gain (Loss) On Sale Of Investments 894.0 119.0 -7.0 -66.0
Gain (Loss) On Sale Of Assets -31.0 -19.0 -72.0 -23.0
Other Unusual Items, Total -76.0 277.0 -364.0 -242.0
Insurance Settlements 40.0 -- -- --
Legal Settlements 32.0 129.0 -- 31.0
Other Unusual Items 27.0 168.0 25.0 -48.0
EBT, INCLUDING UNUSUAL ITEMS 2,700.0 2,361.0 2,049.0 2,177.0
Income Tax Expense 771.0 557.0 579.0 636.0
Minority Interest In Earnings -759.0 -1,080.0 -986.0 -1,083.0
Earnings From Continuing Operations 1,929.0 1,804.0 1,470.0 1,541.0
EARNINGS FROM DISCOUNTINUED OPERATIONS 64.0 -66.0 -475.0 -400.0
NET INCOME 1,234.0 658.0 9.0 58.0
NET INCOME TO COMMON INCLUDING EXTRA ITEMS 1,234.0 658.0 9.0 58.0
NET INCOME TO COMMON EXCLUDING EXTRA ITEMS 1,170.0 724.0 484.0 458.0
Currency in
Millions of US Dollars
  Dec 31
2000
Dec 31
2001
Dec 31
2002
Dec 31
2003
Assets        
Cash And Equivalents 881.0 1,782.0 2,525.0 1,710.0
Short-Term Investments 1,382.0 1,648.0 1,718.0 1,356.0
TOTAL CASH AND SHORT TERM INVESTMENTS 2,263.0 3,430.0 4,243.0 3,066.0
Accounts Receivable 2,095.0 2,142.0 2,283.0 2,554.0
Other Receivables -- 434.0 504.0 565.0
TOTAL RECEIVABLES 2,095.0 2,576.0 2,787.0 3,119.0
Inventory 547.0 560.0 552.0 789.0
Prepaid Expenses 175.0 161.0 215.0 158.0
Deferred Tax Assets, Current 178.0 210.0 300.0 454.0
Restricted Cash 722.0 407.0 404.0 484.0
Other Current Assets 1,102.0 1,123.0 520.0 1,011.0
TOTAL CURRENT ASSETS 7,316.0 8,787.0 9,446.0 9,228.0
Gross Property Plant And Equipment 28,264.0 32,570.0 32,072.0 34,876.0
Accumulated Depreciation -7,385.0 -8,774.0 -8,643.0 -9,145.0
NET PROPERTY PLANT AND EQUIPMENT 20,879.0 23,796.0 23,429.0 25,731.0
Goodwill 1,421.0 1,299.0 1,271.0 3,733.0
Long-Term Investments 901.0 1,242.0 1,369.0 1,422.0
Deferred Tax Assets, Long Term 567.0 587.0 589.0 715.0
Deferred Charges, Long Term 364.0 377.0 -- --
Other Intangibles 500.0 510.0 448.0 566.0
Other Long-Term Assets 2,317.0 2,487.0 3,489.0 3,091.0
TOTAL ASSETS 34,806.0 39,535.0 40,511.0 45,333.0
         
LIABILITIES & EQUITY        
Accounts Payable 1,033.0 1,862.0 1,988.0 2,020.0
Accrued Expenses 1,523.0 1,659.0 1,655.0 2,091.0
Current Income Taxes Payable 377.0 508.0 678.0 773.0
Other Current Liabilities, Total 1,178.0 535.0 630.0 986.0
TOTAL CURRENT LIABILITIES 5,182.0 6,621.0 8,065.0 8,446.0
Long-Term Debt 16,619.0 17,816.0 16,046.0 20,608.0
Minority Interest 3,418.0 4,265.0 4,000.0 3,861.0
Pension & Other Post-Retirement Benefits 1,017.0 1,322.0 1,505.0 1,729.0
Deferred Tax Liability Non-Current 1,115.0 1,090.0 892.0 1,328.0
Other Non-Current Liabilities 3,786.0 3,746.0 3,530.0 3,415.0
TOTAL LIABILITIES 27,719.0 30,595.0 30,038.0 35,526.0
Common Stock 7.0 7.0 8.0 8.0
Additional Paid In Capital 6,832.0 6,868.0 8,444.0 8,507.0
Retained Earnings -8.0 650.0 620.0 678.0
Treasury Stock -144.0 -126.0 -216.0 -489.0
Comprehensive Income And Other -3,018.0 -2,724.0 -2,383.0 -2,758.0
TOTAL COMMON EQUITY 3,669.0 4,675.0 6,473.0 5,946.0
TOTAL EQUITY 7,087.0 8,940.0 10,473.0 9,807.0
TOTAL LIABILITIES AND EQUITY 34,806.0 39,535.0 40,511.0 45,333.0
 
Currency in
Millions of US Dollars
  Dec 31
2000
Dec 31
2001
Dec 31
2002
Dec 31
2003
NET INCOME 1,234.0 658.0 9.0 58.0
Depreciation & Amortization 948.0 932.0 1,097.0 1,235.0
DEPRECIATION & AMORTIZATION, TOTAL 948.0 932.0 1,097.0 1,235.0
(Gain) Loss On Sale Of Investment -887.0 -85.0 797.0 144.0
Asset Writedown & Restructuring Costs 175.0 142.0 410.0 242.0
Other Operating Activities 1,193.0 1,152.0 544.0 1,153.0
Net Cash From Discontinued Operations 42.0 -18.0 39.0 -83.0
Change In Accounts Receivable -451.0 62.0 -98.0 -236.0
Change In Inventories -83.0 -34.0 10.0 -141.0
Change In Accounts Payable 260.0 -308.0 136.0 322.0
Change In Income Taxes 226.0 88.0 166.0 166.0
Change In Other Working Capital -497.0 -396.0 394.0 -59.0
CASH FROM OPERATIONS 2,160.0 2,193.0 3,504.0 2,801.0
Capital Expenditure -2,850.0 -2,520.0 -2,310.0 -2,430.0
Sale Of Property, Plant, And Equipment 105.0 17.0 23.0 117.0
Cash Acquisitions -1,135.0 -- -254.0 -3,562.0
Divestitures 1,328.0 2.0 595.0 927.0
Investments In Marketable & Equity Securities -559.0 123.0 -106.0 60.0
CASH FROM INVESTING -3,581.0 -1,917.0 -2,040.0 -4,906.0
Long-Term Debt Issued 3,081.0 2,511.0 2,018.0 5,705.0
TOTAL DEBT ISSUED 3,081.0 2,511.0 2,018.0 5,705.0
Long Term Debt Repaid -2,344.0 -1,180.0 -2,882.0 -2,724.0
TOTAL DEBT REPAID -2,344.0 -1,180.0 -2,882.0 -2,724.0
Issuance Of Common Stock -- -- 1,567.0 --
Repurchase Of Common Stock -143.0 -- -99.0 -279.0
Other Financing Activities -232.0 -721.0 -1,310.0 -1,290.0
CASH FROM FINANCING 362.0 610.0 -706.0 1,412.0
Foreign Exchange Rate Adjustments -96.0 22.0 8.0 -122.0
NET CHANGE IN CASH -1,155.0 908.0 766.0 -815.0

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