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Groupe Ariele Solution

The document discusses two approaches to calculating the net present value (NPV) of an investment by Groupe Ariele in new recycling equipment in Mexico. Approach 1 calculates the NPV in pesos using a peso discount rate and then translates it to euros. Approach 2 calculates the NPV directly in euros by translating future peso cash flows to euros at expected future exchange rates. While the NPV amounts differ slightly between the two approaches, the second approach is preferred as it accounts for differences between purchasing power parity and actual exchange rates over time between Mexico and France. A lower expected inflation rate in Mexico increases the projected NPV. A significant depreciation of the peso could potentially make the project unprofitable depending on the magnitude of

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Sergio García
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918 views

Groupe Ariele Solution

The document discusses two approaches to calculating the net present value (NPV) of an investment by Groupe Ariele in new recycling equipment in Mexico. Approach 1 calculates the NPV in pesos using a peso discount rate and then translates it to euros. Approach 2 calculates the NPV directly in euros by translating future peso cash flows to euros at expected future exchange rates. While the NPV amounts differ slightly between the two approaches, the second approach is preferred as it accounts for differences between purchasing power parity and actual exchange rates over time between Mexico and France. A lower expected inflation rate in Mexico increases the projected NPV. A significant depreciation of the peso could potentially make the project unprofitable depending on the magnitude of

Uploaded by

Sergio García
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as DOCX, PDF, TXT or read online on Scribd
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APPROACH 1: Compute the NPV of Ariel-Mexico’s recycling equipment in pesos by

discounting incremental peso cash flows at a peso discount rate. How should this NPV be
translated into Euros? Assume expected future inflation for France is 3% and Mexico is 7% per
year.

Groupe Ariele considers weather to invest or not in a new company process, going from a
manual process to an automated process. To assess the impact of this project, the cash flows
were calculated to determine the financial impact.
We calculated the NPV of this project by subtracting the cost of the old equipment by the
cost of the new equipment. Afterwards the depreciation old the equipment and new equipment
were added. Lastly, the tax rate and shield were included.
Cash flows in this case are positive because the reduced cost equals the
cash flows. Afterwards, these incremental cash flows were added to the NPV using a 12.19%
discount rate to obtain the Project NPV in MXN 1,479,932. Last, this number was divided by
the spot exchange rate of MXN15.99/EUR to arrive at €92,553.60 as the project NPV in euro.
Refer to (FIGURE 1)

2. APPROACH 2: Compute the NPV in Euros by translating the project’s future peso cash
flows into Euros at expected future spot exchange rates. Note that Ariel’s Euro hurdle rate for a
project of this type was 8%. Again, assume that annual inflation rates are expected to be 7% in
Mexico and 3% in France.

In order to estimate the future rates we used the PPP equation . The present value of the
net cash flows were calculated in euros and then the net investment was subtracted. The value of
the Project NPV was slightly different than the previous one which gave a result of €92,494.00
or in MXN 1,478,974.
Refer to (FIGURE 1)
3. Compare the two sets of calculations and the corresponding NPVs. How and why do they
differ? Which approach should Arnaud Martin use?

As PPP is not equal in our calculations we would expect Arnaud to select the Euro
approach, besides of being a European company and making it easier for them, the conditions of
the project improve slightly, and Mexico is a country with in which a potential increase in
inflation might affect their valuation.
FIGURE 1
4. Suppose Mexican inflation is projected at 3% instead of 7% per year (assume French inflation
remains at 3%). How does this affect the NPV calculations?

The NPV of the project increases significantly, by considering a lower inflation rate for
Mexico and the increase of some costs for the project the automation becomes even more
profitable that in our original scenario. When we considered a different inflation rates the
project’s NPV value accounted for €92,553.60 & €92,494.00 for scenario 1 & 2. Now with the
new considerations of equal inflation rates the project’s NPV value accounted for €110,728
which represents an increase of about 20%

FIGURE 2
5. Suppose Ariel expects a significant real depreciation of the peso against the Euro. How
should Martin incorporate such an expectation into his NPV analysis? [For simplicity you may
continue with the assumption that inflation is expected to be 3% in both countries.] What is its
effect on the concluded NPV under each of the approaches in questions 1 and 2? Assume a
depreciation from spot of MXP/EUR 15.99 to 22 in Yr 1 and 25 from Yr 2 to Yr 10.
By following the scenario proposed by question 5 we inputted higher exchange rates
which turned out to be negative throughout the projection of the project, the result was a negative
NPV of €670 which is not a hefty amount for a project. This stress test is merely to depict in
which scenario the project could turn unprofitable, however with conditions as the ones in the
case it seem unlikely in the time of the valuation for the MXN to turn into such a volatile
currency.
FIGURE 3
6. Should Groupe Ariele approve the equipment purchase?
We consider Ariele should approve the project because in a more realistic scenario as in
FIGURE 1 we can see it is a profitable project that according to its manager in Mexico will make
the company’s process faster and cheaper. The numbers back this assumption over the new
machine, however is important to acknowledge that as it was demonstrated in question 5 the
project has a major vulnerability when the MXN exchange rate experiences considerable
depreciations which in a severely adverse scenario could turn the project unprofitable.

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