Que-1 Compute the NPV of Ariel Mexicos recycling equipment in

pesos by discounting incremental peso cash flows at a peso

discount rate. How should this NPV be translated into Euros?
Assume future inflation for France is 3% per year?

Solution- For computing the NPV of recycling equipment, we will be finding

out the cost saving with the new investment first in Mexican peso. Below is
the details-

New machinery cost will be 3.5 million peso estimated and it will be
depreciated in 10 years with straight line method.

Old machinery market value is around 175,000 peso and book value is
250,000 peso and will be depreciated in 3 years.

New machine can work with using 4 employees rather than 10. So direct
costs and training costs can be saved.

It would also take less space so that space can be used for other productive
works.

Tax rate has been taken as 35%.

So we have taken below formula for incremental cash flow.

Incremental Cash Flow= Cash Inflows- Cash Outflows- Taxes

Taxes= (Inflows- Outflows-Deprecation Expenses)*tax Rate

Since we may say that revenue from both the processes will be same hence
will be focusing on incremental cash outflows and Depreciation difference to
come up with final values.

Operating Cost differences has been taken in Exhibit 2.

Now our second task for getting NPV is to find out the discount rate in Peso.

For that we will take use of Fisher effect formula and using Ariel hurdle rate
in France we will find out the discount rate for Ariel Mexico.

1+i (mexico)/1+i(france)= 1+inflation rate(mexico)/1+inflation rate

(france)

Hurdle rate for france = 8%

Inflation rate for mexico= 7%

Inflation rate for france = 3%

Putting values in formula

Discount Rate= 12.1942%

Present Value of incremental cash flow in peso using Excel Formula=

4,777,748.89 mexican peso

Net Investment= 3,500,000-175,000(market value of older equipment)

 =3,325,000 mexican peso

So NPV in Mexican peso=4,777,748.89-3,325,000 = 1,452,748.89

mexican peso

Using Spot exchange rate on June 23 we will get the NPV in Euro.

Spot Exchange rate= MXN 15.99/EUR

So NPV in EURO= 1,452,748.89/15.99

=Euro 90,853.59

Que-2 Compute the NPV in Euros by translating the projects future

peso cash flows into Euros at expected future spot exchange rates.
Note that Ariels hurdle rate for this type of project is 8%. Assume
that inflation rates are expected to be 7% and 3% in Mexico and
France respectively.

Solution- Using previous solution NPV in peso we can convert it into cash
flow in Euro using future spot exchange rate. We can use fisher Effect to get
the future spot rate using inflation rates.

Future Exchange rates = Spot Exchange rate *(1+inflation

rate(mexico))/(1+inflation rate(France)) ^n

Where n is time period

Based on the formula below is the calculation of future cash flow into Euros:
So using future spot exchange rates NPV in Euros is coming around
Euro 90,853.59

Which should be same as previous solution value using Mexican

discount rate and it is same.

If we dont go through all calculation and will go via the assumptions that
one international business publication listed that:

MXN/EUR in 2011= 20.00

MXN/EUR in 2013-2018=25.00

So lets us see what will be the impact on calculations:

So we can see that because of depreciation of Mexican peso against Euro the
NPV of project has been reduced to 59,433.09 Euros.