Groupe Ariel S.A.

Situation Analysis:
Group Ariel was a global manufacturer of printers, copiers, fax machines and other document
production equipment. In its Monterrey manufacturing plant, it was planning to switch from the
manual process to automated process. To decide to go ahead with the venture it was
calculating the NPV of the project. The organisation was struggling to decide to go ahead with
Peso or Euro since it wanted to maximize its profit. While deciding the same it had to consider
the inflation of two countries Mexico and France.

Question1:
Compute the NPV of Ariel-Mexico's recycling equipment in pesos by discounting incremental
peso cash flows at a peso discount rate and translate this into Euro.

Answer: To calculate NPV we use exhibit 2 to calculate cost-saving, add tax shield on write off
of the old machine, Tax shield on the depreciation of new machine. To calculate the hurdle rate
1+inflation Mexico
in mexico in terms of hurdle rate in France(8%) we r MXN = (
1+inflationFrance )
( 1+ hurdle france) −1,
and get discount rate of 12.19. Based on this calculation we get NPV in pesos as 1478997 and in
Euro at rate of 1 euro = 15.99 pesos as 92,495.18 (Exhibit 1)

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.
Again, assume that annual inflation rates are expected to be 7% in Mexico and 3% in France.

Answer: In future spot exchange rates we convert the net present value in peso into NPV in Euro by
calculating expected exchange rates in future and converting NPV on basis of those rates. To calculate
expected rates we use formula (E ¿. The NPV in euro also mounts to 92495.18 as calculated
previously using discount rate method.

3.       Compare the two sets of calculations and the corresponding NPVs. How and why do they differ?
Which approach should Arnaud Martin use?

Answer:
In above cases, the NPV’s that were calculated are the exact same number because we used
inflation rate in both cases. Here if the inflation rates don’t remain same in future and interest
rates stay the same, depending on whether the euro depreciates or appreciates against the peso,
the euro value NPV of the project would be greater or respectively less than the peso value.

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?
Answer: If Mexican inflation rates moves from 7% to 3% the discount rates for calculation will change.
1+inflation Mexico
Based on r MXN =
(
1+inflationFrance )
( 1+ hurdle france) −1 we will get discount rate in Mexico of 8%.
Based on change in discount rate The NPV of the project will then be1,770,028.70 in Mexican
Pesos which in Euro will be €110,695.98 on conversion rate of MXN15.99/EUR.

5.       Suppose Ariel expects a significant real depreciation of the pesos 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 are its effects on the
concluded NPV under each of the approaches in questions 1 and 2?

Answer: If Peso depreciates significantly against Euro continuously year after year then there is
possibility that at certain point NPV value of project will turn out to be negative in Euro and you may
have to reject the project

6.       Should Groupe Ariel approve the equipment purchase?

Answer: Based on our analysis if Peso doesn’t depreciate significantly against Euro the NPV of
project will be positive and the project must be implemented.

Exhibit 1