This assignment introduces international capital budgeting, in the setting of a cross-border discounted

cash flow valuation, between France and Mexico.

In this final project, you will read a real-world case study, and write a report demonstrating your ability
to evaluate the complexities of cross-border projects and identify how the competing approaches to DCF
valuation are similar provided purchasing power parity conditions hold. From the perspective of a
consultant, evaluate whether the project from the case study should be undertaken or not. Your
evaluation will come in the form of a written report to the head of the company.

Read the case study provided and use the Excel file to review the exhibits from the case. After reading
the case study and reviewing the Excel file, answer the questions posed below in the “Final Project
Instructions”.

Do not simply answer the questions; they should be used to guide your evaluation. Upon completion,
submit your report for a grade.

Report Formatting:

Written report—standard report format (use a professional format that you may have used in the past)

Word document, 4–5 pages

An Excel file is provided to help complete your report. The first 4 tabs are exhibits from the case study.
The template is for you to use to help evaluate the data. Copy and paste the excel results into the report.
Do not submit the Excel file as a separate file.

Final Project Instructions

1. Read the SACM S.A. case carefully. The managers of SACM S.A. would like to maximize the value
of their investment. What is the relevant currency for the shareholders of SACM S.A.?

2. Carefully estimate the cash flows of the project in Mexican Peso. The relevant peso cash flows
for the project should include the following: the initial outlay; the after-tax salvage value of the
existing equipment; after-tax cost savings from the new equipment; the loss of the
depreciation tax shields on the old equipment; and the depreciation tax shields on the new
equipment. Note that they assume the old equipment will be worthless by year 10 if not sold
now, and that the new equipment likewise will have no salvage value at the end of the year 10.
The Excel Spreadsheet Template tab presents a suggested format for the Peso Cash Flows.

3. From class we know that there are two approaches to solving this problem. The first method is
to calculate the NPV of the project by estimating the cash flows in peso and discounting them
(DCF analysis) using the cost of capital in Mexico (in Peso). This arrives at a peso NPV. The
second method is to calculate the annual peso cash flows into euros using the expected future
 exchange rates and then discounting the euro cash flows at the euro discount rate to get the
euro NPV.

If parity conditions hold, should the two approaches yield different answers, why or why not?

4. Estimate the cost of capital of the project in peso terms (method 1). There are several
possibilities but one possibility is to use the PPP to translate the euro discount rate into the peso
discount rate. Assume the future inflation rate in France is the average of the 2000-2007
period. What are other reasonable choices one could make for the peso cost of capital? Select
your preferred peso cost of capital and calculate the NPV of the project in peso. What is the
NPV of the project when translated into euros at the current exchange? Using this method
should SACM SA reject or accept the project?

5. Estimate the cash flows in euro terms. For this, you need to estimate the future exchange rates.
There are several ways future exchange rates are forecasted. In this case, it is not an
unreasonable approach to use the Purchasing Power Parity (PPP) predictions: that is, given
the differential inflation rate in France and in Mexico what should happen every year to
exchange rates? Compute the PPP forecast rate for the relevant years.

6. Using the euro cash flows and the euro cost of capital to conduct a DCF analysis (method 2).
Does it yield substantially different answers to the first approach?

7. Overall make a recommendation as to whether SACM S.A. should approve the project.

8. Compare and contrast the country risks of France with that of Mexico what sources can you
find to help you in that endeavor?

9. Is it reasonable that the cost of capital for Mexico does not account for a country risk
premium? Why or why not?