Groupe Ariel is a company that manufactures and sells printers, copiers and other document production equipment. The case focuses on an investment project in the company’s Mexican subsidiary that would expand operations into a new market, something it been slow to do in the past. Groupe Ariel believes its products have better durability for a lower after-sales service costs and markets it as a competitive advantage. The company is now considering replacing the manual equipment used for recycling in Mexico by new equipment that requires less material and labor costs.
1. Compute the incremental peso cash flows for the life of the project.
The incremental cash flows of the next 10 years should be calculated. The initial cash outflow is the cost of investment in the new equipment (3,500,000 Pesos). Also, selling the manual equipment for cash value of 175,000 Pesos is subtracted from the cost of the new equipment to arrive at the initial net cash outlay of 3,325,000 Pesos. For the cash flows in the next 10 years, it is calculated by taking the difference of the cost of the manual method and the new automatic equipment. Next, to arrive at after-tax incremental cash flows we add back depreciation cost, which is non-cash expense (if total cost does include depreciation) and deduct tax. The new equipment would have a useful life of 10 years and would be depreciated under the straight-line method for both tax and financial reporting purposes. The corporate tax rate is 35%.
2. Compute the net present value of Ariel-Mexico’s recycling equipment in pesos by discounting the incremental peso cash flows at a peso discount rate.
The present value of all these cash inflows and outflows can be calculated by discounting them at 8.5%, which was calculated by using real peso long-term borrowing rate of 2.2% and a real euro rate of 1.8%. The NPV can be calculated by taking the sum of present values of all the cash flows. This NPV comes out to be 3,754,474 Pesos.
3. Compute the NPV in Euros by translating the project’s future peso cash flows into Euros at the expected future spot rates.
We translate the project’s future peso cash flows into Euros using the expected future spot rates estimated by the international business publication in the article—rise to 20.00 by 2011 from current 15.99 exchange rate and upwards of 25.00 in 2013-2018. We then discount the cash flows in Euros at 8% (the discount rate for similar projects in France) and get the NPV in Euros as 118,903 Euros. 4. Translate the NPV in pesos calculated in 2. To Euros and compare to the answer in 3. Comment on your findings.
We translate the NPV in pesos calculated in 2 to Euros using the spot exchange rate on June 23 at MXN15.99/EUR. It gives an NPV of 234,801 in Euros, which is much higher than our number in question 3 as 118,903 Euros. The difference is driven by prediction of Pesos against Euros, and a slight different discount rate. From our analysis, we see that expectation of steep depreciation in pesos and a slightly higher discount rate in Mexico result in a much higher NPV value if we translate the pesos into Euros now.