Analyzing NPV of Groupe Ariel's Investment Project in Mexico

Categories: Business Economics Marketing

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Abstract

Groupe Ariel is a company that specializes in manufacturing and selling printers, copiers, and other document production equipment. The company is considering an investment project in its Mexican subsidiary to expand its operations into a new market, which has been a slow process in the past. Groupe Ariel prides itself on producing products with superior durability, leading to lower after-sales service costs, giving them a competitive edge in the market. The current project involves replacing manual recycling equipment in Mexico with new, more efficient equipment that requires less material and labor costs.

Analysis of Incremental Peso Cash Flows for the Project's Duration

To calculate the incremental cash flows for the next 10 years, we must consider various factors.

The initial cash outflow involves the investment cost in the new equipment, which amounts to 3,500,000 Pesos.

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Additionally, selling the manual equipment for a cash value of 175,000 Pesos is deducted from the cost of the new equipment to determine the initial net cash outlay of 3,325,000 Pesos.

Over the next 10 years, the cash flows are calculated by comparing the costs of the manual method with the new automatic equipment.

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To determine the after-tax incremental cash flows, we need to add back depreciation costs, a non-cash expense, and deduct taxes. The new equipment has a useful life of 10 years and will be depreciated using the straight-line method for both tax and financial reporting purposes, considering a corporate tax rate of 35%.

Calculation of Net Present Value of Ariel-Mexico's Recycling Equipment in Pesos

The net present value (NPV) of the project can be determined by discounting the incremental peso cash flows at a peso discount rate of 8.5%.

This rate is derived from the real peso long-term borrowing rate of 2.2% and a real euro rate of 1.8%.

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By summing the present values of all cash flows, the NPV is calculated to be 3,754,474 Pesos.

Determination of NPV in Euros by Converting Future Peso Cash Flows

To convert the project's future peso cash flows into Euros, we utilize the expected future spot rates provided by an international business publication. These rates suggest an increase to 20.00 by 2011 from the current 15.99 exchange rate, with projections of reaching 25.00 in 2013-2018. The cash flows are then discounted in Euros at 8%, which is the discount rate for similar projects in France. The resulting NPV in Euros is calculated to be 118,903 Euros.

Comparison of NPV in Pesos and Euros

Translating the NPV in Pesos calculated earlier into Euros using the spot exchange rate on June 23 at MXN15.99/EUR yields an NPV of 234,801 Euros. This value is significantly higher than the previously calculated 118,903 Euros. The disparity is influenced by the anticipated depreciation of the Peso against the Euro and a slightly different discount rate. The analysis indicates that the expectation of a substantial Peso depreciation and a slightly higher discount rate in Mexico contribute to a much higher NPV value when translating Pesos into Euros at the current exchange rate.