Group Ariel Case

Introduction Groupe Ariel SA of France is considering a project in Mexico. They need to analyze the net present value of the project, keeping in mind the exchange rates between Mexican Pesos and Euros in order to maximize their return. They also need to keep in mind the inflation rates over time and the risks involved with this type of investment. Analysis

Number 1. Groupe Ariel is recycling old equipment in Mexico. They will need to use pesos to calculate their cash flows to see how this part of their project will impact their finances. They also need to convert this peso amount into Euros. We began the analysis by computing the Net Present Value (NPV) of Ariel-Mexico’s recycling equipment. This was done by first taking the incremental peso cash flow rate by subtracting the cost of the old manual equipment, from the cost of the new equipment. As is displayed in [exhibit XX] the incremental cash flow is represented as positive numbers because the reduced cost is equal to cash flow. Next the depreciation costs were subtracted from the incremental cost totals. The first three years of depreciation included depreciation from the new equipment and the remaining scheduled depreciation of the old equipment. After tax of 35% was deducted from the cash flow the depreciation was added back to represent the tax shield.

The NPV was calculated using the NPV function on Microsoft Excel. The discount rate that was used for the Peso NPV was calculated using the equation for the International Fisher Effect and as can be seen in the answer to Problem 1 [exhibit XX] which was equal to approximately 12.2%. The final project NPV was equal to the Present value of the Net Cash Flows, less the Project Net investment NPVMXN = | MXN 1,478,998.01 |

NPVEuro = | 92,495.18 €|

Please see appendix A for the complete calculations of this problem. Number 2. Groupe Ariel now needs to compute the project's net present value in Euros. However, the project cash flows will be in pesos. Therefore, Groupe Ariel will need to use future spot exchange rates to determine the Euro NPV. We calculated the NPV of the euro investment in two ways. The first was by simply computed by dividing the Peso NPV by the current spot exchange rate. The second method involved using a derivation of the PPP equation to compute the projected future exchange rates. The NPV was calculated after the Cash flows and Net investment were converted to Euros. The value of the Euro Investment was equal in both situations because of the presumption of PPP. NPVEuro = | 92,495.18 €|

Please see appendix B for a complete calculations and cash flows of this problem. Number 3.

Next, Groupe Ariel needs to understand if, why, and how the NPVs in the two sets of calculations differ. The third problem required us to compare the corresponding NPV calculated in Problems 1 and 2. If purchasing power parity holds for the entire period of the investment there will be no difference between either of the approaches. In order to look at the impact of a lack of purchasing power parity we ran two additional scenarios where the PPP did not exist. In order to simulate this scenario I increased and decreased each expected exchange rate by 5%. The results can be seen in the [appendix XX] representing problem 3. It is clear that if the interest rates remain, yet the euro appreciated against the peso the NPV will be greater than the peso value (assuming no PPP), and if the euro depreciates against the peso the Euro NPV will be less than the Peso NPV (assuming no PPP). Number 4.

Groupe Ariel is concerned that inflation will actually be 3% instead of 7% per year in Mexico. As such they want to know the results of the NPV calculations with this new inflation rate. To find this answer, we recalculated the numbers in steps one and two with a new inflation rate and got much higher NPVs for both Euros and Pesos. This can be seen in the chart below:

| Value| Change| Peso NPV| 177028.70 | + 291030.69| Euro NPV| 110695.98| + 18200.79|

Please see appendix D for the complete calculations for this problem. Number 5. Groupe Ariel is expecting a real depreciation of the peso against the Euro, and needs to account for this when planning for the project. Specifically, they need to know what the peso deprecation effect on the NPVs will be for problems 1 and 2. Our result is as follows:

To calculate the answer, we found the new cash flows based on an exchange rate of MXN22.00/EUR in 2009 and MXN25.00/EUR for years 2010-2018. If the peso depreciates against the Euro in this fashion, the resulting Euro NPV will be reduced to -690.26. When an NPV is negative, a company typically should not go forward with a project. Please see appendix E for complete calculations.

Number 6. Finally, Groupe Ariel needs to decide if they should go ahead with the project, and what currency they should finance the project in.

First, we will analyze the cash flows to determine whether or not Groupe Ariel should do the project. In the first four problems, the NPVs were positive, meaning that Groupe Ariel should go ahead with the

project. However, if Groupe Ariel is expecting depreciation of the peso against the Euro, the NPV turns negative. If that is the case, then they should not finance the project. However, our group recommends financing the project because the risk of depreciation can be offset by using hedging options.

Next, we need to decide what currency the finance the project with. To do this, we will analyze the volatility of the peso against the Euro in the following graph, taken from Google Finance:

The graph shows the value of the Euro and the peso in US dollars over the last three years. We can see that the two currencies follow a similar trend, with neither having any large spikes or declines that the other doesn't also experience. We then consider the current economic situations in each of the areas in order to make a prediction about the future of the currencies. The Euro zone is currently suffering a major economic recession as the members of the EU try to decide what to do in order to ensure economic prosperity. We believe the Euro might lose value as more countries are given bailout packages and countries consider leaving the EU. Therefore, we think it will be less risky to finance the project in Mexican Pesos. Conclusions

In conclusion, due to the positive net present values and the possibility of hedging against any depreciation, we believe Groupe Ariel SA should go ahead with the project. They should finance the project with Mexican Pesos because the future of the Euro and the EU is uncertain at this time.