Groupe Ariel SA: Parity Conditions and Cross-Border Valuation Hints to case study questions: 1. Compute the NPV of Ariel-Mexico's recycling equipment in pesos by discounting incremental peso cash flows at a peso discount rate. How this NPV should be translated into Euros? Assume expected future inflation for France is 3% per year. 1.1. Review principles of estimating project cash flows. Suggested reading: Ch. 9 “Capital Budgeting and Cash Flow Analysis” in “Contemporary Financial Management”, 11th ed. by Moyer, McGuigan, and Kretlow. a. Project Net Investment (NINV): NINV=Capital Expenditure-ATSVold , where ATSVold = After-Tax Salvage Value of the old equipment. ATSVold=MVold+BVold-MVoldt , where MVold = …show more content…
Calculate total peso cash flows over time. 1.3. In order to estimate the peso discount rate, assume that the International Fisher Effect (IFE) holds. Groupe Ariel's Euro hurdle rate for a project of this type was 8%. Assume that inflation rates are expected to be 7% in Mexico and 3% in France. iMXN=1+πMexico1+πFrance1+iAriel-1 1.4. Project NPV: NPV= -NINV+PV(NCFs) 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 Groupe Ariel's Euro hurdle rate for a project of this type was 8%, assume that inflation rates are expected to be 7% in Mexico and 3% in France. To derive expected peso/euro exchange rates, assume the Purchasing Power Parity (PPP) holds: ESt(MXNEUR)=1+πMexico1+πFrancetS0(MXNEUR). 3. Compare the two sets of calculations and the corresponding NPVs. How and why do they differ? Which approach should Ariel's financial analyst use? Hints: 4.1. If the IRP, PPP, and International Fisher Effect conditions hold, the two approaches should yield identical NPV results. 4.2. If one or more parities do not hold, the two approaches will give very different results, possibly causing managers at the French headquarters and in the Mexican subsidiary to disagree about whether the project should be undertaken. 4. Suppose Mexican inflation is projected at 3% instead of 7% per year (assume French
NPV analysis uses future cash flows to estimate the value that a project could add to a firm’s shareholders. A company director or shareholders can be clearly provided the present value of a long-term project by this approach. By estimating a project’s NPV, we can see whether the project is profitable. Despite NPV analysis is only based on financial aspects and it ignore non-financial information such as brand loyalty, brand goodwill and other intangible assets, NPV analysis is still the most popular way evaluate a project by companies.
Finally, in order to complete a more accurate comparison between the two projects, we utilized the EANPV as the deciding factor. Under current accepted financial practice, NPV is generally considered the most accurate method of predicting the performance of a potential project. The duration of the projects is different, one lasts four years and one lasts six years. To account for the variation in time frames for the projects and to further refine our selection we calculated the EANPV to compare performance on a yearly basis.
2. Net Present Value – Secondly, Peter needs to investigate the Net Present Value (NPV) of each project scenario, i.e. job type, gross margin, and # new diamonds drills purchased. The NPV will measure the variance of the present value of cash outflow (drilling equipment investment) versus the future value of cash inflows (future profits), at the benchmark hurdle rate of 20%. A positive NPV associated with the investment means that the investment should be undertaken as it exceeds the minimum rate of return. A higher NPV determines which project scenario will have the highest return on cash flow, hence determining the most profitable investment in terms of present money value.
The old factory needs extensive renovation which will still not leave it as efficient as the new factories planned for the new countries. Therefore, the NPV of the capital investments involved are equal for all three countries.
ii-We would like to know how changing the discount rate would affect the NPV of each project. For both projects we have that as the discount rate decreases each project increases in value, and when the discount rate increases both
d) Information systems charge-backs (both cost reduction and additional expenses) – Only costs associated with each of the different projects should be included in the NPV analysis. For instance, research regarding which system should be purchased would be considered to be a sunk cost and should not be included in the analysis as an incremental cash flow. On the other hand, the cost reduction of each project should be included in the NPV analysis, since the reductions will greatly affect the NPV of each project.
2. The current NPV is negative. One way to save money would be to reduce consulting costs. Please set the average consulting cost per month in cell b33 to $5000. At what discount rate is the NPV for the project 0?_____0.026____
Cash inflows and outflows can occur at any time during the project. The NPV of the project is the sum of the present values of the net cash flows for each time period t, where t takes on the values 0 (the beginning of the project) through N (the end of the project).
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.
When making capital budgeting decisions, there are various techniques that can be utilised. Ross et al. (2008) describes that the predominant capital budgeting methods used as being the Net Present value (NPV) method, the Internal Rate of Return (IRR) method, the Payback method, and the Accounting Rate of Return (ARR) method. Conversely, Brealey, Myers and Allen (2011) proposes that the NPV and IRR methods are considered prestige compared to the ARR and the Payback Methods, as they take into account the time value of money. Thus, the following project evaluation will focus on using the NPV and IRR methods.
So, the NPV can be calculated by taking the sum of present values of all the cash flows. This NPV comes out to be 3,703,176 Pesos. This NPV value can be converted into Euros by dividing the NPV value by the spot exchange rate. The spot exchange rate is 15.99 MXN/EURO. Hence, by dividing 3,703,176 by 15.99, NPV value in terms of Euro comes out to be 231,593 Euros.
In the case of Worldwide Paper Company we performed calculations to decide whether they should accept a new project or not. We calculated their net income and their cash flows for this project (See Table 1.6 and 1.5). We computed WPC’s weighted average cost of capital as 9.87%. We then used the cash flows to calculate the company’s NPV. We first calculated the NPV by using the 15% discount rate; by using that number we calculated a negative NPV of $2,162,760. We determined that the discount rate of 15% was out dated and insufficient. To calculate a more accurate NPV for the project, we decided to use the rate of 9.87% that we computed. Using this number we got the NPV of $577,069. With the NPV of $577,069 our conclusion is to accept this
2. Compute the NPV of both projects. Which would you recommend? What if they are not mutually exclusive?
3. The NPV method is better because it shows the size of the project so you can see how much value a project has not just a percentage. You could have a higher percentage but a much lower value and you would still go for the lower percentage.
Overall, because Expected value of NPV > 0 and IRR > WACC, both results are consisted and strongly recommend the purchase of the Pathrite System. After the calculation, the result of NPV which by using nominal cash flow and nominal WACC is the same as which using real cash flow and real WACC.