In partial fulfillment of Course:

Corporate Finance

Report on

Groupe Ariel S.A.: Parity Conditions and Cross-Border Valuation Case Analysis

Submitted by:

Jatin Agrawal – P19002

Sagar Chowdary– P19010

Juhi Jain – P19018

Shubham Narnoli – P19033

Maddula N K Srikar -P19050

Mohit Yadav – P19056

Date of Submission:

November 26, 2019

We followed the below steps to compute the NPV:

Calculating Total Incremental Cash Flow:

 Initial investment = Cost of new equipment – selling price of old equipment (3.5m-175000 =
3.325m)
 Savings in Operation Costs after deploying automated equipment is calculated on the basis of
data given Exhibit 2
 Used straight line method of depreciation for the new equipment. It will depreciate in next
10years, hence using straight line method, depreciation calculated: (3.5m/10years).
 Depreciation Tax Shield is calculated as 3.5m/10years*Tax Rate
 Depreciation Tax shield on the old equipment is adjusted considering the fact that it was
supposed to fully depreciate in next 3 years and the company could have gained the
Depreciation tax shield on it had they retained the old equipment.
 Added net depreciation and saving in operations to get the total incremental cash flow.

Discount Rate Calculation:-

1+ π Mexico
 Discount rate is arrived at 12.19% using the formula i MXN = ( 1+ π France)( 1+iAriel )−1, i.e.

( 1.07
1.03
∗( 1.08 ) )−1

Discounting the Cash flows:

 We calculated discount factors till 10th year and summed up the PV of yearly cash flows
 To find out the NPV in Pesos, we subtracted the Net investment (3.325m) from total PV of
project
 Used Spot rate MXN/EURO i.e. 15.99 to convert the Pesos NPV to Euro
Calculation Tables
France Inflation 3%
Mexico Inflation 7%
Cost of Capital in euros 8%
Cost of Capital in Pesos 12.2%

(PAID IN CASH)
Year 0 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018
Expenditure (35,00,000)
Old Machine Selling Price 1,75,000
Incremental Cash Flow 7,27,440 8,44,022 9,80,386 10,79,083 11,54,619 12,35,442 13,21,923 14,14,457 15,13,469 16,19,412
Tax Rate 35% 35% 35% 35% 35% 35% 35% 35% 35% 35% 35%
After Tax Cash Flow 1,13,750 4,72,836.13 5,48,614.10 6,37,250.79 7,01,403.82 7,50,502.09 8,03,037.23 8,59,249.84 9,19,397.33 9,83,755.14 10,52,618.00
Dep Tax Shiled Lost (Old Equipment) (29,167) (29,167) (29,167)
Dep Tax Shiled Gain (New Equipment) 1,22,500 1,22,500 1,22,500 1,22,500 1,22,500 1,22,500 1,22,500 1,22,500 1,22,500 1,22,500
Total peso cash flows (32,11,250) 5,66,169 6,41,947 7,30,584 8,23,904 8,73,002 9,25,537 9,81,750 10,41,897 11,06,255 11,75,118

0 1 2 3 4 5 6 7 8 9 10
Year 0 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018
Total peso cash flows (32,11,250) 5,66,169 6,41,947 7,30,584 8,23,904 8,73,002 9,25,537 9,81,750 10,41,897 11,06,255 11,75,118
Discount factor, pesos 1.000 0.891 0.794 0.708 0.631 0.563 0.501 0.447 0.398 0.355 0.316
Present value, pesos (32,11,250) 5,04,634 5,09,987 5,17,320 5,19,990 4,91,093 4,64,058 4,38,741 4,15,014 3,92,756 3,71,859
Net present value, pesos 14,14,201

(PAID USING A BANK DEBT IN MEXICO)

Year 0 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018
Expenditure (35,00,000)
Old Machine Selling Price 1,75,000
Incremental Cash Flow 7,27,440 8,44,022 9,80,386 10,79,083 11,54,619 12,35,442 13,21,923 14,14,457 15,13,469 16,19,412
Interst Payment @ 9.21% (3,22,350) (3,22,350) (3,22,350) (3,22,350) (3,22,350) (3,22,350) (3,22,350) (3,22,350) (3,22,350) (3,22,350)
After Interest Cash Flow 4,05,090 5,21,672 6,58,036 7,56,733 8,32,269 9,13,092 9,99,573 10,92,107 11,91,119 12,97,062
Tax Rate 35% 35% 35% 35% 35% 35% 35% 35% 35% 35% 35%
After Tax Cash Flow 1,13,750 2,63,308.63 3,39,086.60 4,27,723.29 4,91,876.32 5,40,974.59 5,93,509.73 6,49,722.34 7,09,869.83 7,74,227.64 8,43,090.50
Dep Tax Shiled Lost (Old Equipment) (29,167) (29,167) (29,167)
Dep Tax Shiled Gain (New Equipment) 1,22,500 1,22,500 1,22,500 1,22,500 1,22,500 1,22,500 1,22,500 1,22,500 1,22,500 1,22,500
Total peso cash flows 2,88,750 3,56,642 4,32,420 5,21,057 6,14,376 6,63,475 7,16,010 7,72,222 8,32,370 8,96,728 (25,34,409)

0 1 2 3 4 5 6 7 8 9 10
Year 0 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018
Total peso cash flows 2,88,750 3,56,642 4,32,420 5,21,057 6,14,376 6,63,475 7,16,010 7,72,222 8,32,370 8,96,728 (25,34,409)
Discount factor, pesos 1.000 0.891 0.794 0.708 0.631 0.563 0.501 0.447 0.398 0.355 0.316
Present value, pesos 2,88,750 3,17,879 3,43,530 3,68,956 3,87,751 3,73,227 3,59,002 3,45,104 3,31,554 3,18,367 (8,01,999)
- - - - - - - - - -
Final Cash Flows 2,88,750 3,17,879 3,43,530 3,68,956 3,87,751 3,73,227 3,59,002 3,45,104 3,31,554 3,18,367 (8,01,999)
Net present value, pesos 26,32,121

10 years projection, as new equipment is supposed to fully depreciate in 10 years.

We got the positive (+) NPV in Pesos and Euro hence company can go for the investment in new
equipment.
However, if the company goes for debt to finance the purchase of new equipment, the NPV is higher
because the payment of 3.5 million is moved to the 10th year, and interest tax shield for the 10 years
period upto principal repayment. So they should go for debt financing.

To calculate the NPV in Euros, we used the incremental Cash flow in Pesos as calculated in question
1 above, and then followed below steps:

By converting to euros

Calculating Net Investment:

 Net investment in Pesos (3325000) is converted into EURO using current spot rate of 15.99.
Net investment (Euro) = 3325000/15.99 = 207942.5

Calculating the forward rates

 To convert every future year’s cash flow, we find out forward rates using Purchasing Power
Parity model i.e. E ¿
1+0.7 1
 We put the values Expected Spot Price for Year 1i . e . 16.6109= ( 1+0.3 )
∗15.99

 Calculation for 10 years is given in below table

Maxico Inflation 7%
France Inflation 3%
Current Spot Price 15.99

1 2 3 4 5 6 7 8 9 10
16.61097087 17.25606 17.9262 18.62236 19.34556 20.09684 20.8773 21.68807 22.53032 23.40529

Calculating Incremental Cash flow in EURO:

 We applied above forward rates to the cash flow of Pesos

 Used hurdle rate of 8% given in question as the discount rate to find out PV of all cash flows
 And subtracted net investment (EURO) from the PV of all cash flows
Calculation Tables
France Inflation 3%
Mexico Inflation 7%
Cost of Capital in euros 8%
Cost of Capital in Pesos 12.2%
Current Spot Price 15.99

Year 1 2 3 4 5 6 7 8 9 10
Exchange Rates 16.6 17.3 17.9 18.6 19.3 20.1 20.9 21.7 22.5 23.4

0 1 2 3 4 5 6 7 8 9 10
Year 0 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018
Total peso cash flows (32,11,250) 5,66,169 6,41,947 7,30,584 8,23,904 8,73,002 9,25,537 9,81,750 10,41,897 11,06,255 11,75,118
Projected exchange rate 15.99 16.61 17.26 17.93 18.62 19.35 20.10 20.88 21.69 22.53 23.41
Total cash flows, Euros (2,00,829) 34,084 37,201 40,755 44,243 45,127 46,054 47,025 48,040 49,101 50,207
Discount factor, Euros 1.000 0.926 0.857 0.794 0.735 0.681 0.630 0.583 0.540 0.500 0.463
Present value, Euros (2,00,829) 31,559 31,894 32,353 32,520 30,713 29,022 27,438 25,955 24,563 23,256
Net present value, Euros 88442.9

Net present value, Euros

Net present value, Euros 88442.9
Spot exchange rate 15.99
Converted NPV, pesos 14,14,201

Both the sets of calculations i.e. NPV in Pesos and NPV in Euros will give the same NPV when
the assumptions are same. The appreciation/depreciation of the currencies does not matter in
this case. Martin can choose to go with either of the approaches as they yield same NPV.

If inflation rate assumed in Mexico and France is 3%

In approach 1, the inflation rate is now taken as 3% and the NPV is re-calculated. As the new
inflation rate is same as that of France the Hurdle rate (Discount rate) for Mexico is same as that of
France i.e. 8%. Hence the NPV comes out to be,
France Inflation 3%
Mexico Inflation 3%
Cost of Capital in euros 8%
Cost of Capital in Pesos 8.0%

Year 0 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018
Expenditure (35,00,000)
Old Machine Selling Price 1,75,000
Incremental Cash Flow 7,27,440 8,17,021 9,18,014 9,77,588 10,12,491 10,48,832 10,86,681 11,26,112 11,67,204 12,10,041
Tax Rate 35% 35% 35% 35% 35% 35% 35% 35% 35% 35% 35%
After Tax Cash Flow 1,13,750 4,72,836.13 5,31,063.68 5,96,709.31 6,35,432.17 6,58,119.45 6,81,741.04 7,06,342.74 7,31,972.95 7,58,682.87 7,86,526.63
Dep Tax Shiled Lost (Ol d Equipment) (29,167) (29,167) (29,167)
Dep Tax Shiled Gain (New Equipment) 1,22,500 1,22,500 1,22,500 1,22,500 1,22,500 1,22,500 1,22,500 1,22,500 1,22,500 1,22,500
Total peso cash flows (32,11,250) 5,66,169 6,24,397 6,90,043 7,57,932 7,80,619 8,04,241 8,28,843 8,54,473 8,81,183 9,09,027

0 1 2 3 4 5 6 7 8 9 10
Year 0 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018
Total peso cash flows (32,11,250) 5,66,169 6,24,397 6,90,043 7,57,932 7,80,619 8,04,241 8,28,843 8,54,473 8,81,183 9,09,027
Discount factor, pesos 1.000 0.926 0.857 0.794 0.735 0.681 0.630 0.583 0.540 0.500 0.463
Present value, pesos (32,11,250) 5,24,231 5,35,320 5,47,778 5,57,103 5,31,276 5,06,808 4,83,622 4,61,645 4,40,811 4,21,055
Net present value, pesos 17,98,399

Similarly when doing for Approach 2, the forward rates remain same as current spot rate for all 10
years as the inflation rates are same i.e. 3% for both the countries,
France Inflation 3%
Mexico Inflation 3%
Cost of Capital in euros 8%
Cost of Capital in Pesos 8.0%

0 1 2 3 4 5 6 7 8 9 10
Year 0 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018
Total peso cash flows (32,11,250) 5,66,169 6,24,397 6,90,043 7,57,932 7,80,619 8,04,241 8,28,843 8,54,473 8,81,183 9,09,027
Projected exchange rate 15.99 16.61 17.26 17.93 18.62 19.35 20.10 20.88 21.69 22.53 23.41
Total cash flows, Euros (2,00,829) 34,084 36,184 38,494 40,700 40,351 40,018 39,701 39,398 39,111 38,839
Discount factor, Euros 1.000 0.926 0.857 0.794 0.735 0.681 0.630 0.583 0.540 0.500 0.463
Present value, Euros (2,00,829) 31,559 31,022 30,557 29,916 27,462 25,218 23,165 21,286 19,565 17,990
Net present value, Euros 56912.4

Net present value, Euros 56912.4

Spot exchange rate 15.99
Converted NPV, pesos 9,10,029

Hence the NPV will change as per the calculations shown.

From the case we can see that the forward rate is 20 MXN\euro for in 2011 and 25 for 2013-2018,
because the values are different there will be a change in the NPV’s calculated using the approach 2.

France Inflation 3%
Mexico Inflation 3%
Cost of Capital in euros 8%
Cost of Capital in Pesos 8.0%

0 1 2 3 4 5 6 7 8 9 10
Year 0 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018
Total peso cash flows (32,11,250) 5,66,169 6,24,397 6,90,043 7,57,932 7,80,619 8,04,241 8,28,843 8,54,473 8,81,183 9,09,027
Projected exchange rate 15.99 17.99 18.99 20 22.5 25 25 25 25 25 25
Total cash flows, Euros (2,00,829) 31,471 32,880 34,502 33,686 31,225 32,170 33,154 34,179 35,247 36,361
Discount factor, Euros 1.000 0.926 0.857 0.794 0.735 0.681 0.630 0.583 0.540 0.500 0.463
Present value, Euros (2,00,829) 29,140 28,190 27,389 24,760 21,251 20,272 19,345 18,466 17,632 16,842
Net present value, Euros 22458.8

Net present value, Euros 22458.8

Spot exchange rate 15.99
Converted NPV, pesos 3,59,116

The NPV for the equipment purchase has been calculated as above.

We can see that the result is a positive NPV using both the approaches while taking into account
different inflation rates, spot rates and forward rates. Hence, we recommend that Ariel should go
ahead and approve the equipment purchase.