Groupe Ariel S. A. Parity Conditions and Cross Border Valuation Harvard Case Solution & Analysis

Groupe Ariel S. A. Parity Conditions and Cross Border Valuation Case Solution

  1. cash flows should be denominated in Pesos.

In order to determine the cash flows of Groupe Ariel’s Mexican recycling project, the difference of the manual process and the automatic process is taken which derives the cost saving for the company in the future in pesos. The automatic process is carried out with the help of a machine which cost 3.5 million pesos is depreciated using straight line method for the useful life of ten years. In addition to this, depreciation of the remaining three years of an old machine is also calculated. From the values of cost savings for each of the year from this project, the value of total depreciation is subtracted. Using the tax rate of 35% given in the case, the after tax cash flows is calculated. The depreciation of the two machines in then added back to get the true cash flow figure for each year which represents the tax savings.

  1. The expected inflation rate for the foreseeable future is 7% (as given in Exhibit 2 of the case).   (We should not use the inflation rates provided in Exhibits 3 and 4 because those are past rates; we need future / expected rates for our calculation.)

In order to calculate the discount rate for the company, the purchasing power parity occurs in this scenario. Using the inflation rate of Mexican 7% and the inflation rate of France 3%, the discount rate as calculated from the international fisher effect comes out to be 12.19%.

  1. Using answers from #1 and #2, what is the NPV of this project in Pesos?

In order to calculate the NPV of this project, the cash flows generated from the year 2009 to 2018 are discounted back using the discount rate of 12.19%. In addition to this, the initial cash flow relating to the cost of machine is subtracted from this calculation which derives the positive net present value of 1.59 million pesos. It can be seen that the project provides such a high positive net present value which conveys the fact regarding its viability.

In order to consider the interest rate (9.12% of Mexico and 4.81% of France) rather than their inflation rate to convert into Pesos, the discount rate is calculated using then IRP (Interest Rate Parity). From the calculation, the discount rate is calculated to be 16.5%.

In order to calculate Peso- based NPV by using IRP based estimate of discount rate, the value comes out to be 4.79 million pesos. The calculations are shown in the exhibits of this report. Due to the interest rate parity, the value gets significantly changed. However, it can be seen from both the analyses that the project is showing a much higher positive net present value which reveals the fact that project is worth undertaking moreover, it can easily provide the required rate of return from this investment..................

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