Memorandum Ariel Case
Memorandum
To: Prof. Bruce G. Resnick
From: Thibault Usson, Peidan Wu, Jerry Zhang, and Li Zhang
Date: April 27, 2015
Re: Group Ariel Parity Conditions and Cross-Border Valuation
Group Ariel, a global manufacturer of printing and imaging equipment, has to evaluate a proposal from its Mexican subsidiary to purchase and install a new cost-saving machinery at a manufacturing facility in Monterrey. This new equipment will allow automating recycling and remanufacturing of toner and printer cartridges, and would have a useful life of 10 years.
To analyze the investment proposal, Group Ariel needs to conduct a DCF analysis and run an estimate for the Net Present Value (NPV) for capital expenditures. However, the company needs to keep in mind the exchange rate between Mexican Pesos and Euros, as well as the inflation rates over time and the risks involved with this type of investment. Indeed, a major challenge for the analysis will be deciding which currency to use between the Euro and the peso.
Scenario #1: Mexican Inflation = 7%
Given the fact that the expected future inflation is 7% for Mexico and 3% for France. The discount rate used for the Peso NPV can be calculated using the equation for the International Fisher Effect: WACC-Mexico = 12.19%
· Method A: NPV in pesos and then in Euros.
The NPV in Pesos = 1,478,505[1] and using this NPV, we can translate it into Euros using the current MXN15.99/EUR exchange rate. The NPV in Euros is €92,464.
[1] See Exhibit 1.
· Method B: NPV in Euros.
Assume that PPP and Fisher Equation holds, then we can get the future spot rate of exchange for each year and conclude the NPV in Euros at €92,464[2]
· Conclusion:
The NPV of this equipment investment would be same whether we use Method A or Method B as long as IRP and PPP hold. Arnaud Martin should therefore not have any preference between the two methods. Both computed NPVs are positive, so Group Ariel
To: Prof. Bruce G. Resnick
From: Thibault Usson, Peidan Wu, Jerry Zhang, and Li Zhang
Date: April 27, 2015
Re: Group Ariel Parity Conditions and Cross-Border Valuation
Group Ariel, a global manufacturer of printing and imaging equipment, has to evaluate a proposal from its Mexican subsidiary to purchase and install a new cost-saving machinery at a manufacturing facility in Monterrey. This new equipment will allow automating recycling and remanufacturing of toner and printer cartridges, and would have a useful life of 10 years.
To analyze the investment proposal, Group Ariel needs to conduct a DCF analysis and run an estimate for the Net Present Value (NPV) for capital expenditures. However, the company needs to keep in mind the exchange rate between Mexican Pesos and Euros, as well as the inflation rates over time and the risks involved with this type of investment. Indeed, a major challenge for the analysis will be deciding which currency to use between the Euro and the peso.
Scenario #1: Mexican Inflation = 7%
Given the fact that the expected future inflation is 7% for Mexico and 3% for France. The discount rate used for the Peso NPV can be calculated using the equation for the International Fisher Effect: WACC-Mexico = 12.19%
· Method A: NPV in pesos and then in Euros.
The NPV in Pesos = 1,478,505[1] and using this NPV, we can translate it into Euros using the current MXN15.99/EUR exchange rate. The NPV in Euros is €92,464.
[1] See Exhibit 1.
· Method B: NPV in Euros.
Assume that PPP and Fisher Equation holds, then we can get the future spot rate of exchange for each year and conclude the NPV in Euros at €92,464[2]
· Conclusion:
The NPV of this equipment investment would be same whether we use Method A or Method B as long as IRP and PPP hold. Arnaud Martin should therefore not have any preference between the two methods. Both computed NPVs are positive, so Group Ariel