Case solution for the Groupe Ariel case study in which the company reviews a proposal to buy and use cost-saving equipment at a manufacturing facility in Monterrey. The equipment will allow the company to automatically recycle and remanufacture cartridges of toner and printer. Recycling and remanufacturing of these cartridges is an important venture of Ariel's business. The corporate policy of Ariel necessitates an analysis of the discounted cash flow (DCF) and a net present value (NPV) estimate for capital expenditures in international markets. It is facing the challenge of coming up with the decision on which currency to use: the Euro or the peso.
Timothy A. Luehrman; James Quinn
Harvard Business Review (4194-PDF-ENG)
April 19, 2010
Case questions answered:
- Compute the NPV of Groupe Ariel Mexico’s recycling equipment in pesos by discounting incremental peso cash flows at a peso discount rate. How should this NPV be translated into Euros?
- Compute the NPV in Euros by translating the project’s future peso cash flows into Euros at expected future spot exchange rates.
- Compute the two sets of calculations and corresponding NPVs. How and why do they differ?
- Suppose Mexican inflation is projected at 3% instead of 7% per year, the cost savings are:
- Suppose Ariel expects a significant real depreciation of the peso against the Euro. How should we incorporate such an expectation into his NPV analysis?
- Should Groupe Ariel approve the equipment purchase?
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Case answers for Groupe Ariel S.A.: Parity Conditions and Cross-Border Valuation
This case solution includes an Excel file with calculations.
1. Compute the NPV of Groupe Ariel Mexico’s recycling equipment in pesos by discounting incremental peso cash flows at a peso discount rate. How should this NPV be translated into Euros?
To calculate the NPV of Groupe Ariel Mexico’s recycling equipment, we must know the difference in cost savings that the company would be getting if it switches from its old recycling equipment to the new machinery.
Using the operating costs from exhibit 2, we arrive at:
In addition to the cost savings, the tax benefits of depreciation that is obtained through the capital expenditure should also be taken into account.
Since the old equipment is being sold at 175000 instead of the book value of 250000, we are getting a loss of 75000. We can get a tax benefit by showing this loss on our books.
Tax benefit due to the sale of the asset at a reduced price = 75000 * 35% = 26250
Thus, the net Cash flows from the equipment switching exercise can be calculated as: