Groupe Ariel S A Parity Conditions and Cross Border Case Solution

The real interest rate in the exhibit gives the rate for the entire year while the analysis is being done after half the year has been passed. So the real interest rate has been divided by two for the calculation.

The hurdle rate in Pesos comes out to be 12.19% for a project of this nature.

2. Compute the project cash flows in pesos for years 0 through 10 and calculates the NPV in pesos. Calculate the IRR of the project. Show your calculations and assumptions in detail. Should the project be accepted or rejected?

The project under consideration is a replacement project. Replacement projects are mutually exclusive projects, and only one option from a given set of options survives. In the given case, Groupe Ariel is considering a recycling project in Mexico and the financial analyst needs to submit his analysis in a day. The important considerations in the analysis of this project are as follows:

• The exchange rate between the two countries (Mexico and France, MXN/Euro).

• Cash flow from existing manual process.

• Cash flow from the automated process.

• The difference between the cash flows from the two processes.

• Tax rates of two countries.

• Depreciation changes resulting from the changed process.

• Changes in the working capital requirements.

• The salvage value of the old equipment.

• Book value of the old equipment.

• The cost of a new machine.

• Salvage value of the new machine at the end of its useful life.

• The discount rate at which the cash flows will be discounted.

The project shall be evaluated based on the net present value (NPV) of the project. All the considerations listed above are the important inputs for the calculation of the net present value. We begin the analysis by calculating the net investment required for the new equipment. It is important to note that the salvage value of the old equipment will result in reducing the cost of the project’s initial investment and needs to be deducted from the cost of new equipment. Following is the list of inputs required to calculate the Net Investment:

• Salvage value of old equipment

• Cost of new equipment

• Tax impact on sale of old equipment

• Changes in net working capital

We have been told that there are no significant changes in Net Working Capital requirements and can thus be ignored for the analysis. So, to calculate the net investment, we use the following formula:

Net Investment = Cost of new machine – Market value of old machine ± (Market value of old machine – Book value of old machine)* x Tax Rate

*If market value is greater (lower) than the book value, then the tax impact increases (decreases) the net investment.

To calculate the incremental cash flows, the difference in cash inflows from both projects is taken into account by simple subtraction. To calculate incremental depreciation, the difference between the depreciation of both machines have been taken into account. It has been mentioned in the case that the old equipment has a remaining useful life of 3 years and thus the impact of depreciation has been accounted for in the next three years only. This has to be noted, however, that depreciation is a non-cash expense and does not impact net cash flows directly. Depreciation impacts the net cash flow via tax impact. Depreciation is a tax-deductible expense and reduces the amount of tax resulting in tax savings.