Groupe Ariel S A Parity Conditions And Cross Border Valuation Case Solution

1. Assume 3% inflation going forward in France. Based on this assumption and the information contained in the case, what hurdle (discount or cost of capital) rate, in pesos, would you use to discount the cash flows from the project? Show your calculations and assumptions. 

The discount rate is the weighted average cost of capital is used which essentially based on the cost of equity and the cost of debt. First of all, the weight of debt and equity is calculated using the book value of debt and equity. The weight of the debt as shown in Exhibit 1 comes out to be 46%, and the weight of the equity comes out to be 54%. After that, the cost of equity is required which is calculated using the dividend discount model. This model states that the cost of equity is the sum the dividend-yield and the growth rate. The dividend yield is essentially the ratio of current dividends to the current price of the stock. 

To calculate the dividend yield, the dividend 0 Euros is used. The current price of the stock is derived using the earning per share ratio and the book value of equity. The current price of the share comes out to be 9.6 in Euros and 152 in Pesos. The dividend of 0.7 is divided by the book value of share which gives the dividend yield of 7%. The GDP growth rate of 3.8% was assumed as a reasonable growth rate. Therefore, adding these would result in a cost of equity of 11.12%. The cost of debt is fairly simple. It is benchmarked against the 10 year corporate bonds issued in Mexico as the objective is to calculate the NPV in Pesos. The cost of debt is 9.21%. Using the WAAC formula, the discount rate comes out to be 10.25%.

                                                                              Exhibit 1