Groupe Ariel S.A.

Situation Analysis:
Group Ariel is a global manufacturer of printers, copiers, fax machines and other document
production equipment. It is planning to switch from manual to automated cartridge recycle
process at its Monterrey manufacturing plant. To decide whether to go ahead with the venture
or not, it is required to calculate the NPV of the project. The organization is also trying to
determine which currency Peso or Euro should choose since to maximize its profit. While
deciding the same it also has to consider the inflation of two countries Mexico and France.

Problem Statement:
Whether to go ahead with the automation project or not.

Analysis:

 First, we calculate the NPV of Ariel-Mexico’s recycling equipment in pesos by

discounting incremental peso cash flows at a peso discount rate and then convert it into
Euro.
 Using Exhibit 2, to calculate cost saving, we add tax shield on write-off of the old
machine, Tax shield on the Depreciation of new machine. Hurdle rate in Mexico, in
terms of hurdle rate in France (8%) is calculated by:
1+𝑖𝑛𝑓𝑙𝑎𝑡𝑖𝑜𝑛
𝑟𝑀𝑋𝑁 = (1+𝑖𝑛𝑓𝑙𝑎𝑡𝑖𝑜𝑛𝑀𝑒𝑥𝑖𝑐𝑜 ) (1 + ℎ𝑢𝑟𝑑𝑙𝑒𝑓𝑟𝑎𝑛𝑐𝑒 ) − 1
𝐹𝑟𝑎𝑛𝑐𝑒

This gives a discount rate of 12.19%. Using this, we get NPV for the Project in Mexican
Pesos as MXN1,478,997 and in Euro at rate of 1 euro = 15.99 pesos as €92,495.18
(Exhibit 1)
 Another method to calculate NPV of the new project is to compute the NPV in Euro by
translating the project’s future cash flows into Euro at expected future spot exchange
rates. Here, it has been assumed that inflation rates are expected to be 7% in Mexico
and 3% in France
 To calculate expected exchange rate, we use the below formula,

1+𝑖𝑛𝑓𝑙𝑎𝑡𝑖𝑜𝑛𝑀𝑒𝑥𝑖𝑐𝑜 𝑡
(𝐸[𝑆𝑡 (𝑀𝑋𝑁⁄𝐸𝑈𝑅)] = ( ) 𝑆0 (𝑀𝑋𝑁⁄𝐸𝑈𝑅).
1+𝑖𝑛𝑓𝑙𝑎𝑡𝑖𝑜𝑛𝐹𝑟𝑎𝑛𝑐𝑒

The NPV in euro also mounts to €92,495.18 as calculated previously using discount rate
method.
 In both of the above cases, the NPV’s calculated are same as we accounted for inflation
rate in both cases. If the inflation rate doesn’t remain same in future and interest rate
remains unchanged, depending on whether the Euro depreciates or appreciates against
the Peso, the Euro value of project NPV would be greater or lesser than the Peso value.
 Suppose, the Mexican inflation rate moves from 7% to 3% per year and French inflation
remains at 3%, the calculations will change as follows:
 1+𝑖𝑛𝑓𝑙𝑎𝑡𝑖𝑜𝑛
𝑟𝑀𝑋𝑁 = (1+𝑖𝑛𝑓𝑙𝑎𝑡𝑖𝑜𝑛𝑀𝑒𝑥𝑖𝑐𝑜 ) (1 + ℎ𝑢𝑟𝑑𝑙𝑒𝑓𝑟𝑎𝑛𝑐𝑒 ) − 1
𝐹𝑟𝑎𝑛𝑐𝑒
This will give a discount rate in Mexico of 8%. Given the change in discount rate, the
NPV of the project will be recalculated to give a value of MXN 1,770,028.70. Given the
spot exchange rate of MXN 15.99/EUR, the value in EURO will be €110,695.98.
 In case Peso depreciates significantly against Euro continuously year after year, then
there is a possibility that at a certain point the Project Net Present Value will become
negative in Euro and thus the firm should reject the project.

Recommendation:
Based on our analysis, if the Peso doesn’t depreciate significantly against Euro, the NPV of the
project will be positive and project should be implemented. As to decide, whether to choose
Euro or Peso, the company should look at the current economic condition and the volatility in
exchange rates.

Exhibit 1