Groupe Ariel Sa Case Analysis
Groupe Ariel S.A: Parity Conditions and Cross-Border Valuation
This case discusses Cross-Border valuation of projects. This kind of analysis is common for companies that are operating in many countries. Groupe Ariel is one such company that is considering investing in a project in its own subsidiary in Mexico. The company manufactures and sells printers, copiers and other document production equipment in many countries. As far as, expansion into new markets is concerned, company is very slow in taking initiatives as compared to its competitors owing to the recent recession. But the management of the company believes that better durability and lower after-sales service costs of their products enable …show more content…
The cash flows in pesos are then converted into Euros by dividing them by the relevant exchange rate. Once the cash flows are obtained in Euros, their present values can be calculated by using the hurdle rate of 8% as the discount rate. NPV can then be obtained by taking the sum of present values of all the cash flows.
Compare the two sets of calculations and the corresponding NPVs. How and why do they differ? Which approach should Arno Martin use? Relate your answer to the textbook’s treatment of parity disequilibria in capital budgeting.
NPV calculated for the first question is higher than that calculated for the second question. The difference (231593-231507) is 86 Euros. This difference explains that the project has more value for investors in Mexico. The value addition of this project is more to the subsidiary of the company in Mexico as compared to the parent company in France. Hence, the company should hedge the foreign exchange risk to reduce exposure to the currency risk. Hedging provides the company with higher expected value and lower risk.
Suppose Mexican inflation is projected at 3% instead of 7% per year. Assume French inflation remains at 3%. How does this affect the NPV calculations?
If, the inflation rate for both the countries remains the same i.e. 3%, then in that case, the forward premium comes out to be 1. Hence effectively, the exchange rate remains the same for next 10 years i.e. 15.99 MXN/EURO. By dividing the