International Corporate Finance: Value Creation

INTERNATIONAL CORPORATE FINANCE
Study Case: Groupe Ariel S.A. – Parity Conditions and Cross-Border Valuation

1) Compute the net present value (NPV) of 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? Assume expected future inflation for France is 3% per year
The proper discount rate to discount our Peso cash flows, we used the International Fisher Effect:
1+𝑖𝑀𝑒𝑥 / 1+𝑖 𝑀𝑒𝑥 = 𝐸(1+𝜋 )/ 𝐸(1+𝜋 ) 𝐹𝑟
In particular, we have that 𝑖𝐹𝑟 = 8%, 𝜋𝑀𝑒𝑥 = 7% and 𝜋𝐹𝑟 = 3%, then:
Present value (Peso) we have to calculate the future cash flows in order to get the discounted cash flows
𝑖 𝑀𝑒𝑥 𝐹𝑟 = (1.07/ 1.03 ∗ 1.08) − 1 = 0.1219 = 12.19% (O'Brien, 2015)
Discounted cash flows (Peso)
Year MNX Cash Flows Discount Rate PESO Discounted cash
Flow
2009 566,162 12.19% 504,627
2010 641,939 12.19% 509,980
2011 730,574 12.19% 517,313
2012 863,471 12.19% 544,963
2013 915,339 12.19% 514,909
2014 970,838 12.19% 486,771
2015 1,030,222 12.19% 460,404
2016 1,093,763 12.19% 435,673
2017 1,161,751 12.19% 412,459

2018 1,234,499 12.19% 390,650
4,777,749
The project NPV = Initial investment + Savings (from taxes) + DCF
𝑁𝑃𝑉 (𝑃𝑒𝑠𝑜) = −3,500,000 + 201,500 + 4,777,749 = 𝑀𝑁𝑋 1,478,999
Translation of Peso NPV in Euros
𝑀𝑁𝑋 1,478,999 / 15.99 = 𝐸𝑈𝑅 92,495.247
2) Compute the NPV in Euros by translating the project’s future peso cash flows into Euros at
expected future
The spot exchange rate was MNX 15.99/EUR. (Marchioni & Magni, 2016)
Assumptions:
The annual inflation rates: 𝜋𝑀𝑒𝑥 = 7% and 𝜋𝐹𝑟 = 3%
YoY change in the MNX/EUR exchange rate:
𝐸(𝑒) = 0.07-0.03 / 1+0.03 = 3.88%
Year Expected change Differential rate (t) spot exchange
2009 15.99 3,88% + 0.621 16.61
2010 16.61 3,88% + 0.645 17.26
2011 17.26 3,88% + 0.670 17.93

2012 17.93 3,88% + 0.696 18.62
2013 18.62 3,88% +0.723 19.35
2014 19.35 3,88% + 0.751 20.10
2015 20.10 3,88% + 0.780 20.88
2016 20.88 3,88% + 0.811 21.69
2017 21.69 3,88% +0.842 22.53
2018 22.52 3,88% +0.875 23.41
EURO cash flows with the required rate 8%
Yea
r
MNX Expected EUR Cash
Flows
Discount EUR
Discounted
Cashflows Exchange Rate Cashflows
Rate
2009 566,162 16.61 34,083.63 8% 31,558.9166
2010 641,939 17.26 37,200.8 8% 31,893.6926
2011 730,574 17.93 40,754.58 8% 32,352.2962
2012 863,471 18.62 46,367.46 8% 34,081.4654
2013 915,339 19.35 47,315.23 8% 32,201.9502
2014 970,838 20.10 48,308.01 8% 30,442.2418

2015 1,030,222 20.88 49,346.53 8% 28,793.2286
2016 1,093,763 21.69 50,431.56 8% 27,246.6025
2017 1,161,751 22.53 51,563.89 8% 25,794.7837
2018 1,234,499 23.41 52,744.43 8% 24,430.8758
298,796
.05
("Euro Depreciation and Its Impact on Trade with the US - Market Realist", 2020)
The initial cost of the project = EUR 220,000.
The Exchange rate is 15.99 MNX/EUR
The initial cost of the project EUR 218,887.80.
The value of Savings (from taxes) is now:
MNX 201,250 / 15.99 = EUR 12,585.9912
3) Compare the two sets of study calculations and the corresponding NPVs. Do they differ?
Why? Which approach should Arnaud Martin use?
Results from the two counts are the equivalent. This is because the two methodologies join
indistinguishable suspicions about interest rates and inflation rates. ("Ariel | Team & Leadership
Training", 2020) This implies if the IRP, PPP and the International Fisher Effect hold, Arnaud Martin
will be detached in picking which is the best way to deal with use to play out his DCF investigation.
(Jacobs, 2014)
4) Suppose Mexican inflation is projected at 3% instead of 7% per year (assume French inflation
remains at 3%). How does this affect NPV calculations?
A) For the case of NPV in pesos

Assumptions:
Inflation Rate: 7%
As the Mexican inflation rate is presently 3%, we have to survey again the estimation of the
working costs identified with both the new and old gear and the tax impact to think of balanced
incomes which mirror the new inflation rate suspicion. (Lee et al., 2015)
The new cash flows are highlighted in yellow.
As the inflation rate changed, we also have to find the new discount rate:
𝑖𝑀𝑒𝑥 = (1.03/1.03 ∗ 1.08) − 1 = 0.0800 = 8% (Bank, 2020)
Hence, we can calculate now the present value of the new peso cash flows:
Year MNX Cash flows Discount Rate Peso Discounted Cash
flows
2009 548,487 8% 507,858.3

2010 602,008 8% 516,124.8
2011 661,616 8% 525,211.7
2012 758,584 8% 557,581.7
2013 777,666 8% 529,266.6
2014 797,321 8% 502,447.6
2015 817,566 8% 477,041.8
2016 838,418 8% 452,971.1
2017 859,895 8% 430,161.8
2018 882,017 8% 408,544.7
4,907,210.13
Calculation of New Peso NPV:
NPV(Peso) = −3,500,000 + 201,500 + 4,907,210.13 = MNX 1,608,460
The new NPV is:

MNX 1,608,460 > MNX1,478,999
The Euro NPV becomes:
MNX 1,608,460 / 15.99 = EUR 100,591,63 > EUR 92,495.93 15.99
B) For the case of NPV in euros
Calculation of inflation rates difference of the two countries.
𝐸(𝑒) = (𝜋𝑀𝑒𝑥) − 𝜋𝐹𝑟 / (1+𝜋𝐹𝑟) ≈ 𝜋𝑀𝑒𝑥 − 𝜋𝐹𝑟 = 0.03 − 0.03 = 0
Calculation of all the EUR translated future cash flows and discount them by the new required discount
rate: 8%:
Year MNX Cash
Flows
Expected
Exchange Rate
EUR Cash
Flows
Discount
Rate
EUR
Discounted
Cash Flows
2009 548,487 15.99 34,301.87 8% 31,760.99
2010 602,008 15.99 37,649.03 8% 32,277.97
2011 661,616 15.99 41,376.83 8% 32,846.26
2012 758,584 15.99 47,441.14 8% 34,870.65
2013 777,666 15.99 48,634.54 8% 33,099.85
2014 797,321 15.99 49,863.74 8% 31,422.62
2015 817,566 15.99 51,129.82 8% 29,833.76

2016 838,418 15.99 52,433.89 8% 28,328.40
2017 859,895 15.99 53,777.07 8% 26,901.93
2018 882,017 15.99 55,160.55 8% 25,550.01
306,892.44
Initial investment cost for the new equipment = €218,886.80
The value of the Savings = €12,585.9912.
Hence, the new Euro NPV is:
NPV(EUR ) = −218,886.80 + 12,585.9912 + 306,892.44 = EUR 100.591,63
Euro NPV is still assuming the parity conditions where as the new NPV is higher than the 7% inflation.
5) Suppose Ariel expects a significant real depreciation of the peso against the Euro. How should
Martin incorporate such an expectation into his NPV analysis? (For simplicity you may
continue with the assumption that inflation is expected to be 3% in both countries). What is
its effect on the NPV under each of the approaches in questions 1 and 2?
If a real depreciation of the peso against the euro implies then the PPP won't exist.
MXN/EUR rate = 20.00, 2011 and 25.00 in 2013-2018. ("Cambio de Euro (EUR) a Peso mexicano
(MXN)", 2020)
A strong depreciation of the Peso against the Euro will not directly affect the Peso NPV.
= 𝑀𝑁𝑋 1,608,460
Euro appreciation will strongly affect the correspondent Euro NPV, hence more Mexican Pesos are
needed to buy one Euro. (GREGORIOU et al., 2011)
Spot exchange rate

2009 2010 2011 2012 2013 2014 2015 2016 2017 2018
22.00 23.00 24.00 25.00 25.00 25.00 25.00 25.00 25.00 25.00
We still assumed a requested discount rate of 8%.
Therefore, the EURO discounted cash flows:
Year MNX Cash
Flows
Expected
Exchange
Rate
EUR Cash
flows
Discount
Rate
EUR Discounted
Cash Flows
Rate
2009 548,487 22.00 24,931.23 8% 23,084.47
2010 602,008 23.00 26,174.26 8% 22,440.21
2011 661,616 24.00 27,567.31 8% 21,883.82
2012 758,584 25.00 30,343.35 8% 22,303.27
2013 777,666 25.00 31,106.65 8% 21,170.66
2014 797,321 25.00 31,892.85 8% 20,097.91
2015 817,566 25.00 32,702.64 8% 19,081.67
2016 838,418 25.00 33,536.71 8% 18,118.84
2017 859,895 25.00 34,395.82 8% 17,206.47

2018 882,017 25.00 35,280.69 8% 16,341.79
201,729.11
The initial investment cost = EUR 218,886.80
The new equipment = EUR 12,585.9912,
The Euro NPV is:
𝑁𝑃𝑉(𝐸𝑈𝑅) = −218,886.80 + 12,585.9912 + 201,729.11 = −EUR 4,571.70
6) Should Ariel approve the equipment purchase?
The organization ought to decide if to buy the new gear putting together its choice concerning the
undertaking NPV. Specifically, if 𝑁𝑃𝑉 > 0, at that point the venture will be a positive development
opportunity. (Demina et al., 2017)
As should be obvious from the Peso DCF assessment, subbing the old gear with the new robotized
process is by and large a wise venture opportunity (Peso NPV is constantly positive). Right now the
organization ought to enter the new speculation and will be detached whether to put resources into Euros
or Pesos. If rather, the Mexican Peso endures a solid devaluation (expecting equality conditions don't
hold any more), the Euro NPV of the undertaking might be negative, bringing about an awful venture
choice. ("International Capital Budgeting", 2020)

References
Lee, J., Faruqee, H., & Bayoumi, T. (2015). A Fair Exchange? Theory and Practice of Calculating
Equilibrium Exchange Rates. IMF Working Papers, 05(229),
https://doi.org/10.5089/9781451862485.001
Cambio de Euro (EUR) a Peso mexicano (MXN). Themoneyconverter.com. (2020). Retrieved 31 March
2020, from https://themoneyconverter.com/ES/EUR/MXN.
Marchioni, A., & Magni, C. (2016). Sensitivity Analysis and Investment Decisions: NPV-Consistency of
Rates of Return. SSRN Electronic Journal. https://doi.org/10.2139/ssrn.2797685
International Capital Budgeting. Xplaind.com. (2020). Retrieved 31 March 2020, from
https://xplaind.com/175889/international-npv-foreign-project.
Jacobs, J. (2014). Capital Budgeting: NPV v. IRR Controversy, Unmasking Common Assertions. SSRN
Electronic Journal. https://doi.org/10.2139/ssrn.981382
O'Brien, T. (2015). Foreign Exchange and Cross-Border Valuation. SSRN Electronic Journal.
https://doi.org/10.2139/ssrn.348462
Ariel | Team & Leadership Training. Ariel Group. (2020). Retrieved 1 April 2020, from
https://www.arielgroup.com/.
Demina, I., Larionova, E., & Chinaeva, T. (2017). Investments in fixed assets and depreciation of fixed
assets: theoretical and practical aspects of study and analysis. Statistics And Economics, (3), 71-79.
https://doi.org/10.21686/2500-3925-2017-3-71-79

Bank, E. (2020). ECB euro reference exchange rate: Mexican peso (MXN). European Central Bank.
Retrieved 1 April 2020, from
https://www.ecb.europa.eu/stats/policy_and_exchange_rates/euro_reference_exchange_rates/html/
eurofxref-graph-mxn.en.html.
GREGORIOU, A., KONTONIKAS, A., & MONTAGNOLI, A. (2011). Euro Area Inflation
Differentials: Unit Roots and Nonlinear Adjustment. JCMS: Journal Of Common Market Studies, 49(3),
525-540. https://doi.org/10.1111/j.1468-5965.2010.02150.x
Euro Depreciation and Its Impact on Trade with the US - Market Realist. Market Realist. (2020).
Retrieved 1 April 2020, from https://marketrealist.com/2017/01/euro-depreciation-and-its-impact-on-
trade-with-the-us/.
DCF analysis and valuation in emerging markets | AMT Training. Amttraining.com. (2020). Retrieved 1
April 2020, from https://www.amttraining.com/knowledgebank/valuation/dcf-valuation-in-emerging-
markets/.