NET PRESENT VALUE AND DISCOUNTED CASH FLOW.

NET PRESENT VALUE AND DISCOUNTED CASH FLOW 1
UNIVERSITY NAME
STUDENT NAME
STUDENT ID
COURSE
DATE

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EXECUTIVE SUMMARY.
The purpose of this research is to find a solution on whether Groupe Ariel Company should get
rid of the simple equipment with brand sophisticated machinery which will require minimum
labor and less material. The appropriate way of financing the proposed investment is by
conducting global valuations using Pesos and Euros. present values of the loss or profit of the
investment is calculated using the Net Present Value (NPV). the two Net Present Values of
investment will then be compared using Pesos and Euros and then the computation is changed to
one currency for clear basis of comparison. For proper comparison, interest rate, tax rate and
depreciation rate are taken into account. The NPV for Pesos is slightly higher compared to NPV
in Euros and for this reason, the business in Ariel Mexico which is a subsidiary company will
have more returns than the parent company in Mulhouse, France. fluctuations in the currency
value and the rate of inflation will have impact on our conclusion. from the analysis, if Mexico’s
interest rate declines, Peso will rise and the exchange rate will go down and as a result the cash
inflow in Euro will increase. On another hand, if the inflation rate appreciates in Mexico, the
exchange rate too will raise hence causing decrease of NPV in Euros. From this analysis, Arnaud
Martin should mitigate the company’s risks through forward contracts to avoid any losses from
currency value fluctuations. With the expected rise in inflation rate in Mexico, this proposal
ought to be commended considering Pesos’ discounted cash flow analysis (Schauten, Stegink &
Graaff, 2010, pg. 800).
This report provides the possibility of opportunities and risks involved in setting up the new
equipment. Risks can be analyzed by considering several economic factors to be taken into
account like change in exchange rate, fluctuations in inflation rate, tax rates, tariffs and subsidy.
opportunities associated with installation of the new equipment include decline in directs costs
like cost incurred on training, labor cost, maintenance costs and increase in efficiency of
production, utility of the available plant and quality of products. The aim of Ariel is to diversify
and venture in emerging markets and for growth and expansion localization should be considered
to boost customers’ loyalty and brand. In addition, the brand automated machine will provide
opportunities for discovery and research.

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Table of Contents
INTRODUCTION.......................................................................................................................................4
CALCULATION OF NET PRESENT VALUE UNDER PESO.................................................................4
CALCULATION OF NET PRESENT VALUE UNDER EURO.............................................................5
ANALYSIS AND INTERPRETATION.....................................................................................................5
ESTIMATING COST OF CAPITAL....................................................................................................................6
MINIMIZING CURRENCY RISK.............................................................................................................6
RISK AND OPPORTUNITIES...................................................................................................................6
BENEFITS OF REPLACING THE MANUAL MACHINE.......................................................................7
CONCLUSION...........................................................................................................................................8
REFERENCES............................................................................................................................................8
APPENDICES.............................................................................................................................................9
APPENDIX I: COMPUTATION OF NET PRESENT VALUE IN PESOS AND TRANSLATION.....9
APPENDIX II: COMPUTATION OF NET PRESENT VALUE IN EUROS THROUGH
TRANSLATION OF FUTURE CASH FLOW TO EURO AT THE EXPECTED FUTURE SPOT
EXCHANGE RATE..............................................................................................................................10

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INTRODUCTION.
Groupe Ariel is a firm based in Mulhouse, France and Arnaud is The Global financial analyst of
the firm. He has the responsibility of analyzing a proposed investment of a machine used for
recycling of cartridges at a subsidiary firm in Mexico. the objective of the machinery investment
is to provide support for the growth of local demand while the current plant is operational.
Arnaud must provide an advantageous or disadvantageous advice depending on discounted cash
flow analysis on acquiring the equipment and also detailed cost benefit analysis for the firm
(Gollier &Weitzman, 2010, pg. 350). For the above analysis, he will have to consider the global
valuations from Europe and Mexico and come up with the appropriate approach to finance the
investment. Economic factors like tax, inflation, exchange rates and interest rates are important
factors that will influence these decisions in global multinational or global corporations when it
comes to performance analysis on foreign subsidiary investments. Considering the effect from
tax depreciation and inflation rate on investment, Martin will have to compare the NPV from the
two markets (Žižlavský, 2014, pg. 507). Once the comparison is complete, Martin will then
make a recommendation. On this report, detailed analysis and explanation of every part of the
analysis will be covered then we give a recommendation. We will compute NPV using 2
different currencies that is Peso and Euro to determine how the different currencies affect NPV.
After that, both NPVs will be compared using one currency to see if there is a variance. The
computation of NPV is based on the assumption that
2008, t=0,2009-2018, t=1……10
The resale value for the equipment is assumed to be insignificant and therefore will have no
impact.
CALCULATION OF NET PRESENT VALUE UNDER PESO.
Mexico’s discount rate is, 12.19% and is computed based on France’s hurdle rate which is 8%.
We then use International Fisher Effect and assuming that Mexico’s inflation rate =7% and
France’s inflation rate =3%. The purchasing power parity is assumed while International Fisher
Effect remain constant and interest rates are stabled all over the countries and across the border
(Dutta &Fan, 2009, pg. 406).

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In the determination of peso discount rate, IFE, international fisher effect is utilized (Shalishali,
2012, pg. 90).it will be therefore 12.19 % and the NPV of the cash flow is 4778682.12 pesos.
investment value of 3298750 is determined by Lessing 3500000 pesos from the resale value and
also the taxes on that loss. This will result in net present value of 1479932.13 pesos. We then
carry out the translation of this value into Euros by using the spot rate 15.99 per EURO
We then obtain € 92,553.60. (detailed calculation under appendix I)
CALCULATION OF NET PRESENT VALUE UNDER EURO
Determination of the net present value utilizes the same technique but then we change the cash
flows to EURO by using the anticipated rates for each subsequent year. Future rates are
determined by applying the forward premium equation and applying the same France hurdle rate
which is 8% to determine the net present value. We use the assumed rates of inflation of 7 % in
Mexico and France’s 3%, spot rate used is also 15.99 per euro and this can be used to determine
the spot exchange rate in the future. We therefore do multiplication of cash flows every year by
spot rate for that year so that we can obtain the cash flow for that year. After, we use the hurdle
rate of 8% to determine NPV which is € 298,796.05.Net investment amounting to 3,298,750
pesos is then translated to be in Euros with the same spot rate of 15.99 per EURO which yield of
€206, 300.81. The net present value is subtracted from the investment in euros to obtain the net
present value € 92,495.24 (detailed calculation under appendix II).
ANALYSIS AND INTERPRETATION
The NPVs based on Euro and Pesos currencies are almost the same. In the first method, we
obtain the net present value of € 92,552.60 while the second option yield and net present value of
€92,495.24. The firm should reject the project if NPV< 0, but now because the NPVs > 0 the
proposed project will yield returns in both market and therefore the project should be approved
by Martin (Gollier, 2010, pg. 145). However, if the home perception is different from global
parity conditions, IRP and PPP will not hold.
If the NPV in Euro is higher than NPV in Pesos, the Mexican project will have slightly higher
value than value for France’s investors.
In this case also, fluctuation in currency value and inflation rate will affect the decision.

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As seen on the analysis, majority of analysts predicted Pesos will depreciate against Euros over
the following 10 years.MXN/LEURO rises to 25 in the year 2013-2018.the cash flows in Euro
will decline if the inflation rate is constant and Pesos depreciates because the cash flows are
computed using exchange rate Pesos’ cash flows. This will lead to fall in NPV in euro but
constant in Pesos.
From the above analysis, the investment should be accepted using to discounting analysis of cash
flow on Pesos (Steiger, 2010). In addition, if peso depreciates more, it will drive the NPV value
to negative.
A less expected time spot will be arrived if the inflation rate in Mexico drops below 7 % while
inflation in France remain constant. Peso’s converted cash flows are higher o euro therefore
making peso more worthy compared to Euro. However, inflation rate in Mexico will exceed 7%,
the exchange rate will rise resulting in decrease in NPV.
ESTIMATING COST OF CAPITAL
If the project was to be carried out in France, hurdle rate=8% but it is to be done in Mexico and
therefore inflation will be taken into account and assuming that international fisher effect holds,
the hurdle rate is equated to the rate of inflation in these two countries.
Mexico had a much higher rate of inflation based on the forecast at 7% and based on the
calculation in the appendix, discount rate in Mexico is 12.19% which in most cases represent the
weighted average costs of capital to determine budget for new projects. WACC and discount rate
are normally used interchangeably (appendix I).
MINIMIZING CURRENCY RISK
The currency cannot be avoided in this case .it is a challenge to foresee the exchange rate across
the world because of unforeseen factors. Ariel can hedge the future currency rate using future
contracts hence reducing chances of currency risk (Schmittmann, 2010).
RISK AND OPPORTUNITIES
NPV is calculated based on assumption that Peso and Euro will maintain unchanged inflation
rate at 7% and 3% in that order. Always the inflation rate and interest rates fluctuates every year
based on economic situations of a given country. Any change in rate will have impact on the

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conditions of purchasing power parity leading to adjustments of valuation models resulting in
revised decision on investment. There is risk of high debt payment if there will be rise of interest
rates if Ariel company is financing its investments using bank loan.
Unexpected rise in tax rate will have impact on calculations of profits (Alvarez & Barney, 2010,
pg. 560). Even though other factors like political stability and risks influences the investors on
final decision, many will prefer investing in an emerging market where stable government
policies apply. Unfavorable tariff changes, local subsidy printer industry regulation and foreign
government policies can complicate the decision of the investment. A given projected can prove
profitable but such external factors can complicate the conclusion
If the firm will approve and invest on the new machine, there will be many benefits and
opportunities enjoyed. It will be cost effective in terms of direct labor, training costs and time
management in the production cycle. The maintenance cost will be reduced without necessarily
adding working capital.
BENEFITS OF REPLACING THE MANUAL MACHINE.
i. Production of quality products by replacing manual duties, the machine will minimize
errors and also lead to increased production.
ii. It will lead to future economies of scale since the overall fixed cost will be reduced
(direct labor cost)
iii. It will lead to reduced plant space therefore resulting in availability of space which can be
either used as training rooms for employees.
iv. Ariel is able to fulfill its corporate social responsibility and taking in environment
conservation through recycling of cartridges.
v. With the increase in the demand of recycled products, there will be an increase in overall
sales, customer loyalty and satisfaction and will also boost the reputation of the firm.
vi. The investment will give Ariel and opportunity to prove its competitive advantage
through innovation, knowing the competitors.
vii. The new investment will boost the value of Ariel Company hence creating an opportunity
for easy financing of the firm. All in all, the proposed investment has both long term and
short term advantages.

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CONCLUSION.
In conclusion, the project will yield high returns if its NPV is positive and therefore such a
project should be accepted. The company should consider the approval of the new machine
purchase for addition of the company as a whole since the NPVs in both instances are positive.
The mother company will use hedging to avoid exchange risks. Discounted rate ought to be
increased to show higher risk if the company will decide to take a hedge (Agarwal, Daniel
&Naik, 2009, pg. 2255).

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REFERENCES.
Agarwal, V., Daniel, N.D. and Naik, N.Y., 2009. Role of managerial incentives and discretion in
hedge fund performance. The Journal of Finance, 64(5), pp.2221-2256.
Alvarez, S.A. and Barney, J.B., 2010. Entrepreneurship and epistemology: The philosophical
underpinnings of the study of entrepreneurial opportunities. Academy of Management
annals, 4(1), pp.557-583.
Dutta, S. and Fan, Q., 2009. Hurdle rates and project development efforts. The Accounting
Review, 84(2), pp.405-432.
Gollier, C. and Weitzman, M.L., 2010. How should the distant future be discounted when
discount rates are uncertain? Economics Letters, 107(3), pp.350-353.
Gollier, C., 2010. Expected net present value, expected net future value, and the Ramsey
rule. Journal of Environmental Economics and Management, 59(2), pp.142-148.
Schauten, M., Stegink, R. and de Graaff, G., 2010. The discount rate for discounted cash flow
valuations of intangible assets. Managerial Finance, 36(9), pp.799-811.
Schmittmann, J.M., 2010. Currency hedging for international portfolios (No. 10-151).
International Monetary Fund.
Shalishali, M.K., 2012. A test of the international fisher effect in selected Asian
countries. International Journal of Humanities and Social Science, 2(4), pp.86-92.
Steiger, F., 2010. The validity of company valuation using Discounted Cash Flow
methods. arXiv preprint arXiv:1003.4881.
Žižlavský, O., 2014. Net present value approach: method for economic assessment of innovation
projects. Procedia-Social and Behavioral Sciences, 156, pp.506-512.

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APPENDICES.
APPENDIX I: COMPUTATION OF NET PRESENT VALUE IN PESOS AND
TRANSLATION.
APPENDIX II: COMPUTATION OF NET PRESENT VALUE IN EUROS THROUGH
TRANSLATION OF FUTURE CASH FLOW TO EURO AT THE EXPECTED FUTURE
SPOT EXCHANGE RATE.