Groupe Ariel S. A. Parity Conditions and Cross Border Valuation Case Solution
- Now letâ€™s calculate the Euro-based NPV of this project. First, convert the cash flows from #1 into Euros using PPP-based estimates of future Spot rates.
In order to calculate the Euro based NPV of this project, the pesos based cash flows for the ten years of the project are converted into Euro based using the exchange rate. The exchange rate in PPP-based estimate is calculated by using the following formula:
Spot Rate * (1 + Inflation Rate (Mexican))/ (1 + Inflation Rate (France))
Using this formula, the future exchange rates are calculated for each year. With the help of these exchange rates, the Pesos values could be converted into Euros. All the calculations can be seen from the below given exhibits.
- Discount these at the Euro discount rate and find the NPV. How it is different from the Peso-NPV in #3 â€“ is there an obvious relationship between the two?
The discount rate for the Euros is already given in the case to be about 8%. In order to calculate the net present value, all the Euro-based future cash flows are discounted back to the present value and the initial investment of the cost of machinery is subtracted from that value. The net present value in this case comes out to be positive 99,586 Euros. The obvious relationship between the two is due to the change in the exchange values.
The net present value calculated in the first scenario was relatively higher as compared with the second scenario and a positive change of 58.99 Euros can be seen. This difference depicts the fact that although there arise a positive net present value in both the scenarios but the higher value shows that the project has a much higher value for the investors in Mexico rather than in France. This addition in value can significantly impact the subsidiary company in Mexico rather than the parent company in France.
- What if we convert the cash flows into Euros using the IRP-based estimate of future Spot rates? Write down these new cash flows.
In order to convert the Pesos-based cash flows into Euros using the IRP-based estimate of future spot rates the same procedure would be applied as done in question # 7. All the calculations are performed in the below given excel.
- Discount these at the Euro discount rate and find the NPV.Â
By discounting the Euro-based future cash flows through the discount or the hurdle rate of 8%, the value of net present value in this scenario comes out to be 96,126 Euros. Like the previous scenario, the NPV calculated in question # 5 is higher as compared with this NPV which conveys the fact that the investment is worth undertaking for the investors of Mexico rather than the parent company in France.
In order to convert the values of Pesos-based cash flows into Euro-based cash flows using the above given rates the values can be seen in the below given exhibit. By discounting these future cash flows into its present value by using the discount rate of 8% and adding the initial payment of 3.5 million, the net present value in this scenario comes out to be 60,299 Euros which is still showing the positive return which conveys the fact that the investment could provide the required return………………..
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