Groupe Ariel S.A. - Printing and Imaging Equipment

Introduction

Groupe Ariel S.A. is a France based global manufacturer of printing and imaging equipment and operating business in 28 countries around the world. It has a subsidiary in Mexico where it started its cartridge recycling program in 2005. Now an investment proposal from Ariel- Mexico came for the purchase and installation of new automated machinery to recycle and remanufacture toner and printer cartridges. The investment proposal called for replacing the old process with new automated machinery from Germany that cost an estimated 3.5 million pesos (approximately €220,000) fully installed. The company is expecting to realize substantial cost savings in labor and materials from this project. For making decision the company requires to do a discounted cash flow analysis to realize the net present value of the project. The company should accept the project only if the NPV is positive otherwise the proposal will not be profitable for the company. Now there are several issues need to be considered for instance, discount rate and cash flow denominated in two currencies as inflation rate, financing cost are not identical in both countries. Groupe Ariel S.A should choose the currency that will maximize their return. And there is existing a major risk concern due to exchange rate fluctuation which also has a major impact in the decision.

Analysis

1. Compute the net present value of Ariel-Mexico’s recycling equipment by discounting incremental cash flows:

1. Discount peso cash flows at a peso discount rate and convert the NPV:

2. Check (as far as possible) to what extent relative purchasing power parity and interest rate parity is reflected in the historic data given in the case.

The above chart compares the value of the exchange rates MXN/EUR between years 2000-2007 and it can be clearly observed that there are some differences, which is a clear indication that Purchasing power parity doesn`t exist. Moreover, the variance is also not equal to zero.

* The expected MXN/EUR rates are calculated using the PPP formula. We multiplied the spot exchange rate by (1+inflation in Mexico)/ (1+inflation in France) to get the expected values.

The inflation in France is much more stable than the Mexico but on the overall basis there are some different value. Overall, the peso depreciated during these years except for 2001 and 2005 in which it appreciated.

The above chart shows the calculations for Interest Rate Parity (IRP) for the year 2006-2008. The 10 year Bond calculation was done by multiplying the MXN/EUR rate by (1+10 year bond rate in Mexico) / (1+ 10 year bond rate in France). The reason for using the 10 year bond rate was because it is much more stable and are risk free.

In my opinion IRP existed because there were some very minor changes in the Peso and if we calculate the Variance of the difference it is approximately zero. Furthermore, Peso appreciated over time.

1. What is the result in part 1 if it is assumed that parity conditions to hold:

When parity conditions holds then we assume that Net Present Value (NPV) for both investments should be approximately the same whilst putting into consideration that both countries have identical assumptions on inflation rate. This results that we can neglect Fisher’s effect as both investment will give the same rate of return. If the parity condition does not hold then the NPV from both approaches will be different; meaning that we would decide for the investment with the higher NPV value. PPP states that exchange rates between currencies are in equilibrium when their purchasing power is the same in each of the two countries