1)Compute the net present value of Ariel-Mexicos 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.

2) Compute the NPV in Euros by translating the projects future peso cash flows into Euros at expected future spot exchange rates. Note that Ariels Euro hurdle rate for a project of this type was 8%. Again, assume that annual inflation rates are expected to be 7% in Mexico and 3% in France.

3) Compare the two sets of calculations and the corresponding NPVs. How and why do they differ? Which approach should Arnaud Martin use?

4) Suppose Ariel expects a significant depreciation of the peso against the Euro (7%). How should Martin incorporate such an expectation into his NPV analyses? What is the NPV under the approach in question 2.

On June 23, 2008, a Monday morning, Arnaud Martin arrived at his office in Groupe Ariels corporate headquarters in Mulhouse, France. The previous week, Martin had requested additional financial information about an investment proposal from Ariel-Mexico, a wholly owned subsidiary that operated a manufacturing facility and a regional sales office in Monterrey, Mexico. The information had arrived late Fridaytoo late for Martin to analyzeand was waiting for him Monday morning. As a financial analyst for a global manufacturer of printing and imaging equipment, Martin examined many cross-border projects, particularly since Ariel had accelerated its move into emerging markets several years earlier.

The Mexican investment proposal called for the purchase and installation of new automated machinery to recycle and remanufacture toner- and printer cartridges. Cartridge recycling had become an important part of Ariels business in many markets and promised continued growth. Many office product retailers operated formal toner cartridge recycling programs, for both the environmental benefits of keeping materials out of landfills and demonstrated cost savings for their customers. Writing in a leading trade journal, one analyst predicted, We are going to see more and more refined approaches to recycling and remanufacturing [cartridges] in the coming months and years Both corporate and individual consumers are becoming habituated to it. They have simply come to expect recycling as an option, even for smaller cartridges at lower price points.

Ariel-Mexicos Monterrey plant began its cartridge recycling program in 2005. The plants recycling process consisted of a sequence of operations carried out almost entirely by hand, with the help of hand tools and a simple machine. The investment proposal called for replacing this process with new automated machinery from Germany that cost an estimated 3.5 million pesos (approximately 220,000) fully installed. As described in the project summary, Ariel-Mexico expected to realize substantial savings in labor and materials almost immediately. Though the proposed expenditure was relatively small, Ariel required a discounted cash flow analysis for all such investments in its newer foreign markets and a review by corporate headquarters in Mulhouse.

Martin was assigned to perform an analysis of the investment proposal and make an up or down recommendation to his superior by Wednesday morning.

Groupe Ariel S.A.

Groupe Ariel was a global manufacturer of printers, copiers, fax machines, and other document production equipment. The company also provided consulting and document outsourcing services, with after-sales service contracts constituting about 18% of overall revenue. Company sales for 2008 were projected to be 3.35 billion, down from 2007 due to a global recession. Operating profit was expected to be 61.2 million in 2008, and the company projected a small net loss for the year. Exhibit 1 presents selected consolidated financial data for Groupe Ariel.

Ariels low profitability was typical of the industry in 2008; all of its competitors were similarly affected by the recession. One bright spot in the companys outlook, however, was its growth in several emerging markets, including the so-called BRIC economies of Brazil, Russia, India, and China. Ariel had been a global firm for years, but did not move aggressively into emerging markets until 20032004. This was later than some of its competitors. On one hand, this meant Ariels market share lagged in some markets. On the other hand, Ariel avoided some of its competitors earlier mistakes.

The companys international operations were conducted primarily through a large network of subsidiaries, which operated mostly medium-sized regional factories in which printers, copiers and other products were manufactured to suit local tastes. Ariel conducted business in 28 countries around the world, with operations consisting of manufacturing facilities, small research labs, as well as sales and marketing subsidiaries. In 2008, subsidiaries outside the European Union recorded about half of Ariels sales and generated slightly less than 40% of pretax income.

Ariel competed in a relatively mature market, and its chief competitors were both established multinational companiessome of which had developed their consulting and other after-sales services businesses to a higher level than had Arielas well as smaller players serving niche markets. While Ariel marketed and sold its products across the full spectrum of industries, it had enjoyed particular success in financial services, health care, and government sectors.

Operations in Monterrey: Ariel-Mexico

According to Ariels CEO Alphonse Helmont, We were attracted to Mexico for the same reason we built operations in Brazil and other emerging markets. We wanted to diversify our operations and believed we needed to establish a strong presence in places besides Europe and the United States. He added: Certainly there is risk [in these countries], but their economies are dynamic and Ariel must be present. You can see our competitors feel the same way!

A key characteristic of Ariels printing and imaging products was their durability, which Ariels executives felt conveyed a competitive advantage in emerging economies where Ariel positioned equipment as offering a lower total cost of ownership. In particular, the companys marketing material claimed a working life 10 months longer than its closest competitor, with 30% lower service costs. CEO Helmont observed: We demonstrate to our customers that we have a local presence and we are the lowest total-cost provider. This creates loyalty and solid market positions in Mexico and other of our newer markets.

The manufacturing facility in Monterrey was located near a small research and design facility, also owned by Ariel. While many product specifications for Ariels equipment were formulated at the offices in Mulhouse, France, it was customary for regional subsidiaries to conduct fine- tuning research and design activity to tailor the product more closely to local consumers preferences. Thus, it was common for a popular printer or fax machine whose basic design was conceived in Mulhouse to be localized for size, color, weight, and/or range of features by local design staff. Most of the products produced in the Monterrey plant were sold in Mexico and were distributed through large office-product retailers, department stores, as well as small specialty shops.1 Manufacturing inputs were sourced locally, and virtually all of the plants employees were Mexican citizens.

In the summer of 2008 gross output at Ariel-Mexico was running at only about 80% of planned capacity. Nevertheless, plant records indicated that there was a sizable increase in demand for recycled printer and toner cartridges. Ariel-Mexicos Programa de Reciclaje de Cartuchos (Cartridge Recycling Program) was started in 2005 to provide low-cost recycling services to all its distributors and customers. Under the terms of users service contracts, when cartridges reached the end of their useful lives, they could be returned to the Ariel facility in exchange for a significant discount on the purchase of a like number of new cartridges. Ariel pledged to recycle and remanufacture all returned toner and printer cartridges. Ariel-Mexico also had voiced its support for political efforts to pass legislation that would mandate recycling of printing cartridges used by most Mexican businesses and government offices. In 2009 the company planned to launch a pilot program to recycle selected competitors cartridges.

As the number of cartridges returned for recycling increased, Ariel-Mexico management needed to hire and train more employees to carry out the hole-piercing, drilling, vacuuming, and toner/ink evacuation required to recycle cartridges. Its taking more and more of my payroll to handle recycling, said Ernesto da Silva, the Monterrey plant manager. Were happy to see the cartridges coming back in, but the extra volume will become a problem when other operations return to full capacity.

Cost Savings from the Proposed New Equipment

The new equipment could process the Monterrey plants projected volume using four employees rather than 10, resulting in savings of both direct labor and training costs. Under very favorable circumstances, only three workers would be required. It would also eliminate some human error, which currently resulted in cracked or damaged cartridges which had to be destroyed rather than reused. The new equipment would occupy significantly less space in Monterreys over-crowded plant; this space would be freed up for other productive uses. It also would require only minimal maintenance expenditures compared to the equipment it replaced, and no significant change in working capital. Exhibit 2 compares projected operating data for the existing recycling process and the proposed automated process, assuming future Mexican inflation of 7% per year.

The new equipment would have a useful life of 10 years and would be depreciated under the straight-line method for both tax and financial reporting purposes. Salvage value was likely to equal disposal costs at the end of the useful life. The manual equipment being replaced was very simple and, properly maintained, would last many more years. In June 2008 it had a book value and tax basis of 250,000 pesos and three years of straight-line depreciation remaining. However, its market value was thought to be lower, at about 175,000 pesos. After considering Groupe Ariels consolidated tax position, Martin determined that his analysis would use Mexicos federal corporate tax rate of 35%

Real GDP growth in Mexico was 4.2% in 2004the year in which Ariel built its Monterrey plant.

By2006, Mexicos real GDP had risen 5.1%, but subsequently dropped substantially as global recession arrived. Other macroeconomic data in Mexico, including bond yields, bank lending rates, and the consumer price index exhibited similar patterns in recent years. Exhibit 3 shows selected macroeconomic and financial market data for Mexico.

Martin had yet to decide whether to perform the discounted cash flow analysis in Euros or pesos, or indeed, whether NPV would be affected by the choice of currency. Ariels Euro hurdle rate for such a project, if undertaken in France, would be 8%. However, borrowing costs in France and Mexico were clearly different: French banks prime rate for Euro loans was 4.99%, while the rate in Mexico on short-term peso loans was about 8.10%. Longer-term peso-denominated corporate bonds were yielding 9.21%, compared with long-term Euro-denominated corporate issues at 4.75%. The spot exchange rate on June 23 was MXN15.99/EUR. Many analysts were on record predicting a real depreciation of the peso against both the U.S. dollar and the Euro over the next five years. For example, one international business publication noted [Mexicos] rising external financing requirement and the fading impact of the U.S. stimulus package can only increase pressure on Mexicos currency. The article went on to forecast a rise in the MXN/EUR rate to 20.00 by 2011 and

upwards of 25.00 in 20132018. Selected macroeconomic and financial market data for France are presented in Exhibit 4.

Exhibit I Groupe Ariel S.A.-Selected Consolidated Financial Data millions of Euros, except as noted) 2008 2007 2006 200S 2004 3,345.3 61.2 3,561.8 3,576.9 3,078.9 Operating income Net income Total assets Total debt 189.2 729 61.2 2,899.6 613.0 149.9 2,809.3 660.6 3,129.0 578.4 941.0 616.0 865.1 Capital expenditures 7.6 195.0 17.5 (0.0) 0.7 95.1 214.0 19.0 234.1 209.4 R&D expenditures Earnings/share (Euros) Dividend/share (Euros) Return on sales 2.9% 9.4% Return on equity (%) 10.5% 9.9% Exhibit 2 Comparison of Projected Operating Data for Different Recycding Processes (thousands of pesos, except as noted) Assumes 7% Inflation in Mexico Tax Rate: 0.35 2009 2010 2011 2012 2013 2014 2015 2016 2017 Projected Operating Costs, Manual Process Unit volume (000s) 546 985,417 ,054,396 1,128,204 1,207,1781,291,681 ,382,099 1,115,184 1,312,572 1,544,897 1,818,343 ,945,627 2,081,821 2,227,549 2,383,477 2,550,3212,728,843 1,680,000 1,797,600 1,923,432 2,058,072 2,202,137 2,356,287 2,521,227 2,697,713 2,886,553 3,088,611 6,728,555 7,199,553 2.0935 4.1335 564,816 920,951 Direct Labor Total Materials/unit Direct labor/unit Projected Operating Costs, New Automatic Equipment Unit volume (000s) 3,360,000 3,774,960 4,797,366 5,133,182 1.4927 29471 5,492,505 5,876,980 1.5971 3.1534 1.1387 1.2185 1.8286 3.6104 1.9566 2.5741 3.3742 546 542,223 524,136 638,197 616,909 751,158 726,101 884,113 946,001 1,012,22 1,083,076 1,158,8911,240,014,326,815 Direct Labor 914,445 978,456 1,046,948 1,120,23 1,198,651 1,566,211 1,675,846 ,793,155 1,918,676 2,052,983 2,196,692 2,350,460 2,514,993 2,691,042 2,879,415 5,129,707 5,488,786 Total Materials/unit Direct labor unit 2,930,951 1.1697 1.1307 3,270,414 1.2516 1.2098 3,657,410 3,913,429 4,187,369 4,480,484 4,794,118 1.7554 1.6969 1.5333 1.8783 18157 1.2945 1.3852 1.5859 19427 Exhibit 3 tor Mexico Selected Macroeconomic and Financial Market Data consumer r'rice Keal Growth Exehain pte Year- End Spot Inflation (%) 95% 6.4% 5.0% 1.3% 1.7% 3.3% 1.1% 3.8% 6.6 -0.3% 0.9% 1.4% 4.25 3.21% 5.1% 3.3% 9.4 9.5 10.4 12.9 15.3 13.3 4.4 16.2 01 2007 Sauroe: Moxica Caurty Repocts,Ecomomist Inteinigence Unit (EIU) Short Term Bank Lending Rate JP Morgan Mexico 7-10 Year Corporate Bondsb 10-year Covernment Bonds 8.47% Date 31-Mar 7.78% 7.68% 7.50% 7.60% 7.68% 7.62 8.20% 9.35% 29-Sep 06 29-Dec-06 28-Mar-C!? 27-Jun 0 2&-Sep 07 31-Dec-07 26Mar-0s 23-Jun 08 8.24% 7.42% 7.42% 7.50% 719% 8.00% 7.94 S. 10 7.86% 8.17% 7.42% 9.21% 9, 12% Exhibit 4 Selected Macroeconomic and Financial Market Data for France Year-End Exchange Rate Consumer Price Real Growth Souroe: France Country Reports, Economist Inteligence Unit (EIU) JP Morgan Corporate Date 31-Mar-06 31 Dec-06 31-Mar-07 31-Mar-08 Exhibit I Groupe Ariel S.A.-Selected Consolidated Financial Data millions of Euros, except as noted) 2008 2007 2006 200S 2004 3,345.3 61.2 3,561.8 3,576.9 3,078.9 Operating income Net income Total assets Total debt 189.2 729 61.2 2,899.6 613.0 149.9 2,809.3 660.6 3,129.0 578.4 941.0 616.0 865.1 Capital expenditures 7.6 195.0 17.5 (0.0) 0.7 95.1 214.0 19.0 234.1 209.4 R&D expenditures Earnings/share (Euros) Dividend/share (Euros) Return on sales 2.9% 9.4% Return on equity (%) 10.5% 9.9% Exhibit 2 Comparison of Projected Operating Data for Different Recycding Processes (thousands of pesos, except as noted) Assumes 7% Inflation in Mexico Tax Rate: 0.35 2009 2010 2011 2012 2013 2014 2015 2016 2017 Projected Operating Costs, Manual Process Unit volume (000s) 546 985,417 ,054,396 1,128,204 1,207,1781,291,681 ,382,099 1,115,184 1,312,572 1,544,897 1,818,343 ,945,627 2,081,821 2,227,549 2,383,477 2,550,3212,728,843 1,680,000 1,797,600 1,923,432 2,058,072 2,202,137 2,356,287 2,521,227 2,697,713 2,886,553 3,088,611 6,728,555 7,199,553 2.0935 4.1335 564,816 920,951 Direct Labor Total Materials/unit Direct labor/unit Projected Operating Costs, New Automatic Equipment Unit volume (000s) 3,360,000 3,774,960 4,797,366 5,133,182 1.4927 29471 5,492,505 5,876,980 1.5971 3.1534 1.1387 1.2185 1.8286 3.6104 1.9566 2.5741 3.3742 546 542,223 524,136 638,197 616,909 751,158 726,101 884,113 946,001 1,012,22 1,083,076 1,158,8911,240,014,326,815 Direct Labor 914,445 978,456 1,046,948 1,120,23 1,198,651 1,566,211 1,675,846 ,793,155 1,918,676 2,052,983 2,196,692 2,350,460 2,514,993 2,691,042 2,879,415 5,129,707 5,488,786 Total Materials/unit Direct labor unit 2,930,951 1.1697 1.1307 3,270,414 1.2516 1.2098 3,657,410 3,913,429 4,187,369 4,480,484 4,794,118 1.7554 1.6969 1.5333 1.8783 18157 1.2945 1.3852 1.5859 19427 Exhibit 3 tor Mexico Selected Macroeconomic and Financial Market Data consumer r'rice Keal Growth Exehain pte Year- End Spot Inflation (%) 95% 6.4% 5.0% 1.3% 1.7% 3.3% 1.1% 3.8% 6.6 -0.3% 0.9% 1.4% 4.25 3.21% 5.1% 3.3% 9.4 9.5 10.4 12.9 15.3 13.3 4.4 16.2 01 2007 Sauroe: Moxica Caurty Repocts,Ecomomist Inteinigence Unit (EIU) Short Term Bank Lending Rate JP Morgan Mexico 7-10 Year Corporate Bondsb 10-year Covernment Bonds 8.47% Date 31-Mar 7.78% 7.68% 7.50% 7.60% 7.68% 7.62 8.20% 9.35% 29-Sep 06 29-Dec-06 28-Mar-C!? 27-Jun 0 2&-Sep 07 31-Dec-07 26Mar-0s 23-Jun 08 8.24% 7.42% 7.42% 7.50% 719% 8.00% 7.94 S. 10 7.86% 8.17% 7.42% 9.21% 9, 12% Exhibit 4 Selected Macroeconomic and Financial Market Data for France Year-End Exchange Rate Consumer Price Real Growth Souroe: France Country Reports, Economist Inteligence Unit (EIU) JP Morgan Corporate Date 31-Mar-06 31 Dec-06 31-Mar-07 31-Mar-08