Answer the following questions about the case Group Ariel S.A.

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. (Hint: Ariels Euro hurdle rate for a project of this type was 8%, which is Ariels nominal required rate of return in Euros. Use it as Ariels cost of capital in Euros. Assume that Ariels real required rate of return is the same in both currencies. According to Fisher effect, (1+rEuro)/(1+iFrance)=(1+rpeso)/(1+iMexico), where rx is the nominal required rate of return for currency x, and iy is the inflation for country y.)

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.

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

Suppose Mexican inflation is projected at 3% instead of 7% per year (assume French inflation remains at 3%). How does this affect the NPV calculations?

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 concluded NPV under each of the approaches in questions 1 and 2?

Should Groupe Ariel approve the equipment purchase?