Groupe Ariel SA: Parity Conditions and Cross-Border Valuation
Hints to case study questions: 1. Compute the NPV of Ariel-Mexico's recycling equipment in pesos by discounting incremental peso cash flows at a peso discount rate. How this NPV should be translated into Euros? Assume expected future inflation for France is 3% per year.

1.1. Review principles of estimating project cash flows. Suggested reading: Ch. 9 “Capital Budgeting and Cash Flow Analysis” in “Contemporary Financial Management”, 11th ed. by Moyer, McGuigan, and Kretlow. a. Project Net Investment (NINV):

NINV=Capital Expenditure-ATSVold ,

where ATSVold = After-Tax Salvage Value of the old equipment.

ATSVold=MVold+BVold-MVoldt , where MVold = Market Value of the old equipment;BVold = Book Value of the old equipment; t = tax rate; BVold-MVoldt = tax gains.

b. Project Net Cash Flows (NCF):

NCF=∆R-∆O-∆D1-t+∆D-∆NWC,

where R = Revenues; O = Operating Costs; D = Depreciation, NWC = Net Working Capital; t = the tax rate.

In Case 1, R = 0; NWC = 0. Therefore,

NCF=-∆O-∆D1-t+∆D, or

NCF=-∆O1-t+t∆D,

where t∆D is the depreciation tax shield.

c. Specifics of Case 1: i. -∆O = Incremental Cost Savings; -∆O1-t= Incremental Cost Savings after tax ii. ∆D=DNew-DOld, where DNew = Depreciation of the new equipment; DOld = Depreciation of the old equipment.
Thus, the depreciation tax shield includes two components: t∆D=tDNew-tDOld, where tDNew = depreciation tax shield of the new equipment; tDOld = depreciation tax shield of the old equipment

1.2. To estimateannual incremental peso cash flows over the project life (10 years): a. Determine the following cash flows: * Initial investment * After-tax salvage value of the old equipment * Incremental cost savings. Use Exhibit 2 of the case