Answer Happy

Undertake the following valuation exercise for Groupe Ariel’s
Mexican investment from the perspective of the analyst, Arnaud
Martin. Given the information provided in the case. For the
purposes of use the future inflation rates provided in the
case. For Mexico (France) it is expected to be 7% (3%).
(i) What are the incremental free cash flows for the foreign
investment?
(ii) How should Arnaud Martin estimate the cost of capital for
this investment? To answer this question, consider whether the
discount rate used will be different if this were an investment
back in France.
(iii) What would Martin’s advice to management be about the
purchase of new equipment? Would Martin’s recommendation be
different if he were to first estimate the cash flows of the
Mexican project in Euro terms?
Exhibit 1 Groupe Ariel S.A.-Selected Consolidated Financial Data (millions of Euros, except as noted) 2008 2007 2006 2005 2004 Sales 3,345.3 3,561.8 3,576.9 3,078.9 3,050.3 Operating income 61.2 189.2 172.9 163.5 149.9 Net income (0.7) 85.7 61.2 85,7 Total assets 2,809.3 2,764.9 2,899.6 2,445.5 Total debt 660.6 616.0 613.0 504.2 Equity 782.6 819.5 829.7 865.1 87.6 100.0 95.1 Capital expenditures Depreciation 234.1 195.0 209.4 214.0 155.0 R&D expenditures 17.5 20.0 19.0 46.8 Earnings/share (Euros) (0.0) 1.0 0.7 1.0 Dividend/share (Euros) Return on sales 0.7 0.7 0.7 0.0% 1.7% 2.8% Return on equity (%) -0.1% 7.4% 9.9% 0.7 2.4% 10.5% 88.2 3,129.0 578.4 941.0 240.9 152.9 48.2 1.1 0.7 2.9% 9.4%
Exhibit 2 Comparison of Projected Operating Data for Different Recycling Processes (thousands of pesos, except as noted) Assumes 7% Inflation in Mexico Tax Rate: 0.35 2009 2010 2011 2012 2013 2014 2015 2016 Projected Operating Costs, Manual Process Unit volume (000s) 496 546 600 Materials. 564,816 664,788 782,456 Direct Labor 1,115,184 1,312,572 1,544,897 Overhead 1,680,000 1,797,600 1,923,432 Total 3,360,000 3,774,960 4,250,785 Materials/unit 1.1387 1.2185 1.3037 Direct labor/unit 2.2484 2.4057 2.5741 Projected Operating Costs, New Automatic Equipment Unit volume (000s) 496 546 600 Materials 542,223 638.197 751,158 Direct Labor 524,136 616,909 726,101 Overhead 1,566,211 1,675,846 1,793,155 Total 2,632,571 2,930,951 3,270,414 Materials/unit 1.0932 1.1697 1.2516 Direct labor/ unit. 1.0567 1.1307 1.2098 660 920,951 1,818,343 2,058,072 4,797,366 1.3950 2.7543 660 884,113 854,621 1,918,676 3,657,410 1.3392 1.2945 2017 660 660 660 660 660 1,291,681 2,383,477 2,550,321 985,417 1,054,396 1.128,204 1,207,178 1,945,627 2,081,821 2,227,549 2,202,137 2,356,287 2,521,227 5,492,505 5,876,980 1.5971 2,697,713 2,886,553 5,133,182 6,288,369 6,728,555 1.4927 1.7089 1.8286 1.9566 2.9471 3.1534 3.3742 3.6104 3.8631 660 660 660 660 660 1,083,076 1,158,891. 1,240,014 946,001 914,445 1,012,221 978,456 2,196,692 1,046,948 1,198,651 1,120,234 2.350,460 2,514,993 2,691,042 2,052,983 3,913,429 4,187,369 4,480,484 4,794,118 5,129,707 1.4330 1.5333 1.6406 1.7554 1.8783 1.3852 1.4821 1.5859 1.6969 1.8157 2018 660 1,382,099 2,728,843 3,088,611 7,199,553 2.0935 4.1335 660 1,326,815 1,282,556 2,879,415 5,488,786 2.0098 1.9427
Exhibit 3 Selected Macroeconomic and Financial Market Data for Mexico Consumer Price Inflation (%) Real Growth GDP (%) Year-End Spot Exchange Rate (MXN/EUR) Year 2000 9.5% 6.6% 9.4 2001 6.4% -0.3% 9.5 2002 5.0% 0.9% 10.4 2003 4.3% 1.4% 12.9 2004 4.7% 4.2% 15.3 2005 3.3% 3.2% 13.3 2006 4.1% 5.1% 14.4 2007 3.8% 3.3% 16.2 Source: Mexico Country Reports, Economist Intelligence Unit (EIU) JP Morgan Mexico Short-Term 7-10 Year Bank Lending Corporate Bondsb Date Rateª 31-Mar-06 7.78% 8.20% 30-Jun-06 7.68% 9.35% 29-Sep-06 7.50% 8.22% 29-Dec-06 7.60% 7.42% 28-Mar-07 7.68% 7.50% 27-Jun-07 7.82% 7.68% 26-Sep-07 7.77% 7.86% 31-Dec-07 8.00% 8.17% 26-Mar-08 7.94% 7.42% 23-Jun-08 8.10% 9.21% Sources: a Bank of Mexico b Thomson Datastream & CEIC Global Financial Data 10-year Government Bonds 8.47% 9.06% 8.24% 7.42% 7.58% 7.19% 7.82% 8.08% 7.49% 9.12%
Exhibit 4 Selected Macroeconomic and Financial Market Data for France Consumer Price Inflation (%) Real Growth GDP (%) Year-End Exchange Rate (MXN/EUR) Year 2000 1.7% 4.2% 9.4 2001 1.6% 2.1% 9.5 2002 1.9% 1.1% 10.4 2003 2.1% 0.5% 12.9 2004 2.3% 2.3% 15.3 2005 1.7% 1.9% 13.3. 2006 1.7% 2.4% 14.4 2007 1.5% 23% 16.2 Source: France Country Reports, Economist Intelligence Unit (EIU) JP Morgan France 7-10 Year Short-Term Bank Lending Rateª Corporate 10-year Government Bonds Date Bondsb 31-Mar-06 3.08% 3.73% 3.79% 30-Jun-06 3.27% 4.03% 4.08% 30-Sep-06 3.63% 3.69% 3.72% 31-Dec-06 4.07% 3.96% 3.98% 31-Mar-07 4.42% 4.08% 4.11% 30-Jun-07 4.69% 4.60% 4.62% 30-Sep-07 4.91% 4.36% 4.41% 31-Dec-07 5.13% 4.34% 4.42% 31-Mar-08 4.81% 4.00% 4.11% 23-Jun-08 4.99% 4.75% 4.81% Sources: a Thomson Datastream b Thomson Datastream & CEIC Global Financial Data