FIN 751 – CORPORATE FINANCIAL POLICY & STRATEGY, FALL 2012 INSTRUCTOR: TOM BARKLEY

CASE #2 – “Groupe Ariel: Parity Conditions and Cross-Border Valuation”

Written reports are to be no more than five typed pages (based on a 12-point Times New Roman font, double-spaced, with 1-inch margins all around). The assignments are due at the beginning of class on Thursday, November 8, 2012.

This case is designed to introduce discounted cash flow valuation techniques in a cross-border setting. Groupe Ariel’s Mexican subsidiary is proposing the purchase and installation of some cost-saving equipment in its plant in Monterrey. The headquarters at Ariel requires a discounted cash flow analysis and an estimated net present value for expenditures of this magnitude. The issue is whether the analysis should be performed in euros or pesos. Relevant cash flows and appropriate discount rates are the focus in this introduction to cross-border capital budgeting. Industry and competitive analysis, international tax factors, remittance policies, etc. may be ignored.

Answer the following questions in your report:
1. Compute the net present value of Ariel-Mexico’s recycling equipment in: (i) Mexican pesos, by discounting peso cash flows at a peso discount rate (“Method A”); and (ii) euros, by translating future peso cash flows into euros at the expected future spot exchange rates (“Method B”). Assume that Ariel’s hurdle rate in France for a project of this type is 8%. Also assume that at the time of analysis, the annual expected inflation is 7% in Mexico and 3% in France. What do you conclude with respect to the NPVs from using the two different valuation approaches? Are they the same? Why or why not?

2. Suppose the Mexican inflation is the same as that in France (i.e. 3%), and both RPPP and UIP continue to hold. Redo the analysis in Question 1. What do you conclude?

3. Assume the same inflation scenario as in Question 2. However, suppose that PPP breaks down (so,...

...budgeting? a Will an investment generate adequate cashflows to promptly recover its cost? b Will an investment generate an acceptable rate of return? c Will an investment have a positive netpresentvalue? d Will an investment have an adverse effect on the environment? 3 Which of the following is not considered when using the payback period to evaluate an investment? a The profitability of the investment over its entire...

...consider what types and which cashflows should be included in capital budgeting analysis.
D&D was producing and marketing two major product lines:
1. Lift-Off: Low –suds, concentrated powder.
2. Wave: Traditional powder detergent.
Questions & Answers:
1. If you were in Steve Gasper’s place, would you argue to include the cost from market testing as a cash outflow?
If I’m Steven Gasper’s I would not include the cost from market...

...time value of money.
3) All projects can have only one value for NPV and one value for IRR.
4) The NPV technique cannot provide information on how acquiring the project will contribute to shareholders’ wealth.
Explanation: NPV calculates presentvalue of investment and opportunity cost of capital and IRR takes time value of money and cost of capital into consideration as well.
F) Which of the following...

...firms. How is this possible? Does this violate our basic principle of stock valuation? Explain.
Our basic principle of stock valuation is that the value of a share of stock is simply equal to the presentvalue of all of the expected dividends on the stock. According to the dividend growth model, an asset that has no expected cashflows has a value of zero, so if investors are willing to purchase shares of...

...is implied by traditional buy-out and leveraged recapitalizations.
Fair market value of the firm:
Rm: Prime rate = 9% rf: risk free rate = 7.2% Average Unleveraged beta bu = = .839
Assume that growth rate : g = 2%, RPm = 4% , tax rate is 35%
Unlevered cost of equity rsu = rf + RPm (bu) = 7.2% + 4%(.839) = 10.56%
Operating cashflow using base case projections:
1995 1996 1997 1998 1999
CashFlow 7,772...

...decimal places in your calculations and final answers, and at
least4 decimal places for interest rates;
5) Interest rates are annual unless otherwise stated;
6) Bonds pay semi-annual coupons unless otherwise stated;
7) Bonds have a par value (or face value) of $1,000; and
8) You may use the back of the exam paper as your scrap paper.
Good Luck.
32 Calculation Questions (4 marks each)
1. The common stock of Robin's Tools sells for $24.50. The firm's beta...

...000.
Assuming a company tax rate of 30%, the firm’s cashflow from operations is:
(A)
$840,000
(B)
$180,000
(C)
$135,000
(D)
$75,000
4.
Given an effective annual interest rate of 14 per cent, the presentvalue of a
perpetuity consisting of yearly payments of $25,000 starting immediately is,
rounded to the nearest dollar
(A)
(B)
$203,571
(C)
$178,571
(D)
5.
$232,071
$156,641
If the...

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