Consider the following “Pointers”:
1. This is an “International Capital Budgeting” case, necessarily involving Foreign Exchange.
2. Assume that the Theory of “Purchasing Power Parity” holds true.
3. Mexican inflation is expected to be7% per year vs Euro zone inflation of 3%
4. Be sure to estimate the expected future Peso cash flow improvement from this prospective capital investment. Note there will be NO salvage value of the new equipment after year 10. The old equipment will be sold in year 0 for a loss vs book value creating a tax shield benefit, for a total cash inflow from sale (of old equipment) of ___________?
5. Naturally, if the old equipment is disposed of, the corresponding tax shield benefits from depreciation of the old equipment will be foregone.
6. Mexican tax rate is 35%.
7. Be sure to incorporate into your analysis Peso depreciation tax shield benefit on new equipment over its 10-year useful life.
8. Use the “home Currency method” to convert Pesos to Euros. Discount the Euros to today.
9. Don’t forget sensitivity analysis!
Based on the Pointers, answer the 3 questions (show calculation and proof to support your answers):
1. What risks does Ariel face with this prospective investment?
2. What are the possible advantages?
3. Should they go forward with this investment?