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- Incremental Free Cash flow for foreign investment
Incremental free cash flow is understood to be the net cash flow from all cash inflows as well as outflows. Over a given period of time. That is between two or more choices of business that are available to an entity. In the case of Groupe Ariel in this case analysis, the following formula can be used to calculate the incremental free Cash flow for the foreign investment (Bernard, & Stober 1989).
Incremental cash flow = revenues-expenses-initial cost
In that case, the two business opportunities that are available for Groupe Ariel are the manual process and the automated process.
Incremental cash flow = 764162100-3500000 -2632571=758029529
- In order for Arnaud Martin to estimate the cost of capital for the investment, he has to factor in the cost of the new automated system, including the cost of installation. The cost of capital for investment should also take into accounts the cost that will be incurred for labor when operating with the automated system as well as the material requirements (Bowen, Burgstahler, & Daley 1986). Apart from that, there will be a need for research and development of the new products that fit the local Mexican market. In the evaluation of the capital requirements, this factor has to be put into consideration. The reason is that it will also require significant capital to help in ensuring that this new investment is effectively operational (Charitou, & Vafeas 1998). Nevertheless, in the event that this investment as taking place in France, the discounting rate would have been significantly different. That is because of the differences in the inflationary rates as well as the exchange rates. That is because, while inflation in Mexico was set at 7 percent in France, they were are 3 percent. In the same way, the distinction would have been necessitated by the cost of borrowing (Cheng, Liu, & Schaefer. 1997). That is because, in France, the banks` prime rate for Euro loams would be set a 4.99 percent. That is not the case with Mexico since the short term peso loans were about 8.10 percent. In the same way, in Mexico, the long-term peso-dominated corporate bonds were yielding at 9.21 percent. On the contrary, long-term Euro-dominated corporate issues at 4.75 percent. That simply implied that the cost would be distinctively different in the event that the investment was taken in France and not Mexico. Further, the prediction on the potential depression of peso against US dollar and the Euro in the period of next five years could also possibly necessitate the differences in the capital cost it was undertaken in France and not Mexico (Bernard, & Stober 1989).
iii. Martin`s advice to management on purchase of new equipment would be that the investment was worth undertaking because of the possible returns which will be realized. The reason was also reinforced by the possibility of cost-cutting associated with the installation of the new equipment (Bowen, Burgstahler, & Daley 1986). However, in the event that the estimations of the cash flow were to be done first in Euros terms, the advice would have been different. That is because coupled with factors like inflation, depreciation of the peso against the Euro as well as the differences in the exchange rate, there massive deficit (Cheng, Liu, & Schaefer. 1997). For instance factoring in the inflationary differences when using the Euro as well as the peso, it is evident that the estimate would have proved too costly hence inappropriate to undertake the investment (Charitou, & Vafeas 1998).
- in the event that the revised future inflation numbers for Mexico provided by Groupe Ariel`s economies were the same as that of France, then it would be worthwhile to undertake the investment. That is after calculating the projected capital required as well as potential revenues in Euros (Bernard, & Stober 1989). The reason is because, in the event that, the inflation numbers for Mexico were the same as that of France, the cost of making the investment would not be very huge, that is because, the differences in the estimate capital figures would not have a higher deviation as it was the case when the estimations were done in peso while the inflation figures between France and Mexico were different (Bowen, Burgstahler, & Daley 1986). The only difference, in this case, would be the exchange rates for the Peso and Euro, which will also be negligible. As a result of that, the cost difference to rollout the investment would not have huge different as it were the case when the inflation numbers were differences between the two countries (Charitou, & Vafeas 1998).
- A violation of the purchasing power parity will further push the exchange rate between the two countries to have a significantly high deviation. As a result of the deviation, the two approaches used to value the project will have a relatively huge difference (Cheng, Liu, & Schaefer. 1997). That would mean that one approach will be highly affordable with greater levels of returns to investment and low capital requirements. On the other side, the other valuation approach will be very costly (Bernard, & Stober 1989). There will be a high cost in capital requirements as well as low returns to investments due to the cost of capital required. That light, there will be distinctively huge differences between the two valuation approaches that bridging either would not be possible (Bowen, Burgstahler, & Daley 1986). The change would be therefore too large to make the entity have an increased consideration for the Mexico based valuation as compared to a valuation done in Euro. That is because, violation of the purchasing power parity would either devalue or overvalue one currency relative to the other (Charitou, & Vafeas 1998). And that is likely to impact the outcomes of the valuations. It is therefore worth noting that, the outcome of such violation of the purchasing power parity might not give the proper reflection of the possible outcomes of the two valuations (Cheng, Liu, & Schaefer 1997).
References
Bernard, V. L., & TStober, L. (1989). The Nature and Amount of Information Reflected in Cash Flows and Accruals. The Accounting Review, 64(3), 624-652.
Bowen, R. M., Burgstahler, D. & Daley, L. A. (1986, October). Evidence on the Relationship between Earnings and Various Measures of Cash Flow. The Accounting Review, 2(1), 713- 726.
Charitou, A., & N. Vafeas. (1998). The Association between Operating Cash Flows and Dividend Changes: An Empirical Investigation. Journal of Business Finance and Accounting, 25(1), pp. 5-249.
Cheng, C. S. A., Liu, C. S. & TSchaefer, F. (1997). The Value-Relevance of SFAS No. 95 Cash Flows from Operations as Assessed by Security Market Effects. Accounting Horizon, 11(3), pp. 1-15.
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