1. Trefica de Honduras. Texas Pacific, a U.S.-based pri- vate equity firm, is trying to determine what it should pay for a tool manufacturing firm in Honduras named Trefica. Texas Pacific estimates that Trefica will generate a free cash flow of 13 million Honduran lempiras (Lp) next year (2003), and that this free cash flow will continue to grow at a constant rate of 8.0% per annum indefinitely. A private equity firm like Texas Pacific, however, is not interested in owning a company for long, and plans to sell Trefica at the end of three years for approximately 10 times Trefica's free cash flow in that year. The current spot exchange rate is Lp14.80/$, but the Honduran inflation rate is expected to remain at a relatively high rate of 16.0% per annum compared to the U.S. dollar inflation rate- of only 2.0% per annum. Texas Pacific expects to earn at least a 20% annual rate of return on interna- tional investments like Trefica.

a. What is Trefica worth if the Honduran lempira were to remain fixed over the three year invest- ment period?

b. What is Trefica worth if the Honduran lempira were to change in value over time according to purchasing power parity?