7.1

Carambola de Honduras. Slinger Wayne, a U.S.-based private equity firm, is trying to determine what it should pay for a tool manufacturing firm in Honduras named Carambola. Slinger Wayne estimates that Carambola will generate a free cash flow of 13 million Honduran lempiras (Lp) next year, and that this free cash flow will continue to grow at a constant rate of 9.0% per annum indefinitely. A private equity firm like Slinger Wayne, however, is not interested in owning a company for long, and plans to sell Carambola at the end of three years for approximately 10 times Carambola's free cash flow in that year. The current spot exchange rate is Lp14.2225/$, but the Honduran inflation rate is expected to remain at a relatively high rate of 17.0% per annum compared to the U.S. dollar inflation rate of only 4.5% per annum. Slinger Wayne expects to earn at least a 24% annual rate of return on international investments like Carambola.

a. What is Carambola worth if the Honduran lempira were to remain fixed over the three-year investment period?

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