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 (2013), 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 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 Lp14.80/$, 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. Slinger Wayne expects to earn at least a 20% 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?

Assumptions Values Expected free cash flow in 2013 13,000,000 Expected growth rate in free cash flow 8.00% Assumed sale multiple of FCF in year 3 10 Spot exchange rate, Lempiras/$ (2002) 14.80 US dollar inflation rate 2.0% Honduran lempira inflation rate 16.0% Slinger Wayne required return (annual 20.0% 0 2 a) Carambola's value if exchange rate fi: 2012 2013 2014 2015 Carambola's expected free cash flow (Lp) Expected sale value in year 3 Total expected free cash flow (Lp) Expected exchange rate (Lp/$) 14.8000 14.8000 14.8000 14.8000 Carambola's expected FCF in US$ Present value factor 1.0000 0.8333 0.6944 0.5787 Present value of expected FCF in USS Cumulative present value in USS0 2 b) Carambola's value assuming PPP 2012 2013 2014 2015 Carambola's expected free cash flow (Lp) Expected sale value in year 3 Total expected free cash flow (Lp) Expected exchange rate (Lp/$) 14.8000 16.8314 19.1416 21.7688 (PPP: spot * (1+inf in Lp) / (1 + infin $) Carambola's expected FCF in USS Present value factor 1.0000 0.8333 0.6944 0.5787 Present value of expected FCF in USS Cumulative present value in USS