Question

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 11million Honduran lempiras​ (Lp) next​year, and that this free cash flow will continue to grow at a constant rate of 7.5%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 Lp15.9325​/$, but the Honduran inflation rate is expected to remain at a relatively high rate of 17.5​% per annum compared to the U.S. dollar inflation rate of only 5.0​% per annum. Slinger Wayne expects to earn at least a 23.5% 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?

a. Calculate the free cash flows in Honduran lempiras (Lp) below: (Round to the nearest whole number)

	Year 0	Year 1	Year 2	Year 3
Carambola's expected free cash flow		Lp 11,000,000	Lp	Lp
Expected sale value in year 3				Lp
Total expected cash flow		Lp	Lp	Lp
Expected exchange rate (Lp/$)	15.9325

Answer 1

In case of fixed exchange rate, the NPV is higher and in case of varying exchange rate, the NPV would be lower because of currency fluctuation.

Year 2 Year 3 12711875 127118750 a) Year 0 Year 1 11,000,000 11825000 Carambola's expected free cash flow Expected sale value in vear 3 Total expected cash flow PV @ discount rate 23.5% Total PV Expected exchange rate (Lp/S US$ worth 11,000,000 11,825,000 139,830,625 8906882.591 7752954.482 74233754.454 90893591.528 15.9325 5704917.09 Expected exchange rate Exchange rate (t-1) *(1tinflation (Honduras))/(1+inflation(USA)) Year 0 Year 2 Year 1 11,000,000 11825000 Year 3 12711875 127118750 Carambola's expected free cash flow Expected sale value in vear 3 Total expected cash flow Expected exchange rate (Lp/$) Expected Cash Flow in S PV @ discount rate-23.5% Total PV in US$ 11,000,000 11,825,000 139,830,625 19.9518 592,680 499566.414 388585.125 3324848.004 15.9325 17.8292 616,965 22.3270 6,262,860 4212999.54