Homework:Chapter 18 Homework

Question 1, Problem 18-1 (algorithmic)

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Part 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

11

million Honduran lempiras (Lp) next year, 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

Lp15.4599/$,

but the Honduran inflation rate is expected to remain at a relatively high rate of

14.0%

per annum compared to the U.S. dollar inflation rate of only

5.0%

per annum. Slinger Wayne expects to earn at least a

20.5%

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?

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Part 1

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/$)	15.4599
Carambola's expected cash flow in US$