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 12 million Honduran lempiras (Lp) next year, and that this free cash flow will continue to grow at a constant rate of 8.5% 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 Lp14.5144/S, 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 5.5% 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? 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 Expected sale value in year 3 Total expected cash flow Lp 12,000,000 Lp Expected exchange rate (Lp/S) 14.5144 Carambola's expected cash flow in US$
Explanation / Answer
Assumptions Values Expected free cash flow in 2003 12,000,000 Expected growth rate in free cash flow 7.00% Assumed sale multiple of FCF in year 3 10 Spot exchange rate, Lempiras/$ (2002) 14.14 US dollar inflation rate 4.0% Honduran lempira inflation rate 18.0% Slinger Wayne required return (annual rate) 21.5% 0 1 2 3 a) Carambola's value if exchange rate fixed 2012 2013 2014 2015 Carambola's expected free cash flow (Lp) 12,000,000 12,840,000 13,738,800 Expected sale value in year 3 137,388,000 Total expected free cash flow (Lp) 12,000,000 12,840,000 151,126,800 Expected exchange rate (Lp/$) 14.1438 14.1438 14.1438 14.1438 Carambola's expected FCF in US$ $ 848,428 $ 907,818 $ 10,685,021 Present value factor 1.0000 0.8230 0.6774 0.5575 Present value of expected FCF in US$ $ 698,295 $ 614,959 $ 5,957,260 Cumulative present value in US$ $ 7,270,514 0 1 2 3 b) Carambola's value assuming PPP 2012 2013 2014 2015 Carambola's expected free cash flow (Lp) 12,000,000 12,840,000 13,738,800 Expected sale value in year 3 137,388,000 Total expected free cash flow (Lp) 12,000,000 12,840,000 151,126,800 Expected exchange rate (Lp/$) 14.1438 16.0478 18.2081 20.6591 (PPP: spot * (1+inf in Lp) / (1 + inf in $) Carambola's expected FCF in US$ $ 747,767 $ 705,183 $ 7,315,253 Present value factor 1.0000 0.8230 0.6774 0.5575 Present value of expected FCF in US$ $ 615,446 $ 477,693 $ 4,078,501 Cumulative present value in US$ $ 5,171,640