GIMP is the free alternative to Photoshop. I don't know anything about Photoshop so I will be unable to answer questions about it.
Download GIMP from here
http://www.gimp.org/
You will need a DDS Plug-in as well
http://code.google.com/p/gimp-dds/
Google will help you figure out how to install the plug-in. Essentially you just need to put a file into the right folder and start the program.
So after you load up GIMP and choose to open a DDS file I get this dialog box.
I uncheck the mip maps box to make things simpler and I don't care if that dialog ever comes back.
This is how your texture should look
For the sake of changing something, I selected the green of the jersey and terribly recolored it black. For tips on the tools available in GIMP, you should check out Google and YouTube, there are tons of tools and techniques that I am too bad at to teach others...thankfully, this being an open-source program, there are tons of resources.
That image was taken with the Layer Mask both disabled and with the [Edit Layer Mask] unchecked.
Now it's time to save it, but it's not as easy as it sounds. You need to be sure to match the exact compression and dimensions of the original file. All the dds files also have mip maps, so you need to be sure to save with those generated as well. This information can be found in the bottom left corner of the Mod Tool.
Knowing that this texture is a DXT5 compression and 1024, 512 and has mip maps will help with the next step.
Now if you just hit save in GIMP it will not allow you to edit any of the compression information, so we need to hit SAVE AS
Once this dialog pops up you need to be sure that you have the .dds extension in the save box. Instead of having a drop down box that lets you choose what file type you want to save as, you need to manually type in the 3 letter extension like dds, png, bmp, jpg.
Finally this last DDS dialog box will pop up asking you for compression and other parameters.
We need to hit the drop down box to change the compression to DXT5 and check the Generate MipMaps box.
If no errors pop up, you should be all set to import this texture back into the iff file with the Mod Tool or the Cyberface Importer/Exporter. For help with that, check out the tutorials above.