Sarah Palin reportedly was paid a $11 million advance to write her book Going Ro

Question

Sarah Palin reportedly was paid a $11 million advance to write her book Going Rogue. The book took one year to write. In the time she spent writing, Palin could have been paid to give speeches and appear on TV news as a political commentator. Given her popularity, assume that she could have earned $8 million over the year (paid at the end of the year) she spent writing the book. Assume that she was unable to fulfill her media commitments of appearing on TV news as a political commentator or give speeches.while she was writing the book.

Assume that once her book is finished, it is expected to generate royalties of $5 million in the first year (paid at the end of the year) and these royalties are expected to decrease by 40% per year in perpetuity. Assuming that Palin's cost of capital is 10% and given these royalties payments, the NPV of Palin's book deal is closest to:

(Please Explain properly how each value was calculated.)

Explanation / Answer

Cashflow at year 0 = 11 million

Cashflow at year 1 = -8 million (the loss from potential speeches)

Cashflow at year 2 = 5 million (royalty)

Cashflow from year 3 onwards is 5*60%, 5*60%*60%, etc, as they will reduce by 40% every year.

PV of these cashflows as of year 2 is 5*60%/(1+10%) , 5*60%*60%/(1+10%)/(1+10%), etc, which means that each year the multiplying factor is 60%/(1+10%) = 6/11

So PV of all cashflows from year 2 onwards as of year 2 = year 2 cashflow / (1-discounting factor)

= 5 / (1-6/11) = 11 million

So PV as of year 0 (at time of receiving payment) = 11 -8/(1+10%) + 11/(1+10%)/(1+10%) = $12.82 million

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