P 8-10 (similar to Question Help Bill Clinton reportedly was paid $15.0 million
ID: 2795441 • Letter: P
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P 8-10 (similar to Question Help Bill Clinton reportedly was paid $15.0 million to write his book My Life. The book took three years to write. In the time he spent writing, Clinton could have been paid to make speeches. Given his popularity, assume that he could earn $8.6 million per year (paid at the end of the year) speaking instead of writing. Assume his cost of capital is 10.1% per year. a. What is the NPV of agreeing to write the book (ignoring any royalty payments)? b. Assume that, once the book is finished, it is expected to generate royalties of $4.7 million in the first year (paid at the end of the year) and these royalties are expected to decrease at a rate of 30% per year in perpetuity. What is the NPV of the book with the royalty payments? a. What is the NPV of agreeing to write the book (ignoring any royalty payments)? The NPV of agreeing to write the book (ignoring any royalty payments) is $1 . (Round to the nearest dollar.)Explanation / Answer
a
In agreeing to write the book Mr Clinton is foregoing the money he could have earned by giving speeches. Here, the opportunity cost is a relevant cost in calculation of NPV
End of year payment in year 0 = $15 Mn
Annual Payments for years 1 throygh 3 for speeches = Opportunity cost = $8.6 Mn
NPV for agreeing to write My Life = Payment for book -Opportunity cost/(1+10.1%) - Opportunity cost/(1+10.1%) 2 - Opportunity cost/(1+10.1%) 3
NPV for agreeing to write My Life = $15 Mn -$8.6 Mn/(1+10.1%) - $8.6 Mn/(1+10.1%) 2 - $8.6 Mn/(1+10.1%) 3 = $15,000,000 - $21,349,331 = -$6,349,331
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b
End of year payment in year 0 = $15 Mn
Annual Payments for 3 years for speeches = Opportunity cost = $8.6 Mn
Royalties received in 4th year = $4.7 Mn
Now royalty for year 5 would be $4.7 * (1-30%)
royalty for year 6 would be $4.7 * (1-30%)2
These calculations for future royalties can be done can be done using Present value of perpetuity concept
To calculate the present value of the royalties received in perpetuity in future , we'll use the present value of perpetuity formula which says,
Present Value of perpetuity (in 4th year)= Cashflow/( Rate of return - Growth rate)
Rate of return = 10.1%
Growth rate = -30%
Present Value of perpetuity in 4th year = $4.7 Mn/(10.1% - (-30%)) = $11,720,698
Calculating NPV inclusive of this royalty we have,
NPV for agreeing to write My Life = Payment for book -Opportunity cost/(1+10.1%) - Opportunity cost/(1+10.1%) 2 - Opportunity cost/(1+10.1%) 3 + Royalty received/ (1+ 10.1%)4
NPV for agreeing to write My Life = $15 Mn -$8.6 Mn/(1+10.1%) - $8.6 Mn/(1+10.1%) 2 - $8.6 Mn/(1+10.1%) 3 + $11,720,698/ (1+10.1%)4 = $15,000,000 - $21,349,331 + $7976350= $1,627,019
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