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In: Finance

reportedly was paid $ 9.8 million to write his book The Fork in the Road. The...

reportedly was paid $ 9.8 million to write his book The Fork in the Road. The book took three years to write. In the time he spent​ writing, Jack Smith could have been paid to make speeches. Given his​ popularity, assume that he could earn $ 8.3 million a year​ (paid at the end of the​ year) speaking instead of writing. If his cost of capital is 10 % per​ year, then the NPV of agreeing to write the book​ (ignoring any royalty​ payments) is negative $ 10,840,872. How many IRRs are there in this​ problem? Does the IRR rule give the right answer in this​ case? (Note: Consider the upfront payment as a positive cash flow and the opportunity cost of missed speaking fees as negative cash​ flows.)

Solutions

Expert Solution

There is only 1 IRR in this problem, since the sign is changing only once.

However it does not give the right answer. It is greater than the cost of capital while NPV is negative. Since NPV is negative, the proposal should not be accepted.

Year Amount received upfront Loss of revenue
from speeches		 Net CF
0 9800000 9800000
1 -8300000 -8300000
2 -8300000 -8300000
3 -8300000 -8300000
NPV -10840871.53
IRR 66.27%

jeff jeffy answered 7 months ago
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