Question

In: Finance

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 $8.4 million per year (paid at the end of the year) speaking instead of writing. Assume his cost of capital is 9.2% 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 $4.9 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 $_______ (Round to the nearest dollar.)

Solutions

Expert Solution

a. Calculation of NPV of agreeing to write the book (ignoring any royalty payments) :

NPV = present value of cash inflow - present value of cash outflow

= $15 million (WN 1) - $21.1882 million (WN 2)

= -$6.1882 million

Therefore, NPV of agreeing to write the book (ignoring any royalty payments) is -$6.1882 million.

b. Calculation of NPV of the book with the royalty payments :

= NPV of book without royalty payments + Present value of royalty payments

= -$6.1882 million + $9.6 million (WN 3)

= $3.4118 million

Therefore, NPV of the book with the royalty payments is $3.4118 million.

Working Notes:

WN 1. Present value of cash inflow = sign in fee paid at the beginning = $15 million

WN 2. Present value of cash outflow is the present value of money that Clinton would have earned had he decided to give speeches instead of writing a book and it is calculated in the following manner: (figures in million)

Year	Potential earning	PVF @9.2%	Present value
1	8.4	0.9158	7.6927
2	8.4	0.8386	7.0442
3	8.4	0.768	6.4512
			21.1882

WN 3. Present value of royalty payments:

First, let's calculate present value of royalty payment at year end 4 (royalty will be received for the first time at year end 4 when counted from the date of signing of contract for writing a book)

= Royalty of 4th year + Present value of perpetual royalty decreasing at 30% each year

= $4.9 million + $4.9 million* (1-0.3)/ (9.2% + 30%)

= $4.9 million + $3.43 million/ 39.2%

= $4.9 million + $8.75 million

= $13.65 million

Now, let's discount above present value by 9.2% for 4 years to arrive at the present value of royalty payments as on today

= $13.65 million * PVF (9.2%, 4 years)

= $13.65 million * 0.7033

= $9.6 million

jeff jeffy answered 2 years ago

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