Question

Bill ClintonBill Clinton

reportedly was paid an advance of

$10.0

million to write his book

My LifeMy Life.

Suppose 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

$8.1

million a year? (paid at the end of the? year) speaking instead of writing. Assume his cost of capital is

9.7%

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

$4.5

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?

Answer 1

PVA _{10%, 3 years} = 1/ 1.097 + 1 / ( 1.097) ² + 1 / ( 1.097 ) ³ = 0.91158+ 0.83097 + 0.75750 = 2.50005

a. Present value of fees foregone = $ (8,100,000) x 2.50005 = - $ 20,250,405.

Net Present Value ( NPV ) of agreeing to write the book = - $ 20,250,405 + $ 10,000,000 = - $ 10,250,405.

b. Royalties per annum : $ 4,500,000.

Present value of the royalties in year 3 = $ 4,500,000 / ( 0.097 - ( - 0.30) ) = $ 4,500,000 / 0.397 = $ 11,335,013

Present value year 0 = $ 11,335,013 / ( 1.097) ³ = $ 11,335,013 / 1.32014 = $ 8,586,220.

NPV of the book with the royal payments = $ 8,586,220 - $ 10,250,405 = - $ 1,664,185.