Overview
Question 1
Professor Wendy Smith has been offered the following opportunity: A law firm would like to retain her for an upfront payment of
$48,000.In return, for the next year the firm would have access to eight hours of her time every month. As an alternative payment arrangement, the firm would pay Professor Smith's hourly rate for the eight hours each month. Smith's rate is
$535 per hour and her opportunity cost of capital is 15%per year. What does the IRR rule advise regarding the payment arrangement? (Hint: Find the monthly rate that will yield an effective annual rate of15%.)
What about the NPV rule?
Question 2
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
$8.2 million per year (paid at the end of the year) speaking instead of writing. Assume his cost of capital is
9.5% 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 $5.2
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?
Question 3
You have just been offered a contract worth $1.23 million per year for 6 years. However, to take the contract, you will need to purchase some new equipment. Your discount rate for this project is 11.8%. You are still negotiating the purchase price of the equipment. What is the most you can pay for the equipment and still have a positive NPV?
Question 4
You are considering making a movie. The movie is expected to cost $10.7 million up front and take a year to produce. After that, it is expected to make $4.8 million in the year it is released and $2.1million for the following four years. What is the payback period of this investment? If you require a payback period of two years, will you make the movie? Does the movie have positive NPV if the cost of capital is 10.6%?
Question 5
Marian Plunket owns her own business and is considering an investment. If she undertakes the investment, it will pay
$5,800 at the end of each of the next 3 years. The opportunity requires an initial investment of
$1,450 plus an additional investment at the end of the second year of $7,250.
What is the NPV of this opportunity if the interest rate is 1.9% per year? Should Marian take it?