1) Your factory has been offered a contract to produce a part for a new printer.
ID: 2719142 • Letter: 1
Question
1) Your factory has been offered a contract to produce a part for a new printer. The contract would last for 3 years and your cash flow from the contract would be $4.88 million per year. Your upfront setup costs to be ready to produce the part would be $8.19 million. Your discount rate for this contractis 7.7%.
a) What is the NPV?
b) If you take the contract the value added to the firm will be?
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 $8.5 million per year (paid at the end of the year)
speaking instead of writing. Assume his cost of capital is 9.9% 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 $5.3 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?
Explanation / Answer
a) What is the NPV? Ans) NPV Value Year Cash flow Amount in Million Rate of Interest@7.7% Net Cash flow 0 $ (8.19) 1 $ (8.19) 1 $ 4.88 0.929 $ 4.53 2 $ 4.88 0.862 $ 4.21 3 $ 4.88 0.800 $ 3.91 NPV of the Inflow $ 4.45 b) If you take the contract the value added to the firm will be? Ans) NPV of the firm is $4.45 Million so we better to take the advantage Question -2 a. What is the NPV of agreeing to write the book (ignoring any royalty payments)? Year Cash flow Amount in Million Rate of Interest@9.9% Net Cash flow 0 $ (15) 1 $ (15) 1 $ 9 0.910 $ 8 2 $ 9 0.828 $ 7 3 $ 9 0.753 $ 6 $ 6 a. What is the NPV of agreeing to write the book (ignoring any royalty payments)? Ans) $6 Million b. Assume that, once the book is finished, it is expected to generate royalties of $5.3 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? Ans) Year Cash flow amount in Million Rate of interest@9.9% Net Cash flow 0 -15 1 -15 1 5 0.910 4.822565969 2 4 0.828 3.071698069 3 3 0.753 1.956495586 -5.149240376 NPV is $-5.149240376 Million
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