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Take&Test-Tiara; Anderson Google Chrome Secure https//www.mathol.com/Student/PlayerTest.aspotestld 17042517 8centerwinayes MGMT 273 Fall Tara Anderson 11/21/174 17AM Quiz: Chapter 8 Quiz Submit Qur This Question: 1 pt 12 of 14 (0 complete) This Quiz: 14 pts possible Jack Smith reportedy was paid $10 5 millions 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 7 5 million a year (paid at the end of the year) have beer cost of capital is 10% per year therte NPV of agreeing to wite the book (ighong any royaly paymens) is-sa 1st sortow many RRne resents Proble Does the IRR rule give the right answer in this case? (Note Consider the upfront payment as a positive cash fow and the opportunity cost of missed speaking fees as negative cash flows) The IRR is (Round to two decimal places) How many IRRs are there in this problem? (Select the best choice below) ° C. Four Rs OD, ThreeIRRs Does the IRR nule gie the right answer in this case? (Select the best choice below) o A. No because the RR is negative B. No because the NPV is negative (-SS 151 390) and therefore the IRR gives the wrong answer OC. Yes because the IRR (50 46%) is geater than the cost of apeal O D. Yes because the NPV is positive

Explanation / Answer

IRR is the rate at which NPV is zero

PV factor = 1 / (1 + r)^t

Assuming interest rate of 50%

Since NPV is negative, interest rate will be higher. Assuming interest rate of 51%

Hence IRR is between 50% and 51%

IRR = R1 + [NPV1 x (R2 - R1)] / (NPV1 - NPV2)

Where:

R1 = Lower discount rate

R2 = Higher discount rate

NPV1 = Higher Net Present Value (derived from R1)

NPV2 = Lower Net Present Value (derived from R2)

IRR = 50% + [(-55555.56) x (51%-50%)] / ((-55555.56) - 65419.32)

= 50% + (-55555.56) / (-120974.88)

= 50% + 0.4592%

= 50.46%

There is only one IRR in this problem as there is no sign change i.e combination of negative and positive cash flows in the problem. Answer B is correct

Although the IRR is higher than the cost of capital, the NPV is negative and hence IRR rule does not apply. Answer B is correct

Year Cash Flow PV factor Present value A B A x B 0 10500000 1 10500000 1 -7500000 1/(1+0.50)^1 0.666667 -5000000 2 -7500000 1/(1+0.50)^2 0.444444 -3333333.333 3 -7500000 1/(1+0.50)^3 0.296296 -2222222.222 NPV -55555.55556

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