Question

Marthin Luther, governor of the Cyprus National Bank (Cyksbanken), reportedly was paid 6 million SEK in advance to write his book How we boosted inflation. The book took three years to write. In the time he spent writing, Stefan could have been paid to work as a professor and give speeches as an economic commentator in TV shows. Given his knowledge and experience, assume that he could have earned 8 million SEK per year (paid at the end of the year) working and commenting instead of writing the book. Assume his cost of capital is 12% per year.

What is the NPV of agreeing to write the book (ignoring any royalty payments)?

a)The NPV is ---- million SEK. (Round to three decimals)

b)

Assume that, once the book is finished, it is expected to generate royalties of $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?

The NPV of the book with the royalty payments is --- million SEK. (Round to three decimals)

c) i) How many IRRs are there in part (a)?

i) Does the IRR rule give the right answer in this case?

d) How many IRRs are there in part (b)?

ii) Does the IRR rule give the right answer in this case?

c)

Answer 1

a)	Amount in millions		Amount in millions
Year	Cash Flow	PV @ 12%	Present Value
0	6	1.0000	$       6.000
1	-8	0.8929	$     (7.143)
2	-8	0.7972	$     (6.378)
3	-8	0.7118	$     (5.694)
		NPV	$   (13.215)	Millions
b)
	Amount in millions		Amount in millions
Year	Cash Flow	PV @ 12%	Present Value
0	6	1.0000	$       6.000
1	-8	0.8929	$     (7.143)
2	-8	0.7972	$     (6.378)
3	-8	0.7118	$     (5.694)
4	5	0.6355	$       3.178
5	3.5	0.5674	$       1.986
Present value of royalty payment at Year 5 = 5/(12%-(-30%)	$                        11.905	Million
Present value of royalty payment at Year 0 =  11.905 /(1+12%)^3	$                          8.474	Million
The NPV of the book with the royalty payments is (-13.215 + 8.474) million	$                          (4.74)	Million
c)
There is one IRR in part A
IRR	121%
Since the IRR is much greater than the discount rate, the IRR rule says write the book. Since this is a negative NPV project , the IRR gives the wrong answer.
d)
The plot shows that there are 2 IRRs -3.01% and 110%. The IRR does give an answer in this case, so it does not work.

NPV (in millions) Discount Rate $70.00 $60.00 $50.00 $40.00 NPV (in millions) $65.53 $10.55 ($1.33) ($4.50) ($5.06) ($4.74) ($4.11) ($3.41) ($2.72) ($2.08) ($1.51) ($0.99) ($0.52) ($0.10) $0.27 $0.61 $0.91 $1.19 -20% -10% 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% 110% 120% 130% 140% 150% $30.00 $20.00 $20.00 $0.00 -40% -20% 0 20% 80% 100% 120% 140% 160% ($10.00)