Bill Clinton reportedly was paid an advance of $10.0 million to write his book My Life. Suppose the book took 3 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 a year (paid at the end of the year) speaking instead of writing. Assume his cost of capital is 9.5 % per year.
a. Based on the above cash flows, how many IRRs does the opportunity have?
i. One
ii. Two
iii. Three
iv. Four
b. Does the IRR rule give the right answer in this case?
i. Yes, because the IRR is less than the cost of capital and the NPV is negative, both rules would suggest rejecting the project.
ii. No, because the IRR is greater than the cost of capital and so would suggest taking the project, but its NPV is negative and so it should be rejected.
iii. No, because the IRR is less than the cost of capital and so would suggest rejecting the project, but its NPV is positive and so it should be taken.
iv. Yes, because the IRR is greater than the cost of capital and the NPV is positive, both rules would suggest taking the project.
c. Assume that, once the book is finished, it is expected to generate royalties of $4.8 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. How many IRRs are there in this case?
i. None
ii. One
iii. Two
iv. Three
d. Does the IRR rule work in this case?
i. Yes, because when there are 2 IRRs, the NPV is negative if and only if the cost of capital is between the IRRs.
ii. No, because there are 2 IRRs for this project, so the IRR rule cannot be applied.
iii. No, because there is no IRR for this project, so the IRR rule cannot be applied.
iv. Yes, because when there is no IRR, NPV must be positive.