Complete The Following And Submit It In A Word Document

Complete The Following And Submit It In a Word Document Be Sure To Sh

Assume you have just retired as the CEO of a successful company. A major publisher has offered you a book deal. The publisher will pay you $1 million upfront if you agree to write a book about your experiences. You estimate that it will take three years to write the book. The time you spend writing will cause you to give up speaking engagements amounting to $500,000 per year. You estimate your opportunity cost to be 10%. Should you accept this deal? Plot a diagram that measures NPV (on the y-axis) vs. discount rate (on the x-axis) to solve this problem. (Hint: Have your scale on the x-axis go to 50% (discount rate)). Determine the IRR for this deal. (Hint: IRR is the point at which NPV = 0). Suppose you inform the publisher that it needs to sweeten the deal before you will accept it. The publisher offers $550,000 advance and $1,000,000 in four years when the book is published. Should you accept or reject the new offer? Again, plot a diagram that measures NPV (on the y-axis) vs. discount rate (on the x-axis) to solve this problem. (Hint: Have your scale on the x-axis go to 50% (discount rate)). Determine the IRRs for this deal (Hint: There are two IRRs for this problem). Discuss if the IRR rule for making budgetary decisions can be used in this case. Finally, you are able to get the publisher to increase your advance to $750,000, in addition to the $1 million when the book is published in four years. Should you accept or reject this new offer? Again, plot a diagram that measures NPV (on the y-axis) vs. discount rate (on the x-axis) to solve this problem. (Hint: Have your scale on the x-axis go to 50% (discount rate)). Determine the IRR for this deal. State three conclusions regarding the use of IRR vs. NPV that you can make from questions 2–4. Which is the stronger method to use (IRR or NPV), and why?

Paper For Above instruction

Introduction

The decision to accept or reject a book deal based on financial analysis involves critical evaluation of various factors such as present value, opportunity costs, and rate of return. This paper explores the valuation of three different deals using Net Present Value (NPV) and Internal Rate of Return (IRR) calculations, complemented by graphical illustrations to comprehend the economic implications. The analysis emphasizes the importance of these financial metrics in making informed investment decisions and discusses the advantages and limitations associated with each method.

Scenario 1: Initial Deal Analysis

The initial deal offers a $1 million upfront payment with an estimated three-year writing period. During this period, the opportunity cost includes the forfeited speaking engagements valued at $500,000 annually. The opportunity cost is discounted at a rate of 10%. To evaluate this proposal, the total costs and benefits over the three-year period are calculated. The present value of the foregone earnings (speaking engagements) is computed as:

PV of opportunity costs = \( \( \frac{\$500,000}{(1 + 0.10)^1} + \frac{\$500,000}{(1 + 0.10)^2} + \frac{\$500,000}{(1 + 0.10)^3} \) \) = \$1,139,173

Net Present Value (NPV) = Upfront payment - PV of opportunity costs = \$1,000,000 - \$1,139,173 = -\$139,173.

Since the NPV is negative at a 10% discount rate, the deal appears unfavorable. Plotting NPV versus discount rate shows the NPV decreasing with increasing discount rates. The IRR, the rate at which NPV equals zero, is found by solving:

\[

0 = \$1,000,000 - \left( \frac{\$500,000}{(1 + IRR)^1} + \frac{\$500,000}{(1 + IRR)^2} + \frac{\$500,000}{(1 + IRR)^3} \right)

\]

Calculations reveal an IRR approximately at 17.2%, indicating profitability if the discount rate is below this threshold.

Scenario 2: Negotiation for a Better Deal

The publisher offers $550,000 upfront and a payment of $1,000,000 in four years. Using similar PV calculations, the present value of the $1,000,000 in four years discounted at 10% is:

PV = \$1,000,000 / (1 + 0.10)^4 ≈ \$683,013.

NPV at 10% discount rate = \$550,000 + \$683,013 - total costs (if any additional costs are considered). Since the opportunity cost of writing the book is three years, but the benefit occurs after four years, the delay introduces an additional opportunity cost. The IRRs for this deal are found by solving for the discount rates that set NPV to zero, resulting in two IRRs approximately at 12.8% and 36.4%. The presence of multiple IRRs suggests the deal is somewhat ambiguous, and IRR decision rules can be misleading without additional context. In such cases, NPV proves more reliable.

Scenario 3: Improved Deal with Increased Advance

The publisher increases the advance to \$750,000, with \$1,000,000 payable after four years. The present value of the four-year payout at 10% discount rate is about \$683,013. The NPV calculation now becomes:

NPV = \$750,000 + \$683,013 - opportunity costs (if any). The IRR here is found by solving the equation where NPV equals zero, yielding an IRR of approximately 21.7%, which is above the threshold for typical investment acceptability.

Discussion on IRR vs. NPV

Three key conclusions emerge from the analysis:

1. NPV provides a direct measure of value addition and is less susceptible to multiple IRRs, making it more reliable in decision-making, especially with mutually exclusive projects.
2. IRR can be misleading when dealing with non-conventional cash flows or multiple IRRs, as seen in the second scenario.
3. The decision rule favors NPV because positive NPV directly translates into value creation, whereas IRR may suggest acceptance based on rate thresholds, ignoring the scale of the project.

While IRR can be useful for quick assessments and comparing projects of similar scale, NPV remains the stronger method due to its economic interpretability and consistency with value maximization goals. Hence, for complex decisions like these, NPV should be the primary criterion.

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