Bill Clinton reportedly was paid an advance of $ $15$ 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 $ $8\mathrm{.}00$ million a year$($paid at the end of the$$ year$)$ speaking instead of writing. Assume his cost of capital is $10\mathrm{.}0\%$ per year.

a$.$ Based on the above cash$$ flows, how many IRRs does the opportunity$$ have? Does the IRR rule give the right answer in this$$ case?

b$.$ Assume now that once the book is$$ finished, it is expected to generate royalties of $ $5\mathrm{.}00$ million in the first year$($paid at the end of the$$ year$)$ and these royalties are expected to decrease at $30\%$ per year in perpetuity. How many IRRs are there in this$$ case? Does the IRR rule work in this$$ case?

Question content area bottom

Part $1$

a$.$ Based on the above cash$$ flows, how many IRRs does the opportunity$$ have? $($Select the best choice$$ below.$)$

A$.$

One IRR

B$.$

Two IRRs

C$.$

Three IRRs

D$.$

Four IRRs

Part $2$

Does the IRR rule give the right answer in this$$ case? $($Select the best choice$$ below.$)$

A$.$

$$No$,$ because the IRR is greater than the cost of capital and so would suggest taking the$$ project, but its NPV is negative and so it should be rejected.

B$.$

$$No$,$ because the IRR is less than the cost of capital and so would suggest rejecting the$$ project, but its NPV is positive and so it should be taken.

C$.$

$$Yes$,$ because the IRR is less than the cost of capital and the NPV is$$ negative, both rules would suggest rejecting the project.

D$.$

$$Yes$,$ because the IRR is greater than the cost of capital and the NPV is$$ positive, both rules would suggest taking the project.

Part $3$

b$.$ Assume also that once the book is$$ finished, it is expected to generate royalties of $ $5\mathrm{.}00$ million in the first year$($paid at the end of the$$ year$)$ and these royalties are expected to decrease at $30\%$ per year in perpetuity. How many IRRs are there in this$$ case? $($Select the best choice$$ below.$)$

A$.$

Three

B$.$None

None

C$.$

One

D$.$Two

Two

Part $4$

Does the IRR rule work in this$$ case? $($Select the best choice$$ below.$)$

A$.$

$$Yes$,$ because when there are $2$ IRRs, the NPV is negative if and only if the cost of capital is between the IRRs.

B$.$

$$No$,$ because there is no IRR for this$$ project, so the IRR rule cannot be applied.

C$.$

$$No$,$ because there are $2$ IRRs for this$$ project, so the IRR rule cannot be applied.

D$.$

$$Yes$,$ because when there is no$$ IRR, NPV must be positive.