en years ago Diana Torres wrote what has become the leading Tort textbook. She has been receiving royalties based on revenues reported by the publisher. These revenues started at

$ 1.2

million in the first year, and grew steadily by

5.9 %

per year. Her royalty rate is

17 %

of revenue. Recently, she hired an auditor who discovered that the publisher had been under reporting revenues. The book had actually earned

10 %

more in revenues than had been reported on her royalty statements.

a. Assuming the publisher pays an interest rate of

3.4 %

on missed payments, how much money does the publisher owe Diana?

b. The publisher is short of cash, so instead of paying Diana what is owed, the publisher is offering to increase her royalty rate on future book sales. Assume the book will generate revenues for an additional

20

years and that the current revenue growth will continue. If Diana would otherwise put the money into a bank account paying interest of

3.6 %

,

what royalty rate would make her indifferent between accepting an increase in the future royalty rate and receiving the cash owed today.