Robert Merton wrote five years ago a book that has become the leading finance textbook. He has been receiving royalties based on revenues reported by the publisher. These revenues started at $2 million in the first year, and grew steadily by 5% per year. Her royalty rate is 10% of revenue. Recently, he hired an independent auditor who discovered that the publisher had been under reporting revenues. The book had actually earned 20% more in revenues than had been reported on his royalty statements.

(a) Assuming the publisher pays an interest rate of 4% on missed payments, how much money does the publisher owe Bob?

(b) The publisher is short of cash, so the publisher agreed to pay 50% of the royalty short- fall in cash today and increase Bobs royalty rate on future book sales to pay for the remaining 50% shortfall. Assume the book will generate revenues for an additional 10 years and that the current revenue growth of 5% will continue. If Bob would otherwise put the money into a bank account paying interest of 3%, what adjusted royalty rate would make him indifferent between accepting an increase in the future royalty rate and receiving the total cash owed today.