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Valuing the investment options

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1. A best-selling author decides to cash in on her latest novel by selling the rights to the book's royalties for the next 6 years to an investor. Royalty payments arrive once per year, starting one year from now. In the first year, the author expects $400,000 in royalties, followed by $300,000, then $100,000, then $10,000 in the three subsequent years. If the investor purchasing the rights to the royalties requires a return of 7% per year, what should the investor pay?

I saw a similar question in the solution library, but I could not understand how the answer was reached. I'm having trouble figuring out exactly how to input the discount rate to find the answers. (1/1.07n) I get the right answer for the 1st year, but past that, my answers aren't coming out right.

2. Suppose a preferred stock pays a quarterly dividend of $2 per share. The next dividend comes in exactly one-fourth of a year. If the price of the stock is $80, what is the effective annual rate of return that the stock offers investors?

3. Gail Dribble is analyzing the shares of Petscan Radiology. Petscans stock pays a dividend once each year, and it just distributed this year's $0.85 dividend. The market prie of the stock is $12.14. Gail estimates that Petscan will increase its dividends by 7% per year forever. After contemplating the risk of Petscan stock, Gail is willing to hold the stock only if it provides an annual expected return of at least 13%. Should she buy Petscan shares or not?

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Solution Summary

This solution depicts the steps to estimate the present value of given investment options.

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1. A best-selling author decides to cash in on her latest novel by selling the rights to the book's royalties for the next 6 years to an investor. Royalty payments arrive once per year, starting one year from now. In the first year, the author expects $400,000 in royalties, followed by $300,000, then $100,000, then $10,000 in the three subsequent years. If the investor purchasing the rights to the royalties requires a return of 7% per year, what should the investor pay?

PV of royalty of Year 1=400000/(1+7%)^1=$373831.78
PV of ...

Solution provided by:
Lokesh Jain, MSc
Education
  • BEng (Hons) , Birla Institute of Technology and Science, India
  • MSc (Hons) , Birla Institute of Technology and Science, India
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