John’s Publishing Company, a new service that writes term papers for college students, provides 11-page term papers from a list of more than 500 topics. Each paper will cost $7.50 and is written by a graduate in the topic area. John’s will pay $20,000 for the rights to all of the manuscripts. In addition, each author will receive $0.50 in royalties for every paper sold. Marketing expenses are estimated to be a total of $20,000 divided equally between Years 1 and 2, and John’s cost of capital is 11 percent. Sales are expected as follows:
YEAR VOLUME
1 10,000
2 7,000
3 3,000
a. What is the payback period for this investment? Its NPV? Its IRR? b. What are the ethical implications of this investment?
a. To determine the payback period, NPV (Net Present Value), and IRR (Internal Rate of Return) for this investment, we need to calculate the cash flows and discount them appropriately.
1. Calculate the cash flows:
In Year 0, the cost of purchasing the rights to all manuscripts is $20,000.
In Year 1, the sales revenue is the volume of papers sold (10,000) multiplied by the price per paper ($7.50). So the revenue in Year 1 is $10,000 * $7.50 = $75,000. The royalties paid to authors in Year 1 is $0.50 * 10,000 = $5,000.
In Year 2, the revenue is $7,000 * $7.50 = $52,500 and the royalties paid to authors is $0.50 * 7,000 = $3,500.
In Year 3, the revenue is $3,000 * $7.50 = $22,500 and the royalties paid to authors is $0.50 * 3,000 = $1,500.
2. Calculate the payback period:
To calculate the payback period, divide the initial investment by the cash flow per year.
Payback period = $20,000 / ($75,000 + $5,000 + $52,500 + $3,500 + $22,500 + $1,500) = $20,000 / $160,000 = 0.125 years.
3. Calculate the NPV:
NPV is calculated by discounting each cash flow to its present value and summing them up.
NPV = -$20,000 (initial investment) + ($75,000 / (1 + 0.11)^1) + ($5,000 / (1 + 0.11)^1) + ($52,500 / (1 + 0.11)^2) + ($3,500 / (1 + 0.11)^2) + ($22,500 / (1 + 0.11)^3) + ($1,500 / (1 + 0.11)^3) - $20,000 (marketing expenses).
Calculate the NPV using a financial calculator or a spreadsheet software. If the NPV is positive, the investment is considered profitable.
4. Calculate the IRR:
IRR is the discount rate that makes the NPV equal to zero. To calculate the IRR, set the NPV equation equal to zero and solve for the discount rate using a financial calculator or a spreadsheet software.
b. Ethical implications:
There are several ethical implications to consider with this investment:
1. The service provided by John's Publishing Company may be considered unethical as it involves writing term papers for students, which some may view as academic dishonesty or cheating.
2. Paying authors only $0.50 in royalties for each paper sold might be viewed as exploitative, especially considering the company is selling the papers for $7.50 each.
3. The overall business model of profiting from student academic needs might be seen as unethical by some who believe that students should be responsible for their own academic work.
It's important to consider the ethical implications before engaging in such a business.