Question

Professor Wendy Smith has been offered the following​ opportunity: A law firm would like to retain her for an upfront payment of

$50,000.

In​ return, for the next year the firm would have access to eight hours of her time every month. As an alternative payment​ arrangement, the firm would pay Professor​ Smith's hourly rate for the eight hours each month. ​ Smith's rate is

$555

per hour and her opportunity cost of capital is

15%

per year. What does the IRR rule advise regarding the payment​ arrangement? (Hint: Find the monthly rate that will yield an effective annual rate of

15%​.)

What about the NPV​ rule?

Answer 1

a.
IRR: It is the discount rate at which the present value of projects cash outflows (cost) is equal to the present value of projects cash inflow.

IRR (yearly) = 12.57%

The IRR (12.57%) must be above the cost of capital/required rate of return (15%) in order to accept the upfront payment.

In this case, we should reject the upfront payment of $50,000

b. Net present value.
NPV = present value of cash inflow- the present value of cash outflow.

Discounted at the cost of capital/required rate of return (0.0011715)

NPV = -$564.69

NPV must be positive to accept the upfront payment.

As NPV is negative we should not accept the upfront payment of $50,000.

Upfiont Amount 50,000 0Coch utflono) Savid month houns x koely ra x $555 44440 Noot Martode Cmontha) 1PFM/ IPRY =12 12 Σ 444 0 50,000 C1+IPfm" O.991306 /.Monthy IPR Tate te IPR Tate ot tue pero d) IRR D-OD 191307t 12 1RR Yeaely CIPRy)= C1+ IRfm) 1.5 7 CI-15) 2-1=1.1715% Discount rati NPV- - o-01705 12 4140 5 0, O0 N PV= C1.ON F15) D 1 -564. 69 NPV =

4440 o, 00 D Cl-013 4440 4440 +4440 Cuo17 + 4440 C-01175) + Cl O75 CI.01I) 44 40 4410 +. 50 000 ChO1 49, 432. 50,00D 564-69 (app 4440 x dicout Actr @1.115 O. 9884 paticulaus x 44 40 1 1 0-9 t69 2 3 O. 9657 4- O.9 544 0.9434 '1 444p x G o.9325 o.9217 o.911 0 0.900 4 0. 8901 ০.৪+१+ 11 12 O-86 95 Total 49,4 32.27