Professor Wendy Smith has been offered the following opportunity. A law firm wou

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 $550 per hour and her efective annual rate of 15% ) What about the NPV rule? cost of capdal is 15% per year what does the IRR nk a se regarding the payment arrangement? Hint Find the monthly rate that wil yeld an The RRs084% (Round to two decmal places ) The IRR rule advises (Select the best choice below) 0 A. Since the RR is less than the cost of capital, 15%. Smith should turn down this opportunity O B. Srce the IRR is less than the cost of captal, 15%, Smith should accept this opportunity Oc wman RR of 15% and wth s ms cost of capital at 1067% a coeding to the IRR 1 O D. None of the abovo she should repect this opportunity 7 6 8 0. W E

Explanation / Answer

Cash Outflow $50,000 PMT(monthly) = 8 hours x $550 per hour -$4,400 Period 12 Period Cashflow 0 50000 1 -4400 2 -4400 3 -4400 4 -4400 5 -4400 6 -4400 7 -4400 8 -4400 9 -4400 10 -4400 11 -4400 12 -4400 IRR (monthly) 0.85% Annual effective rate = (1+0.85%)^12 -1 10.67% Option A she should turn down this opportunity because IRR is less than Cost of Capital. NPV Effective monthly rate =[ (1+15%)^(1/12)] -1 1.17% Period Cashflow PV @ 1.17% Present Value 0 $50,000 1 $50,000 1 -$4,400 0.988420733 -$4,349.05 2 -$4,400 0.976975546 -$4,298.69 3 -$4,400 0.965662885 -$4,248.92 4 -$4,400 0.954481217 -$4,199.72 5 -$4,400 0.943429025 -$4,151.09 6 -$4,400 0.932504808 -$4,103.02 7 -$4,400 0.921707086 -$4,055.51 8 -$4,400 0.911034394 -$4,008.55 9 -$4,400 0.900485284 -$3,962.14 10 -$4,400 0.890058324 -$3,916.26 11 -$4,400 0.879752102 -$3,870.91 12 -$4,400 0.869565217 -$3,826.09 NPV $1,010.06 Npv is positive so the correct decision is to accept the deal. Smith can also be relatively confident in this decision

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