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 $545 per hour and her opportunity cost of capital is 15% per year. What does the IRR rule advise regarding the payment arrangement? What about the NPV rule? The IRR is %.

Explanation / Answer

Monthly Hours of engagement                       8 Hourly rate of Prof Smith                  545 Monthly Engagement bill            4,360 Monthly interest rate =15% pa =1.25% NPV Calculation Two ways the problem can be interoreted. 1 st option   Month   PV factor @1.25% Cash Flows PV of Cash flows period 0                     1               (50,000)        (50,000)                                                                                            1            0.988                    4,360      4,306.17                                                                                            2            0.975                    4,360      4,253.01                                                                                            3            0.963                    4,360      4,200.50                                                                                            4            0.952                    4,360      4,148.65                                                                                            5            0.940                    4,360      4,097.43                                                                                            6            0.928                    4,360      4,046.84                                                                                            7            0.917                    4,360      3,996.88                                                                                            8            0.905                    4,360      3,947.54                                                                                            9            0.894                    4,360      3,898.80                                                                                          10            0.883                    4,360      3,850.67                                                                                          11            0.872                    4,360      3,803.13                                                                                          12            0.862                    4,360      3,756.18 Total      (1,694.2) So NPV of the arrangement is   $ (1,694.2) IRR Calculation Month   PV factor @0.705% Cash Flows PV of Cash flows period 0                     1               (50,000)        (50,000)                                                                                            1            0.993                    4,360      4,329.48                                                                                            2            0.986                    4,360      4,299.17                                                                                            3            0.979                    4,360      4,269.07                                                                                            4            0.972                    4,360      4,239.18                                                                                            5            0.965                    4,360      4,209.51                                                                                            6            0.959                    4,360      4,180.04                                                                                            7            0.952                    4,360      4,150.78                                                                                            8            0.945                    4,360      4,121.72                                                                                            9            0.939                    4,360      4,092.86                                                                                          10            0.932                    4,360      4,064.21                                                                                          11            0.926                    4,360      4,035.76                                                                                          12            0.919                    4,360      4,007.51 Total               (0.7) IRR is 0.705 per month = 8.46% pa 2nd way as mentioned in the problem   If the required rate of IRR is the rate that   yield effective annual rate =15% Assume annual IRR =r So (1+r/12)^12-1=15% r= 14.04%   Monthly IRR =14.04/12=1.17%

Related Questions

Navigate

• Browse (All)
• Browse P
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.