Professor Wendy Smith has been offered the following opportunity: A law firm wou
ID: 2795531 • Letter: P
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 S545 per hour and her opportu nity 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? The IRR is[1% (Round to two decimal places) The IRR rule advises: (Select the best choice below.) A. O B. With an IRR of 15% and with Smith's cost of capital at 8 79%, according to the IRR rule, she should reject this opportunity Since the IRR is less than the cost of capital, 15%, Smith should accept this opportunity. C. O Since the IRR is less than the cost of capital, 15%, Smith should turn down this opportunity. D. None of the above. The NPV is S (Round to the nearest dollar) The NPV rule advises: (Select the best choice below.) 0 A. Since the NPV is negative, the correct decision is to accept the upfront retainer. O B. Even though the NPV is positive, the IRR is high enough to accept the upfront retainer O C. Even though the NPV is negative, the IRR is below the cost of capital, so the correct decision is to reject the upfront payment 0 D. None of the above.Explanation / Answer
The firm would like to retain Smith for an upfront payment of 50000 and thus it is cash outflow for her and it is -50000
Also the firm would get access to Smith's additional eight hours every month for which the company would pay 545*8= 4360 per month and this too is cash inflow for Smith.
Thus NPV measured at 15% ie 15/12 = 1.25% per month of her opportunity cost and IRR will be:
Month
Cash flow
0
-50000
1
4360
2
4360
3
4360
4
4360
5
4360
6
4360
7
4360
8
4360
9
4360
10
4360
11
4360
12
4360
NPV at 1.25%
-$1,673.28
IRR
0.705%
The IRR for the project is 0.705*12 = 8.46%.
The IRR rule advises:
C. Since the IRR is less than the cost of capital, 15%, Smith should turn down this opportunity
The NPV is -$1673.28
The NPV rule advises:
D. None of the above
As the NPV is negative project should be rejected irrespective of the IRR
Month
Cash flow
0
-50000
1
4360
2
4360
3
4360
4
4360
5
4360
6
4360
7
4360
8
4360
9
4360
10
4360
11
4360
12
4360
NPV at 1.25%
-$1,673.28
IRR
0.705%
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