Question

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

$ 49 comma 000$49,000.

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

$ 540$540

per hour and her opportunity cost of capital is

15 %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 %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 of the opportunity= 11.05%

Decision: As internal rate of return is less than the cost of capital the opportunity of upfront payment should not be accepted.

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

Discounted at the cost of capital/required rate of return. (1.1715%)

NPV= -$900.79

Decision: As the net present value is negative the opportunity of upfront payment should not be accepted.