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 $540 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?

Question A) What is the IRR

Question B) What is the NPV

Answer 1

Let the monthly rate be r.

Therefore, (1+r)¹² = (1+15%) = 1.15

r = 1.15^1/12 - 1 = 1.17%

Payment per month = 8*$540 = $4,320

Therefore, the firm would need to pay $4,320 for 12 months.

For IRR, the NPV should be 0.

Formulas Used:

Because IRR is less than 15%, Smith should take the upfront payment of $50,000 and turn down the alternative arrangement.

Since the IRR is less than the cost of capital, 15%, Smith should turn down this opportunity

Since the NPV is negative, the correct decision is to accept the upfront retainer.