What does perpetuity mean? Please describe a financial example of a perpetuity.

Expert Solution

Perpetuity is a very important concept in Finance. Normally when we invest in something we receive cash flows till the time the investment matures. For example a security or a bond. However in perpetuity, the annuities received never ends. That means we continue to receive cash flows indefinitely , throughout the end of time.

However it is noteworthy to mention that perpetuities have finite value given as

Value of perpetuity= Cash flow/ rate of return

Examples:

Perpetuities are largely used in Discounted cash flow valuations.

Suppose a company grows 10% annually until year 5 after which it grows 2% until perpetuity.

So in order to value the stock of the company we require to find the terminal value of the perpetuity and discount them to present value.

In Real estate also the concept of perpetuity in there. Once we buy and have possession of a house, we expect to receive rental income till perpetuity

jeff jeffy answered 2 years ago

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