Question

The Maybe Pay Life Insurance Co. is trying to sell you an investment policy that will pay you and your heirs $28618 per year forever. If the required return on this investment is 7 percent, how much will you pay for the policy?

Answer 1

Here, the policy will pay $28618 per year forever. So, it is the perpetuity. We need to calculate the present value of perpetuity. The formula for present value of perpetuity is given by:

PV = D/r

where, PV = Present value, D = Annual cash flows and r = rate of interest.

Now, putting the values given in the above formula, we get,

PV = $28618 / 7%

PV = $28618 / 0.07

PV = $408828.57

So, we will pay $408828.57, the present value, for this policy.