Question

Curly’s Life Insurance Co. is trying to sell you an investment policy that will pay you and your heirs $40,000 per year forever. A representative for Curly’s tells you the policy costs $650,000. At what interest rate would this be a fair deal? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

Answer 1

Here we need to find the interest rate that equates the perpetuity cash flows with the PV of the cash flows. Using the PV of a perpetuity equation:

PV = C/ r

$650,000 = $40,000 / r

We can now solve for the interest rate as follows:

r = $40,000 / $650,000

r = 0.0615, or 6.15%