Question

1. Calculating Perpetuity Values [LO1] The Maybe Pay Life Insurance Co. is trying to sell you an investment policy that will pay you and your heirs $35,000 per year forever. If the required return on this investment is 4.7 percent, how much will you pay for the policy?
2. Calculating Perpetuity Values [LO1] In the previous problem, suppose a sales associate told you the policy costs $800,000. At what interest rate would this be a fair deal?

Answer 1

a). PV of Policy = Perpetual Annual Payment / Required Return

= $35,000 / 0.047 = $744,680.85

b). PV of Policy = Perpetual Annual Payment / Required Return

$800,000 = $35,000 / r

r = $35,000 / $800,000 = 0.04375, or 4.375%