Suppose you are offered a $1,000 payment each year until you die. After that, your children...

Suppose you are offered a $1,000 payment each year until you die. After that, your children will inherit the payment. Then their children. Forever. (And you love your progeny as much as you love yourself.) The payment is guaranteed by the Bank of Japan, and you want a 4% return on your investment. What is the maximum price you should pay for this perpetuity?

Select one:

a. $10,000

b. $20,000

c. $25,000

d. $100,000

Solutions

Expert Solution

As we know that the cash flow is perpetual and the payment is constant. As we have to pay for it today, we need to find the Present Value of the annuity.

The formula for perpetual annuity is

PV = PMT/i

where

PMT = Payment received every period =$1000

i = Rate of interest = 0.04

PV = 1000/0.04

= $25,000

Option c.

jeff jeffy answered 2 years ago

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