Question

How much would investors be willing to pay for a perpetuity that pays $60,000 per year if interest rates are 5%?

Answer 1

How much would investors be willing to pay for a perpetuity that pays $60,000 per year if interest rates are 5%?

This is the case of infinite life alternative. We need to calculate the capitalized cost of the cash outflows assumed to continue upto an infinite period.

Capitalized cost is the present worth of an alternative that will last forever.

The formula to calculate the capitalized cost is PW = A (P/A, i, n) where the n = ∞

Hence, CC = A/I or annual disbursement / rate of interest

In the above question annual payment is 60000

Rate of interest is 5% or .05

CC = 60000/.05 = 1,200,000

The investor would be willing to pay 1,200,000 for a perpetuity that pays 60000 per year if interest rates are 5%.