Question

Item1 Time Remaining 41 minutes 21 seconds00:41:21 Item 1Item 1 Time Remaining 41 minutes 21 seconds00:41:21 An investment offers to pay $260 a year forever starting at the end of year 6. If the interest rate is 10%, what is the investment's value today? (Assume annual compounding)

Answer 1

The investment will generate cash flow of $ 260 forever starting from year 6.

Interest rate = 10%

Note: The cashflow will start at the end of year 6.

Present value of perpetuity at the beginning of year 6 can be calculated with help of below formula -

PV = Annual cash flow / rate of interest

PV = 260 / 0.10

= 2600 $

This is the PV at 6 years from now.

Present value of investment today can be calculated with help of below formula -

Where,

PV = present value

FV = Future value

n = no. of years

r = rate of return

PV = 2600 / ( 1 + 0.10)⁶

PV = 2600 / (1.10)⁶

PV = 2600 / 1.771561

PV = 1467.632218 $

PV = $ 1467.63 (approx)

Hope it helps!