Question

2. You are offered the right to receive $1000 per year forever, starting in one year. If your discount rate is 5%, what is the pattern of this cash flow (annuity, perpetuity, growing annuity, or growing perpetuity)? How much is this offer worth to you?

Answer 1

An annuity is end of year/beginning of year payments over a fixed interval of time at a specified interest rate.

A perpetuity is fixed payments at a specified interest rate for an indefinite period of time

A growing perpetuity is an indefinite stream of cash flows growing at a specified growth rate

A growing annuity is end of year/beginning of year payments over a fixed interval of time at a specified interest rate but they keep on growing at a constant growth rate

Hence this is a case of perpetuity

Present value of perpetuity=Annual cash flows/discount rate

=1000/0.05

=$20,000