Question

Explain how a finite series of cash flows converges to a no growth perpetuity and provide a numerical example to show this concept.

Answer 1

finite series of cash flows converges to a no growth perpetuity because they are lacking Time value of money.present value of the money will not be equal to the future value. there can be major differences between the values,that's why the same amount of return for a period of time incur huge loss.

for example,if a company expected to give dividend of rs 3 after 1 year ,next dividend is expected to grow @ 10% p.a. investor required rate of return is 12%

so,present value cash inflow= 3/0.12-0.1=150

if,we do not consider growth rate then,no growth perpetuity=3/0.12=25

we can see there is major difference in the values of the two cash flows.