Question

6.3 The Maybe Pay Life Insurance Co. is trying to sell you an investment policy that will pay you and your heirs $35,000 per year forever. (1) If the required return on this investment is 4.7 percent, how much will you pay for the policy? (2) Now suppose a sales associate told you the policy costs $800,000. At what interest rate would this be a fair deal?

6.4 What happens to the future value of a perpetuity if interest rates increase? What if the interest rate decrease?

6.5 What happens to the future value of an annuity if you increase the rate r? What happens to the present value?

Answer 1

6.3

Present Value = Cash Flow / r

= 35000 / 0.047

= 744680.85

800,000 = 35000 / r

r = 35000 / 800,000

r = 0.04375 OR 4.375%

6.4

When the r increase the Future Value increase and when the r decreases, the Future value also decreases. The interest rate and the Future value has direct relationship.

6.5

The Future Value of annuity and r also has a direct relationship. So the Futire Value also increase when the r increases. While the Present Value and the r has inverse relatioship. therefore when the r increases, the Present Value of Annuity decreases.