Question

A firm has initial fund of $800. The market rate of return is 12%. The firm has identified good investment opportunities to invest $640 at an average 25 per cent rate of return. How much dividend would be paid in next period under Two-Period Perfect Certainty Model?

Answer #1

Two-Period Perfect Certainty Model:

It is a Trade off between consuming now or future.

Fisher created a model in which people are assumed to live for two periods. In the first period, the consumer earns an income of Y1 and in the second period he earns Y2. He is assumed to have no initial wealth.

Relies on three assumptions:

- Perfect certainity

- Perfect capital markets

- Rational Investors

Expected dividend = 640* 0.25 = 160

Current wealth = 800 + 800*0.12

Future wealth = 640 + 640*0.25

PVLR = 800+96 + (640+160/1+.25) = 1,536/-

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