Question

Consider an investment that pays $41.98 in year 1, and then stabilizes and pays $6.1 every year forever after that (the first cash flow is in year 2) This firm does not intend to grow and has an interest rate (required rate of return) of 7%. What is the present value of this investment opportunity? Give your answer to two decimals

Answer 1

first let us know the present value of $41.98 in year 1.

=> $41.98 * 1 /(1+r)^n

here,

r = 7%

n=1.

=>$41.98 * 1/(1.07)^1

=>$39.23.

now,

let us know the value of $6.1 received in perpetuity by the end of year 1.

=>cash flow / required return

=>$6.1 / 0.07

=>$87.14.

now, this value is at the end of year1, so we need to find the present value of this amount.

=>$87.14 * 1/(1.07)^1

=>$81.44.

now,

present value of the investment = $39.23+81.44

=>$120.67.