Question

An investment offers a perpetual stream of $4,000 annual payments.  The first payment will be received in 8 years. The interest rate is 4.5% per year. What is the value of this investment in year 3?

Answer 1

Value of Investment on a particular day is the Present Value of all Future Cash Flows from the Investment Discounted at the Required rate of return.

In the Given case, The investment offers a payment of $4000 each year from the 8 th year ,

Step 1: Let us calculate the Value of investment at the begining of the 8 th year from when the First payment will be received.

Value of Investment =

[In case of perpetuity, The PV is caluculated using the given Formula]

Therfore, The Value of Investment at the begining of year 8 (or, The end of year 7)

= 4000/4.5%

= $88,889.

Step 2: Calculation Of value of Investment in year 3:

Value of investment at the end of year 3 is Present value of $88,889 discounted @4.5% for 3 years

Therefore, Value of Investment = = $77893 (approx.)