Q:
For $800,000 invested today, an insurance company promises to start making perpetual payments to you beginning seven years from now. What must these perpetual payments be if the long-term savings rate is expected to remain constant at 5.5%?
A) $60,669
B) $64,006
C) $166,249
D) Present value is infinite because payments continue into infinity.
A:
The correct answer is: A)
We must first link the $800,000 today to the period when the perpetuity payments will begin. In this case: PV=800,000; I=5.5; N=6; thus, FV=1,103,074. Note that the $1,103,074 is the value of the perpetuity by the end of the sixth year. We also know that:
Present Value of a Perpetuity @ period t = [cash flow for period t+1]
                                                                 [Period interest rate]
Therefore:
Present value of $1,103,074 @ period 6 = [Cash flow beginning period 7]
                                                                               0.055
Therefore, the cash flow beginning in period 7 and continuing indefinitely is ($1,103,074)*(0.055) = $60,669.08.

RELATED FAQS

  1. Is an annuity a perpetuity?

    Find out how an annuity can sometimes be a perpetuity, and understand how an annuity's payments can be set up to make it ...
  2. What are the differences between an annuity derivation and perpetuity derivation ...

    Understand the differences between an annuity derivation and perpetuity derivation of the time value of money. Learn the ...
  3. Is Social Security Income a perpetuity?

    Find out why Social Security income is not classified as a perpetuity, including what constitutes a perpetuity and the basics ...
  4. How is perpetuity used in determining the intrinsic value of a stock?

    Learn about the basics of a perpetuity, its valuation, how it is calculated and how it is used when evaluating the intrinsic ...
  5. How is perpetuity used in the Dividend Discount Model?

    Learn about how the concept of a stock perpetuity is used in the basic dividend discount model, which is also known as the ...
  6. When evaluating terminal value, should I use the perpetuity growth model or the exit ...

    Examine the important calculation of a terminal value in discounted cash flow analysis, and learn which method of calculating ...
RELATED TERMS
  1. Delayed Perpetuity

    A perpetual stream of cash flows that start at a predetermined ...
  2. Perpetuity

    A constant stream of identical cash flows with no end. The formula ...
  3. Perpetual Bond

    A bond with no maturity date. Perpetual bonds are not redeemable ...
  4. Perpetual Preferred Stock

    A type of preferred stock that has no maturity date. The issuers ...
  5. Perpetual Subordinated Loan

    A type of junior debt that continues indefinitely and has no ...
  6. Perpetual Option - XPO

    A non-standard financial option with no fixed maturity and no ...

You May Also Like

Hot Definitions
  1. Law Of Demand

    A microeconomic law that states that, all other factors being equal, as the price of a good or service increases, consumer ...
  2. Cost Of Debt

    The effective rate that a company pays on its current debt. This can be measured in either before- or after-tax returns; ...
  3. Yield Curve

    A line that plots the interest rates, at a set point in time, of bonds having equal credit quality, but differing maturity ...
  4. Stop-Limit Order

    An order placed with a broker that combines the features of stop order with those of a limit order. A stop-limit order will ...
  5. Keynesian Economics

    An economic theory of total spending in the economy and its effects on output and inflation. Keynesian economics was developed ...
  6. Society for Worldwide Interbank Financial Telecommunications ...

    A member-owned cooperative that provides safe and secure financial transactions for its members. Established in 1973, the ...
Trading Center