Question of the Week

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.

Answer:

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.


Have a Financial Question?

Let us know what’s on your mind!

Sign Up For Our Professionals in the Money Newsletter!

Marketplace
Professionals FAQs
  1.

    Where can I look for a financial planner?

    References from trusted friends or family members can help you find a financial planner; however, keep in mind that your friends' financial situations and goals may differ from yours and, therefore, their planners won't necessarily be the best fit for you.The Certified Financial Planner (CFP) Board of Standards certifies financial planners and maintains an online list of certified financial planners on its CFP Board of Standards website.
  2.

    If I am looking to get an Investment Banking job. What education do employers prefer? MBA or CFA?

    If you are looking specifically for an investment banking position, an MBA may be marginally preferable over the CFA. The caveat here is that the MBA would most probably need to be from a Top-20 B-School.The Chartered Financial Analyst (CFA) is well worth considering if you (a) are aiming for an entry-level position in investment banking, and/or (b) cannot afford to shell out six figures for an MBA or have to settle for a lesser-known B-school.That's because in the investment banking field, most entry-level positions are at the analyst level.
  3.

    Can I still pass the CFA Level I if I do poorly in the ethics section?

    You may still pass the Chartered Financial Analysis (CFA) Level I even if you fare poorly in the ethics section, but don't count on it. The CFA Institute has long emphasized that ethics is a particular area of focus for it. The seriousness with which the CFA Institute views ethics is evident from the fact that for exam candidates with borderline total scores, performance on the ethics section can mean the difference between passing and failing the exam.
  4.

    Where do most fund managers get their market information?

    Many fund managers, whether they manage a mutual fund, trust fund, pension or hedge fund, have access to resources that the "average Joe" investor does not, but the type and quality of information generally remains the same for all investors. The information that managers use comes from publicly available information in the form of news releases, annual reports and filings with pertinent exchanges.