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AM Co will receive a perpetuity starting in 2 years’ time of $10,000 per year,increasing by the rate inflation (which is 2%). what is the present value of perpetuity assuming a money cost of capital of 10.2%?
in the solution they have in order to use perpetuity factor the annual amount must be constat so calculation need to be done in real term ans they have calcululated real COC and then calculated perpetuity using real cost of capital.
DOUBT – we could have also calculated the value of perpetuiy as such = 10000(+0.02)/(0.102-0.02) like we do in dividend valuation model when there is constant growth right ?
DOUBT – is the dividend valuation method wrong ? and when i do calculate in such a manner why is my answer different than the solution shown in the textbook
The dividend valuation method is not wrong and will give the same answer.
However it assumes that the first receipt will be in 1 years time (and that Do is the current amount). Neither is the case here and so the answer from the dividend valuation method need adjusting.
1 year discount factor @10.2% =0.907 & 2 year discount factor @10.2% =0.823
even if i use the dividend valuation model to find the present value of the perpetuity at year 2 i get (10000*(1+0.02))/(0.102-0.02) = 124390.24
and if i discount 124390 using 1 year dicsount facto i get (124390*0.907) =112821.73
and if i discount 124390 using 2 year dicsount facto i get (124390*0.823) =102372.97
DOUNT – neither of the answer matches to the ans shown in th textbook aven after adjusting the present value to time zero why is that
The dividend valuation model gives the PV now if the first dividend in in 1 years time.
Your calculation of 124390 gives the PV at time 2 of the dividends starting from time 3.
You need to discount this for 2 years and also add on the PV of the dividend of 10,000 at time 2.Have you watched my free lectures working through chapter 15 of our free lecture notes, because example 7 illustrates how to deal with the problem.
Hi sir, I’ve encountered the same problem. If I use the dividend valuation method, to discount 124390 and 10000 to year 0, do we use 8% rate? If I use 8% rate, then my answer will be like this :
pv = (124390*0.857) + (10000*0.857)
= $115,172The answer given is $115,740. Does my answer differ from the actual answer due to rounding?
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