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I have been trying to understand the calculation to arrive to the result of $65000 but I clueless.
Can you please help me.A project is expected to earn $5000 per year (at current prices) in perpetuity, inflating at 4% per year.
The first receipt will be in one years time
The cost of capital is 12%What is the present value of the receipts?
Have you watched the free lectures that do with this chapter (because there is no point at all in using the lecture notes without watching the lectures)?
You need to discount the current price flows at the real (effective) rate.
Using the Fisher formula, the real rate = (1.12 /1.04 ) – 1 = 0.076923 or 7.6923%Then discount the perpetuity: 5,000 x 1/0.076923 = 65,000
Alternatively you can use the dividend growth formula (it gives the PV of any perpetuity with constant growth. So 5,000 (1.04) / (0.12 – 0.04) = 65,000
I think after that you also need to discount the 65.000 to the present as the first receipt will be in one year’s time?
No you don’t !
Using the factor 1/r to discount is always for a perpetuity that starts in 1 years time.
Alternatively, using the dividend valuation model uses the current flow (5,000) as Do.
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