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In the following question, I simply calculated present value of perpetuity by plugging in the values 1500 and 6% in the formula: A/r. Hence 1500/6% was my answer, but it was incorrect. Also, the statement ” with the first receipt starting in 3 years’ time” seems confusing and I probably don’t understand what is implied by this statement.
Question: An investment will produce an annual return of $1500 in perpetuity with the first receipt starting in 3 years’ time.
What is the present value of this perpetuity discounted at 6%?The discount factor for a perpetuity is 1/r, but applies to a perpetuity that starts in 1 years time.
If the perpetuity starts in 3 years time, then the discount factor is 1/r minus the annuity factor for 2 years.
When you have calculated the discount factor, then to get the annual return you need to divide $1,500 by this discount factor.
This is explained in my free lectures on investment appraisal. The lectures are a complete free course for Paper MA and cover everything needed to be able to pass the exam well.
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