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Mr Manaton has recently won a competition where he has the choice between receiving $5,000 now or an annual amount forever starting now 9(i.e a level perpetuity starting immediately). The interest rate is 8% per annum.
What would be the value of the annual perpetuity to the nearest$?
Dear Sir,
Please explain above question.Thank you.
Have you watched my free lectures on discounting?
If so, you will know that the present value of a perpetuity (an equal amount each year from 1 to infinity) is calculated by multiplying the annual amount by 1/r , where r is the rate of interest.
Here, instead of being 1 to infinity, the first receipt is immediate.So for the two to be equivalent, if P is the annual amount, then
5000 = P + (P x (1/0.08))
If you solve this you should get P = $370.37 (or $370 to the nearest $)
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