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Good day Mr.Moffat
Could you please explain this question.AM Co will receive a perpertuity starting in two years time of $10.000 per annum, increasing by the rate of inflation (which is 2%).
What is the present value of this perpetuity assuming a money cost of capital of 10.2 %?A $90,910
B $125,000
C $115,740
D $74,403Thanks in advance
You must surely have an answer in the same book in which you found the question 🙂
In future please ask about whatever it is in the answer that you are not clear about and then I will explain.The real cost of capital is 1.102 / 1.02 – 1 = 0.08 i.e. 8%
Therefore to discount the perpetuity you multiply by 1/0.08.
And then because the perpetuity starts 1 year late (at time 2 instead of at time 1) you multiply by 1.08 to discount for the extra year.
Do watch my free lectures on this. The lectures are a complete free course for Paper FM and cover everything needed to be able to pass the exam well.
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