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I think this might be related to my English problem. I’m so confused
1. take $90,000 per annum indefinitely starting in 3 years’ time
2. take a lump sum of $910,000 in 1 years timeThe answer uses the discount factor over 2 years for Q1, and uses the discount factor over 1 year for Q2. Why is that? Is it because its perpetuity? Is the PV=$90.000 (no discount) if starting in 1 year time, then why do we apply discount rate to Q2?
Thank you.
For the first question, to discount a perpetuity we multiply by 1/r where r is the interest rate. However, that only applies to a perpetuity starting in 1 years time. Here, then perpetuity starts in 3 years time, which is 2 years later, so the answer needs discounting for 2 years to get the present value.
In the second case, if the flow is in 1 years time we discount for 1 year to get to a present value ‘now’.
You really should watch my free lectures on this. The lectures are a complete free course for Paper F2 and cover everything needed to be able to pass the exam well.
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