Question

13) A perpetuity that pays $125 at the end of each year costs $625 today. a) What is the implied rate of return on this investment? b) If the payments of the perpetuity were made at the beginning of each year, what is the implied rate of return on this investment? ha Krishnaswami Lecture Notes Page 2 of 4

Answer 1

Perpetuity of $125, at the end of each year, cost $625 today

a), We know that PV of a perpetuity that pay A at end of each year end with implied rate = A/i

So, i = A/PV = 125/625 = 20%

So, implied rate of return on this investment = 20%

b). when 125 is paid every year at the start of the year, its PV = A + A/i

So, 625 = 125 + 125/i => i = 125/500 = 25%

So, it's implied rate of return = 25%