Question

8. You have just struck oil in the middle of your hay field. An oil company has offered to pay you a perpetual annuity of $12,500 per year for the rights. What is the value of the offer, assuming a 10% discount rate? The value with the discount rate would be $125,000. 9. What would be the value of the annuity in question 8 if the company increased the payment by 3% each year? 11. Sam Crosby is a professional hockey player who is considering two contract offers. Contract A will pay him $6 million at the end of each of the next seven years. Contract B will pay him $5 million for the first three years and $7 million for the last four years. What is each contract's present value using an annual interest rate of 7%? Which contract is better?

Answer 1

Ques 8). Present value of a perpetuity discounted with rate i = A/i

So, here $12500 at end of each year, PV at discount rate of 10% = 12500/0.10 = $125000

Ques 9). When annual payment increases by 3%, it works as inflation

So, inflation rate = 3%

Nominal rate = 10%

So, real rate = ((1+nominal rate)/(1+inflation rate)) - 1 = (1.1/1.03)-1 = 6.80%

So, new discount rate = 6.80%

So PV of this perpetuity = 12500/0.068 = $183928.57

Hope this solves your issue.

Please post Question 11 separately, as per rules only one question is permitted to attempt. So request you to post the remaining question separately.