An annuity pays $3,000 per year in perpetuity.
(a) If the discount rate is 5%, what should the value of this asset be?
(b) If the discount rate falls, what happens to the asset's price? Explain briefly. (You don't need a
calculation here.)
annuity payment = 3000 in perpetuity
a) discount rate = 5%
The present value of annuity payment in perpetuity is = A/i
A is annual payment, i is the interest rate
Present value of the asset = 3000 / 0.05
= 60000
b) As stated above, present value and interest rate have an inverse relationship, therefore when interest rate falls, the present value of annuity payment rises, so asset price will increase.
An annuity pays $3,000 per year in perpetuity. (a) If the discount rate is 5%, what...