Problem

Calculating Perpetuity Values [LO1] In the previous problem, suppose a sales associate tol...

Calculating Perpetuity Values [LO1] In the previous problem, suppose a sales associate told you the policy costs $475,000. At what interest rate would this be a fair deal?

Step-by-Step Solution

Solution 1

Here we need to find the interest rate that equates the perpetuity cash flows with the PV of the cash flows.

Using the PV of a perpetuity equation:

$$ \begin{aligned} &\mathrm{PV}=\frac{\mathrm{C}}{\mathrm{r}} \\ &\$ 475,000=\frac{\$ 30,000}{\mathrm{r}} \end{aligned} $$

We can now solve for the interest rate as follows;

$$ \begin{aligned} r &=\frac{\$ 30,000}{475,000} \\ &=0.0632 \end{aligned} $$

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