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}