Question

Which of the following are characteristics of a perpetuity? Check all that apply.

1. The value of a perpetuity cannot be determined.
2. The current value of a perpetuity is based more on the discounted value of its nearer (in time) cash flows and less by the discounted value of its more distant (in the future) cash flows.
3. The value of a perpetuity is equal to the sum of the present value of its expected future cash flows.
4. A perpetuity is a stream of regularly timed, equal cash flows that continues forever.

A local bank’s advertising reads: “Give us $50,000 today, and we’ll pay you $800 every year forever.” If you plan to live forever, what annual interest rate will you earn on your deposit?

1. 2.56%
2. 2.24%
3. 1.60%
4. 1.44%

Oops! When you went in to make your deposit, the bank representative said the amount of required deposit reported in the advertisement was incorrect and should have read $75,000. This revision, which will (Reduce, Increase) the interest rate earned on your deposited funds, will adjust your earned interest rate to (1.12%, 1.23%, 1.02%, 1.07%).

Answer 1

1.
The current value of a perpetuity is based more on the discounted value of its nearer (in time) cash flows and less by the discounted value of its more distant (in the future) cash flows.

The value of a perpetuity is equal to the sum of the present value of its expected future cash flows.

A perpetuity is a stream of regularly timed, equal cash flows that continues forever.

2.
=Annual amount/Amount required today
=800/50000
=1.60%

3.
Reduce as rate is inversely proportional to present value

4.
=800/75000
=1.06667%