Question

14. Perpetuities Aa Aa Perpetuities are also called annuities with an extended, or unlimited, life. Based on your understanding of perpetuities, answer the following questions Which of the following are characteristics of a perpetuity? Check all that apply. In a perpetuity, returns-in the form of a series of identical cash flows-are earned. A perpetuity continues for a fixed time period. The principal amount of a perpetuity is repaid as a lump-sum amount. The present value of a perpetuity is calculated by dividing the amount of the payment by the investor's opportunity interest rate. Your grandfather wants to establish a scholarship in his father's name at a local university and has stipulated that you will administer it. As you've committed to fund a $25,000 scholarship every year beginning one year from tomorrow, you'll want to set aside the money for the scholarship immediately. At tomorrow's meeting with your grandfather and the bank's representative, you will need to deposit can fund the scholarship forever, assuming that the account will earn 4.00% per annum every year. (rounded to the nearest whole dollar) so that you Oops! The bank representative just reported that he misquoted the available interest rate on the scholarship's account. Your account should earn 6.50%. The amount of your required deposit should be revised to relationship between the interest rate earned on the account and the present This suggests there is value of the perpetuity.

Answer 1

1) Characteristics of perpetuity

• In a perpetuity, returns-in the from of series of identical cash flows-are earned.
• The present value of a perpetuity is calculated by dividing the amount of the payment by the investor's opportunity interest rate.

Present Value of Perpetuity = Cash flow per period / Discount Rate

= 25000/.04

= 625000

Present Value of Perpetuity = Cash flow per period / Discount Rate

= 25000/.065

= 384615

There is an inverse relationship between the interest rate earned on the account and the present value of the perpetuity.