A rich relative has bequeathed you a growing perpetuity. The first payment will occur one year...
A rich relative has bequeathed you a growing perpetuity. The first payment will occur one year from now and will be $1,000. Each year after that, you will receive a payment on the anniversary of the previous payment that is 8% larger than the previous payment. This pattern of payments will go on forever. Assume that the interest rate is 12% per year.
a) What is today’s value of the bequest?
b) What is the value of the bequest immediately after the first payment is made?
Homework Answers
a. The today's value of the bequest is computed as shown below:
= Payment after one year / ( interest rate - growth rate )
= $ 1,000 / ( 0.12 - 0.08)
= $ 25,000
b. The value is computed as shown below:
= Today's value as computed in above part x (1 + growth rate)
= $ 25,000 x 1.08
= $ 27,000
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