Your uncle, in his will, left you the sum of $40,000/year forever with payments starting three...
Your uncle, in his will, left you the sum of $40,000/year forever with payments starting three years (Year 3) from today (Year 0). However, the news is even better. He has specified that the amount would grow at 2% per year after the first payment to offset inflation rate (i.e., the second payment would be $40,000 x (1 + 0.02)). With an APR of 3% compounded annually, what is the PV of the inheritance today?
(Draw the time line and the payment in each period before calculating the PV).
Homework Answers
First payment at the end of Year 3 = $40,000
Growth Rate = 2%
Interest Rate = 3%
Calculating Present Value at the end of Year 2 using Constant Growth Model,
Value = 40,000/(0.03 - 0.02)
Value = $4,000,000
Value today = 4,000,000/(1.03)2
Value today = $3,770,383.64
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