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Present Value with Ordinary Perpetuity

 Present Value with Ordinary Perpetuity

The word perpetuity is an annuity in which the cash flows continue forever.

The ordinary cash flows occur at the end of each period.

Time Line

Question

If the market interest rate is 11 percent, a consol with a yearly interest payment of $50. What is the current price of consol?

Solution

PV=C/r=$50/0.11=$455

So, price of consol is $455

Question

You plan to buy stock from Group Investment Company.

Suppose Group Investment Company has a policy of paying a $10 per share dividend every year. If this policy is to be continued indefinitely. What is the value of a share of stock if the required return is 12 percent?

Solution

PV=D/r which D: perpetuity dividend

PV=$10/0.12=$83

So the value of a share of stock is $83.

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