Question

Victor wants to purchase a perpetuity paying 100 per year with the first payment due at the end of year 11. He can purchase it by either: (i) paying 90 per year at the end of each year for 10 years; or i) payıng K per year at the end of each year for the years and nothing for the next 5 years. Calculate K

Answer 1

K = 151.9422481

Explanation:

At the end of year 10, your perpetuity is worth 100/i

(1) is worth 90×s_{10%i}

So if you set them equal you get 90*[(1+i)^10 - 1]/i = 100/i or [(1+i)^10 - 1] = 10/9 or (1+i)^10 = 19/9 or i = 0.077583937

So now the question compare (1) to (2), at t = 0

(1) is worth 90×a_{10%i} = 90(1 - 1/(1.077583937)^10)/0.077583937 = 610.5441743

(2) is worth K×a_{5%i} = 4.018264714×K

Therefore K = 151.9422481