Question

Larry's Life Insurance Co. is trying to sell you an investment policy that will pay you and your heirs $25,000 per year forever. Assume the required return on this investment is 4 percent. How much will you pay for the policy? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

Answer 1

To calculate the cost of a perpetuity that provides a $25,000 annual payment at a 4 percent return, use the formula PV = PMT / r to get a present value of $625,000.

Step-by-step explanation:

The student is asking about the price one would pay for a perpetuity, which is an investment that pays a fixed amount annually. The formula to calculate the present value of a perpetuity is PV = PMT / r, where PV is the present value or the price paid for the policy, PMT is the annual payment, and r is the required rate of return. Given an annual payment (PMT) of $25,000 and a required return (r) of 4 percent (or 0.04), the calculation would be PV = $25,000 / 0.04, which equals $625,000.