Question

Ralf Wilson wants to receive $25,000 in perpetuity and will invest his money in an investment that will earn a return of 14 percent annually. What is the value of the investment that he needs to make today to receive his perpetual cash flow stream? (Round to the nearest dollar.)

A) $640,225
B) $252,325
C) $144,350
D) $178,571

Answer 1

The correct answer is D. Ralf Wilson needs to invest $178,571 today at a 14% return to receive an annual perpetuity payment of $25,000. This is calculated using the perpetuity present value formula, which factors in the time value of money.

Step-by-step explanation:

Ralf Wilson needs to invest $178,571 today to receive $25,000 in perpetuity at an annual return of 14%.

To calculate the present value of a perpetuity (i.e., infinite series of equal payments), we use the formula PV = PMT / r, where PMT is the annual payment (in this case $25,000) and r is the annual interest rate (0.14). Plugging the numbers into the formula, we get PV = $25,000/0.14, which equals $178,571.

This perpetuity formula assumes that the payments continue forever and the rate of return, or discount rate, remains constant. It's a fundamental concept in finance related to time value of money, which determines how much an investment needs to be worth today to achieve a certain future cash flow. Rounding to the nearest dollar, we can confirm that answer is $178,571 is correct.