Question

Calculating Perpetuity Values

Curly’s Life Insurance Co. is trying to sell you an investment policy that will pay you and your heirs $25,000 per year forever. A representative for the company tells you the policy costs $500,000. At what discount rate would this be a fair deal?

Provide the formula through excel

Answer 1

a discount rate of 5%

Explanation:

The formula to calculate the present value of a perpetuity is:

PV = PMT / r

Where PV is the present value, PMT is the constant payment, and r is the discount rate.

In this case, the PMT is $25,000 and the PV is -$500,000 (negative because it represents a cash outflow). So we can rearrange the formula to solve for r:

r = PMT / PV

r = $25,000 / -$500,000

r = -0.05 or -5%

Therefore, at a discount rate of 5%, the policy would be a fair deal.

To calculate this in Excel, you can use the following formula in a cell:

=r(-25000/500000)

This will give you a result of -0.05, or -5%, which represents the fair discount rate.

Hope this helps!