Question

A financial instrument just paid the investor $462 last year. The cash flow is expected to last forever and increase at a rate of 1.2 percent annually. If you use a 6.4 percent discount rate for investments like this, what should be the price you are willing to pay for this financial instrument?

Answer 1

We can use the perpetuity formula to calculate the price of the financial instrument:

Price = Cash flow / Discount rate - Growth rate

Where:

Cash flow = $462

Discount rate = 6.4%

Growth rate = 1.2%

Plugging in the values, we get:

Price = $462 / (0.064 - 0.012)

Price = $462 / 0.052

Price = $8,884.62

Therefore, the price you should be willing to pay for this financial instrument is $8,884.62.