Question

John receives a perpetuity paying 2 at the end of year 4, 4 at the end of year 6, 6 at the end of year 8, etc. The present value of this perpetuity at an annual effective rate of 10% equals X. Calculate X

Answer 1

45.35

Explanation:

From the above question, we are told that the annual effective rate = 10% = 0.10

Note also that payment is been made every 2 years

Hence , we apply the formula of effective interest rate for a period of 2 years.

Effective Interest rate(j) = (1 + r)² - 1

= (1 + 0.10)² - 1

= 1.10² - 1

= 1.21

= 0.21

Present value of perpetuality = t/[j × j/(1 + r)²]

Where t = time in years = 2

r = 0.10

= 2/ [0.21 × 0.21/(1 + 0.10)²

= 54.87528

Present value at time t = 0

= 54.87528(1 + r)^-2

= 54.87528(1 + 0.10) ^-2

= 54.87528(1.10)^-2

= 45.35

Therefore, the present value at time (t) is 0 = 45.35