Question

You are considering buying a perpetuity contract from your insurance company that will pay you $500 annually where the payment will grow by 3% each year. Using a discount rate of 9%, the most you should be willing to pay for this contract is closest to:

Answer 1

Maximum Amount Payable = $8333.33

Step-by-step explanation:

Perpetual Annuity Payment = $500

Growth Rate = 3%

Discount Rate = 9%

Maximum Amount Payable = Present Value of Perpetual Annuity

Present Value of Perpetual Annuity = Perpetual Annuity Payment / (Discount rate - Growth rate)

Maximum Amount Payable = $500 / (0.09 - 0.03)

Maximum Amount Payable = $500 / 0.06

Maximum Amount Payable = $8333.33