Question

What is the present value of a perpetuity of $100 per year if the appropriate discount rate is 7%? If interest rates in general were to double and the appropriate discount rate rose to 14%, what would happen to the present value of the perpetuity? Ehrhardt, Michael C.. Corporate Finance: A Focused Approach (p. 187). Cengage Learning. Kindle Edition.

Answer 1

As the interest rate doubles, the present value is the half.

Step-by-step explanation:

Giving the following information:

Cf= $100

i= 0.07

i= 0.14

To calculate the present value of a perpetuity, we need to use the following formula:

PV= Cf/i

PV= present value

Cf= cash flow

i= interest rate

First perpetuity:

PV= 100/0.07

PV= $1,428.57

Second perpetuity:

PV= 100/0.14

PV= $714.286

As the interest rate doubles, the present value is the half.