Chapter 11, Problem 1PS

Summary Introduction

To determine:

The reason behind infinite maturity of the perpetuity which can last as short as ten or twenty years.

Introduction:

Perpetuity refers to the annuity which comprises of stream of identical flow of cash. Such a stream persists for an infinite period of time. Perpetuity is usually takes into consideration for detemining the present value of the cash flow of the company that is discounted at a specific rate.

Answer to Problem 1PS

The present value approaches zero for the flow of cash in the distant future, so that the impact on the weighted average can be reduced or nullified.

Explanation of Solution

Duration stands to be the weighted average of the cash flow associated with the maturity which is being paid to the perpetuity holder wherein weight pertaining to each flow of cash stands equivalent to the cash flow's present value divided by the Total present value of all cash flows. The weight becomes very small for the cash flow in the distant future, so that there is virtually, eventually no or very little impact on the weighted average due to these distant cash flows.