Concept explainers
Perpetuities You have just read an advertisement stating, “Pay us $100 a year for 10 years and we will pay you $100 a year thereafter in perpetuity.” If this is a fair deal, what is the rate of interest?
To determine: The rate of interest.
Answer to Problem 27PS
The rate of interest is 7.18%.
Explanation of Solution
Determine the rate of interest
The PV of $100 a year for 10 year is calculated as,
The PV of $100 a year forever is calculated as,
Combine Equation (1) and (2),
By solving for r using trial and error method, we get r as 7.18%.
Therefore the rate of interest is 7.18%.
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