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An investment promises to pay you $270 per year starting immediately
An investment promises to pay you $270 per year starting immediately. The cash flow from the investment is expected to increase by 2 percent per year forever. If alternative investments of similar risk earn a return of 9 percent per year. Determine the maximum you would be willing to pay for the investment. a. $4,204.29 b. $5407.56 c. $2304.45 d. $1454.67
Expert Solution
Computation of Maximum Amount you would be willing to pay for the Investment:
Present Value of Growing Perpetuity = Cash Flow*(1+Growth rate)/(Required Rate of Return - Growth Rate)
= $270*(1+2%)/(9%-2%)
= $275.40/7%
Present Value of Growing Perpetuity = $3,934.29
Maximum Amount = $3,934.29+$270 = $4,204.29
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