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An investment promises to pay you $100 per year starting in 5 years
An investment promises to pay you $100 per year starting in 5 years. 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 12 percent per year, determine the maximum you would be willing to pay for the investment
Expert Solution
Computation of Maximum Payment for the Investment (PV):
PV = (C/(r-g))*(1+r)^-k
Here,
C = Cash Flow = $100
r = Rate of Return = 12%
g = Growth Rate = 2%
k = 4
PV = ($100/(12%-2%))*(1+12%)^-4
= ($100/10%)*0.635518
= $1000*0.635518
PV = $635.518 or $635.52
So, Maximum Payment for the Investment is $635.52
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