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Homework answers / question archive / 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

Finance

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

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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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