The Perpetual Life Insurance Co. is trying to sell you an investment policy that

Question

The Perpetual Life Insurance Co. is trying to sell you an investment policy that will pay you and your heirs $18,500 per year forever.

If the required return on this investment is 5.9 percent, how much will you pay for the policy? (Round your answer to 2 decimal places. (e.g., 32.16))

Suppose the Perpetual Life Insurance Co. told you the policy costs $460,000. At what interest rate would this be a fair deal? (Round your answer to 2 decimal places. (e.g., 32.16))

The Perpetual Life Insurance Co. is trying to sell you an investment policy that will pay you and your heirs $18,500 per year forever.

Explanation / Answer

Answer: This cash flow is a perpetuity. To find the PV of a perpetuity, we use the equation:

PV =C/r

Present value = $18,500 / 0.059= $313,559.32

Answer: Here we need to find the interest rate that equates the perpetuity cash flows with the PV of the cash flows.Using the PV of a perpetuity equation:

PV =C/r

$460,000 = $18,500 /r

We can now solve for the interest rate as follows:

r= $18,500 / $460,000 = 0.0402, or 4.02%

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