2C Q2 Part 1 Calculating Perpetuity Values [LO1] The Maybe Pay Life Insurance Co

Question

2C Q2

Part 1

Calculating Perpetuity Values [LO1] The Maybe Pay Life Insurance Co. is trying to sell you an investment policy that will pay you and your heirs $40,000 per year forever. If the required return on this investment is 5.1 percent, how much will you pay for the policy?

Part 2

Calculating Perpetuity Values [LO1] In the previous problem, suppose a sales associate told you the policy costs $650,000. At what interest rate would this be a fair deal?

Part 3

Growing Annuity [LO1] You have just won the lottery and will receive $1,500,000 in one year. You will receive payments for 30 years, and the payments will increase by 2.5 percent per year. If the appropriate discount rate is 7 percent, what is the present value of your winnings?

Please specify answers between Parts 1, 2, & 3

Explanation / Answer

Part 1)

Maximum price:

= $40,000/5.1%

= $784,314

Part 2)

Minimum income per year for fair deal:

= $650,000×5.1%

= $33,150

Part 3)

Present value of winnings [P÷(r-g)]×[1-[(1+g)÷(1+r)]^n] Here, 1 Interest rate per annum 7.00% 2 Number of years                                                                                                      30 3 Number of compoundings per per annum                                                                                                        1 4 = 1÷3 Interest rate per period ( r) 7.00% 5 = 2×3 Number of periods (n) 30 Growth rate (g) 2.50% First payment (P) $                                                                                   1,500,000 Present value of growing annuity $                                                                                 24,148,286 (1,500,000/(7%-2.50%))*(1-((1+2.50%)/(1+7%))^30)

Related Questions

Navigate

• Browse (All)
• Browse 2
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.