Present Value with Ordinary Perpetuity
The word perpetuity is an annuity in which the cash flows continue forever.
The ordinary cash flows occur at the end of each period.
Time Line
Question
If the market interest rate is 11 percent, a consol with a yearly interest payment of $50. What is the current price of consol?
Solution
PV=C/r=$50/0.11=$455
So, price of consol is $455
Question
You plan to buy stock from Group Investment Company.
Suppose Group Investment Company has a policy of paying a $10 per share dividend every year. If this policy is to be continued indefinitely. What is the value of a share of stock if the required return is 12 percent?
Solution
PV=D/r which D: perpetuity dividend
PV=$10/0.12=$83
So the value of a share of stock is $83.