Video 4 (Topic 2.2.2): Perpetuities 6/17/2018 9:43 AM Video 4 (Topic 2.2.2): Perpetuities FIN 614: Financial Management Larry Schrenk, Instructor © 2007 Microsoft Corporation. All rights reserved. Microsoft, Windows, Windows Vista and other product names are or may be registered trademarks and/or trademarks in the U.S. and/or other countries. The information herein is for informational purposes only and represents the current view of Microsoft Corporation as of the date of this presentation. Because Microsoft must respond to changing market conditions, it should not be interpreted to be a commitment on the part of Microsoft, and Microsoft cannot guarantee the accuracy of any information provided after the date of this presentation. MICROSOFT MAKES NO WARRANTIES, EXPRESS, IMPLIED OR STATUTORY, AS TO THE INFORMATION IN THIS PRESENTATION.

Topics What are Perpetuities? Valuing Perpetuities Constant Perpetuities Growing Perpetuities

What are Perpetuities? Cash Flows that are: Examples: Infinite Constant (or Growing at a Constant Rate) At Regular Intervals Examples: I promise to pay you $100 per year forever. I promise to pay you $10 per week forever.

Valuing Constant Perpetuities Formula Notes: No Financial Calculator Function No Future Value C and r are per Period

Constant Perpetuity Example What is the present value of $1,000 per year forever? (r = 10%)

Growing Perpetuities Example: I promise to pay you $100 per year growing at 3% forever. I am promising you the following cash flow: 100 100(1.03) 100(1.03)2 100(1.03)3… or 100 103.00 106.09 109.27…

Valuing Growing Perpetuities Formula Notes: Same as Constant Perpetuity Growth can be Positive or Negative C1 is Next Period’s Cash Flow ‘g’ will never be greater then ‘r’

Growing Perpetuity Example 1 What is the present value of receiving forever $1,000 per year growing at 3% per year? (r = 10%)

Growing Perpetuity Example 2 What is the present value of receiving forever $1,000 per year declining at 3% per year? (r = 10%) It might be better to call them ‘changing’ perpetuities, since the growth rate can be negative.

Cash Flow and Rate Problems A perpetuity is valued at $5,000 and the interest rate is 7%. What is its cash flow? Solve the formula for ‘C’ A perpetuity valued at $5,000 has a cash flow of $400. Find the discount rate. Solve the formula for ‘r’

Using Perpetuities Perpetuity Assets Perpetuity as a Cash Flow Pattern British ‘consol’ Real Estate Perpetuity as a Cash Flow Pattern Stocks Long Term Value of Projects

Video 4 (Topic 2.2.2): Perpetuities 6/17/2018 9:43 AM Video 4 (Topic 2.2.2): Perpetuities FIN 614: Financial Management Larry Schrenk, Instructor © 2007 Microsoft Corporation. All rights reserved. Microsoft, Windows, Windows Vista and other product names are or may be registered trademarks and/or trademarks in the U.S. and/or other countries. The information herein is for informational purposes only and represents the current view of Microsoft Corporation as of the date of this presentation. Because Microsoft must respond to changing market conditions, it should not be interpreted to be a commitment on the part of Microsoft, and Microsoft cannot guarantee the accuracy of any information provided after the date of this presentation. MICROSOFT MAKES NO WARRANTIES, EXPRESS, IMPLIED OR STATUTORY, AS TO THE INFORMATION IN THIS PRESENTATION.