Perpetuity is an annuity of limitless period.

For instance, the British government has issued bonds called CONSOLS which pay annual interest without end. Present Value of Perpetuity: The present value of perpetuity may be expressed as follows: P = A x PVIFA

Where P is the present value of perpetuity and A is the continuous annual payment. The value of PVIFAr
1 / (1+r) ^t = 1/r t=1

The formula for PVIFAr, is derived as follows:

PVIFAr, = 1(1+r) ^-1 + 1(1+r) ^-2 +...+ 1(1+r) ^- (A)

Multiplying both the sides of (A) by (1+r) provides: PVIFAr, (1+r) =1 + 1(1+r) ^-1 +...+ 1(1+r) ^-+1 (B) Subtracting (A) from (B) yields:

The formula for PVIFAr, is derived as follows: PVIFAr, x r = 1-1(1+r) ^- (C) In view of the fact that the 2nd term on the right hand side of (C) vanishes, we get: PVIFAr, x r = 1 The outcome will be: PVIFAr =1/r (D) (E)

Put in phrase, it implies that the present value interest factor of perpetuity is simply 1 divided by the interest rate articulated in decimal form. Therefore the present value of perpetuity is just equal to the continuous yearly payment divided by the interest rate. For instance, the present value of perpetuity of $5,000 if the interest rate is 10% is equivalent to $5,000/0.10 = $50,000. Instinctively this is somewhat persuasive as an original sum of $50,000 would, if invested at a rate of interest of 10%, present continuous yearly takings of $5,000 everlastingly devoid any mutilation of the capital value.

Growing Perpetuity explained with Illustration

An office complex is anticipated to fetch a net rental of $1.50 million the subsequent year, which is anticipated to augment by 5% every year. If we assume that the increase will continue indefinitely, the rental stream is a growing perpetuity. If the discount rate is 5 percent, the present value of the rental stream is:

Intra Year Compounding and Discounting : We are going to discuss when compounding is done more often. Illustration : $500 is deposited in a finance company that offers 12% interest semi-annually. Calculate principal at the end.

Solution : First 6 months:

Principal at the start $500 Interest for 6 months $30 $500 x 0.12/2 Principal at the end $530

Second 6 months: Principal at the start $530 Interest for 6 months $31.80 $530 x 0.12/2 Principal at the end $561.80

Students should note that if compounding is done annually, the principal at the end of one year would be $500 x (1.12) = $560. The difference is 1.8 (between 561.80 under semiannual compounding and $560 under annual compounding) denotes interest on interest for the second half year.

The universal formula for the future value of a single cash flow after n years when compounding is done m times a year is as below:

FVn = PV x (1 + (r / m)) ^ m x n

TUTORSONNET