Your Neighbor Owns a Perpetuity of $100 Per Year That

question 90

Multiple Choice

Your neighbor owns a perpetuity of $100 per year that has a discount rate of 6% per year.He offers to sell to you all but the next 20 cash flows (the first to be received one year from today) for $500.In other words,he keeps the first 20 cash flows of his perpetuity and you get all of the rest.Is this a good price for you if the appropriate discount rate is 6%?

• A)No,because the entire perpetuity is worth only $1,666.67 and your neighbor is taking the best cash flows worth more than $1,200 in present value terms
• B)Yes,because the present value of the remaining cash flows is $519.68 and you are buying them for only $500.
• C)No,because the cash flows you receive are only worth $482.16 and that is less than the $500 your neighbor is asking for the cash flows.
• D)This question cannot be answered.

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Definitions:

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A conflict fought in 1898 between Spain and the United States, resulting from U.S. intervention in the Cuban War of Independence, leading to U.S. acquiring territories in the western Pacific and Latin America.