Derek Owns a Perpetuity Contract That Promises to Pay Him

question 62

Essay

Derek owns a perpetuity contract that promises to pay him $1,000 per year in end-of the-year cash flows with the first cash flow beginning one year from today.Derek perceives some risk with the promised cash flows and has discounted them at an annual rate of 10.00% to determine the present value of the contract.Derek has offered to sell a portion of the contract to his brother Cam.The agreement is that Derek will keep the first 25 cash flows and that Cam will keep the remaining cash flows beginning with the first cash flow 26 years from today.What is the present value of the original contract? What is the present value of the first 25 cash flows? What is the present value of the cash flows received in year 26 and beyond? If Derek makes the deal as described and charges Cam $1,000 for the year 26 and beyond cash flows,which brother is getting a better deal? Please provide dollar values for each of these questions.

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Definitions:

Agents

Individuals or entities authorized to act on behalf of another (the principal) in dealings with third parties.

Respondeat Superior

A legal doctrine holding employers or principals liable for the wrongful acts of their employees or agents, committed within the scope of their employment or authority.

Tort Liability

Legal responsibility arising from a civil wrong that causes harm or loss to another party, not based on contractual obligations.

Unauthorized Acts

Actions taken by an individual or entity that have not been approved or sanctioned by the necessary authority or party.