Assuming, that discount rate is 7% per annum, how much would you pay toreceive Rs.50, growing at 5%, annually, forever.(a) 2500(b) 3000(c) 3500(d) 4000
Question
Assuming, that discount rate is 7% per annum, how much would you pay toreceive Rs.50, growing at 5%, annually, forever.(a) 2500(b) 3000(c) 3500(d) 4000
Solution
This is a question of calculating the present value of a growing perpetuity. The formula for the present value of a growing perpetuity is:
PV = D / (r - g)
where:
- PV is the present value
- D is the dividend or cash flow
- r is the discount rate
- g is the growth rate
In this case, D = Rs.50, r = 7% or 0.07, and g = 5% or 0.05.
Substituting these values into the formula, we get:
PV = 50 / (0.07 - 0.05) = 50 / 0.02 = 2500
So, you would pay Rs.2500 to receive Rs.50, growing at 5%, annually, forever. Therefore, the answer is (a) 2500.
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