Stuart Weddle's father is 55 years old and wants to set up a cash flow stream that would be forever. He would like to receive $15,000 every year, beginning at the end of this year. If he could invest in an account earning 9 percent, how much would he have to invest today to receive his perpetual cash flow?

a. $135,200

b. $166,667

c. $200,000

d. $222,222

The correct option is B,$ 166,666.67 approximately $166,667

Explanation:

Present value of perpetual cash flow=yearly payment/rate of interest

yearly payment is $15,000

rate of interest is 9%

Present value of perpetual cash flow=$15,000/9%

=$ 166,666.67

In order to receive $15,000 per year perpetually, Stuart Weddle would have to invest $ 166,666.67 today at the rate of return of 9%

Option D, would be correct if the annual payment is $20,000 ($20000/9%=$ 222,222.22)

B

Explanation:

Perpetuity formula for present for present value to be invested today

Pv = C / R

where c is the amount of continuous cash payment and R is the interest rate

PV = $ 15000 / 0.09 = $ 166666.67 approx $ 166667