The interest rate will be 10% for one more year, but a year from now, it will fall to 5% and stay at 5% forever.What is the market value of an investment that is sure to pay $220 a year forever, starting two years from today?
A)$4,000
B)$4,400
C)$2,000
D)$2,200
E)$5,000

Question

Quizplus · Accepted Answer

The present value of the investment is the sum of the present values of the two cash flows: the $220 payment in two years and the perpetuity of $220 payments starting in three years. The present value of the first payment is $220/(1.1)^2 = $176.47. The present value of the perpetuity is $220/0.05 = $4,400. The total present value is $176.47 + $4,400 = $4,576.47.

The Interest Rate Will Be 10% for One More Year