A perpetuity pays $250 per year and interest rates are 8.5%. How much would its value change if interest decreased to 5.5%? Did the value increase or decrease?

Question

Quizplus · Accepted Answer

The present value of a perpetuity is calculated as:
PV = Payment / Interest rate

At 8.5% interest rate, the value of the perpetuity is:
PV1 = $250 / 0.085 = $2,941.18

At 5.5% interest rate, the value of the perpetuity is:
PV2 = $250 / 0.055 = $4,545.45

The change in value is:
Change in value = PV2 - PV1 = $4,545.45 - $2,941.18 = $1,604.27

Since the value increased, the correct answer is A) $1,604.27; increase.

A Perpetuity Pays $250 Per Year and Interest Rates Are