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

Question

Quizplus · Accepted Answer

The present value of a perpetuity can be calculated using the formula: PV = C/r, where C is the annual payment and r is the interest rate.
At 5.5% interest rate, the PV of the perpetuity is: PV1 = 250/0.055 = $4,545.45.
At 8.5% interest rate, the PV of the perpetuity is: PV2 = 250/0.085 = $2,941.18.
The change in value is: PV2 - PV1 = $2,941.18 - $4,545.45 = -$1,604.27.
The value decreased due to the increase in interest rates. Therefore, the best choice is B.

A Perpetuity Pays $250 Per Year and Interest Rates Are