Perpetuities and Annuities EC 1745 - Harvard （永续年金和年金EC 1745 -哈佛）.pdf

Perpetuities and Annuities EC 1745 Borja Larrain Today: 1. Perpetuities. 2. Annuities. 3. More examples. Readings: Chapter 3 Welch (Did you read Chapters 1 and 2? Don’t wait.) Assignment 1 due next week (09/29). Questions/Goal of this class: • NPV and excel are a pain: Do we always have to compute these long summations for projects with many periods? • Some people seem to have a calculator in their heads: How do they compute the NPV of a project so fast? Examples: If a firm produces $5 million/year forever, and the interest rate is a constant 5% forever, what is the value of the firm? (A: $100 million) • In this class we’ll see some shortcuts that can make these calculations very easy. • These formulas also illustrate the importance of as- sumptions about interest rates for evaluating projects and assets. Yes, 1% can be the difference between being a millionaire and bankruptcy. 1 Perpetuities A perpetuity is a financial instrument that pays C dollars per period, forever. If the interest rate is constant and the first payment from the perpetuity arrives in period 1, then the Present Value of the perpetuity is: ∞ X C C C C PV = = + + ...= t=1 (1 + r)t (1 + r) (1 + r)2 r IMPORTANT: the first cash flow is tomorrow (t = 1), not today (t= 0). • If a firm produces $5 million/year forever, beginning next year, and the interest rate is a constant 5% forever, what is the value of the firm? ∞ X 5 5 =