CFA Level I · CFA Level I Exam · The Time Value of Money in Finance
A preferred share is expected to pay a fixed annual dividend of 50 forever, with the first payment one year from today. If the appropriate discount rate is 8% per year, the present value of the dividend stream is closest to:
The present value is about 625. A perpetuity with the first payment one year away is worth the payment divided by the discount rate, so 50 divided by 0.08 equals 625. Multiplying the payment by the rate or discounting one payment gives wrong values.
- A4.00
- B46.30
- C625.00Correct
Explanation
The value of an ordinary perpetuity is payment divided by the discount rate: 50 / 0.08 = 625. The figure 4.00 comes from multiplying 50 by 0.08, and 46.30 comes from discounting only one payment (50 / 1.08).
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