ACCA Applied Skills · Financial Management · Investment appraisal techniques
Kestrel Co will receive a constant cash inflow of $12,000 at the end of every year in perpetuity, starting one year from now. The cost of capital is 8%. What is the present value of this perpetuity?
The present value is $150,000. A level perpetuity beginning one year from now is valued by dividing the annual cash flow of $12,000 by the discount rate of 8%, which equals $150,000.
- A$96,000
- B$150,000Correct
- C$162,000
- D$12,960
Explanation
Present value of a perpetuity = cash flow / r = 12,000 / 0.08 = 150,000. Multiplying by the rate gives 960 per year, not a value; 12,000 x 8 = 96,000 is a wrong-operation error. 162,000 results from using 1.08 incorrectly (150,000 x 1.08).
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