Principles of Finance

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Perpetuity

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Principles of Finance

Definition

A perpetuity is a financial instrument that provides infinite periodic payments with no end date. The value of a perpetuity is calculated by dividing the periodic payment by the discount rate.

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5 Must Know Facts For Your Next Test

  1. The formula for valuing a perpetuity is Payment / Discount Rate.
  2. Perpetuities are often used in models to estimate the value of stocks with constant dividends.
  3. A key characteristic of a perpetuity is that it has no maturity or end date.
  4. The concept of perpetuities can be applied in calculating the terminal value in Dividend Discount Models (DDMs).
  5. When the discount rate increases, the present value of a perpetuity decreases.

Review Questions

  • What is the formula for valuing a perpetuity?
  • How does an increase in the discount rate affect the present value of a perpetuity?
  • In what financial model might you use a perpetuity to estimate stock value?
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