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26 June, 17:06

You just won a national sweepstakes! For your prize, you opted to receive never-ending payments. The first payment will be $12,500 and will be paid one year from today. Every year thereafter, the payments will increase by 3.5 percent annually. What is the present value of your prize at a discount rate of 8 percent?

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  1. 26 June, 20:15
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    The present value of your prize at a discount rate of 8 percent is $277,777.78

    Explanation:

    In order to calculate the present value of your prize at a discount rate of 8 percent we would use the DDM to compute the present value today as follows:

    As per ddm model value today = Expected earning next year / (required rate - growth rate)

    expected cash flow after 1 year = $12,500

    Growth = 3.50%

    required rate = 8%

    Therefore, Value today = $12,500 / (8%-3.5%)

    Value today = $277,777.78

    The present value of your prize at a discount rate of 8 percent is $277,777.78
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