You have two contracts available to you: ONE is a perpetuity with cash flows of $500 per year,with the first cash flow beginning today.TWO is a perpetuity with cash flows of $500 per year,with the first cash flow beginning one year from today.Which has a greater present value if the required rate of return is 5%?
A)Contract ONE is preferred because it has a present value that is $500 greater than contract TWO.
B)Contract TWO is preferred because it has a present value that is $500 greater than contract ONE.
C)Contract ONE is preferred because it has a present value that is $476.19 greater than contract TWO.
D)Because these are perpetuities with equal required rates of return,they have equal value.

Question

Quizplus · Accepted Answer

Contract ONE is preferred because it starts paying immediately, effectively adding an extra payment at the present, which increases its present value by $500 compared to Contract TWO, which starts paying a year later.

You Have Two Contracts Available to You: ONE Is a Perpetuity