The fact that the fixed payments that you will receive have a constantly decreasing present value allows us to calculate perpetuity. The present value of a perpetuity is equal to the regular payment divided by the discount rate .
PV = D / R
Let us consider,
- PV is the present value of perpetuity – how much the perpetuity is worth,
- D is the dividend or regular payment – the amount of cash flow received every period,
- R is the discount rate – a percentage amount that represents the time value of money concept. It lowers the value of the future cash flows.
In this example, you will see how to calculate perpetuity step by step. You are offered a bond that pays a $20 dividend yearly and carries on indefinitely. Assuming a 5% discount rate.
PV = $20 / 5%
The answer is PV = $400.