Determine how much you would be willing to pay for a bond that pays $60 annual interest indefinitely and never matures (i.e., a perpetuity), assuming you require an 8% rate of return on this investment.
0.08x = 60
x = 60 / 0.08
x = 750
To determine the price you would be willing to pay for the perpetuity bond, you need to calculate its present value. The present value is the current worth of the expected future cash flows, discounted at the required rate of return.
In this case, you have a perpetuity bond that pays $60 annual interest indefinitely and requires an 8% rate of return. So, the perpetuity bond is essentially an infinite series of $60 cash flows.
The formula to calculate the present value of a perpetuity bond is:
Present Value = Annual Cash Flow / Required Rate of Return
Substituting the given values:
Present Value = $60 / 0.08
Simplifying the expression:
Present Value = $750
Therefore, you would be willing to pay $750 for the perpetuity bond that pays $60 annual interest indefinitely, assuming your required rate of return is 8%.