The present value of a perpetuity that pays an annual cash flow of Rs. X per period is:

PV = X/r

As an example, suppose that perpetuity pays Rs.100 per year; assume that the appropriate rate of interest is 5% per year. The present value of the perpetuity is Rs.100/0.05 = Rs.2,000.

This is a constant perpetuity. Let us also look at how the value of a growing perpetuity is calculated in this case.

Suppose that the cash flows provided by perpetuity grow at a fixed rate each year. The present value formula is adjusted as follows:

PV = C/(r – g)

where:

g = annual growth rate of the perpetuity

For simplicity, let us suppose that perpetuity currently pays Rs.50 per year; assume that the appropriate rate of interest is 7% per year, and that the cash flow paid by the perpetuity is estimated to grow at a rate of 3% per year. The present value of the perpetuity is: Rs.50/(0.07 – 0.03) = Rs.1,250.

The terms “Term Structure of Interest Rates” and “Yield Curves” intimidates most MBA students. We believe the concepts of term structure of interest rates and yield curves intimidates MBA students is because almost all MBA students encounter it in their finance courses but do not go deep into understanding what the term structure or yield curve are, how interest rates, yield curves and term structure are related, what drives interest rates, how the term structure or yield curves is built and interpreted and most importantly how the insights gained from the term structure is used. We believe that understanding the term structure of interest rates and yield curves is very useful to all MBA students and that they can understand how the term structure of interest rates and yield curves are built and interpreted and how the insights gained from the term structure, yield curves and interest rates are used if they spend a little time on it. To help, we have below a good overview of the term structure, interest rates and yield curves.

Niraj Mehtaanswered.The present value of a perpetuity that pays an annual cash flow of Rs. X per period is:

PV = X/r

As an example, suppose that perpetuity pays Rs.100 per year; assume that the appropriate rate of interest is 5% per year. The present value of the perpetuity is Rs.100/0.05 = Rs.2,000.

## This is a constant perpetuity. Let us also look at how the value of a growing perpetuity is calculated in this case.

Suppose that the cash flows provided by perpetuity grow at a fixed rate each year. The present value formula is adjusted as follows:

PV = C/(r – g)

where:

g = annual growth rate of the perpetuity

For simplicity, let us suppose that perpetuity currently pays Rs.50 per year; assume that the appropriate rate of interest is 7% per year, and that the cash flow paid by the perpetuity is estimated to grow at a rate of 3% per year. The present value of the perpetuity is: Rs.50/(0.07 – 0.03) = Rs.1,250.