Growing perpetuity

Definition

A growing perpetuity is a series of cash flows that continue indefinitely with each payment growing at a constant rate. The payments occur at regular intervals and increase by a fixed percentage every period.

5 Must Know Facts For Your Next Test

1. The formula to calculate the present value of a growing perpetuity is PV = C / (r - g), where C is the initial cash flow, r is the discount rate, and g is the growth rate.
2. A growing perpetuity assumes that the growth rate (g) is less than the discount rate (r); otherwise, the value would be infinite.
3. Growing perpetuities are used to value assets that generate increasing streams of income over time, such as certain types of stocks or real estate investments.
4. The concept relies on the time value of money principle, which states that money available now is worth more than the same amount in the future due to its potential earning capacity.
5. Understanding growing perpetuities helps in making long-term financial decisions and valuations.

Review Questions

• What is the primary difference between a perpetuity and a growing perpetuity?
• How do you calculate the present value of a growing perpetuity?
• Why must the growth rate be less than the discount rate in a growing perpetuity?

Related terms

Perpetuity: A series of equal payments made at regular intervals indefinitely without any growth.

Discount Rate: The interest rate used to discount future cash flows to their present value.

Time Value of Money: A financial concept stating that money available now is worth more than an identical sum in the future due to its potential earning capacity.