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Question to be solved from CFA Level 1 mock – Perpetuity

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    • Avatar of cool_khanarohancool_khanarohan
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        • Undecided
        29 Jan 2018 at 3:19 am
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        Kindly help me in answering the following question:

        Reena, a
        successful inventor has decided to set up a scholarship fund for deserving at
        her Alma matter. Her plan is for fund to the capable of awarding $25000
        annually in perpetuity the first scholarship is to be awarded and paid out
        exactly four years from today. The fund will be deposited into an account
        immediately and will grow at a rate of 4%, compounded semiannually for the
        foreseeable future. How much money must the inventor donate today to fund the scholarship?

        a.      
        $545,789

        b.     
        $549,487.

        c.      
        $543,254 

      • Avatar of krishTakrishTa
        Participant
          • CFA Level 1
          29 Jan 2018 at 4:09 am
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          This can be solved in 2 steps.
          Time line 1 -> What is the amount that Reena need to deposit to award $25,000 annually @ 4% semi annually, starting from next year
          Step 1 -> calculate Effective Annual rate which is ((1 + r/m)^m) -1. Hence EAR = ((1+0.04/2)^2) -1 = 4.04%
          Step 2 -> PV of a perpetuity where annual return is $25,000 and rate of return is 4.04% is A/r = 25,000/0.0404 = 618,811.88
          Time line 2 -> What is the amount that Reena needs to deposit now so that the deposit is 618,811.88 by the end of 3 years @4% semi annually
          This is simple TVM problem where FV = 61,8811.88, r = 4.04, N = 3. I got the answer $549,487.24
          Option b.

          Hope I am correct
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