Suppose Auburn plans to pay Coach Malzahn a perpetuity if he wins a National Cha

Question

Suppose Auburn plans to pay Coach Malzahn a perpetuity if he wins a National Championship this season. The payment will be $37,000 each year for the rest of his life. Assume a 6% real interest rate. What is the present value of the perpetuity?

You are negotiating a deal to purchase a recreation center. You feel that the best way to value a firm is using yearly profits. The current owners want $1 million for the center. They let you take a look at their financial information, and you see that they see a pretty steady average of $50,000 per year. Assume a standard interest rate of 6%. Would you purchase the fitness center at the asking price?

Explanation / Answer

1) Pv of perpetuity = payment /real interest rate = 37000/0.06 = 616666.667

2)Pv of perpetuity = income/real interest rate = 50000/0.06 = 833333.333

No , asking price is more than the intrinsic value

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