# Difference between revisions of "Perpetuity"

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− | 2. ''Fixed perpetuity'' | + | 2. ''Fixed perpetuity.'' |

A fixed perpetuity is a periodic cash flow starting one period in the future, then carrying on for ever thereafter. | A fixed perpetuity is a periodic cash flow starting one period in the future, then carrying on for ever thereafter. | ||

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− | 3. ''Growing perpetuity'' | + | 3. ''Growing perpetuity.'' |

A growing perpetuity is an infinite series of cash flows, modelled to grow by a constant proportionate amount every period. | A growing perpetuity is an infinite series of cash flows, modelled to grow by a constant proportionate amount every period. | ||

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− | 4. ''Declining perpetuity'' | + | 4. ''Declining perpetuity.'' |

Growth can be negative, in other words, decline. | Growth can be negative, in other words, decline. | ||

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== See also == | == See also == | ||

* [[Annuity]] | * [[Annuity]] | ||

+ | * [[Consol]] | ||

* [[Discounted cash flow]] | * [[Discounted cash flow]] | ||

* [[Dividend growth model]] | * [[Dividend growth model]] |

## Latest revision as of 13:25, 12 June 2021

1. *Valuation.*

A series of cash flows modelled to carry on for an infinite amount of time in the future.

2. *Fixed perpetuity.*

A fixed perpetuity is a periodic cash flow starting one period in the future, then carrying on for ever thereafter.

Each cash flow is an equal fixed amount.

The present value of a fixed perpetuity is calculated - assuming a constant periodic cost of capital (r) for all periods from now to infinity - as:

Present Value = A_{1} x 1/r

where:

A_{1} = Time 1 cash flow

r = periodic cost of capital

**Example 1: Fixed perpetuity valuation**

Time 1 cash flow = $10m, continuing at the same amount each period thereafter in perpetuity.

Periodic cost of capital = 5%

The present value of the fixed perpetuity is:

= $10m x (1 / 0.05)

= $10m x 20

= $**200**m

3. *Growing perpetuity.*

A growing perpetuity is an infinite series of cash flows, modelled to grow by a constant proportionate amount every period.

For a growing perpetuity, the present value formula is modified to take account of the constant periodic growth rate, as follows:

Present Value = A_{1} x 1 / (r - g)

where g = the periodic rate of growth of the cash flow.

**Example 2: Growing perpetuity valuation**

Time 1 cash flow = $10m, growing by a constant percentage amount each period thereafter in perpetuity.

Periodic cost of capital = 5%.

Periodic growth rate = 2%

The present value of the growing perpetuity is:

= A_{1} x 1 / (r - g)

= $10m x (1 / (0.05 - 0.02) )

= $10m x (1 / 0.03)

= $10m x 33.3

= $**333**m

The modest rate of growth in the cash flow has added substantially to the total present value.

4. *Declining perpetuity.*

Growth can be negative, in other words, decline.

For a declining perpetuity, the present value formula is the same as the growing perpetuity, but the growth rate (g) is entered as a negative number as follows:

**Example 3: Declining perpetuity valuation**

Time 1 cash flow = $10m, declining by a constant percentage amount each period thereafter in perpetuity.

Periodic cost of capital = 5%.

Periodic growth rate = -(2)% negative = -0.02

The present value of the declining perpetuity is:

= A_{1} x 1 / (r - g)

= $10m x (1 / (0.05 - -0.02) )

= $10m x (1 / 0.07)

= $10m x 14.3

= $**143**m

The small negative rate of growth in the cash flow has reduced the total present value very substantially.

The growing / declining perpetuity concept is applied in many contexts.

For example, the Dividend growth model for share valuation.

## See also

- Annuity
- Consol
- Discounted cash flow
- Dividend growth model
- Growing annuity
- Growing perpetuity
- Growing perpetuity factor
- Irredeemable
- Perpetuity due
- Perpetuity factor
- Simple annuity

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