The Maybe Pay Life Insurance Co. is trying to sell you an investment policy that will pay you and your heirs $35,000 per year forever. If the required return on this investment is 4.7%, how much will you pay for the policy? How much would you pay today for the policy if payments grew at a rate of 3% annually to keep up with inflation?

 

Present value of the policy is computed using the equation given below:

Present value = Annual payment ÷ Required rate

                      = $35,000 ÷ 4.70%

                      = $744,680.85

Present value of the policy with inflation is computed using the equation given below:

Present value = Annual payment ÷ {Required rate - Growth rate}

                      = $35,000 ÷ {4.70% - 3.0%}

                      = $35,000 ÷ 1.70%

                      = $2,058,823.53