ilovejesus215
New member
The net present value of a perpetuity is calculated as
PV = C / (r-g)
where C is the cash flow in the first period, r is the market interest rate (or discount rate) and g is the growth rate of the cash flow. Importantly, the formula doesn't work if the growth rate is higher than the interest rate. What I don't understand is that if this formula (and the related one for growing annuities) is pretty fundamental and supposedly very useful, then why would it be limited to only when an investment grows below the discount rate?
Here's an example from Fundamentals of Corporate Finance. They use the formula to calculate the price of a stock. You can see how the value of the stock and value of its dividend both grow at 6% a year when the interest rate is 11%. But isn't the whole point of investing in the stock market to at least equal the market interest rate if not do better than it?
I must be misunderstanding something pretty fundamental here, but I don't know what it is.
PV = C / (r-g)
where C is the cash flow in the first period, r is the market interest rate (or discount rate) and g is the growth rate of the cash flow. Importantly, the formula doesn't work if the growth rate is higher than the interest rate. What I don't understand is that if this formula (and the related one for growing annuities) is pretty fundamental and supposedly very useful, then why would it be limited to only when an investment grows below the discount rate?
Here's an example from Fundamentals of Corporate Finance. They use the formula to calculate the price of a stock. You can see how the value of the stock and value of its dividend both grow at 6% a year when the interest rate is 11%. But isn't the whole point of investing in the stock market to at least equal the market interest rate if not do better than it?
I must be misunderstanding something pretty fundamental here, but I don't know what it is.