This article describes a concept which could impact a variety of companies, countries or industries. To see what companies and articles reference this concept page, click here.

TOP CONTRIBUTORS

Thomas Shyr

A Perpetuity is a steady stream of cash payments that continues forever. It is basically an annuity that has no end. Perpetuities as an financial security are not very common, although they do exist in practice such as the British government bonds "consols". In theory, some investment securities such as real estate and equities are effectively perpetuities, since they have no definite end to their ability to generate an income stream.

Valuing a Perpetuity

While it might seem like a cash stream that continues infinitely into the future should have an infinite value, this is not the case. Since perpetuities payments remain constant over time, the present value of payments very far into the future becomes negligible. The present value of payments very far in the future are discounted greatly due to inflation and the time value of money. To value a perpetuity, simply divide the annual payments by the interest return.

Present Value = Annual Payment / Interest Return

This method is also used to create a reference valuation of a stock. Using annualized quarterly dividends and a required rate of return that is in some way proportional to the investment risk.

CAPM models of required returns and/or WACC models using market Beta terms are often used to estimate the Interest Rate.

Use of this model does help explain why there are sudden price drops in the case of a stock's unexpected quarterly earnings report.