Question

A local bank will pay you $275 at the end of each year for your lifetime if you deposit $4,400 in the bank today. If you plan to live forever, what interest rate is the bank paying? (Enter your answers as a percent rounded to 2 decimal places.)

Answer 1

Answer:

Interest rate = 6..3%

Explanation:

An investment that pays a fixed amount for life is called a perpetuity. The worth of a perpetuity today is the present value of the future cash flow. Using the present value of the perpetuity formula, we can work out the interest rate as follows:

PV = A ×   1/r

Where PV = present value, r- Interest rate , A- annual cash flow

4,400 = 275×    1/r

cross multiply

4,400 ×  r= 275

divided both sides by 4,400

r = 275/4400

r= 0.0625  × 100

r= 6.25%

r= 6.3%

Interest rate = 6..3%