GROWING PERPETUITY

Summary

A growing perpetuity is a financial investment that pays out cash flows forever, with each payment being larger than the previous one by a fixed percentage growth rate. Unlike a regular perpetuity where payments stay the same, a growing perpetuity accounts for factors like inflation or business growth. The formula for its present value is PV = C₁/(r-g), where C₁ is the first cash flow, r is the discount rate, and g is the growth rate. This concept is crucial for valuing stocks with dividends that grow consistently over time.

Usage Context

This term is essential when learning about stock valuation, particularly the dividend discount model, and when calculating terminal values in discounted cash flow analysis. It's also important for understanding how to value assets that generate growing income streams.

Common Confusions

• Confusing the formula with regular perpetuity (forgetting the growth component)
• Using a growth rate that equals or exceeds the discount rate (makes the formula undefined)
• Mixing up which cash flow to use (C₁ vs C₀)
• Forgetting that the growth rate must be less than the discount rate
• Assuming all investments can be modeled as growing perpetuities