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Exercise 7.1 · Q3

Q.If the cash equivalent of a perpetuity of ₹300 payable at the end of each quarter is ₹24,000. Find the rate of interest compounded quarterly?

Puducherry CbseNCERTSubjective· 3mImportance★★★★★
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✓ Free question

A perpetuity's present value equals the periodic payment divided by the periodic interest rate. Here, ₹24,000 = ₹300 / rr, so r=0.0125r = 0.0125 per quarter, which is 5% per annum compounded quarterly.

The core idea here is the present value of a perpetuity. A perpetuity is a stream of equal cash flows that continues forever. When you see "cash equivalent" or "present value" of a perpetual payment, you are looking at the amount you would need to invest today, at a given interest rate, to generate those payments indefinitely without ever touching the principal.

Think of it this way: if you deposit ₹24,000 in a bank account that pays interest at a rate rr per quarter, and you withdraw only the interest each quarter (₹300), the principal stays untouched forever. The interest earned in one quarter on ₹24,000 must exactly equal ₹300. That is the logic behind the formula.

Present Value of a Perpetuity (payments at end of each period):

PV=PMTrPV = \frac{PMT}{r}

where PMTPMT is the payment per period and rr is the interest rate per period (in decimal).

Let us apply this step by step.

  1. Identify the given values.

    The cash equivalent (present value) is PV=₹24,000PV = ₹24,000.

    The payment at the end of each quarter is PMT=₹300PMT = ₹300.

    The interest rate we need is the rate per quarter, because payments are quarterly. Let this quarterly rate be rr (in decimal form).

  2. Set up the perpetuity equation.

    Since payments occur at the end of each quarter and continue forever, the present value is:

24,000=300r24,000 = \frac{300}{r}

  1. Solve for the quarterly rate rr. Multiply both sides by rr:

24,000×r=30024,000 \times r = 300

r=30024,000=3240=180=0.0125r = \frac{300}{24,000} = \frac{3}{240} = \frac{1}{80} = 0.0125

So the interest rate per quarter is 0.01250.0125, or 1.25%1.25\% per quarter.

  1. Convert to the annual rate compounded quarterly. The problem asks for "the rate of interest compounded quarterly". This means the nominal annual rate, which is simply the quarterly rate multiplied by the number of quarters in a year (4):

Annual nominal rate=0.0125×4=0.05=5%\text{Annual nominal rate} = 0.0125 \times 4 = 0.05 = 5\%

Watch out

A common mistake is to treat the ₹300 as an annual payment and use an annual rate directly. But the payment is quarterly, so the rate must be found per quarter first. If you blindly used PV=PMTrPV = \frac{PMT}{r} with PMT=1200PMT = 1200 (annual total) and PV=24000PV = 24000, you would get r=0.05r = 0.05 per year — which is the same number here, but only because the compounding frequency matches the payment frequency. In general, always match the period of the rate to the period of the payment.

Tip

Notice that the quarterly rate r=0.0125r = 0.0125 is exactly 1.25%1.25\%. A quick check: 1.25%1.25\% of ₹24,000 is ₹300. That confirms the logic — the interest earned each quarter exactly funds the payment.

✓Final answer

The rate of interest compounded quarterly is 5% per annum.

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