Growing Annuities Stuart Gabriel, a second-year MBA student, has just been offered a job at $80,000 a year. He anticipates his salary increasing by 9 percent a year until his retirement in 40 years. Given an interest rate of 20 percent, what is the present value of his lifetime salary?
We simplify by assuming he will be paid his $80,000 salary exactly one year from now, and that his salary will continue to be paid in annual installments. The appropriate discount rate is 20 percent.
From Equation 4.17, the calculation is:
Present value of Stuart’s lifetime salary = $80,000 × [ .20 − .09 ]= $711,730.71
Though the growing annuity formula is quite useful, it is more tedious than the other simplifying formulas. Whereas most sophisticated calculators have special programs for perpetuity, growing perpetuity, and annuity, there is no special program for a growing annuity. Hence, we must calculate all the terms in Equation 4.17 directly.
1 − (_1.09 )40 __1.2_0