1 1 1 1
1
1
1
2
2
15
Present Value of an Annuity (cont.)
Using the example, and assuming a discount rate of
10% per year, we find that the present value is:
( ) ( ) ( ) ( ) ( )
PV
A
= + + + + =
100
110
100
110
100
110
100
110
100
110
379 08
1 2 3 4 5
. . . . .
.
0 1 2 3 4 5
100 100 100 100 100
62.09
68.30
75.13
82.64
90.91
379.08
16
Present Value of an Annuity (cont.)
Actually, there is no need to take the present
value of each cash flow separately
We can use a closed-form of the PV
A
equation
instead:
( )
( )
PV
Pmt
i
Pmt
i
i
A
t
t
t
N
N
=
+
=
+
(
(
( =
1
1
1
1
1
17
Present Value of an Annuity (cont.)
We can use this equation to find the present
value of our example annuity as follows:
( )
PV Pmt
A
=
(
(
(
=
1
1
110
010
379 08
5
.
.
.
This equation works for all regular annuities,
regardless of the number of payments
18
The Future Value of an Annuity
We can also use the principle of value additivity to
find the future value of an annuity, by simply
summing the future values of each of the
components:
( ) ( ) ( )
FV Pmt i Pmt i Pmt i Pmt
A t
N t
t
N
N N
N
= + = + + + + +
1 1 1
1
1
1
2
2
19
The Future Value of an Annuity (cont.)
Using the example, and assuming a discount rate of
10% per year, we find that the future value is:
( ) ( ) ( ) ( )
FV
A
= + + + + = 100 110 100 110 100 110 100 110 100 61051
4 3 2 1
. . . . .
100 100 100 100 100
0 1 2 3 4 5
146.41
133.10
121.00
110.00
}
= 610.51
at year 5
20
The Future Value of an Annuity (cont.)
Just as we did for the PV
A
equation, we could
instead use a closed-form of the FV
A
equation:
( )
( )
FV Pmt i Pmt
i
i
A t
N t
t
N
N
= + =
+
(
(
1
1 1
1
This equation works for all regular annuities,
regardless of the number of payments
21
The Future Value of an Annuity (cont.)
We can use this equation to find the future
value of the example annuity:
( )
FV
A
=
(
(
= 100
110 1
010
61051
5
.
.
.
22
Annuities Due
Thus far, the annuities that we have looked at begin
their payments at the end of period 1; these are
referred to as regular annuities
A annuity due is the same as a regular annuity,
except that its cash flows occur at the beginning of
the period rather than at the end
0 1 2 3 4 5
100 100 100 100 100
100 100 100 100 100 5-period Annuity Due
5-period Regular Annuity
23
Present Value of an Annuity Due
We can find the present value of an annuity due in
the same way as we did for a regular annuity, with
one exception
Note from the timeline that, if we ignore the first cash
flow, the annuity due looks just like a four-period
regular annuity
Therefore, we can value an annuity due with:
( )
( )
PV Pmt
i
i
Pmt
AD
N
=
+
(
(
(
(
+
1
1
1
1
24
Present Value of an Annuity Due (cont.)
Therefore, the present value of our example
annuity due is:
( )
( )
PV
AD
=
(
(
(
(
+ =
100
1
1
110
010
100 416 98
5 1
.
.
.
Note that this is higher than the PV of the,
otherwise equivalent, regular annuity
25
Future Value of an Annuity Due
To calculate the FV of an annuity due, we can
treat it as regular annuity, and then take it
one more period forward:
( )
( )
FV Pmt
i
i
i
AD
N
=
+
(
(
+
1 1
1
0 1 2 3 4 5
Pmt Pmt Pmt Pmt Pmt
26
Future Value of an Annuity Due (cont.)
The future value of our example annuity is:
( )
( )
FV
AD
=
(
(
= 100
110 1
010
110 67156
5
.
.
. .
Note that this is higher than the future value
of the, otherwise equivalent, regular annuity
27
Uneven Cash Flows
Very often an investment offers a stream of
cash flows which are not either a lump sum
or an annuity
We can find the present or future value of
such a stream by using the principle of value
additivity
28
Uneven Cash Flows: An Example (1)
Assume that an investment offers the following cash
flows. If your required return is 7%, what is the
maximum price that you would pay for this
investment?
0 1 2 3 4 5
100 200 300
( ) ( ) ( )
PV = + + =
100
107
200
107
300
107
51304
1 2 3
. . .
.
29
Uneven Cash Flows: An Example (2)
Suppose that you were to deposit the following
amounts in an account paying 5% per year. What
would the balance of the account be at the end of the
third year?
0 1 2 3 4 5
300 500 700
( ) ( )
FV= + + = 300 105 500 105 700 155575
2 1
. . , .