Annuity

Definition

An annuity is a series of equal payments made at regular intervals. It can be used to calculate the present and future value of cash flows in financial decision-making.

5 Must Know Facts For Your Next Test

1. The present value of an annuity can be calculated using the formula PV = Pmt × [(1 - (1 + r)^-n) / r], where Pmt is the payment amount, r is the interest rate per period, and n is the number of periods.
2. The future value of an annuity can be calculated using the formula FV = Pmt × [((1 + r)^n - 1) / r].
3. Annuities can be classified into ordinary annuities (payments at the end of each period) and annuities due (payments at the beginning of each period).
4. In capital budgeting, annuities are used to evaluate projects with recurring cash flows, making it easier to compare different investment opportunities.
5. Understanding annuities is crucial for calculating loan repayments, retirement planning, and any financial scenario involving regular payments.

Review Questions

• What are the key differences between an ordinary annuity and an annuity due?
• How do you calculate the present value of an annuity?
• Why are annuities important in capital budgeting decisions?

Related terms

Present Value:

The current worth of a sum that will be received or paid in the future, discounted at a specific interest rate.

Future Value:

The value of a current asset at a specified date in the future based on an assumed rate of growth over time.

Time Value of Money:

A financial principle stating that money available now is worth more than the same amount in the future due to its earning potential.