Economics and The Time Value of Money - Ordinary annuity, Annuity Due and Net Present Value
Ordinary Annuity and Annuity Due
What are annuities?
Annuities are a series of fixed payments required from you, or paid to you, at a specified frequency over the course of a fixed period of time. The most common payment frequencies are yearly (once a year), semi-annually (twice a year), quarterly (four times a year) and monthly (once a month). There are two basic types of annuities: ordinary annuities and annuities due:
- Ordinary annuity
Payments are made at the end of each period.
- Annuity due
Payments are made at the beginning of each period. Regular investments made at the beginning of a compounding period grow into larger sums because they have more time to compound.
Net present value (NPV)
What is net present value?
NPV is the difference between the present value of cash inflows and the present value of cash outflows. NPV is used in capital budgeting to analyze the profitability of an investment or project.
NPV analysis is sensitive to the reliability of future cash inflows that an investment or project will yield.
NPV compares the value of a dollar today to the value of that same dollar in the future, taking inflation and returns into account. If the NPV of a prospective investment is positive, it should be accepted. However, if the NPV is negative, the investment should probably be rejected because cash flows will also be negative.