Present Value Of An Annuity

AAA

DEFINITION of 'Present Value Of An Annuity'

The current value of a set of cash flows in the future, given a specified rate of return or discount rate. The future cash flows of the annuity are discounted at the discount rate, and the higher the discount rate, the lower the present value of the annuity.

 

Present Value Of An Annuity

C = Cash flow per period
i = Interest rate
n = Number of payments

This calculates the present value of an ordinary annuity. To calculate the present value of an annuity due, multiply the result by (1+i). (The payments start at time zero instead of one period into the future.)

VIDEO

Loading the player...

BREAKING DOWN 'Present Value Of An Annuity'

The essence of this concept is that receiving money now is worth more than receiving the same amount in the future. By the same logic, receiving $5,000 today is worth more than getting $1,000 per year for five years. This is because if you got the lump sum today, you could invest it and receive an additional return.

Using this example, and assuming a discount rate of 6%, the present value of an annuity that pays $1,000 per year for five years is $4,212 (1,000*[1-(1+0.06)-5/0.06]= 4,212). This means that if you could get a return on your invested funds of 6% per year, receiving $4,212 today would have the same value to you as receiving $1,000 per year for five years.

RELATED TERMS
  1. Annuity

    A financial product that pays out a fixed stream of payments ...
  2. Discount Rate

    The interest rate charged to commercial banks and other depository ...
  3. Time Value of Money - TVM

    The idea that money available at the present time is worth more ...
  4. Present Value - PV

    The current worth of a future sum of money or stream of cash ...
  5. Future Value - FV

    The value of an asset or cash at a specified date in the future ...
  6. Annuity Due

    An annuity whose payment is to be made immediately, rather than ...
Related Articles
  1. Fundamental Analysis

    Calculating the Present Value of an Annuity

    The present value of an annuity is the current, lump sum value of periodic future payments as calculated using a specific rate.
  2. Home & Auto

    Watch Your Back In The Annuity Game

    Find out how to get the upper hand when dealing with this payout challenge.
  3. Investing Basics

    Calculating The Present And Future Value Of Annuities

    At some point in your life, you may have had to make a series of fixed payments over a period of time - such as rent or car payments - or have received a series of payments over a period of time, ...
  4. Investing Basics

    Understanding The Time Value Of Money

    Find out why time really is money by learning to calculate present and future value.
  5. Bonds & Fixed Income

    Explaining Types Of Fixed Annuities

    Learn about this popular retirement tool, its pros and cons and how annuities work to create a guaranteed regular stream of retirement income.
  6. Options & Futures

    Getting the Whole Story on Variable Annuities

    Variable annuities are another way to save money tax-deferred - but don't jump in blindly!
  7. Options & Futures

    Taking The Bite Out Of Annuity Losses

    If this investment product has caused you sleepless nights, it's time to consider alternatives.
  8. Retirement

    Retirement Planning for Entrepreneurs and Small Businesses

    If your business has receiveables, here's a smart way to leverage them to build up your retirement fund fast.
  9. Retirement

    Best Ways to Save For Retirement Without an IRA or 401(k)

    Learn the most common types of savings vehicles used to accumulate money for retirement outside employer-sponsored 401(k)s or IRA accounts.
  10. Professionals

    How to Buy Annuities When Interest Rates Are Low

    The current low interest rate environment complicates the decision to buy an annuity. Here's what financial advisors need to consider for their clients.
RELATED FAQS
  1. What are the best ways to sell an annuity?

    The best ways to sell an annuity are to locate buyers from insurance agents or companies that specialize in connecting buyers ... Read Full Answer >>
  2. How are non-qualified variable annuities taxed?

    Non-qualified variable annuities are tax-deferred investment vehicles with a unique tax structure. After-tax money is deposited ... Read Full Answer >>
  3. Can a variable annuity be rolled into an IRA?

    You can roll qualified variable annuities, such as other qualified retirement plan accounts, into a traditional IRA. Non-qualified ... Read Full Answer >>
  4. Are variable annuities subject to required minimum distribution (RMD)?

    Variable annuities are insurance contracts that provide tax-deferred growth of assets that can later generate a guaranteed ... Read Full Answer >>
  5. For what types of financial instruments would I want to calculate the present value ...

    Because the present value of an annuity formula relies on a consistent interest rate and identical payments for a set period ... Read Full Answer >>
  6. What exact information is included in the interest rate when calculating the present ...

    When calculating the present value of an annuity, the interest rate percentage is the rate at which future payments are discounted ... Read Full Answer >>

You May Also Like

Hot Definitions
  1. Financial Crisis

    A situation in which the value of financial institutions or assets drops rapidly. A financial crisis is often associated ...
  2. Election Period

    The period of time during which an investor who owns an extendable or retractable bond must indicate to the issuer whether ...
  3. Shanghai Stock Exchange

    The largest stock exchange in mainland China, the Shanghai Stock Exchange is a nonprofit organization run by the China Securities ...
  4. Dead Cat Bounce

    A temporary recovery from a prolonged decline or bear market, followed by the continuation of the downtrend. A dead cat bounce ...
  5. Bear Market

    A market condition in which the prices of securities are falling, and widespread pessimism causes the negative sentiment ...
  6. Alligator Spread

    An unprofitable spread that occurs as a result of large commissions charged on the transaction, regardless of favorable market ...
Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!