What Is the Present Value of an Annuity Formula and What Are Annuities?

If you know the concept of Perpetuities the concept of annuities is very easy. It is very similar to Perpetuities only that the payments are not forever. Instead of forever these payments are only for a fixed period of time .Annuity Formula

Let's say I gave him a piece of paper or a certificate, and I promised to pay $ 10 a year for exactly 12 years , and then I stop paying immediately after . It is still a "perpetual " ? There is regular payments of the same amount , as a perpetuity , but not always , has a limited period of time . So , in this case , is not called in perpetuity, but an "income" .Annuity Formula

So now, as in the case of a permanent , an important question now is ... How much are you willing to pay for that piece of paper ? How much are you willing to pay for this "income" ?

To do this, you must use the present value of an annuity formula . For general managers, you do not need to know the ' actual step by step process to calculate this , as it can easily be done by accountants or online calculators and free smartphone apps . However, if you need to learn the process itself , you can see a lot of videos online tutoring many different free websites and YouTube.Annuity Formula

Application of real-life Annuity Formula

Let's say you are offered to invest their severance pay ( or the payment of retirement or lump sum equivalent ) of $ 10,000 with a company pension and investment company , and that the promise to pay $ 30 600/year years. A normal person might think it's a good deal for $ 600/year x 30 years = $ 18,000 , which will be much more than the original $ 10,000 investment .Annuity Formula

However, using the present value of an annuity formula , we find that the " fair value " of the annuity is actually only $ 9.223 if interest rates are at 5% ... and are therefore " overpaying " if you pay more than $ 9,223 . In other words, if you pay more than $ 9223 , then it was as good or better still put money in the bank instead of the bank and earn interest (or other investment " risk-free " ) . A $ 9.223 , the rate of return on investment / pension will be exactly equal to the rate of return to put your money in the bank. If you pay more than $ 9.223 for your investment , then the rate of return on investment will be less than the return of the bank .
Annuity Formula