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Present value of annuity cash flow

Forums › Ask ACCA Tutor Forums › Ask the Tutor ACCA FM Exams › Present value of annuity cash flow

  • This topic has 1 reply, 2 voices, and was last updated 7 years ago by John Moffat.
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  • September 3, 2017 at 6:27 am #405087
    evelynlzy
    Member
    • Topics: 11
    • Replies: 5
    • ☆

    Hi sir, can you explain to me why present value formula works this way? I don’t get it why there’s two way to do it.

    Scenario 1: Present value of an annuity year 1 to year 5 at start of each year.
    Formula: PV = annuity cash flow x (1+annuity factor for Y4)

    Scenario 2: Present value of an annuity from Y2 to Y5
    Formula: PV = annuity cash flow x (annuity factor Y5 – Y1 annuity factor)

    Thank you and have a nice day!

    September 3, 2017 at 11:50 am #405145
    John Moffat
    Keymaster
    • Topics: 57
    • Replies: 54699
    • ☆☆☆☆☆

    The five year annuity factor give the total factor for time 1 to 5.

    In scenario 1, since the amounts are at the start of each year, they are from 0 to 4.
    (time 0 is the start of the first year, time 1 is the start of the second year, and so on).

    The PV of an amount at time 0 is the same figure. The PV for flows from 1 to 4 is found by multiplying by the 4 year annuity factor.

    In scenario 2, the 5 year annuity factor gives the total for time 1 to 5. Since we only want the total for times 2 to 5, we subtract the discount factor for time 1.

    I do suggest that you watch the free Paper F2 lectures on discounting, because this is all revision from Paper F2.

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