Calculating Present and Future Value of Annuities

Calculating Present and Future Value of Annuities
First, distinguish between an ordinary annuity and an annuity due
 Two Types of Annuities

 Future Value of Ordinary Annuity
 Present Value of Ordinary Annuity
 Future Value of Annuity Due
 Present Value of Annuity Due
 The Bottom Line
Most of us have had the experience of making a series of fixed payments over a period of time—
such as rent or car payments—or receiving a series of payments for a period of time, such as
interest from a bond or certificate of deposit (CD). These recurring or ongoing payments are
technically referred to as "annuities" (not to be confused with the financial product called an
annuity, though the two are related).
There are several ways to measure the cost of making such payments or what they're ultimately
worth. Here's what you need to know about calculating the present value (PV) or future value
(FV) of an annuity.
KEY TAKEAWAYS
 Recurring payments, such as the rent on an apartment or interest on a bond, are

sometimes referred to as "annuities."
 In ordinary annuities, payments are made at the end of each period. With annuities due,
they're made at the beginning of the period.
 The future value of an annuity is the total value of payments at a specific point in time.
 The present value is how much money would be required now to produce those future
payments.
Two Types of Annuities
Annuities, in this sense of the word, break down into two basic types: ordinary annuities and
annuities due.
 Ordinary annuities: An ordinary annuity makes (or requires) payments at the end of
each period. For example, bonds generally pay interest at the end of every six months.
 Annuities due: With an annuity due, by contrast, payments come at the beginning of
each period. Rent, which landlords typically require at the beginning of each month, is a
common example.
You can calculate the present or future value for an ordinary annuity or an annuity due using the
following formulas.
Calculating the Future Value of an Ordinary Annuity

Future value (FV) is a measure of how much a series of regular payments will be worth at some
point in the future, given a specified interest rate. So, for example, if you plan to invest a certain
amount each month or year, it will tell you how much you'll have accumulated as of a future
date. If you are making regular payments on a loan, the future value is useful in determining the
total cost of the loan.
Consider, for example, a series of five $1,000 payments made at regular intervals.
Image by Julie Bang © Investopedia 2019

Because of the time value of money—the concept that any given sum is worth more now than it
will be in the future because it can be invested in the meantime—the first $1,000 payment is
worth more than the second, and so on. So, let's assume that you invest $1,000 every year for the
next five years, at 5% interest. Below is how much you would have at the end of the five-year
period.

Rather than calculating each payment individually and then adding them all up, however, you
can use the following formula, which will tell you how much money you'd have in the end:
\begin{aligned} &\text{FV}_{\text{Ordinary~Annuity}} = \text{C} \times \left [\frac { (1 + i) ^

n - 1 }{ i } \right] \\ &\textbf{where:} \\ &\text{C} = \text{cash flow per period} \\ &i =
\text{interest rate} \\ &n = \text{number of payments} \\ \end{aligned}FVOrdinary Annuity
=C×[i(1+i)n−1]where:C=cash flow per periodi=interest raten=number of payments
Using the example above, here's how it would work:
\begin{aligned} \text{FV}_{\text{Ordinary~Annuity}} &= \$1,000 \times \left [\frac { (1 +

0.05) ^ 5 -1 }{ 0.05 } \right ] \\ &= \$1,000 \times 5.53 \\ &= \$5,525.63 \\
\end{aligned}FVOrdinary Annuity=$1,000×[0.05(1+0.05)5−1]=$1,000×5.53=$5,525.63
Note that the one-cent difference in these results, $5,525.64 vs. $5,525.63, is due to rounding in
the first calculation.
Calculating the Present Value of an Ordinary Annuity

In contrast to the future value calculation, a present value (PV) calculation tells you how much
money would be required now to produce a series of payments in the future, again assuming a set
interest rate.
Using the same example of five $1,000 payments made over a period of five years, here is how a
present value calculation would look. It shows that $4,329.58, invested at 5% interest, would be
sufficient to produce those five $1,000 payments.
would be sufficient to produce those five $1,000 payments.
This is the applicable formula:
\begin{aligned} &\text{PV}_{\text{Ordinary~Annuity}} = \text{C} \times \left [ \frac { 1 - (1 +

i) ^ { -n }}{ i } \right ] \\ \end{aligned}PVOrdinary Annuity=C×[i1−(1+i)−n]
If we plug the same numbers as above into the equation, here is the result:
\begin{aligned} \text{PV}_{\text{Ordinary~Annuity}} &= \$1,000 \times \left [ \frac {1 - (1 +

0.05) ^ { -5 } }{ 0.05 } \right ] \\ &=\$1,000 \times 4.33 \\ &=\$4,329.48 \\
\end{aligned}PVOrdinary Annuity=$1,000×[0.051−(1+0.05)−5]=$1,000×4.33=$4,329.48
Calculating the Future Value of an Annuity Due

An annuity due, you may recall, differs from an ordinary annuity in that the annuity due's
payments are made at the beginning, rather than the end, of each period.
To account for payments occurring at the beginning of each period, it requires a slight
modification to the formula used to calculate the future value of an ordinary annuity and results
in higher values, as shown below.
The reason the values are higher is that payments made at the beginning of the period have more
time to earn interest. For example, if the $1,000 was invested on January 1 rather than January 31
it would have an additional month to grow.
The formula for the future value of an annuity due is as follows:
\begin{aligned} \text{FV}_{\text{Annuity Due}} &= \text{C} \times \left [ \frac{ (1 + i) ^ n -

1}{ i } \right ] \times (1 + i) \\ \end{aligned}FVAnnuity Due=C×[i(1+i)n−1]×(1+i)
Here, we use the same numbers, as in our previous examples:

\begin{aligned} \text{FV}_{\text{Annuity Due}} &= \$1,000 \times \left [ \frac{ (1 + 0.05)^5 -
1}{ 0.05 } \right ] \times (1 + 0.05) \\ &= \$1,000 \times 5.53 \times 1.05 \\ &= \$5,801.91 \\
\end{aligned}FVAnnuity Due
=$1,000×[0.05(1+0.05)5−1]×(1+0.05)=$1,000×5.53×1.05=$5,801.91
Again, please note that the one-cent difference in these results, $5,801.92 vs. $5,801.91, is due to
rounding in the first calculation.
Calculating the Present Value of an Annuity Due

Similarly, the formula for calculating the present value of an annuity due takes into account the
fact that payments are made at the beginning rather than the end of each period.
For example, you could use this formula to calculate the present value of your future rent
payments as specified in your lease. Let's say you pay $1,000 a month in rent. Below, we can see
what the next five months would cost you, in terms of present value, assuming you kept your
money in an account earning 5% interest.
This is the formula for calculating the present value of an annuity due:
\begin{aligned} \text{PV}_{\text{Annuity Due}} = \text{C} \times \left [ \frac{1 - (1 + i) ^ {

-n } }{ i } \right ] \times (1 + i) \\ \end{aligned}PVAnnuity Due=C×[i1−(1+i)−n]×(1+i)
So, in this example:
\begin{aligned} \text{PV}_{\text{Annuity Due}} &= \$1,000 \times \left [ \tfrac{ (1 - (1 + 0.05)

^{ -5 } }{ 0.05 } \right] \times (1 + 0.05) \\ &= \$1,000 \times 4.33 \times1.05 \\ &= \$4,545.95 \\
\end{aligned}PVAnnuity Due
=$1,000×[0.05(1−(1+0.05)−5]×(1+0.05)=$1,000×4.33×1.05=$4,545.95
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Calculating Present and Future Value of Annuities

First, distinguish between an ordinary annuity and an annuity due

 Two Types of Annuities

 Recurring payments, such as the rent on an apartment or interest on a bond, are

Calculating the Future Value of an Ordinary Annuity

Image by Julie Bang © Investopedia 2019

Image by Julie Bang © Investopedia 2019

\begin{aligned} &\text{FV}_{\text{Ordinary~Annuity}} = \text{C} \times \left [\frac { (1 + i) ^

Using the example above, here's how it would work:

\begin{aligned} \text{FV}_{\text{Ordinary~Annuity}} &= \$1,000 \times \left [\frac { (1 +

Calculating the Present Value of an Ordinary Annuity

Image by Julie Bang © Investopedia 2019

This is the applicable formula:

\begin{aligned} &\text{PV}_{\text{Ordinary~Annuity}} = \text{C} \times \left [ \frac { 1 - (1 +

\begin{aligned} \text{PV}_{\text{Ordinary~Annuity}} &= \$1,000 \times \left [ \frac {1 - (1 +

Calculating the Future Value of an Annuity Due

Image by Julie Bang © Investopedia 2019

Image by Julie Bang © Investopedia 2019

The formula for the future value of an annuity due is as follows:

\begin{aligned} \text{FV}_{\text{Annuity Due}} &= \text{C} \times \left [ \frac{ (1 + i) ^ n -

Here, we use the same numbers, as in our previous examples:

Calculating the Present Value of an Annuity Due

Image by Julie Bang © Investopedia 2019

\begin{aligned} \text{PV}_{\text{Annuity Due}} = \text{C} \times \left [ \frac{1 - (1 + i) ^ {

So, in this example:

\begin{aligned} \text{PV}_{\text{Annuity Due}} &= \$1,000 \times \left [ \tfrac{ (1 - (1 + 0.05)

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