Financial Management: Core Concepts, Third Edition

4.3 Present Value of an Annuity

Just as we found the present value of a lump sum in Chapter 3, we can also find the present value of an annuity stream. In fact, in finance we use the present value concept in a number of applications. When we determine the monthly payment on a mortgage or car payment, we are using a present value view, not a future value view. Here we are trying to determine the present value of a future cash flow that has annuity stream characteristics, equal amounts at regular intervals for a finite period.

Take the case of receiving four equal payments of $250 over the next four years (at the end of each year) with a discount rate of 8%. Using the separate lump-sum approach, the present value is

$$\begin{array}{lll}PV\hfill & =\hfill & F{V}_{\text{1}}\hfill \end{array}$$