Unformatted text preview: ordinary annuity, the cash flow
occurs at the end of each period. For an annuity due, the cash flow occurs at the
beginning of each period.
Fran Abrams is choosing which of two annuities to receive. Both are 5-year,
$1,000 annuities; annuity A is an ordinary annuity, and annuity B is an annuity
due. To better understand the difference between these annuities, she has listed
their cash flows in Table 4.1. Note that the amount of each annuity totals
$5,000. The two annuities differ in the timing of their cash flows: The cash flows
are received sooner with the annuity due than with the ordinary annuity.
Although the cash flows of both annuities in Table 4.1 total $5,000, the
annuity due would have a higher future value than the ordinary annuity, because
each of its five annual cash flows can earn interest for one year more than each
of the ordinary annuity’s cash flows. Similarly, the present value of the annuity
due would be greater than that of the ordinary annuity, because each annuity due
cash flow is discounted back one less year than for the ordinary annuity. In general, both the future value and the present value of an a...
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