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Unformatted text preview: increasing the required return have on the present value
of a future amount? Why?
How are present value and future value calculations related? Annuities
How much will you have at the end of 5 years if your employer withholds and
invests $1,000 of your year-end bonus at the end of each of the next 5 years, guaranteeing you a 9 percent annual rate of return? How much would you pay today,
given that you can earn 7 percent on low-risk investments, to receive a guaranteed
$3,000 at the end of each of the next 20 years? To answer these questions, you
need to understand the application of the time value of money to annuities.
An annuity is a stream of equal periodic cash flows, over a specified time
period. These cash flows are usually annual but can occur at other intervals, such
as monthly (rent, car payments). The cash flows in an annuity can be inflows (the
$3,000 received at the end of each of the next 20 years) or outflows (the $1,000
invested at the end of each of the next 5 years). Types of Annuities
There are two basic types of annuities. For an...
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