What is Annuity kind of cash flow? Its a question from the book Financial Management.
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An annuity is a special kind of cash flow, a special pattern of cash flow. In an annuity, the person who is the beneficiary gets a certain...
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An annuity is a stream of equal annual cash flows. Annuities involve calculations based upon the regular periodic contribution or receipt of a fixed sum of money.
An example: Say Mr Banda deposits Kw 2,000 at the end of every year for 45 years in his saving account, paying 5% interest compounded annually. Determine the sum of money, he will have at the end of the 5th year.
End of Yr: Amount deposited: Nr:of yrs. compounded:
1 2,000 4
2 2,000 3
3 2,000 2
4 2,000 1
5 2,000 0
Compounded interest factor: Future Sum:
Amount at the end of the 5th year Kw 11,054
Finding the common factor of Kw 2,000
=Kw 2,000 (1.216+1.158+1.103+1.050+1.000)
=Kw 2,000 (5.527)
The above depicts that in order to find the sum of annuity, the annual amount must be multiplied by the sum of the appropriate compound interest factors. Such calculations are available for a wide range of 1 and n. To find the answer to the annuity question of illustration above, we are required to look for the 5% column and the row for five years and multiply the factor by annuity amount of Kw 2000. From the illustration we find that the sum of annuity Re. 1 deposited at the end of each year for 5 years is 5.527(IF). Thus, when multiplied by Kw 2,000 annuity (A) we find the total sum as Kw 11,054,
IF= Represents the appropriate factor for the sum of the annuity of Re.1
Sn= Represents the compound sum of annuity.
Annuity tables are great innovations in the field of investment banking as they guide the depositors and investors as to what sum amount (X) paid for the number of years,n, will accumulate to, at a stated rate of compound interest.