Question

What is the difference between ordinary annuities, annuities due, perpetuities and uneven cash flows?

Course：Business Finance

Use your own word to answer

Answer 1

Annuities are cash flows where equal payment are made on periodic basis for a finite basis. For example, when you buy a car and pay equal monthly installments for n number of months, it is an annuity. Now these annuities can be classified into 2 types - ordinary annuity and annuity due.

In an ordinary annuity, the payment is made at the end of the period. For example, assume your salary to be a constant amount, which is paid to you at the end of month. So assuming your salary does not change for 5 years, and you are paid at the end of the month, your salary will then be example of ordinary annuity. For an annuity due, the payment is made at the beginning of the period. This could be exemplified by annual college fees (assuming it to be constant over the course period). Assume you have to pay annual equal fees for 4 years of your college, which you generally pay at the beginning of the course and start of every year thereafter next. This is an annuity due.

Perpetuity is a type of annuity with INFINITE equal payment stream. This implies perpetuity makes constant cash flow payments for an infinite period of time. This can be exemplified by pension income, which is made till the pensioner is alive, which is not finite and can be any number of months/years.

Uneven cash flows are simply cash flow payments that are not constant but are periodic. For an annuity/perpetuity, there were 2 features of those streams - periodicity and equity of payments. But, in case of uneven cash flows, equity of payment is not there. This can be exemplified by dividend income from a share. Say you receive some dividend at the end of each quarter, which couyld be different. So, even though periodicity is there, cash flows are not equal.