Question

Sam, Mary, and David are expecting to receive cash flow stream of $20,000 for five years, starting in three years. If the relevant discount rate for the entire period is 10%. What is the PV of this cash flow stream? Does this stream represent an annuity due or an ordinary annuity? Initial response should be 250-300 words.

Answer 1

As mentioned in the question, Sam, Mary and David are expecting to receive the cash flow stream of $ 20,000 for five years and the payments are commencing in three years and will continue till year 7 since there are cash flows for 5 years.

The PV of this cash flow stream is computed as shown below:

= Future value / (1 + r)ⁿ

= $ 20,000 / 1.10³ + $ 20,000 / 1.10⁴ + $ 20,000 / 1.10⁵ + $ 20,000 / 1.10⁶ + $ 20,000 / 1.10⁷

= $ 62,657.63 Approximately

An ordinary annuity can be defined as an annuity where the payments are made at the end of the period. In contrast the annuity due can be defined as an annuity where the payments are made at the beginning of the period.

In the present case as can be seen the payments are being made at the end and the same has been started from year 3 and are continuing till year 7.

So, the type of annuity as presented in the question is an ordinary annuity.

Feel free to ask in case of any query relating to this question