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Ordinary Annuities and Annuities Due

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Many business transactions involve a temporary stream of payments. Loans, for instance, are often paid over the course of many years at a set interest rate.

This stream of equal payments is often called an annuity.

There are two types of annuities:

  • Ordinary annuities are paid at the end of each period.
  • Annuities due are paid at the beginning of each period.

A simple trick to remember the difference is that the earlier in the name you see the word annuity, the sooner in a period each payment is required.

Inputting the type of annuity, the number of periods, and the interest rate into a complicated formula yields the present value factor. Multiplying this factor by the size of a single payment provides the present value of the stream of payments.

Question Harvey Co., the power-hungry scissor manufacturer, bought an annuity that pays $3,379.00 at the end of each year, for the next 5 years. The prevailing interest rate is 10%.
  • The present value factor for an ordinary annuity at 10% for 5 years is 3.79079.
  • The present value factor for an annuity due at 10% for 5 years is 4.16987.
What is the present value of the annuity?
Answer