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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.