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Corporate Finance: Effect Of Time In The Future Value Of Annuity (Other (Not Listed) Sample)


explain the effect of time in the future value of annuity, effect of increasing interest rate on the present value of annuity, my opinion on the use of apr versus ear

Corporate Finance
An annuity is a financial product which creates a contractual relationship between an individual or an organization and a financial institution. Annuity payments may either be made in advance, thus Annuity Due or at the end of a payment period, which is referred to as Ordinary Annuity.
Present value (PV) refers to the current amount of the future cash flow sets, given a specific rate of return. Increasing the length of the period involved in an annuity arrangement rises the PV of an annuity, provided that the rate of return is constant. This change is informed by the increase in the invested amount which automatically gives a higher present value. On the same note, it increases the future value (FV) using a similar concept. Making a higher number of annuities gives a higher FV at a constant discount rate (Yogo 22).
The rate of interest, otherwise known as the discount rate or the rate of return also has a significant effect on the PV and the FV. According to Yogo (25), we use the interest rate to compute future cash flows. Thus, it implies that a higher rate of interest means that we discount the future value using the same rate. Hence, the increasing the rate lowers the PV of the annuity.
The main difference effective annual rate (EAR) and annual percentage rate (APR) is that EAR applies the concept of compound interest while APR uses a simple interest model. For example, a lending institution that offers a monthly interest rate of 1% automatically translat...
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