Page 223 - BA2 Integrated Workbook - Student 2017

Long-term decision making

4.2 Annuities

In the special case where a project has equal annual cash flow, the discounted cash
flow can be calculated in a quicker way.

When a project has equal annual cash flows for a number of years the annuity factor
may be used to discount the cash flows.

The present value of an annuity can therefore be quickly found using the formula:

PV = Annual cash flow × annuity factor (AF)

The annuity factor can be looked up on the annuity (cumulative present value) table
or found using an annuity formula:

-n
1− (1 + r)
Annuity factor = ————————
r

4.3 Perpetuities

While an annuity is a constant annual cash flow for a set number of years, a
perpetuity is a constant annual cash flow which continues indefinitely. It is often
described as a cash flow continuing ‘for the foreseeable future’.

PV = Annual cash flow × Perpetuity factor

The perpetuity factor can be calculated as:

1
Perpetuity factor = ——
r

Go over illustration 5 and try TYU 11 for annuities

Go over illustration 6 and try TYU 12 for perpetuities

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