Formula for the present value of an annuity due

What is the Formula for the Present Value of an Annuity Due?

The present value of an annuity due is used to derive the current value of a series of cash payments that are expected to be made on predetermined future dates and in predetermined amounts. The calculation is usually made to decide if you should take a lump sum payment now, or to instead receive a series of cash payments in the future (as may be offered if you win a lottery).

The present value calculation is made with a discount rate, which roughly equates to the current rate of return on an investment. The higher the discount rate, the lower the present value of an annuity will be. Conversely, a low discount rate equates to a higher present value for an annuity.

The formula for calculating the present value of an annuity due (where payments occur at the beginning of a period) is:

P = (PMT [(1 - (1 / (1 + r)n)) / r]) x (1+r)

Where:

P = The present value of the annuity stream to be paid in the future
PMT = The amount of each annuity payment
r = The interest rate
n = The number of periods over which payments are made

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This is the same formula as for the present value of an ordinary annuity (where payments occur at the end of a period), except that the far right side of the formula adds an extra payment; this accounts for the fact that each payment essentially occurs one period sooner than under the ordinary annuity model.

The factor used for the present value of an annuity due can be derived from a standard table of present value factors that lays out the applicable factors in a matrix by time period and interest rate. For a greater level of precision, you can use the preceding formula within an electronic spreadsheet.

Example of the Present Value of an Annuity Due

ABC International is paying a third party $100,000 at the beginning of each year for the next eight years in exchange for the rights to a key patent.  What would it cost ABC if it were to pay the entire amount immediately, assuming an interest rate of 5%? The calculation is:

P = ($100,000 [(1 - (1 / (1 + .05)8)) / .05]) x (1+.05)

P = $678,637

Rate Table for the Present Value of an Annuity Due of 1

n 1% 2% 3% 4% 5% 6% 8% 10% 12%
1 1.0000 1.0000 1.0000 1.0000 1.0000 1.0000 1.0000 1.0000 1.0000
2 1.9901 1.9804 1.9709 1.9615 1.9524 1.9434 1.9259 1.9091 1.8929
3 2.9704 2.9416 2.9135 2.8861 2.8594 2.8334 2.7833 2.7355 2.6901
4 3.9410 3.8839 3.8286 3.7751 3.7232 3.6730 3.5771 3.4869 3.4018
5 4.9020 4.8077 4.7171 4.6299 4.5460 4.4651 4.3121 4.1699 4.0373
6 5.8534 5.7135 5.5797 5.4518 5.3295 5.2124 4.9927 4.7908 4.6048
7 6.7955 6.6014 6.4172 6.2421 6.0757 5.9173 5.6229 5.3553 5.1114
8 7.7282 7.4720 7.2303 7.0021 6.7864 6.5824 6.2064 5.8684 5.5638
9 8.6517 8.3255 8.0197 7.7327 7.4632 7.2098 6.7466 6.3349 5.9676
10 9.5660 9.1622 8.7861 8.4353 8.1078 7.8017 7.2469 6.7590 6.3282
11 10.4713 9.9826 9.5302 9.1109 8.7217 8.3601 7.7101 7.1446 6.6502
12 11.3676 10.7868 10.2526 9.7605 9.3064 8.8869 8.1390 7.4951 6.9377
13 12.2551 11.5753 10.9540 10.3851 9.8633 9.3838 8.5361 7.8137 7.1944
14 13.1337 12.3484 11.6350 10.9856 10.3936 9.8527 8.9038 8.1034 7.4235
15 14.0037 13.1062 12.2961 11.5631 10.8986 10.2950 9.2442 8.3667 7.6282
16 14.8651 13.8493 12.9379 12.1184 11.3797 10.7122 9.5595 8.6061 7.8109
17 15.7179 14.5777 13.5611 12.6523 11.8378 11.1059 9.8514 8.8237 7.9740
18 16.5623 15.2919 14.1661 13.1657 12.2741 11.4773 10.1216 9.0216 8.1196
19 17.3983 15.9920 14.7535 13.6593 12.6896 11.8276 10.3719 9.2014 8.2497
20 18.2260 16.6785 15.3238 14.1339 13.0853 12.1581 10.6036 9.3649 8.3658
21 19.0456 17.3514 15.8775 14.5903 13.4622 12.4699 10.8181 9.5136 8.4694
22 19.8570 18.0112 16.4150 15.0292 13.8212 12.7641 11.0168 9.6487 8.5620
23 20.6604 18.6580 16.9369 15.4511 14.1630 13.0416 11.2007 9.7715 8.6446
24 21.4558 19.2922 17.4436 15.8568 14.4886 13.3034 11.3711 9.8832 8.7184
25 22.2434 19.9139 17.9355 16.2470 14.7986 13.5504 11.5288 9.9847 8.7843
26 23.0232 20.5235 18.4131 16.6221 15.0939 13.7834 11.6748 10.0770 8.8431
27 23.7952 21.1210 18.8768 16.9828 15.3752 14.0032 11.8100 10.1609 8.8957
28 24.5596 21.7069 19.3270 17.3296 15.6430 14.2105 11.9352 10.2372 8.9426
29 25.3164 22.2813 19.7641 17.6631 15.8981 14.4062 12.0511 10.3066 8.9844
30 26.0658 22.8444 20.1885 17.9837 16.1411 14.5907 12.1584 10.3696 9.0218

The Difference Between an Annuity Due and an Ordinary Annuity

The key difference between an annuity due and an ordinary annuity is that the payments for an annuity due are scheduled to be issued at the beginning of each payment period, while the payments for an ordinary annuity are scheduled for the end of each period. This timing differential causes another difference, which is that the earlier payments for an annuity due give it a higher present value than the present value of an ordinary annuity.

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