Perpetuities and Annuities

Perpetuities and Annuities

Introduction

The purpose of this study is to expand the boundaries of our knowledge by exploring some relevant facts and figures relating to the difference between perpetuities and annuities. The concepts of Perpetuities and Annuities have emerged from the principle of Time value and money. Apart from theoretical implementation of these two concepts, they are also being used in the real world. Both perpetuities and annuities are stream of structured payments. The major difference between a perpetuity and annuity is that the payments in perpetuity are made for an infinite period where as payments in annuity are made for a fixed period (Ndubizu, 2006). In the next section, we will examine the concept of time value and money and also the differences between the two concepts by using appropriate examples.

Discussion & Analysis

In order to examine the differences between perpetuities and annuities, we will first understand the basics of time value and money. To say that the dollar, which you have today, is worth more than a dollar received at some time is sufficiently obvious to most of us, and does not require the use of complex models or patterns. The main principles of the present value (called PV) form the basis of this claim and allow estimating exactly how much in terms of U.S. dollar today is worth U.S. dollars promised in the future. They also allow the streams move cash flows over time. The concept of present value of money is easy to understand, simple to calculate and has many uses. Facilitates decision making; ranging from simple personal decisions (buying a house, saving for children's education, calculation of future pensions) on complex financial decisions undertaken by the company ending. The latter may include, among others selection projects in which business can invest, together with the selection of an appropriate method of funding (Morishima, 1977).

The timeline helps you analyze and compare the values of cash flows arising at different times. Timeline shows both the time impact and the amount of streams. Cash flow can be positive or negative. Positive flows are called cash receipts (cash inflows), and negative cash outflows (called cash outflows).

The process of discounting future cash flows is to express them in current values. The reverse situation, which consists of calculating the value of future cash flow of current, is called the submission. One can distinguish five basic types of cash flows (Horngren, 1989):

Simple Cash Flows

Annuities

Growing Annuities

Perpetual annuity (called Perpetuities)

Growing Perpetuities

In this paper, we will only focus on Annuities and Perpetual Annuities (Perpetuities).

Annuities

In Annuity, a series of payment is made on regular basis at a predetermined interest rate. Following are some of the factors that are considered for the calculation for the Annuity:

The number of payments

Time period

Future value or Present value of the series of payments

The payments in annuities are usually composed of some proportion of interest and principle, the payments that are made earlier in the period are referred to as interest, where as payments that are made in the later period are referred as ...