Present Value of an Annuity Help
An "annuity" is a fixed sum of money paid someone each period, typically for the rest of their life. More loosely, it means any regular cash flow stream which may or may not have an explicit declared term. If an annuity is scheduled for 10 annual payments of $10,000 each, the sum of the payments is $100,000. However, if instead of being paid in 10 annual installments you wanted to receive a single sum, you would not receive $100,000. Why? Because if you receive a single sum today, there is no future risk of not receiving the amount due. Therefore, you would take less today to eliminate the risk of not collecting all payments.
If you are scheduled to receive a series of regular fixed payments of $2,500 for 20 years, what is today's cash value, assuming a 5.5% annual discount rate? The "annual discount rate" is the rate of return that you expect to receive on your investments. This is a personal number. There is no "right" answer, though you want to use a realistic number based on your investment history. The discount rate will vary from individual to individual.
Enter $2,500 in the "Cash Flow Amount" field (never type the currency symbol or commas). The cash flow frequency will be monthly. Enter 240 for the "Number of Cash Flows" (240 months is 20 years). Assume monthly compounding. Since the first payment isn't due until a month from now, set the "First Cash Flow Date" to one month from "Today's Date".
The PV is $363,431.62. Thus, you could accept $363,431.62 today in lieu of receiving $2,500 a month for twenty years. For you, the two are equal.
A note or two about "Compounding Frequency". The "Exact/Simple" option is actually exact day simple interest. When you make this selection, the calculator uses no compounding and the exact number of days between cash flow dates are used. The "Daily" option uses the exact number of days between dates, but daily compounding is assumed. If you are considering receiving a single amount in lieu of a cash flow stream, the "Exact/Simple" compounding option is the most conservative setting. That is, it will result in the highest present value calculation.
The prior version of this calculator provided you with an option to set the "Cash Flow Timing". Since you can enter "Today's Date" and the "First Cash Flow Date" this option is no longer necessary because the calculator will calculate the exact dates the cash flow is due.
One additional point about "Today's Date". This input does not have to be set to the current date. The date you use is the date you want to know the present value. If you were closing on a deal to buy a mortgage and the deal is expected to close in a week, then you would want to use the date of the closing for "Today's Date" so you'll know the present value on the closing date.