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CS Executive · Corporate Accounting and Financial Management · Time Value of Money

Kavita will receive Rs 20,000 at the end of each year for 5 years. Compared with the same payments received at the beginning of each year (annuity due), at a positive discount rate, how does the present value of the ordinary annuity compare?

The ordinary annuity has a lower present value than the annuity due. Each of its payments occurs one period later, so it is discounted for one extra period. The annuity due value equals the ordinary annuity value multiplied by (1 + r).

  1. AIt is lower, because each payment is discounted for one more periodCorrect
  2. BIt is higher, because payments are delayed
  3. CIt is equal, because the total cash is the same
  4. DIt is higher, because the discount rate applies to fewer periods

Explanation

In an ordinary annuity every payment falls one period later than in an annuity due, so each is discounted one more period. The present value of an annuity due equals the ordinary annuity PV multiplied by (1 + r). Hence the ordinary annuity has the lower PV.

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