Present Value Of An Annuity

Categories: Company Valuation

Ever hear your grandparents wax nostalgic about how much things cost when they were kids? Like, a movie only cost four dollars, and they could get a hot dog, fries, and a large Coke for three dollars. Or college came free with 10 cereal box tops, and you could trade three baseball cards and a bag of Red Vines for a 5-year-old Ford Focus.

The point of those stories (to the extent that there is one) is that inflation is a real thing. A dollar today is worth more than a dollar will be in the future. This fact makes it difficult to value contracts that take a long time to unfold.

For example, think of an annuity. These contracts involve you paying a large chunk of money now in order to receive periodic income at some point in the future, usually for retirement. Part of the challenge of figuring out whether you're getting a good deal when you buy an annuity comes from the fact that you don't get the pay off until well into the future. The present value of an annuity helps you make that calculation.

The equation can get complicated and, by necessity, it's based on a number of assumptions, often related to inflation or growth rates. But it puts the comparison on a more apples-to-apples framework.

The figure provides the current value for an annuity. It gives its worth as a present lump sum, even though the contract itself pays off in installments during some future period.

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Finance: What are Time-Weighted Rate Of ...1 Views

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Finance allah shmoop what are time and risk waited rates

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of return a dollar today is worth more than a

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dollar tomorrow Like that's the central prayer of the financial

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force Here's the gist You've double your money in an

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investment Is that good Bad ugly mon We need a

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whole lot more information here Tto answer Did you buy

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thirty eight million and two dollars worth of lottery tickets

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and that last two dollar ticket got you seventy six

00:28

million in winnings Was that like a good investment Or

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how about this You took thirty six years to double

00:35

your money Was that good I answer to both No

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not at all The lottery ticket example is a risk

00:42

waited return The lottery famously takes advantage of ignorant people

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spending their hard earned money on tickets representing dreams but

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which have horrible odds of any kind of decent pay

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back But the lottery makes go into a vegas casino

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look like actually a good deal so you may win

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but it's a bad risk no matter how you look

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at it And hey somebody has to pay those teacher

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pension bill So why shouldn't it be people who didn't

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graduate high school Right Well the time waiting is a

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big deal to in a world where the stock market

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broadly speaking doubles on its own About every eight nine

01:15

ten twelve years Something like that This calculation is done

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over very long periods of time and it's held true

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for about a century and change in america So if

01:23

he took thirty six years to double your money well

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it implies you only made two percent a year as

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your rate of return Remember that rule of seventy two

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thing Yeah that right there Seventy two divided by thirty

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six and you get a whopping two percent return Well

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in that same period of time the market might have

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doubled in four times So the ten grand that double

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to be twenty grand in thirty six freakin years under

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your watch we'll have you just put it into an

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index fund of the s and p five hundred over

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that same time period Well it would have doubled once

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along the timeline here to be twenty grand then doubled

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again here to be forty grand and then doubled again

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here to be a tigre rine and then ah forthe

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doubling right here after thirty six years maybe one hundred

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sixty grand And that's just an index fund Nothing fancy

02:07

Not warren buffett Just a basic vanilla index fund that

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anyone with two hundred fifty bucks in their pocket can

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buy And it's worth noting dividends which often get ignored

02:17

in the financial press actually matter a ton when it

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comes to the calculation of long term investment results Generally

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speaking that continued payment of dividends is a low risk

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adventure Very few companies ever cut or fully do away

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with their dividends And if they do well it means

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a pretty much everything is rotten in denmark so you

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can count on dividends The bolster overall returns that historically

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dividends have had a wide range of somewhere between two

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and seven or eight percent for the mid range of

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the s and p five hundred But if you pegged

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them around and three ish percent today and changed to

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reflect the modern era well then the overall market need

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only compounded about five percent To deliver that five plus

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three percent and change eight ish percent total returns That

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will allow the stock market to double about every nine

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years or so right so we're ignoring taxes here but

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we're ignoring the use of dividends proceeds to buy more

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shares every quarter as well when those dividends air paid

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So when you think about time and risk think about

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them like they're a kind of financial stone soup which

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when mixed together with the right spices of tax hedges

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leverage and a bull market well make a really nice

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retirement meal and you don't even need your teeth on 00:03:22.773 --> [endTime] a bonus

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