Explain how the future value of an ordinary annuity interest table is

QUESTION

Explain how the future value of an ordinary annuity interest table is converted to the future value of an annuity due interest table.

Annuity is a stream of cash flows at equal intervals. Cash flows could be either receipts (as in case of interest on investments) or payments (as in case of loan payments). Such cash flows could be due annually, monthly, weekly or for any other time period. Annuities can be of two types: ordinary annuity and annuity due. In ordinary annuity, it is assumed that the cash flows become due at the end of the period. For example in a monthly annuity, it is assumed the cash flows become due at the end of each month. However, in case of annuity due, it is assumed that the cash flows become due at the beginning of the period. Thus, while calculating the future values; one more period has to be considered. So, for calculating the future value of an annuity due, compounding is done for one more period as compared to the ordinary annuity. So, to¦

use the future value table of ordinary annuity, for annuity due, the values are multiplied with (1 i). This means FVIFAi,n (annuity due) = FVIFAi,n x (1 i); where FVIFA is the future value interest factor for an annuity. So, if the annuity is for 4 years, then future value value will be calculated for 4 years in ordinary annuity. However, for annuity due, future value for an additional first period has to be calculated. Hence after calculating the future value of ordinary annuity for 4 years, (1 i)has to be multiplied, to get the true value.

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