What is Annuity Due?

What is Annuity Due?

An annuity due is an annuity whose payment is due immediately at the beginning of each period. A common example of an annuity due payment is rent, as landlords often require payment upon the start of a new month as opposed to collecting it after the renter has enjoyed the benefits of the apartment for an entire month.

Annuity due is an annuity whose payment is due immediately at the beginning of each period.

Annuity due can be contrasted with an ordinary annuity where payments are made at the end of each period.

A common example of an annuity due payment is rent paid at the beginning of each month.

An example of an ordinary annuity includes loans, such as mortgages.

The present and future value formulas for an annuity due differ slightly from those for an ordinary annuity as they account for the differences in when payments are made.

How Annuity Due Works

An annuity due requires payments made at the beginning, as opposed to the end, of each annuity period. Annuity due payments received by an individual legally represent an asset. Meanwhile, the individual paying the annuity due has a legal debt liability requiring periodic payments.

Because a series of annuity due payments reflect a number of future cash inflows or outflows, the payer or recipient of the funds may wish to calculate the entire value of the annuity while factoring in the time value of money. One can accomplish this by using present value calculations.

A present value table for an annuity due has the projected interest rate across the top of the table and the number of periods as the left-most column. The intersecting cell between the appropriate interest rate and the number of periods represents the present value multiplier.

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Finding the product between one annuity due payment and the present value multiplier yields the present value of the cash flow.

A whole life annuity due is a financial product sold by insurance companies that require annuity payments at the beginning of each monthly, quarterly, or annual period, as opposed to at the end of the period.

This is a type of annuity that will provide the holder with payments during the distribution period for as long as they live. After the annuitant passes on, the insurance company retains any funds remaining.

Annuity Due Formula

The below formulae can be used depending upon what is sort for, whether the present value or the future value.

  • Annuity Formula = r * PVA / [{1 – (1 + r)n} * (1 + r)]
  • Present Value of Annuity Due = Pmt x [ (1 – 1/(1+r)n) / r ] * (1 + r)

Where:

PMT – Periodic cashflows

r – Periodic interest rate, which is equal to the annual rate divided by the total number of payments per year

n – The total number of payments for the annuity due

The second formula is intuitive, as the first payment (PMT on the right side of the equation) is made at the start of the first period, i.e., at time zero; hence it comes without a discounting effect.

  • Future Value of Annuity Due = Pmt * [(1 + r)n – 1] * (1 + r) / r

Where:

PMT – Periodic cashflows

r – Periodic interest rate, which is equal to the annual rate divided by the total number of payments per year

n – The total number of payments for the annuity due

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Relevance and Use of Average Fixed Cost Formula

Annuity due can be considered as another form of the time value of money used to value a similar amount of cash flows paid out at similar intervals. The basic use and relevance of this formula are to find the worth of your money after a certain period of time given a specific rate.

The application of this formula is huge and is applied in the insurance companies, to find out the number of lease payments. This logic is also used for the calculation of provident fund where the salary is considered as a periodic payment.

Annuities are also sold as financial products and are appropriate for risk-averse investors as annuities are considered as stable and safe. These products are also appropriate for investors who have a large sum of money and want to invest a limited amount of cash flow at each specific interval.

Examples of an Annuity Due

As an example of an annuity due, a company acquires a copier through a lease that requires a payment of $250 at the beginning of each month for three years. Since all payments are in the same amount ($250), they are made at regular intervals (monthly), and the payments are made at the beginning of each period, the payments are an annuity due.

As another example of an annuity due, a company enters into an office lease, under which the lessor requires the company to make monthly payments of $12,000 for the next 24 months, no later than the beginning of the month to which each payment applies. Since all payments are in the same amount ($12,000), they are made at regular intervals (monthly), and the payments are made at the beginning of each period, the payments are an annuity due.