CFA Program Level I Prerequisite Readings for 2024 % ' (

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K Home Lesson 7 of 15 : Future Value of a Series of Cash Flows 3 4 7 6

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Learning Outcomes
e Discussions Continue !
calculate and interpret the future value (FV) and present value (PV) of a single sum of money, an
B Search ordinary annuity, an annuity due, a perpetuity (PV only), and a series of unequal cash flows
Category
demonstrate the use of a time line in modeling and solving time value of money problems
Interest Rates, Present Value,
In this section, we consider series of cash flows, both even and uneven. We begin with a list of terms and Future Value

commonly used when valuing cash flows that are distributed over many time periods.
r Related Questions:

An annuity is a finite set of level, or identical, and sequential cash flows. Practice questions related to
this topic
An ordinary annuity has a first cash flow that occurs one period from now (indexed at t = 1).

An annuity due has a first cash flow that occurs immediately (indexed at t = 0).

A perpetuity is a perpetual annuity, or a set of level, or identical, never-ending sequential cash flows,
with the first cash flow occurring one period from now.

Equal Cash Flows—Ordinary Annuity

Consider an ordinary annuity paying 5 percent annually. Suppose we have five separate deposits of $1,000
occurring at equally spaced intervals of one year, with the first payment occurring at t = 1. Our goal is to find
the future value of this ordinary annuity after the last deposit at t = 5. The increment in the time counter is
one year, so the last payment occurs five years from now. As the time line in Exhibit 4 shows, we find the
future value of each $1,000 deposit as of t = 5 with Equation 2, FVN = PV(1 + r)N. The arrows in Exhibit 4
extend from the payment date to t = 5. For instance, the first $1,000 deposit made at t = 1 will compound
over four periods. Using Equation 2, we find that the future value of the first deposit at t = 5 is $1,000(1.05)4
= $1,215.51. We calculate the future value of all other payments in a similar fashion. (Note that we are
finding the future value at t = 5, so the last payment does not earn any interest.) With all values now at t = 5,
we can add the future values to arrive at the future value of the annuity. This amount is $5,525.63.

Exhibit 4: The Future Value of a Five-Year Ordinary Annuity

We can arrive at a general annuity formula if we define the annuity amount as A, the number of time periods
as N, and the interest rate per period as r. We can then define the future value as

FV N = A [(1 + r) N−1 + (1 + r) N−2 + (1 + r) N−3 + … + (1 + r) 1 + (1 + r) 0 ]

which simplifies to

[ ]
(1 + r) N − 1 7
FV N = A
r

The term in brackets is the future value annuity factor. This factor gives the future value of an ordinary
annuity of $1 per period. Multiplying the future value annuity factor by the annuity amount gives the future
value of an ordinary annuity. For the ordinary annuity in Exhibit 4, we find the future value annuity factor from
Equation 7 as

[ ]
(1.05)5 − 1
= 5.525631
0.05

With an annuity amount A = $1,000, the future value of the annuity is $1,000(5.525631) = $5,525.63, an
amount that agrees with our earlier work.

The next example illustrates how to find the future value of an ordinary annuity using the formula in Equation
7.

EXAMPLE 7

The Future Value of an Annuity

Suppose your company’s defined contribution retirement plan allows you to invest up to EUR20,000
per year. You plan to invest €20,000 per year in a stock index fund for the next 30 years. Historically,
this fund has earned 9 percent per year on average. Assuming that you actually earn 9 percent a year,
how much money will you have available for retirement after making the last payment?

Hide Solution

Solution:

Use Equation 7 to find the future amount:

A = €20,000

r = 9% = 0.09

N = 30

(1 + r) N − 1 (1.09)30 − 1
FV annuity factor = = = 136.307539
r 0.09

FVN = €20,000(136.307539)

= €2,726,150.77

Assuming the fund continues to earn an average of 9 percent per year, you will have €2,726,150.77
available at retirement.

Unequal Cash Flows

In many cases, cash flow streams are unequal, precluding the simple use of the future value annuity factor.
For instance, an individual investor might have a savings plan that involves unequal cash payments
depending on the month of the year or lower savings during a planned vacation. One can always find the
future value of a series of unequal cash flows by compounding the cash flows one at a time. Suppose you
have the five cash flows described in Exhibit 5, indexed relative to the present (t = 0).

Exhibit 5: A Series of Unequal Cash Flows and Their Future Values at 5

Percent

Time Cash Flow ($) Future Value at Year 5

t=1 1,000 $1,000(1.05)4 = $1,215.51

t=2 2,000 $2,000(1.05)3 = $2,315.25

t=3 4,000 $4,000(1.05)2 = $4,410.00

t=4 5,000 $5,000(1.05)1 = $5,250.00

t=5 6,000 $6,000(1.05)0 = $6,000.00

Sum = $19,190.76

All of the payments shown in Exhibit 5 are different. Therefore, the most direct approach to finding the future
value at t = 5 is to compute the future value of each payment as of t = 5 and then sum the individual future
values. The total future value at Year 5 equals $19,190.76, as shown in the third column. Later in this
reading, you will learn shortcuts to take when the cash flows are close to even; these shortcuts will allow you
to combine annuity and single-period calculations.

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done
SH

Created 5 days ago by Shahid Hussain Mir 0 replies | Last Activity: 5 days ago
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Done
CM

Created 11 days ago by Carlos Morais 0 replies | Last Activity: 11 days ago
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In exhibit 5, why are the exponential value inversed to the time value i.e in t=0 why is value of FV at the year 5 = 4?
YM

Created a month ago by Yahya Mumtaz 1 reply | Last Activity: 18 days ago
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VM You are looking for the future value (FV) of your investments at t = 5, therefore we have to find the future value of each $1,000 deposit as
of t = 5, using this equation FVN = PV(1 + r)N. The exponential value N is the number of time periods left from the moment you invest and
T = 5. You can look the Exhibit 4 to understand the mechanism
Vincent Mella replied 18 days ago

how can you solve practice question 3 with CF function in BA II plus? There's a solution below (by Isabella Arias) using the TVM buttons, but it seems too time consuming.
DT

Created a month ago by Duong Thi Minh Phuong 0 replies | Last Activity: a month ago
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In Exhibit 5, I'm trying to calculate on the calculator BA2plus the FV at year 5 but I always end with 15036.45$ as an answer. This is how I enter the numbers on the calculator :
LM
CFo= 0 , C01= 1000, F01 = 1 , C02 = 2000, F02 = 1, C03= 4000, F03 = 1, C04 = 5000, F04 = 1, C05 = 6000, F05 = 1, PRESS NPV, I = 5 press down NPV appears and I press
CPT and the result is still 15 036,45968... Anyone has the same issue ? Thank you

Created 3 months ago by Lina Maria Cala 4 replies | Last Activity: 2 months ago
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VC Go down twice to NFV after you entered I=5. Now you are trying to calculate Net Present Value while you need Net Future Value.

Vitalijs Cvetkovs replied 3 months ago

LM Thank you for your answer.. I couldn't go down twice because I don't have the professional version of BA2plus.

Lina Maria Cala replied 3 months ago

GS after getting PV multiply iy by (1.05)^5 to get the future value you will have your answer

Gurupreet Singh Sachdev replied 3 months ago

AM hi after you find NPV you have to calculate NFV, using the BA II Plus you then compute the following:N=5( coming from the 5 year
cashflow) I/Y= 5(interest) PV=15036.46 PMT=0 therefore FV=19190.76
Argentina Muianga Chamucha replied 2 months ago

Why in the Exhibit 5, the FV Annuity Factor is (1.05)^N, and NOT [ (1+r)^N - 1) / r ]. What am I missing? What did I not understand? Is the formula for FV Annuity Factor in
KS
Uneven Cash Flow similar to a normal compounding factor, which is (1+r)^N

Tags: question 3 replies | Last Activity: 2 months ago

Created 2 months ago by Kamran Shahzad
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SL You use the formula [((1+r)^N-1)/r] only when the cash flows are even, as in case of example 7. Because the cash flows in Exhibit 5 are
uneven, you cannot use the annuity formula, and compute the future value using (1+r)^N.
Siddhi Lodha replied 2 months ago

SM The formula in equation 7 (which is the Annuity formula for uniform cashflows), I believe has been derived using the Geometric
Progression series. However, in the case of uneven cash flows, the A (annuity amount) is different, and hence because of different A in
different time periods, you cannot form a Geometric Progression series, and hence can't use the Annuity formula in equation 7. You would
have to calculate the future value of each Annuity amount till maturity. Hope this helps.
Sumit Mani replied 2 months ago

KS Thank you very much for helping to understand. Appreciate the help!

Kamran Shahzad replied 2 months ago

I want to go back to previous lessons in the pre-requisites readings to attempt related questions to each topic that I forgot to attempt. Please advise how to do it?
TG

Created 3 months ago by TEHSEEN GALAMALI 1 reply | Last Activity: 2 months ago
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KK Click on 'Table of Contents' at the top of the page. You will see 3 topics and if you expand them, you will see a note-like icon on some of
the lessons. In whichever lessons the icon is displayed, those lessons will have practice problems
Krishna Kumar Ramu replied 2 months ago

in the practice questions no. 3...when i make the calculations using my calculator i am not getting the same future values as the answer...can anyone show me how they are
LL
getting the correct answer on hp12c. thank you

Created 6 months ago by Leila Louise Forsythe 1 reply | Last Activity: 4 months ago
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IA Remember to match the periodicity of the interest rate and the number of years. Because compounded semiannually, multiply N*2 and
divide r/2. In calculator:
Year 1: PV= -4,000, N= 6 (3*2), I/Y= 2 (4/2) CPT FV= $4,504.65
Year 2: PV= -8,000, N= 4 (2*2), I/Y= 2 (4/2) CPT FV= $8,659.46
Year 3: PV= -7,000, N= 2 (1*2), I/Y= 2 (4/2) CPT FV= $7,282.80
Year 4: The last payment does not earn interest so it will simply be FV = $10,000
Now add all the individual FVs $4,504.65 + $8,659.46 + $7,282.80 + $10,000 = $30,447
Isabella Arias replied 4 months ago

How am i Calculation Exhibit 5 on BA2 plus?

CB

Created 6 months ago by Chandru Bhatia 4 replies | Last Activity: 4 months ago
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MB
First hit CF. That will bring you to CF0 (cash flow 0), hit ENTER, then there's F01 (Frequency of first payment), hit enter, hit down. Now
you're at CF01; enter in $1,000. Hit Enter. Hit down. This brings you to F01. Make sure its at 1 and hit enter. Go down. Enter the other
numbers in the same manner. When you are at CF05, enter 6,000, enter, F05, enter. Now you are at C06. Since there is no C06, hit the
NPV button. This brings up I = something. Type the interest rate (5) and enter. Go down twice to NFV and hit CPT to compute. You will
have $19,190.756. I don't know why they don't show us BA 2+ programs here. Hope that helped.
Michael Beda replied 6 months ago

AF
Hi Michael, thank you very much!! i had no idea that we can do that with the calculator. One quick question just in case that you know, how
do i reset the values on the CF and NPV buttons sections?? And how can we use those functions when the interest rate compunds more
than one time in a year (m>1) <For example the 3rd practice problem)?
Andres Felipe Ramirez Saavedra replied 6 months ago

XW
Very helpful

Xiaodong Wang replied 6 months ago

CH
Hi Andres, you could try hitting 2ND then CE|C while you're on the CF page. It should reset both CF and NPV but do double check.
I'm not too sure about the 3rd practice problem, but it seems faster to work it out by drawing a timeline and computing separately.
Cheng Hui Hazel Yong replied 4 months ago

In example 7, seems like an error description. it's like investing €20,000 per year, not just initial investment of €20,000.
YP

Created 5 months ago by YAQIANG PAN 1 reply | Last Activity: 5 months ago
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MR
The point is that the FV Factor is first calculated .

FV annuity factor = [(1+r)^N −1] / r

= [(1.09)^30−1] / 0.09=136.307539

Now you have the factor and can multiply this by the contribution that will occur each period N.

The reason this works is because the contributions of 20,000 are constant. Hope this helps.

Matthew Roberts replied 5 months ago

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