Discounted cash flow techniques - part 3

In this lesson

1. 0:00 Annuities and discounting cash flows
2. 1:01 Normal annuities explained
3. 2:00 Single discount factor method
4. 3:18 Annuity factor method step by step
5. 6:00 Advanced annuities at time zero
6. 9:09 Delayed annuities two-step process

About this lesson

You'll discover two methods for calculating present value: the single discount factor method (discounting each cash flow individually) and the faster annuity factor method (multiplying the periodic cash flow by a pre-calculated annuity factor). This technique is essential for investment appraisal questions in FM, AFM, and strategic papers where you need to evaluate project cash flows quickly and accurately. The annuity factor method is your efficiency tool. Rather than discounting each year's cash flow separately—which becomes tedious with long-term investments—you add the discount factors together into one annuity factor, then multiply once. The formula is straightforward: annuity factor equals one over R multiplied by one minus one over (one plus R) to the power of N, where R is your discount rate and N is the number of periods. For a normal annuity, you apply this factor directly to your periodic cash flow. For advanced annuities, you add one to the annuity factor to account for the immediate cash flow at time zero. For delayed annuities, you apply the normal annuity factor first (which gives you the value at year one before the cash flows begin), then discount that result back to today. Understanding when to use each annuity type is crucial for exam success. A normal annuity assumes cash flows start in year one and continue for a set period—this is your default assumption. An advanced annuity starts immediately (at time zero), so you adjust your factor upward by one. A delayed annuity doesn't begin until year two or later, requiring a two-step process: first calculate the value using the annuity factor as if it were normal, then discount that intermediate value back to the present day. Small rounding differences between methods won't affect your exam marks, as questions are designed to account for this variation. Mastering these shortcuts means you'll handle investment appraisal questions confidently and efficiently under exam pressure.

Duration: 13m