Question

How does the present value of a lump sum compare to the present value of an annuity?

Answer 1

Lump sum is the single payment to be received in future at a specified time period while annuity is the series of payments to be received over a time period in future.

The present value of lumpsum is the the discounted value of a single payment to be received in future. The present value of annuity involves the discounted value of the consecutive payments to be received in equal installment in future. The discounted rate can be the opportunity cost like the risk-free rate. Example of lumpsum is $10,000 to be received in future to be discounted at 6% to arrive at the present value. whereas example of annuity is $500 to be received in future every month after retirement to be discounted at 4% to arrive at the present value of future anuities.