A perpetuity is an infinite sequence of payments. If someone offered to pay you $100 per year from now until the end of the world, that would be a perpetuity. An annuity is a finite sequence of payments. If someone offered to pay you $100 per year for the next ten years, that would be an annuity. Perpetuities and annuities are commonly encountered in time value of money calculations. A series of coupon payments on a bond and monthly payments on a 30-year mortgage are examples of annuities.
The following formula is used to calculate the present value of a perpetuity that starts one year from the present date:
PV = |
CF r |
where CF is the annual cashflow amount and r is the discount rate.
The following formula is used to calculate the present value of an annuity that lasts n years and starts one year from the present date:
PV = | CF * ( |
1 r |
- |
1 r * (1 + r)^{n} |
) |