If you have a choice between a massive sum of money or an annuity, and you're not sure which one to pick, this PVIFA calculator is your new best friend. In this article, we will use simple examples to show you what is PVIFA. and how you can utilize it in investment decisions. We will also provide you with a small PVIFA table for quick reference.
What is PVIFA?
PVIFA is an abbreviation for Present Value Interest Factor of Annuity. It is an idea based on the time value of money: the money you have now is worth more than the same amount of money a few years from now.
Why is money worth more today? The reason is simple - you can decide to invest it so that it will generate interest. All that potentially earned money increases the value of the cash you have right now.
Now, imagine you're given a choice: you can either get a considerable sum of money today or regular payments spread over a few years (also called annuity payments). Which option should you choose? It's a tricky question, because the future value of annuity is different than the same amount of money today. To answer it, you need to use this PVIFA calculator.
Now that we know what is PVIFA, and how to use it, let's transform our knowledge into a mathematical equation. The PVIFA formula looks like this:
PVIFA = (1 - (1 + r)-n) / r
PVIFAis the present value interest factor of annuity;
ris the interest rate per period, expressed as a decimal; and
nis the number of periods (years).
We can use this PVIFA formula to figure out what's the future value of eight consecutive payments, obtained once a year at an interest rate of 4% per year. How? Let's take a look at an example below.
How to use the PVIFA calculator? An example
Imagine you have invested in a promising startup which produces 3D printers. Your investment will result in you getting eight payments of $3,000 - one per year. The interest rate, as we mentioned above, is equal to 4%. What is the present value of this annuity?
Determine the number of periods and interest rate. In this case, we have
n = 8, and
r = 4% = 0.04.
Calculate PVIFA according to the PVIFA formula:
PVIFA = (1 - (1 + r)-n) / r
PVIFA = (1 - (1 + 0.04)-8) / 0.04
PVIFA = 6.73
Now we know that every $1 you receive is, on average, worth 6.73 times more in present value - that is, $6.73.
How much is the payment worth, then? The total value of these eight payments will not be equal to simply
8 * $3,000. Instead, we have to multiply the payment value by the PVIFA:
6.73 * $3,000 = $20,198
The present value of this annuity is equal to $20,198.
If you want to calculate the present value of the annuity, make sure to open the advanced mode of the PVIFA calculator!
Before our handy PVIFA calculator existed, people had to deal with these calculations differently. Instead of using the formula, you could work with a PVIFA table, where you'd find the PVIFA values for most common interest rates, and numbers of periods.
The PVIFA table below shows the value of PVIFA for interest rates spanning from 1% to 5% and for 1 to 5 periods. If your investment has a higher rate, or you're planning on getting the annuity for more than five years, make sure to use the PVIFA calculator instead!
|Interest rate → / Periods ↓||1%||2%||3%||4%||5%|