Question & Answer: How does compounding compare with discounting? How does the future value of an annu…..

Compounding interest can be defined as interest that is earned on a given deposit and taht became a part of the principle amount at the end of a certion specified period. When the value is compounded, the value grows upon itself to a higher value and that higher value continuously grows upon itself to earn higher values. A value can be compounded continously, semi annually and annually. The more the value is comppinded, the higher the future value will be.

Discounting on the other hand is the process of reducing something’s future value to its present value. If a company’s cash flow valuation as of present is astertained, then the same can be compounded to estimate its value in future.

Annuity is a stream of equal periodic cash flow over a specifed period of time. These cash flows can be the inflows of the returns earned on investments or outflows of funds invested to earn future returns. The main purpose of an annuity is that to provide a steady cash flows especially for retirement individuals. Annuties are illiquid and cannt be withdrawn without penalty. Unlike an annuity that is dispersed periodically over time, a lump sum is a one time payment. The future value of a lump sum amount will be less than the future value of an annuity because an individual will receive more of the money over time if one chooses annuity payments.