Which one of the following will decrease the present value of an annuity?

• A. Decreasing the interest rate
• B. Increasing the interest rate
• C. Decreasing the number of periods
• D. Increasing the payment amount

Answer: (B)

Verified step by step guidance

1. Understand the concept of present value of an annuity: The present value of an annuity is the current worth of a series of future payments, discounted at a specific interest rate. It is influenced by factors such as the interest rate, number of periods, and payment amount.
2. Analyze the impact of increasing the interest rate: When the interest rate increases, the discount factor becomes larger, which reduces the present value of future payments. This is because future payments are discounted more heavily.
3. Evaluate the effect of decreasing the number of periods: Reducing the number of periods means fewer payments are included in the annuity calculation. This decreases the total present value since there are fewer discounted cash flows.
4. Consider the impact of increasing the payment amount: Increasing the payment amount raises the total cash flows in the annuity, which increases the present value. This does not decrease the present value.
5. Conclude that the factors which decrease the present value of an annuity are increasing the interest rate and decreasing the number of periods, as both reduce the total discounted value of future payments.