And she asks me to be her tutor if she needs more after this exam, once again Ren explains it very well.
Jen and everyone, let me try to dumb down the concept of PV and annuities for conceptual understanding.
Let's say we knew we could get a 10% return on every dollar we had. Well, a dollar today would be worth $1.10 a year from now, or, alternatively, a dollar a year from now would be worth “roughly” 90 cents today.
(I will show actual calculations in a minute but follow the concept). Since we could get about 10% if we had that today, 90 cents today is worth a dollar a year from now. So the “present value” of that dollar a year from now is roughly 90 cents, or a dollar 2 years from now is roughly worth 80 cents today.
That's present value, and thats PV factors, conceptually. So the PV factor 1 year from now is .90, 2 years is .80.
SO, if we knew we could get a 25% return on our dollar, “roughly”, a dollar today would be worth 1.25 a year from now, or alternatively a dollar a year from now would be worth (roughly) only 0.75C today, or a dollar 2 years from now is worth 0.50C today.
In this simple form, at a 10% return we would have 1 year and 2 year PV factors of 0.90 and 0.80, and at a 25% return we would have 1 year and 2 year PV factors of 0.75 and 0.50. IE higher return (or WACC or IRR or various types of “discount” factors they may use) means lower PV in the future
The ACTUAL math is based on 1 / ( (1 + r) ^ n ), where r is the return like .10 or .14, and n is how many periods, IE 1 year, 2 year, etc. so with a 10% return our PV factor for the value today of money 1 year out is 1 / 1.10 = 0.909, or money today 2 years out is 1 / (1.10^2) or – 1 / (1.10 * 1.10) = 0.826, thats what the PV factor is. IE, if I knew I could make 10% on a dollar, and you offered me a dollar in 2 years, that's worth $0.826 dollars today in my mind.
(if it was 3 years is just 1 / (1.10 * 1.10 * 1.10), 4 years is the same, etc., multiplying the denominator just adds the idea of compounding, IE, $1 today is $1.10 next year, then we re-invest $1.10 and get 10% return on THAT principle instead of just the original dollar).
ALL an annuity is is saying okay, so in this example we have a 10% return, well if we get the same amount at year 1 and year 2, the 2 year annuity factor here is literally adding the value of what we get in 1 year plus the (present) value of what we get in 2 years, so the 2 year annuity at 10% would be (0.909 + 0.826) = 1.736
If we had a 20% return instead, our discount factors would be 0.833 and 0.694, and 2 year annuity = 1.528
If we demand a higher return, money later is worth less today, so our PV or annuity factor is lower.
Does that add anything conceptually? If any of that math makes sense try running the numbers on a few problems, it can help make it click and make these PV factors alot less scary.
All an annuity factor is is saying you have the same exact payments each year. $1 a year from now, $1 2 years from now, etc. There is a more complicated annuity formula you DONT NEED TO KNOW; in the extremely unlikely event you needed to calculate an annuity factor, you can add up the PV factor for that rate of return for each period for however many periods it wants (Probably no more than 3-4).
Make sure you conceptually understand how PV works. This is a good problem for that conceptual piece, I would re-work this one once or twice before your exam and make sure you know why it works that way. Let me know if I can add more.
(PS, Teal – Page 12 🙂 )
And regarding
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I'm not 100% sure what to say the best strategy is. I know becker did not prepare me for what I saw in regards to IT. But, Becker is also the gold standard here. So, maybe those IT were really pre-test questions? Becker says they've updated it for anything we are expected to be tested on, so I don't know? I did Wiley's free trial and went through their MCQ on IT 100% and I'm very glad I did, those were in the last 3 days, at a minimum I had exposure to a WHOLE LOT more terms that I never saw in Becker, so I had seen them and answered questions once.
“I Like it when…” says he used CPAreviewforfree for IT. I popped on to that but didnt really use it, I only saw it in crunch time. That sounds like a good recommendation if you have time.
If you're facing an upcoming exam, definitely go through becker's IT. Get a sense of it, and maybe burn through the other materials like CPAreview above, and/or Wiley. I don't know what to tell you on IT strategy. I know I had 3 or 4 questions on 1 specific IT term out of the 100 some possible IT terms that could come up, but there is NO WAY I would have devoted my study time in advance to understanding every tiny piece of that obscure item.
So maybe Becker covered what we needed and the rest was pre-test? Or maybe Becker actually fell short? I don't know, and none of us ever will. (Well, unless this is the one section I horribly fail then I would blame Becker)
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