- CFA Exams
- 2021 Level I
- Study Session 2. Quantitative Methods (1)
- Reading 6. The Time Value of Money
- Subject 6. The Cash Flow Additivity Principle

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##### Subject 6. The Cash Flow Additivity Principle PDF Download

The

**additivity principle**: Dollar amounts indexed at the same point in time are additive.Suppose we are considering two series of cash flows (A and B). The annual interest rate is 5%. We want to know the future value of combined cash flows at t = 3.

- We can calculate the future value of each series and add them up. The future value of series A is 100 x 1.05
^{2}+ 100 x 1.05 + 100 = 315.25 and the future value of series B is 150 x 1.05^{2}+ 150 x 1.05 + 150 = 472.875. The future value of A + B is 788.125. - Alternatively, we can add the cash flows of each series first and then find the future value of the combined cash flows: 250 x 1.05
^{2}+ 250 x 1.05 + 250 = 315.25 = 788.125.

We can use this principle to solve many uneven cash flow problems if we add dollars indexed at the same point in time. Consider a cash flow series, A, with $100 indexed at t = 1, 2, 3 and 5, and $0 at t = 4. This series is an almost-even cash flow, flawed only by the missing $100 at t = 4. How do we find the present value of this series?

- We can create an annuity B with $100 indexed at t = 1, 2, 3, 4, 5. It's easy to find the present value of this series.
- Then we isolate an easily evaluated cash flow B - A; it has a single cash flow of $100 at t = 4. It's also easy to find the present value of this single cash flow.
- We then subtract the present value of B - A from the present value of B.

**Learning Outcome Statements**

CFA® 2021 Level I Curriculum, 2021, Volume 1, Reading 6

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**User Contributed Comments**
14

User |
Comment |
---|---|

BRENDAMBITHE |
YOUR study notes are simply the best although this is my first time I find them easy to understand |

odette |
I really agree with you. I couldnt read QM from the text sent to me. But i am really enjoying reading it now. |

TammTamm |
I understand this now but it would be nice to have a couple of basic questions. |

lisalett |
I don't understand the lack of sample questions. |

Metalpro |
I totally agree with BRENDAMBITHE. The notes will surely help me a lot. |

vixignus |
yeah these are good |

VikramJ |
we need questions! |

TiredHand |
Analyst Notes describes it SO MUCH BETTER THAN THE CFA textbook. |

MNSaleem |
I need help here, i am confused that through which formula The Future Value of Series A is determined, as t = 3 i expect calculation like 100 x 1.05(3) + 100 x 1.05(2) + 100. OR also i think formula for Future value of regular annunity should be used. So please some one make me clear. Thanks. |

ybavly |
@MNSaleem The diagram will make it clear. We are looking for the value AT t=3 not at the end of the year t=3. This is still an ordinary annuity. The FV here happens on t=3 which is the first day of year 3. So, we simply add the $100 because there was no time to reinvest it. |

sgossett86 |
Using the BAII+ cf key makes solving uneven cash flows very simple. |

Chl4072 |
Not understand at all How to find it by using TI..? |

saika |
Analyst Notes, you should create a tutorial for using cashflows. a small video for the calculator functions would help tremendously! Thanks. |

shanshan34 |
please upload a video. this is a little confusing thanks |

Your review questions and global ranking system were so helpful.