Annuity

ANNUITIES

An annuity is a series of equal payments occurring at equal periods of time Annuities occur in the following instances:

1. Payment of a debt by a series of equal payments at equal interval of time. This occurs when goods are brought on the installment plan, the payments for w/c are usually of equal amounts paid periodically, usually monthly.

2. Accumulation of a certain amount by setting equal amounts periodically. This occurs when a person saves equal amounts and deposits these periodically in a

bank; when equal amounts are set aside at equal intervals of time to take care of the depreciation of equipment & to provide for their replacement at a definite future time.

3. Substitution of a series of equal amounts periodically in lieu of a lump sum at retirement of an individual.

Types of Annuities:

An ordinary annuity is one where the equal payments are made at the end of each payment period starting from the first period.

A deferred annuity is one where the payment of the first amount is deferred a certain number of periods after the first.

An annuity due is one where the payments are made at the start of each period, beginning from the first period.

A perpetuity is an annuity where the payment periods extend forever or in w/c the periodic payments continue indefinitely.

Symbols & their meaning

P = value of money at present

F = value of money at some future time

A = a series of periodic, equal amounts of money

n = number of interest periods

ORDINARY ANNUITY

Finding P when A is given

A _A A _A A P 0 _{1 2} 3 n-1 n A(P/F,i%,1) A(P/F,i%,2) A(P/F,i%,3) A(P/F,i%,n-1) A(P/F,i%,n)

P = A 1 – (1 + i) -n = A ( 1 + i)n - 1 i i ( 1 + i)n

The quantity in brackets is called

“uniform series present

worth factor”

and is designated by the functional symbol

P/A,i%,n

, read as

“P given A at i percent in n interest

periods.”

And can be expressed as

Finding F when A is given 0 1 2 3 A A _A A A n-1 n F A(F/P,i%,1) A(F/P,i%,n-3) A(F/P,i%,n-2) A(F/P,i%,n-1)

(1+i)n _{- 1}

F = A

i

The quantity in brackets is called the “uniform series compound amount Factor” and is designated by the functional symbol

F/A,i%,n, read as“F given A at I percent in n interest periods. And can be written as

Finding A when P is given

i 1-(1+i)-n

The quantity in brackets is called the “capital recovery factor.” It is denoted by the

Functional symbol A/P,i%,n w/c is read as “A given P at i percent in n interest

periods.” Hence, A = P(A/P, i%,n)

Finding A When F is Given

A = F

(1+i)n_-1

i

The quantity in brackets is called the “sinking fund factor.” It is denoted by the Functional symbol A/F,i%,n w/c is read as “A given F at i percent in n

interest Periods.” Hence,

A = F(A/F,i%,n)

0 1 2 3 9 10

F

P10,000 _P10,000

P10,000 P10,000 P10,000

1. What are the present worth and the accumulated amount of a 10-year annuity paying P10,000 at the end of each year, w/ interest at 15%

compounded annually?

Solution:

P = A(P/A,i%,n)

[

1-(1+i)-n

]

= A i = P10,000 [1 – (1.15)-10_] 0.15 P = P50,187.68626 F = A(F/A,i%,n) = A [(1+i)n _{- 1} i = 10,000 [(1.15)10_-1] 0.15 = P203,037.1824

2.What is the present worth of P500 deposited at the end of every three months for 6 years if the interest rate is 12% compounded

semi-annually?

Solution:

Solving for the interest rate per quarter, (1+i/4)4 _{– 1 = (1 + 0.12/2)}2 _{– 1} i/4 = 0.0296 or 2.96% i = 0.1182520564 P = A (P/A,2.96%,24) A[1-(1+i)-n _{] i = .1182520564/4 = 0.0296} = i = P500 [1-(1+0.0296)-24_] 0.0296 = P500 (17.0087) = P8,504

SAMPLE PROBLEMS ON ORDINARY ANNUITIES

1. Ria rose borrowed P50,000.00 fr. SSS in the form of calamity loan, w/

int.@8% comp. quarterly payable in equal quarterly installments for 10yrs. Find the quarterly payments.

2. A manufacturing firm wishes to give each 80 employees a holiday bonus.

How much is needed to invest monthly for a yr. @ 12% nominal interest rate, comp. mo., so that each employee will receive a P2,000.00 bonus?

3. A man paid a 10% down payment of P200,000.00 for a house & lot & agreed

to pay the balance on monthly installments for 5yrs. @ an int. rate of 15% compounded mo. What was the mo. Inst. In pesos?

4. Money borrowed today is to be paid in 6 equal payments @ the end of 6

quarters. If the int. is 12% comp. quarterly, how much was initially borrowed if quarterly payments is P2,000.00?

5. Mr. Robles plans a deposit of P500.00 @ the end of each month for 10yrs. @

DEFERRED ANNUITY

A deferred annuity is one where the first payment is made several periods after the beginning of the annuity.

m periods n periods Deferred periods Ordinary annuity periods m n 0 ₁ 2 3 0’ 1 2 3 ₄ A A A A A

FORMULA:

P = A 1 – (1 + i) –n _{( 1 + i)} -m _i

Sample problem

1. A new generator has just been installed. It is expected that there will be no maintenance charges until the end of the 6th _{year, when P300}

will be spent at the end of each successive year until the generator is scrapped at the end of its fourteenth year of service. What sum of money set aside at the time of installation of the generator at 6% will take care of all maintenance expenses for the generator?

2. A parent wishes to develop a fund for a new born child’s college

education. The fund is to payp50,000.00 on the 18th_{, 19}th_{, 20th & 21}st

birthdays of the child. The fund will be built up by the deposit of fixed sum on the child’s first to seventeenth birthday’s.

3. A man loans P187,400.00 from a bank w/ int. at 5%

compounded annually. He agrees to pay to pay his obligations by paying 8 equal annual payments, the first being due at the end of 10yrs. Find the annual payments.

4. A house & lot can be acquired with a down payment of

P500,000.00 and a yearly payment of P100,000.00 at the end of each year for a period of 10yrs., starting at the end of 5 yrs. from the date of purchase. If money is worth 14%

compounded annually, what is the cash price of the property? 5. If money is worth 5% compounded semi-annually, find the

present value of a sequence of 12 semi-annual payments of P500.00 each, the first of which is due at the end of 4 ½ years.

it is anannuity where payments are made indefinitely or forever P = A/i PERPETUITY P 0 1 2 3 4 5 n =∞ A A A A A

SAMPLE PROBLEM:

1. A wealthy man donated a certain amount of money in a bank at a rate of 12% compounded

annually to b able to pay the following scholarship awards; P4,000 per year for the first 5 yrs.; P6000 per yr. for the next 5 yrs. and P9,000 per year on the years thereafter. Find the amount of money deposited by the man.

1 2 3 4 5 6 7 8 9 10 11 12 13 14 P_O Ordinary annuity P4,000 ea. P_d deferred Annuity P6,000 ea. P_F perpetuity P_P m=5 n=5

The equation of value at 0 is, P = P_O + P_d + P_F

0’

- It is the annuity where the payment started at the beginning of the annuity periods.

FINDING P WHEN A IS GIVEN

0 1 2 3 4 n-1 n A A A A A A P = A 1 – (1 + i ) – (n-1) + i F = A ( 1 + i )(n+1) - 1 ₁ i

ANNUITY DUE

1

A man bought a car costing P 450,000 payable in 5 years at a rate of 24% compounded annually in installment basis. If each semi-annual payment is payable at the beginning of each period,