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10
Annuities
O
Ordinary A nnuities
Chapter 10
McGraw-Hill
McGraw-HillRyerson©
Ryerson©
Ordinary 10-2
10
Annuities
Learning Objectives
After completing this chapter, you will be able to:
Define and distinguish between…
LO-1 … ordinary simple annuities and ordinary
general annuities
Calculate the…
LO-2 … Future Value and Present Value of
ordinary simple annuities
McGraw-Hill Ryerson©
Ordinary 10-4
10 Terminology
Annuities
LO-1 Annuity
- A series of equal payments at regular
intervals
McGraw-Hill Ryerson©
Ordinary 10-6
10 Terminology
Annuities
Suppose Term
you obtain
48 months or 4years.
a personal
loan payment interval
to be 1 month
repaid by
ordinary annuities
48 equal monthly
payments first payment will be due 1 month after
you receive the loan,
i.e. at the end of the first payment interval
McGraw-Hill Ryerson©
Ordinary 10-7
10 Terminology
Annuities
n-1 n Interval
0 1 2 3 number
PMT PMT PMT PMT PMT
= differs from
the compounding interval the compounding interval
0 1 2 3 4 Interval
number
$1000 $1000 $1000 $1000
n=1 $1000 (1.04)1
n=2
$1000 (1.04)2
n=3
$1000 (1.04)3
Sum = FV of annuity
…the sum of the future values of all the payments
McGraw-Hill Ryerson©
Ordinary Future Value 10-10
10 of an
Annuities Ordinary Simple Annuity
Assume that there are four(4) annual $1000 payments
with interest at 4%
0 1 2 3 4 Interval
number
$1000 $1000 $1000 $1000
n = 1 $1000 (1.04)1
n=2
$1000 (1.04)2
n=3
$1000 (1.04)3
Sum = FV of annuity
FV of annuity = $1000 + $1000(1.04) + $1000(1.04)2 + $1000(1.04)3
= $1000 + $1040+ $1081.60 +$1124.86
= $4246.46
McGraw-Hill Ryerson©
Ordinary Future Value 10-11
10 of an
Annuities Ordinary Simple Annuity
Suppose that you vow to save $500 a month for the next
four months, with your first deposit one month from today.
If your savings can earn 3% converted monthly, determine
the total in your account four months from now.
0 1 2 3 4 Month Result
$500 $500 $500 $500
$ 500.00
$500(1+.03/12) 501.25
$500(1+.03/12)2 502.50
$500(1+.03/12)3 503.76
Sum = FV of annuity $2,007.51
McGraw-Hill Ryerson©
Ordinary Future Value 10-12
10 of an
Annuities Ordinary Simple Annuity
Now imagine that you save $500 every month for the
next three years. Although the same logic applies, I
certainly don’t want to do it this way!
Using the …
McGraw-Hill Ryerson©
Ordinary Future Value 10-13
10 of an
Annuities Ordinary Simple Annuity
You save $500 every month for the next three years.
Assume your savings can earn 3% converted monthly.
Determine the total in your account three years from now.
P/Y==
FV 18810.28
120
Note
Keys direction 3 36 0
12
500
McGraw-Hill Ryerson©
Ordinary Future Value 10-15
10 of an
Annuities Ordinary Simple Annuity
You save $500 every month for the next three years.
Assume your savings can earn 3% converted monthly.
Determine the total in your account three years from now.
FV = PMT (1+ i)
i
n -1
[ ] 18810.28
37.6206
1.0025
0.0941
0.0025
1.0941
.03 12
1 36
1
500
McGraw-Hill Ryerson©
Ordinary Solving earlier Question 10-16
10 using Annuities
Annuities
McGraw-Hill Ryerson©
Ordinary 10-17
10
Annuities
Cash Flows
..a term that refers to payments
that can be either …
Therefore…
Using the …
McGraw-Hill Ryerson©
Ordinary Future Value 10-19
10 of an
Annuities Ordinary Simple Annuity
PV = 0 n = 4 payments PMT -500
3
You vow to save 0
$500/month for the 12
next four months, FV = 2007.51
with your first 500
deposit one month
from today.
If your savings can 4
earn 3% converted We already have
monthly, determine these from before, so
the total in your we don’t have to enter
account four them again!
months from now.
McGraw-Hill Ryerson©
Formula solution
Ordinary 10-20
You vow to save $500/month for the next
10
four months, with your first deposit
Annuities one month from today. If your savings can
earn 3% converted monthly, determine the
total in your account four months from now.
Formula FV = PMT [ (1+ i)n - 1
i ]
PMT = $500
n= 4
2007.51
4.0150
0.0100
1.0100
1.0025
0.0025
i = .03/12
= 0.0025 .03 12
1 4
1
500
McGraw-Hill Ryerson©
Ordinary 10-21
10 Not seeing the total picture!
Annuities
McGraw-Hill Ryerson©
Ordinary 10-22
10
FV Contributions
Contribution
Annuities 10% Compounded Annually $
FV
$10.00 14.64
$10.00 13.31
$10.00
$10.00 12.10
$10.00 11.00
10.00
0 1 2 3 4 5 $61.05
Years
McGraw-Hill Ryerson©
Ordinary Future Value 10-23
10 of an
Annuities Ordinary Simple Annuity
P/Y==
FV 4140.69
12
You decide to save
$75/month for the
next four years. 7 48
If you invest all of
these savings in an 0 75
account which will 12
pay you 7%
compounded
monthly, determine: FV……….. $4,140.69
a) the total in the Deposits…... 3,600.00
account after 4 years
b) the amount you Interest Earned = $ 540.69
deposited
c) the amount of
interest earned Formula solution
McGraw-Hill Ryerson©
Ordinary 10-25
10
Annuities
Formula FV = PMT [ (1+ i)n - 1
i ]
1.005833
0.005833
55.20924
0.32205
1.32205
4140.6927
You decide to save
$75/month for the
next four years. .07 12
If you invest all of
these savings in an 1 48
account which will
pay you 7% 1
compounded
monthly, determine:
a) the total in the 75
account after 4 years
b) the amount you FV $4,140.69 - Deposits 3,600.00
deposited = Interest Earned $540.69
c) the amount of
interest earned
McGraw-Hill Ryerson©
Ordinary PresentValue 10-26
10 of an
Annuities Ordinary Simple Annuity
McGraw-Hill Ryerson©
Ordinary Present Value 10-27
10 of an
Annuities Ordinary Simple Annuity
Assume that there are four(4) annual $1000
payments with interest at 4%
0 1 2 3 4 Interval
Number
$1000 $1000 $1000 $1000
$1000 (1.04)-1 n=1
n=2
$1000 (1.04)-2
n=3
$1000 (1.04)-3
n=4
$1000 (1.04)-4
Sum = PV of annuity …the sum of the present values of all the
payments
McGraw-Hill Ryerson©
Ordinary Present Value 10-28
10 of an
Annuities Ordinary Simple Annuity
Assume that there are four(4) annual $1000
payments with interest at 4%
0 1 2 3 4 Interval
Number
$1000 $1000 $1000 $1000
$1000 (1.04)-1 n=1
$1000 (1.04)-2 n=2
$1000 (1.04)-3 n=3
$1000 (1.04)-4 n=4
Sum = PV of annuity PV of annuity
= $1000(1.04)-1 + $1000(1.04)-2 + $1000(1.04)-3 + $1000 (1.04)-4
= $961.54 + $924.56 + $889.00 + $854.80
= $3629.90
McGraw-Hill Ryerson©
Ordinary Present Value 10-29
10 of an
Annuities Ordinary Simple Annuity
…Since you are making payments, not receiving them, PMT = -450
… n = 9 payments … Repaid 9 payments at $450 = $4,050
… Interest - use 12, not .12 when using financial calculator
… At the end of the loan, you don’t owe any money, so FV =0
McGraw-Hill Ryerson© Solve…
Ordinary 10-30
10
Annuities
You PV = 3,918.24
overhear your
friend saying the 12
he is repaying a 8 9 0
loan at $450 every 450
month for the next
nine months.
The interest rate he
has been charged is Amount Borrowed (PV) $ 3,918.24
8% compounded
monthly. Calculate Repaid.…………………. 4,050.00
the amount of the Interest Paid = $ 131.76
loan, and the
amount of interest
involved. Formula solution
McGraw-Hill Ryerson©
Ordinary 10-31
10 Formula PV = PMT [ 1-(1+ i)-n ]
i
Annuities
You -0.0580479
1.006667
0.006667
3,918.24
0.94195
overhear your
friend saying the
he is repaying a .08 12
loan at $450 every
month for the next 1 9
nine months.
The interest rate he 1
has been charged is
8% compounded 450
monthly. Calculate
the amount of the Repaid $4,050.00 - Borrowed $3,918.24
loan, and the
amount of interest = Interest Charged $131.76
involved.
McGraw-Hill Ryerson©
Ordinary 10-32
10
Annuities
Contribution of
Each Payment
to an
Annuity’s Present Value
McGraw-Hill Ryerson©
Ordinary 10-33
10
PV Contributions
PV
Contribution
Annuities $
$10.00 9.09
$10.00 8.20
$10.00
$10.00 7.51
$10.00 6.83
$10.00 6.21
0 1 2 3 4 5 $37.91
McGraw-Hill Ryerson©
Years
Ordinary 10-34
10
Annuities
LO-3
McGraw-Hill Ryerson©
Ordinary 10-35
10 You have received two offers on a
Annuities building lot that you want to sell.
LO-3 Ms. Armstrong’s offer is
$25,000 down plus a
$100,000 lump sum payment
five years from now.
Mr. Belcher has offered $20,000 down plus
$5000 every quarter for five years.
Compare the economic values of the two offers
if money can earn 5% compounded annually.
McGraw-Hill Ryerson©
Ordinary 10-36
10 On what information
Annuities
ocu
should we focus?
The economic value of a payment stream
on a particular date (focal date)
refers to
a single amount
that is an
economic substitute for the payment stream
WE need to choose a focal date, and determine the
values of the two offers at that focal date.
(Obvious choices would be today, the date of the
offers, or the end of the term i.e. 5 years from now.)
McGraw-Hill Ryerson©
Preparing Time Lines
Ordinary Time Lines 10-38
10 $25,000 down plus a $100,000 lump sum payment
A
Annuities five years from now
B $20,000 down plus $5,000 every quarter for five years
Years
0 1 2 3 4 5
$25,000 Ms. Armstrong $100,000
$20,000 Mr.Belcher
$5000 every quarter
$20,000
$20,000
$20,000
$20,000
$20,000
McGraw-Hill Ryerson©
Ordinary 10-39
10
Annuities
Step 1–Determine today’s value of Ms. Armstrong’s offer
You have received
two offers on a today’s
today’s value
building lot that you PV= 103,352.62
78352.692 ofvalue
Ms. A’s
of
want to sell. Ms. lump sum
Armstrong’s offer is total offer
$25,000 down plus a
$100,000 lump sum 100,000
payment five years
from now. Mr. Belcher 1 5 5
has offered $20,000
down plus $5000 every 0
quarter for five years.
Compare the economic 25,000
values of the two offers
if money can earn 5%
compounded annually.
McGraw-Hill Ryerson©
Step 2…
Ordinary 10-40
10
Annuities Step 2 – Determine today’s value of Mr. Belcher’s offer.
You have received today’s value
today’s
two offers on a of Mr.of
value B’s
building lot that you P/Y
C/Y
PV == 79,376.93
99,376.93
410 lump sum
total offer
want to sell. Ms.
Armstrong’s offer is
$25,000 down plus a 5 0
$100,000 lump sum 4
payment five years 4500
from now. Mr. Belcher
has offered $20,000 20
down plus $5000 every 1
quarter for five years. 20000
Compare the economic
values of the two offers
if money can earn 5%
compounded annually.
McGraw-Hill Ryerson©
Ordinary 10-41
10
Annuities
Total Value
of each offer
McGraw-Hill Ryerson©
Ordinary Calculating the 10-42
10
Annuities
Original Loan
LO-4 and a Subsequent Balance
The required monthly payment on
a five-year loan, bearing 8% interest,
compounded monthly, is $249.10.
McGraw-Hill Ryerson©
Ordinary 10-43
10 Original Principal = PV of all 60 payments
Annuities
PMT = 249.10 FV = 0 n = 5*12 = 60 i = .08/12 c= 1
The required
monthly payment Original loan
on a five-year loan, PV = 12,285.220 value
bearing 8% interest,
compounded
monthly, is $249.10. 0 8
a) What was the
original principal 12
amount of the loan? 249.10
b) What is the
balance owed just 60
after the twentieth
payment?
McGraw-Hill Ryerson©
Ordinary Balance after 20 payments 10-44
10 = PV of 40 payments left
Annuities
PMT = 249.10 FV = 0 n = 60 - 20 = 40 i = .08
The required
monthly payment New loan
on a five-year loan, PV = 8,720.75 balance
bearing 8% interest,
compounded
monthly, is $249.10.
a) What was the
original principal 40
amount of the loan?
b) What is the
balance owed just We will leave it to you to do
after the twentieth
payment? the algebraic solution…!
McGraw-Hill Ryerson©
Ordinary 10-45
10
Annuities
LO-5
A Deferred Annuity
may be viewed as an
ordinary annuity
that does not begin until a
time interval
(named the period of deferral)
has passed
McGraw-Hill Ryerson©
Ordinary 10-46
10 Deferred Annuities
Annuities
d = Number of payment intervals
in the period of deferral
A Deferred
Annuity Two-step procedure to find PV:
may be viewed as
Calculate the present value, PV1,
an
of the payments at the end of the
ordinary annuity
period of deferral — this is just the
that does not begin
until a time PV of an ordinary annuity
interval Calculate the present value,
(named the period PV2, of the STEP 1 amount
of deferral) at the beginning of the period
has passed
of deferral
McGraw-Hill Ryerson©
Ordinary 10-47
10
Annuities
McGraw-Hill Ryerson©
Solve…
Ordinary Present Value 10-48
10 of a
Annuities Deferred Annuity
Step 1 – Determine PV of Annuity 10 months from now
0 10 11 12 13 14 Months
$500 $500 $500 $500
McGraw-Hill Ryerson©
Ordinary 10-49
10
Annuities
Using calculators…
McGraw-Hill Ryerson©
Ordinary 10-51
10
Annuities
McGraw-Hill Ryerson©
Ordinary 10-52
10
Annuities
McGraw-Hill Ryerson©
Ordinary 10-53
10
The 12
Annuities is a default
setting
Appears
automatically
McGraw-Hill Ryerson©
…Example
Ordinary 10-54
10
Annuities
Typical P/Y ==
C/Y 12.00
12.00
2.00
Canadian
Using 12
mortgage
Interest is
compounded
semi-annually 2
and
payments are
each month.
McGraw-Hill Ryerson©
…Example
Ordinary 10-56
10 Step 1 To determine the number of Interest
Annuities
c
periods per ompounding interval
i2 = (1+i)c - 1
Typical
Canadian i2 = (1+ .06/2).16666 -1
mortgage
6% Interest is
compounded 0.0049
1.0049
0.166666 = i2
semi-annually
and
payments are 1.03
each month. 1
Find C and i2.
McGraw-Hill Ryerson©
…another example
Ordinary 10-58
10
Annuities
Step 1 To determine the number of
compoundings
C = number of interest compoundings per year
Mortgage number of payments per year
5% interest
is 0.23076 = C
compounded
monthly
and 12 52
payments are
each week
Step 2 Use c to determine i2
McGraw-Hill Ryerson©
Ordinary 10-59
10 Step 2 Use c to determine i2
Annuities
i2 = (1+i)c - 1
Mortgage i2 = (1+ .05/12).2308 -1
5% interest
is
compounded 0.00096 = i2
1.0041667
0.230769
1.00096
0.0041667
monthly
and
0.05 12 1
payments are
each week
1
McGraw-Hill Ryerson©
…another example
Ordinary 10-60
10 Is the following a
Annuities General Annuity?
You decide to save $50/month for the next three years.
If you invest all of these savings in an account which will
pay you 7% compounded semi-annually,
determine the total in the account after 3 years.
Criteria
The payment interval
differs from
the compounding interval
0.00575
0.1666
1.00575
You decide to
save $50/month 2 12
for the next
three years. Step 2 Find i2 i2 = (1+i)c - 1
If you invest all
of these savings i2 = (1+ .07/2).1666-1
in an account
which will pay i2 = 0.00575
you 7%
compounded 1.035
semi-annually,
determine the 1
total in the
account after
3 years. Step 3 Use i2
McGraw-Hill Ryerson©
Ordinary 10-62
Step 3 Use i2 in the appropriate formula
10
Annuities Formula FV = PMT [ (1+ i)n - 1
i ]
You decide to PMT = 50 PV = 0 n = 3*12 = 36
save $50/month i = .07/2 c = 2/12 = .16666 i2 = 0.00575
for the next
three years.
If you invest all
of these savings 1.229255
0.229255
0.00575
1993.51
39.8702
1.00575
in an account
which will pay 1 36
you 7%
compounded
semi-annually, 1
determine the
total in the 50
account after
3 years.
McGraw-Hill Ryerson©
Solve…
Ordinary 10-63
10
Annuities
You decide to
save $50/month
for the next P/Y=== 1993.51
C/Y
FV 12
1220
three years.
If you invest all 12
of these savings 50 36
in an account
which will pay
you 7% 2 7 0
compounded
semi-annually,
determine the
total in the
account after
3 years.
McGraw-Hill Ryerson©
Ordinary 10-64
10
C = number of interest compoundings per year
Annuities number of payments per year
the value for c can be a repeating decimal
SAVE c in memory…
McGraw-Hill Ryerson©
Ordinary 10-65
10
Annuities
McGraw-Hill Ryerson©
Ordinary 10-66
10 Reid David made annual deposits of $1,000 to
Fleet Bank, which pays 6% interest compounded
Annuities annually. After 4 years, Reid makes no more
deposits. What will be the balance in the account
10 years after the last deposit?
Step 1 – Determine FV1 of Annuity 10 years from now
0 1 2 3 4 14 Years
$1000 $1000 $1000 $1000
Reid David
made annual value 14 years
deposits of $1,000 to FV == 7834.27
4374.62 from now
Fleet Bank,
that pays
6% interest 0
compounded
annually.
After 4 years, Reid 10
makes no more
deposits.
What will be the
balance in the
account
10 years after the
last deposit?
McGraw-Hill Ryerson©
Formula solution
Ordinary 10-69
10 Step 1 – Determine FV of Annuity 4 years from now
Annuities n -1
(1+ i)
Formula FV = PMT [ i ]
Reid David PMT = 1000 n = 4 i = 0.06 c = 1
made annual
deposits of $1,000 to
Fleet Bank,
that pays value at end
6% interest 0.262477
1.262477
4374.62 of 4 years
compounded
annually.
After 4 years, Reid 1.06 4
makes no more
deposits. 1 0.06
What will be the
balance in the
account 1000
10 years after the
last deposit? Step 2…
McGraw-Hill Ryerson©
Ordinary 10-70
10 Step 2 – Determine FV using compound interest
Annuities
Formula FV = PV(1 + i)n
Reid David made PV =4374.62 n = 10 i = 0.06
annual deposits of
$1,000 to Fleet Bank,
which pays value 14 years
6% interest 11.262477
0.262477
.1708477
4374.62
7834.27 from now
compounded
annually.
After 4 years, Reid
makes no more 1.06 10
deposits.
What will be the
balance in the account
10 years after the last
deposit?
McGraw-Hill Ryerson©
Ordinary 10-71
10
Annuities Step 1 – Determine FV of Annuity 4 years from now
value at end
How much P/Y
C/Y
C/Y 110
FV === 4386.52
365 of 4 years
more interest 1
will Reid
David 1000 4
accumulate
over the 14 365 6
years if his
0
account earns
6%
compounded
daily?
McGraw-Hill Ryerson©
Ordinary 10-72
10
Annuities
Step 2 – Determine FV in 10 years
using compound interest
value 14 years
How much P/Y
FV
FV== 4386.52
7992.37
36510 from now
more interest
will Reid
David
accumulate 0 3650
over the 14 365
years if his
account earns
6%
compounded
daily?
McGraw-Hill Ryerson©
Ordinary 10-73
10
Annuities
Interest
$7,992.37 $7,834.27
McGraw-Hill Ryerson©
Ordinary 10-74
10
Annuities
McGraw-Hill Ryerson©