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Chapter 11
Annuity
Practical Business Math Procedures, 14th Edition
Jeffrey Slater and Sharon Wittry
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Learning Unit Objectives
LU11-1: Annuities: Ordinary Annuity and Annuity
Due (Find Future Value)
1. Differentiate between contingent annuities and
annuities certain.
2. Calculate the future value of an ordinary annuity
and an annuity due.
LU 11-2: Present Value of an Ordinary Annuity
(Find Present Value)
3. Calculate the present value of an ordinary annuity.
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Compounding Interest (Future Value)
Annuity – A series of payments
Term of the annuity – The time from the
beginning of the first payment period to the end of
the last payment period
Future value of annuity – The future dollar
amount of a series of payments plus interest
Present value of an annuity – The amount of
money needed to invest today in order to receive a
stream of payments for a given number of years in
the future
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Classification of Annuities
Contingent annuities – have no
fixed number of payments (ending
date is not fixed in advance) but
depend on an uncertain event.
E.g. Life insurance payments,
retirement payments
Annuities certain – have a specific
stated number of payments (ending
date is fixed). E.g. Mortgage
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Classification of Annuities
Ordinary annuity – regular
deposits/payments made at the end of the
period (e.g. salary, stock dividends)
Annuity due – regular deposits/payments
made at the beginning of the period (e.g.
life insurance premiums, rent,
Example of Period Dates:
mortgage/housing loan)
End of Period Period Beginning of Period
Jan. 31 Monthly Jan. 1
June 30 Quarterly April 1
Dec. 31 Semiannually July 1
Dec. 31 Annually Jan. 1
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Future Value of an Annuity
of $1 at 8%
PERIOD 1
At end of period 1-the $1 is still
worth $1 because it was invested
at the END of the period
PERIOD 2
An additional $1 is invested. The
$2 is now worth $2.08. The $1
from period 1 earns interest but
not the $1 invested at the end of
period 2
PERIOD 3
An additional $1 is invested. The
$3 is now worth 3.25. Remember
the last dollar invested earns no
interest
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Future Value of Ordinary Annuity
= Periodic payment
= interest rate
= Term of
investment
period
= FV of annuity at
the end of
interest period
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Future Value of Ordinary Annuity
Thus, interest earned () from
investing in annuity is given
by:
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Future Value of Ordinary Annuity
Example 1
RM1000 is deposited every month for 2 years and 7 months at
an interest rate of 3% compounded monthly. What is the future
value of this annuity at the end of the investment period? How
much interest earned?
= RM1,000 ; = ;
RM32,191.09
Interest earned
= RM32,191.09 – (31 × 1000)
= RM1,191.09
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Future Value of Ordinary Annuity
Example 2
Find the amount of annuity and the interest earned when RM200 is
payable at the end of each month for 5 years if the interest rate offered
is 12% compounded monthly.
R = RM200 ; ;
] RM16,333.94
Interest earned
= RM16,333.93 – (60 × 200)
= RM4,333.93
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Future Value of Ordinary Annuity
Quick Check
1. RM500 is deposited every year for 2 years and 9 months
at an interest of 4% compounded annually. What is the
future value of this annuity at the end of the investment
period? How much interest is earned?
2. Find the future value and the interest earned for each
of the following annuities.
a) RM6,000 every year for 8 years at an interest rate of
12% compounded annually.
b) RM800 every month for 2 years 5 months at an interest
rate of 5% compounded monthly.
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Present Value of an Annuity of
$1 at 8%
This illustrates how much you would have to invest today if you
wanted to withdraw/deposit $1 at the end of each period shown. You
would have to invest $2.58 in the bank today at 8% interest.
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Present Value of Ordinary Annuity
= Periodic payment
= interest rate
= Term of
investment
period
= PV of annuity at
the end of
interest period
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Present Value of Ordinary Annuity
Thus, interest paid () from loan
in annuity is given by:
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Present Value of Ordinary Annuity
Example 3
Hana has to pay RM300 every month for 24 months to settle a
loan at an interest rate of 12% compounded monthly. Calculate
the original value of the loan and total interest that she has to
pay.
= RM300 ; = 12%/12 ; = 24
RM6,373.02
Interest paid
= (RM300 x 24) – RM6,373.02
= RM826.98
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Present Value of Ordinary Annuity
Example 4
You are considering purchasing a used car valued at RM150,000.
Through a financing plan, you need to make a down payment of
20% followed by 60 equal monthly payments. The interest
charged on the financing plan is 5% compounded monthly.
Calculate the monthly payment.
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Present Value of Ordinary Annuity
Example 5
What lump sum deposited today would be equivalent to equal
payments of RM650 at the end of each year for 9 years at 4%
compounded annually?
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Present Value of Ordinary Annuity
Quick Check
1. John wants to receive an RM8,000 annuity for 3 years.
Interest on the annuity is 8% annually. John will make
withdrawals at the end of each year. How much must John
invest today to receive a stream of payments for 3 years?
2. Jim Riles was in a car accident. He sued the person at fault
and was awarded a structured settlement in which an
insurance company will pay him RM600 at the end of each
month for the next seven years. How much money should
the insurance company invest now at 4.7%, compounded
monthly, to guarantee that all the payments can be made?
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