Professional Documents
Culture Documents
ANNT-F
ANNT-G
Annuities
ANNT-H
ANNT-Y
ANNT-A
ANNT-Z
ANNT-B
ANNT-C
ANNT-D
ANNT-E
ANNT-A
.................................................................. ANNT 3
Present value of an ordinary annuity .................................................... ANNT 3
Mathematics
Learning Centre
The Future Value of an ordinary annuity ............................................ ANNT 6
A
nn
ui
tie
s
Objectives ..............................
.................................................
................. ANNT 1
Sequences................................
.................................................
................ ANNT 2
Annuities ................................ Objectives
1. To understand the concept of an annuity.
2. To perform calculations involving annuity lump sums.
3. To perform calculations involving annuity payments.
4. To determine if an annuity is an annuity due or an ordinary annuity.
5. To do calculations on amortised loans.
ANNT 2
Annuities
ANNT-B
Sequences
number called the common ratio. The sequence 2, 4, 8, 16, 32, 64 is a geometric sequence
because any new value is found by multiplying the previous value by 2. The next term in this
sequence is 128 (i.e. 64x2).
Lets consider the Geometric Sequence 1, 3, 9, 27, 81, 243 The second term was determined
by multiplying the first term by 3 (3=1x3). The third term was found by multiplying the second
term by 3 (9=3x3). The fourth term was found by multiplying the third term by 3 (27 = 9x3) and
so on.
In this example the common ratio is 3. The common ratio is given the pronumeral r, the first
term is given the pronumeral a, therefore any sequence can be expressed as:
a, ar, ar 2 , ar 3 , ar 4 ,.........ar n1
For the geometric sequence 100, 110, 121, 133.1, 146.41,, the first term a is 100, the
common ratio r is110 100 1.1. It is important to note that 121 110 & 133.1 121 also
give 1.1.
For the geometric sequence where a =10 and r = 1.5, the sequence is 10, 15, 22.5, 33.75,
50.625
When the terms of a geometric sequence are added together
ie: a ar ar 2 ar 3 ......... ar n1 , this is called a Geometric Series.
An Annuity is simply a special type of Geometric Series.
ANNT 3
Annuities
ANNT C
Annuities
An annuity is a series of regular, equally spaced, payments over a defined period of time (often
called the term) at a constant rate of interest. The payments may occur weekly, fortnightly,
monthly, quarterly or yearly. Example of annuities includes: regular payments into a savings
account or superannuation fund, loan payments and periodic payments to a person from a
retirement fund. An Ordinary annuity is an annuity where the regular payment is made at the
end of the successive time periods. Another type of annuity, called an Annuity Due, will be
covered later in the module.
ANNT D
Present
0
R - periodic payment
Each repayment must be changed to its present value (see Finance module). Doing this and then
considering the sum of the series, the sum of the series is
1 (1 r )n
r
Where $ A is the present value of an ordinary annuity, $ R is the amount of each payment, r is
the rate per period (payment) and n is the number of periods (payments). An ordinary annuity is
an annuity where the payment is made at the end of the payment period.
A R
In this module, normal rounding will be used. However, be aware that financial institutions will
use a different method.
ANNT 4
Annuities
Examples ANNT-D1
1. Mr. and Mrs. Lyons wish to have an annuity for when their daughter goes to university.
They wish to invest into an annuity that will pay their daughter $1000 per month for 4
years. What is the present value of the annuity given that current interest rates are 8%
p.a?
0.08
0.00666667 per month, n 12 4 48 months .
12
This annuity is considered to be an ordinary annuity, that is, each payment will occur at the end
of the payment period.
The information given is: R 1000, r
A R
11 r
A 1000
r
1 (1 0.00666667)48
0.00666667
0.273079396
A 1000
0.00666667
A 40961.91
This means $40 961.91 invested now at 8% will provide $1000 per month for 4 years.
2.
Roger Little borrows $20 000 to buy a car. He wishes to make monthly payments for 4
years. The interest rate he is charged is 10.5% p.a. What is the size of each monthly
payment?
The lump sum of $20 000 is given at the beginning of the loan, this indicates it is the present
0.105
12
annuity is considered to be an ordinary annuity because each payment occurs at the end of the
payment period.
A R
R
R
11 r
r
Ar
1 (1 r ) n
20000 0.00875
1 (1 0.00875)48
R $512.07
This means Roger will pay $512.07 per month for 4 years to repay the loan.
ANNT 5
Exercise ANNT-D1
For each of the following situations, find the present value of the ordinary annuity
described.
1. $2000 per month for 5 years at a rate of 6% compounded monthly.
1
2. $5500 per quarter for 6 years at 5.6% compounded quarterly.
2
3. $150 per month for 3 years at 8% compounded semi-annually.
4. Joe wants to invest a lump sum of money now to cover a monthly commitment
of $100 over 5 years. If the lump sum is invested at 7.5% compounded monthly,
what amount will Joe invest?
ANNT 6
Annuities
ANNT E
Where regular payments are made with a lump sum at the end, the lump sum at the end is called
the Future Value of an annuity. A good example of this is a saving scheme where regular
payments are made to build to a lump sum at the end of a period of time. In business, this is
called a sinking fund. It is used to save for the future replacement of major capital items.
Future
Value ($)
0
R
1
R
8
R
9
R
10
R
The future value of an annuity is the value of all payments at the end of the term. It is given by
(1 r )n1
S R
r
the equation:
, where S is the future value of the ordinary annuity, R is the
periodic payment, r is the interest rate per period and n is the number of payments.
Examples ANNT E1:
George deposits $150 into a bank account at the end of the month for 5 years at a rate of
1.
7% compounded monthly.
(1 r )n 1
r
R 150, r 0.07 12 0.005833&
n 512 60
S R
S 150
S 150 71.59290091
S 10738.94
The future value of the annuity is $10 738.94
ANNT 7
Annuities
2. Wally is planning for his retirement 20 years away. When he retires he wants a lump
sum of $300 000. His financial advisor suggested that 5% p.a. was a suitable interest rate to
consider. How much will he have to pay per month into his retirement fund (assume ordinary
annuity).
(1 0.005833)601
0.005833&
Given: S 300000, r 0.05 12 0.00416, n 12 20 240
S R
(1 r )n1
r
Sr
R
(1 r )n 1
300000 0.00416&
R
(1.00416)2401
R 729.87
Wally will have to pay $729.87 per month until he retires in 20 years.
Exercise ANNT-E1
1. Find the future value of an annuity where $1200 is paid at the end of each year for 15
years at a rate of 7% compounded annually.
2. The ABC concreting company set up a sinking fund to assist in buying a new truck in 5
years time. They can only afford $3000 a quarter which is paid into a savings account
with an interest rate of 8% p.a. Assuming quarterly compounding, what will be the size
&
of the sinking fund after 5 years? (Assume ordinary annuity)
3. Colin invests $500 per month, paid into a savings account for 10 years. What is the
balance of the account at the end of the period assuming an interest rate of 7%
compounded monthly?
4. In 5 years, a printing machine is to &be replaced. A new machine is expected to cost
$33000. Assuming an annual interest rate of 8% compounded monthly, what will be the
size of each monthly payment?
ANNT 8
Annuities
11 r
1 r
Examples ANNT F1
1. A company wishes to deposit an amount of money into an account at the beginning of
each year for the next 5 years to purchase a new machine costing $50000. How much will each
yearly payment be if the current interest rate is 7.2%p.a?
This is a sinking fund scenario. It is an annuity due.
Given: n 5, r 0.072, S 50000
S D R1 r
SD r
1 r
50000 0.072
3600
R
0.445639816
R 8078.27
$8 078.27 is required at the beginning of the year for 5 years at 7.2% to have $50 000 in the
sinking fund at the end of 5 years.
ANNT 9
Annuities
2. Joe pays $250 rent per week at the beginning of each week. He is considering paying a
whole years rent in advance; given the interest rate is 5.2% p.a. How much is this amount?
This is a present value calculation. This is an annuity due situation.
Given: R 250, r 0.052 52 0.001, n 52
1rr
1 r11
1
AD R1 r
11.001
1 1.072
AD1.072
25051.001
0.001
AD 12674.28
Joe would have to pay $12 674.28 now to cover his rent for the year.
52
Exercise ANNT F1
1. Find the future value of an annuity due if $800 is paid into an account at the beginning of
each month for 5 years at a rate of interest of 5% p.a. compounded monthly.
2. Find the present value of an annuity if the periodic amount is $450 per quarter for 20
years at the rate of 4.5% p.a. compounded quarterly.
3. A company leases office space for a period of 12 months. The monthly rent of $2500 is
paid at the beginning of each month. If the company is to cover all rents with a single
lump sum at the beginning of the year and invests this at 6.3% p.a. how much will the
lump sum be?
ANNT 10
Annuities
ANNT G
Mixed Questions
Example ANNT G1
Kevin Smith won $820 000 in a lotto game. With this lump sum he purchases an annuity to give
him a monthly income for the next twenty years. The first payment occurs a month after the start
of the annuity. If the interest rate is 6.8% p.a. compounded monthly, calculate the amount of
each payment.
This is an ordinary annuity (The periodic payments occur at the end of the period.)
This annuity involves a present value (The lump sum is at the beginning of the term of the
annuity.)
The formula required is A R
1 (1 r ) n
r
ANNT 11
Presnt
uVealA
Ordinary Annuity
Annuities
1 (1 r )
A R
r
Annuity Due
n
11 r
Mathematics
Centre
AD R1 Learning
r
r
Futre
uVealS
n
n
0.068
0.005666& n 2012 240 1 r1
Information given is A 820000
(1 r r
)1
12
S R
S D R1 r
r
r
Rearranging the formula to make R the subject:
1 (1 r ) n
A R
r
Ar
R
1 (1 r ) n
820000 0.005666&
1 (1.005666)240
R $6259.38
Kevin will receive $6259.38 per month for 20 years.
R
Exercise ANNT G1
1. Sally borrows $10 000 to buy a car. If the interest rate charged is 10.5% p.a. calculate the
monthly repayment over the term of the loan, 5 years. The first payment is made a month
after the loan lump sum is advanced.
2. Brett wishes to set aside all his rent for one year. This money will be put into an account
paying 6.6% p.a. compounded monthly and his rent is $1040 per month. Rent is always
paid in advance. Calculate the amount Brett must deposit.
3. From the time Jane and Johns daughter was born, they decided to save for her university
education. Jane and John assume their daughter will require $1000 per month for her
four years of study, payments being made at the beginning of each month. If Jane and
John save for 18 years, calculate the amount they must save at the beginning of each
month. Assume 6% p.a. interest is compounded monthly. Hint: there are two annuities
here, calculate the lump sum required to fund the $1000 p.m. allowance first, then the
monthly amount the parents must save.
4. The PS Transport Company decide that they must start saving for a new vehicle in 5
years time. In an account that pays 5.4% p.a. compounded monthly they deposit a one
off payment of $20 000 and $500 at the end of each month. How much will they have at
the end of 5 years? (Hint: treat the two amounts separately, one is an annuity and the
other compound growth)
&
ANNT 12
Annuities
ANNT H
Amortization of Loans
The term amortization refers to loans where each payment is made up of principal and interest
components. An example of where amortization is commonly used is housing mortgage loans
which usually have a term of many years. Early in the term of the loan, the amount of principal
outstanding is large, hence the interest component of the loan is high and the amount paid off the
loan is small. As the loan progresses, the amount of principal paid each repayment increases and
the amount of interest decreases. The operation of the loan can be shown using an amortization
schedule.
Example ANNT H1
For this example, a loan of $100 000 is being considered over a term of 10 years at an interest
rate of 9%p.a. with monthly repayments. Repayments on loans are made at the end of the month
so this is an ordinary annuity. The lump sum is at the beginning of the annuity so the present
value formula is used.
The first step is to calculate the repayment amount of the loan.
0.09
12
A R
R
R
11 r
r
Ar
1 (1 r ) n
100000 0.0075
1 (1 0.0075)120
R $1266.76
The monthly repayment for this loan (annuity) is $1266.76 per month.
The amount of interest for the first month is $100000 0.0075 $750 , so the amount of principal
paid off the loan during the first month is $1266.76 - $750 = $516.76. So the balance of the loan
for the second month is $100000 - $516.76 = $99483.24, and this continues until the loan is paid
off after 10 years. The amortization schedule for the first six months of the loan is shown below.
ANNT 13
Annuities
The total amount of interest paid over the 10 years of the loan is calculated by calculating the
total paid in repayments 1201266.76 $152011.20 subtract the amount borrowed $100 000 to
give $52 011.20
The amount of principal outstanding at the beginning of the 25th month: At the beginning of
the 25th month, 24 payments have been made, resulting in 96 months left on the loan. Using the
present value of an annuity, the amount of principal outstanding is given by:
11 r
A R
r
11 .0075
A 1266.76
0.0075
A 86467.06
The amount of principal outstanding at the beginning of the 25th month (which is also the
balance at the end of the 24th month) is $86 467.06
96
Because this is the amount of principal outstanding at the beginning of the 25th month, the
$97377.15
Annuities
$730.33
$1266.76
ANNT 14
$536.43
$96 840.72
Exercise ANN-H1
1. Construct an amortization schedule for the following scenario: A loan of $1200 is repaid
ANNT 16
Annuities
TRIG-Y
Index
Topic
Amortization of Loans
Amortization Schedule
Annuities
Annuity Due
Future Value of an Ordinary Annuity
Future Value of an Annuity Due
Geometric Sequence
Geometric Series
Interest Paid
Ordinary Annuity
Periodic Payment
Present Value of an Ordinary Annuity
Present Value of an Annuity Due
Principal Outstanding
Sequence
Term
Page
ANNT
12
ANNT
12
ANNT
3
ANNT
3,
ANNT
8
ANNT 2
ANNT 2
ANNT 13
ANNT 2
ANNT 3
ANNT 3
ANNT 8
ANNT 13
ANNT
6
ANNT 2
ANNT
8
ANNT 3
ANNT 17
1(1 r)
A R
r
60
1(10.00625)
A100
0.00625
A10049.90530818
A 4990.53
1 (1 r)
A R
r
60
1 (1 0.005)
A 2000
0.005
A 2000 51.72556075
A 103451.12
1
6 years at 5.6%
2
compounded quarterly. Both n & i must be
2. $5500 per quarter for
expressed in quarters.
1
R 5500, n 6 4 26,
2
i 0.056 4 0.014
1(1 r)
A R
r
24
1(1 0.003)
A 41.50
0.003
A 41.5023.122934
A 959.60
1 (1 r )
A R
r
26
1 (1 0.014)
A 5500
0.014
A 5500 21.66802573
A 119174.14
R 150 6 900, n 3 3 6,
i 0.08 2 0.04
n
1 (1 r)
r
6
1 (1 0.04)
A 900
0.04
A 900 5.242136857
A 4717.92
A R
ANNT 17
A R
1 (1 r)
r
Ar
R n
1 (1 r)
25000 0.004375
R48
1 (1 0.004375)
109.375
R
0.189044389
R 578.57
The monthly payment will be $578.57
A 50000, n 10 4 40,
r 0.05 4 0.0125
Ar
R n
1 (1 r)
50000 0.0125
R40
1 (1 0.0125)
625
R
0.391586664
R 1596.07
The quarterly payment will be $1596.07.
ANNT 18
(1 r)1
r
15
(1.07)1
S 1200
0.07
S $30154.83
S R
(1 r)1
S R
r
120
(1.00583)&1
S 500
0.00583&
S $86542.40
(1 r )1
S R
r
(1 r)1
S R
r
20
(1.02)1
S 3000
0.02
S $72892.11
The company will have saved $72892.11 towards the
new truck.
Sr
n R
(1 r)1
220
R
0.489845649
R $449.12
ANNT 19
0.05
R 800, r 0.0041666,& n 512 60
12
(1 r)1
S R(1 r )
r
60
(1.0041666)&1
S 8001.0041666&
0.0041666&
S 54631.55
The future value of this annuity due is $54 631.55
0.045
R 450, r 0.01125, n 20 4 80
4
0.063
R 2500, r 0.00525, n 112 12
12
1 (1 r )
A R(1 r )
r
80
1 (1.01125)
A 4501.01125
0.01125
A 23921.41
1 (1 r )
A R(1 r )
r
A 25001.00525
1 (1.00525)
0.00525
12
A 29153.10
The company must invest $29 153.10 to cover rent
for the entire year.
ANNT 20
A R
1 (1 r )
r
Ar
R n
1 (1 r )
10000 0.00875
R60
1 (1.00875)
R 214.94
Sally will pay $214.94 per month.
1 (1 r )
AD R(1 r )
r
1 (1.005)
AD 10001.005
48
0.005
AD 42793.22
(1 r)1
r
S R(1 r)
Sr
n
(1 r)(1
r ) 1
42793.22 0.005
216
1.005[(1.005)1]
R 109.93
1 (1 r )
AD R(1 r )
r
AD 10401.0055
1 (1.0055)
0.0055
AD 12111.31
Brett must deposit $12 111.31
60
R 500, r 0.0045, n 60
n
(1 r ) 1
r
60
(1.0045) 1
S 500
0.0045
S 34352.36
Altogether, there will be $60 535.79 available to
purchase a new vehicle.
S R
ANNT 21
Exercise ANN H1
1. Construct an amortization schedule for the following scenario: a loan of $1200 is repaid by 6 quarterly
payments, interest is 10% compounded quarterly.
To do this a repayment figure is required. This scenario involves the present value of an ordinary annuity.
R 1200,
A R
R
R
i 0.10 4 0.025, n 6
1 (1 r ) n
r
Ar
1 (1 r ) n
1200 0.025
1 (1.025)6
R 217.86
Quarter
1
2
3
4
5
6
Beginning Principal
1200
1012.14
819.58
622.21
419.91
212.55
Interest
0.025x 1200=30
0.025x1012.14=25..30
0.025x819.58=20.49
0.025x622.21=15.56
0.025x419.91=10.50
0.025x212.55=5.31
Payment
217.86
217.86
217.86
217.86
217.86
217.86
End Principal
1200-187.86=1012.14
1012.14-192.56=819.58
819.58-197.37=622.21
622.21-202.30=419.91
419.91-207.36=212.55
212.55-212.55=0
2. John and Joanne take out a mortgage housing loan for $250 000 over 20 years at an interest rate of 8% p.a.
with monthly payments. Calculate the size of each payment.
A loan like this is an example of an ordinary annuity with a present value (the amount borrowed).
A 250000, r
A R
R
R
0.08
0.00666,& n 2012 240
12
1 (1 r ) n
r
Ar
1 (1 r ) n
250000 0.00666&
1 (1.00666)&240
R 2091.10
3. John and Joannes interest rate (from question 2) has just been increased to 9%, by how much will their
payments increase by so they can still repay the loan after 20 years?
A 250000, r
A R
R
R
0.09
0.0075, n 2012 240
12
1 (1 r ) n
r
Ar
1 (1 r ) n
250000 0.0075
1 (1.0075)240
R 2249.31
The new monthly repayment is $2249.31, an increase of $158.21
ANNT 22
4. A $45 000 mortgage loan for 25 years for home additions is obtained at a rate of 7.75% repaid in monthly
repayments. Find
(a) The monthly repayment: A loan like this is an example of an ordinary annuity with a present value (the
amount borrowed).
A 45000, r
A R
R
R
0.0775
12
1 (1 r ) n
r
Ar
1 (1 r ) n
45000 0.0064583&
1 (1.0064583)300
R 290.62
(b) The principal outstanding at the beginning of the 36th month.
At the beginning of the 36th month,35 payments have been made, so there are 300-35=265 months remaining.
1 (1 r ) n
A R
r
1 (1 0.0064583)265 The principal outstanding at the beginning of
2
9
0.
6
2
A 36827.42
(c) The interest in the 36th payment.
Interest for the 36th payment is
A150000, r
A R
R
R
0.06
12
1 (1 r ) n
r
Ar
1 (1 r ) n
150000 0.005
1 (1.005)240
R 1074.65
Each repayment will be $1074.65
ANNT 23
&
&
(b) After 10 years, Marilyn receives a lump sum payout of $30 000 after being made redundant from her
university position. She decides to pay this off the principal of the loan. She also decides to shorten the term of
the loan to just 5 more years (15 in total).
What will the size of the new repayments be?
After 10 years (120 months) the $30 000 is paid off the principal of the loan, therefore the lump sum is paid off
during the 121st payment. The outstanding principal at the end of the 121st month, which is the same as the
outstanding principal at the beginning of the 122nd month. After the 121st month, there are 240-121 = 119
months remaining
1 (1 r ) n
A R
A 1074.65
1 (1 0.005)119
0.005
A 96206.77
The balance of the loan at the end of the 121st month (beginning of the 122nd month) is $96 206.77 .
Because $30 000 is paid off the loan during the 121st month, the new principal outstanding will be $96206.77 $30 000 = $66 206.77 .
If the loan is now shortened to 4 years 11 months at the beginning of 122 nd month, a new repayment figure can
be calculated.
A 66206.77, r
A R
R
R
0.06
0.005, n 59
12
1 (1 r ) n
r
Ar
1 (1 r ) n
66206.77 0.005
1 (1.005)59
R 1298.57
The new repayment figure is $1298.57
ANNT 24