Handout # 01: Time Value of Money

1. Annuity definition

A simple annuity definition is that it is an amount of cash that you receive for money invested.
Annuity means a specified amount of money that is paid during specific intervals.

Annuity Due
An annuity can be paid at the beginning of the term. This means that you will receive your payment at
the beginning of each period. The period can be monthly, quarterly, annually, etc.

Why is it called due? This refers to the payment being made immediately (due) as opposed to the
end of the period. (Compare with ordinary annuity.). To be simple about it: When you put some
money into your bank in return for interest, the interest normally occurs at the end of the period.
However, with a due annuity, you can receive the payment at the beginning instead. This may
have its advantage if you cannot wait for the end of the quarter, year, etc., for your payment.
You will usually receive less interest by having the payment up front. So it depends on your
specific needs to determine if this is the most beneficial for you.

Ordinary Annuity
It can be paid at the end of each term. In other words, it means that you will receive your payment at
the end of each period. The period can be monthly, quarterly, annually, etc.

Why is it called ordinary? To be simple about it: When you put some money into your bank in
return for interest, when does the interest record? At the end of the period, right? And that
is ordinary, right? If your annuities agreement specifies that you will be paid every quarter, then
your payments will come at the end of each quarter.

2. FV annuity:
Future Value Annuity: What is your annuity worth when it matures? As you are putting in
money on a regular basis, with interest, what is the final amount you will have at the end? The
future value annuity can be used to calculate the end result of your savings, investments, and
other monies that are coming to you. Again, as there is interest involved, it is free to know what
you will finally end up with.
Example 1
Let's say that you are paying Tk.10,000 a year into a 10 year annuity at 8% interest.
Your Tk.10,000 at 8% interest for 10 years gives you Tk.144,865.62 at the end of the term.

Example 2
Let's say you plan to put Tk.25 a month into your savings for 5 years. What will that give you if
the expected interest is 3%?
Tk.25 for 12 months = Tk.300.
You will have saved Tk.1,592.74
Note: This amount can change depending on when, and how often, the interest on your funds is
compounded.
Example 3
Such as, how to get Tk.10,000 in your account at the end of 5 years. And let's say the account
gets 4% interest compounded annually. How much do you deposit each month?

8190/(12x5) = 136.5

3. PV annuity: The present value of an annuity is less than the future value. Thus it is important
to know what an annuity is worth in today's dollars. Interest and inflation are the factors that
cause the money today, to be worth less tomorrow. The present value annuity can be used to
determine the value of your lease, car payments, loans, investments, sales deals, etc. As the
payments have interest added to them, it is important to your financial planning to know what is
the value of your deal or purchase.

Example 1
Let's say that you were paying Tk.10,000 a year into a 10 year annuity. Let's pick an 8% interest
rate, fixed.
Merely go to our present value annuity table. The number in 10 periods (10 years) at 8%
(interest) = 6.7101
Tk.10,000 x 6.7101 = Tk.67,101. That is what your annuity is worth today.
However, in actuality, in the next 10 years you put in Tk.100,000 (not to mention the interest).
Your Tk.10,000 at 8% interest for 10 years gives you Tk.144,865.62 at the end of the term.

Example 2
Let's say you have Tk.10,000 that you can use to pay off on a loan. How much can you borrow
for 6 years at 10%?
Go to the present value annuity table and you will find 4.3553 at 6 periods and 10%.
Tk.10,000 x 4.3553 = Tk.43,553. That is how much you can borrow.
Note: This number can change depending on how the interest is compounded.

Example 3
Let's say you made a deal to sell your car for Tk.15,000 for the next 3 years. And let's say that
the going interest rate is 6%. What is the value of the deal you were offered?
Go the present value annuity table and you will find 2.6730 at 3 periods and 6%.
Tk.15,000 x 2.6730 = Tk.40,095. That is the value of your deal.