10-1

Ordinary
Ordinary

10

O
Ordinary A nnuities

Annuities
Annuities

Chapter 10
McGraw-Hill Ryerson

Ordinary
Ordinary

Terminology

10
Annuities
Annuities

10-2

Annuity

LO-1

- A series of equal payments at regular

intervals
Term of the Annuity
- the time from the beginning of the first payment period
to the end of the last payment period

Present Value
the amount of money needed to
invest today in order to
receive a series of payments
for a given number of years
in the future

Future Value
the future dollar amount of a
series of payments plus interest

Ordinary
Ordinary

10

Terminology

10-3

Annuities
Annuities

PMT is the amount of each payment in an annuity

PMT

is the number of payments in the annuity

payment interval is the time between

successive payments in an annuity
ordinary annuities are ones in which payments
are made
at the end of each payment
interval

Ordinary
Ordinary

10

Terminology

10-4

Annuities
Annuities

Suppose
you obtain
a personal
loan
to be
repaid by
48 equal monthly
payments

Term
48 months or 4years.

payment interval
1 month

ordinary annuities
first payment will be due 1 month after
you receive the loan,
i.e. at the end of the first payment
interval

Ordinary
Ordinary

10-5

Terminology

10
Annuities
Annuities

for an n-payment Ordinary Annuity

Payment interval

PMT

PMT

n-1

Interval
number

PMT PMT PMT

Term of the annuity

Ordinary
Ordinary

10
Annuities
Annuities

FutureValue
Value
Future
an
ofofan
OrdinarySimple
SimpleAnnuity
Annuity
Ordinary

10-6

LO-2 Assume that there are four(4) annual $1000 payments

with interest at 4%

$1000

$1000

3
$1000
n=1
n=2

n=3

4 Interval
number

$1000
$1000 (1.04)1
$1000 (1.04)2
$1000 (1.04)3

Sum = FV of annuity
the sum of the future values of all the payments

Ordinary
Ordinary

10
Annuities
Annuities

FutureValue
Value
Future
an
ofofan
OrdinarySimple
SimpleAnnuity
Annuity
Ordinary

10-7

Assume that there are four(4) annual $1000 payments

with interest at 4%
0

1
$1000

4 Interval
number
$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
2

FV of annuity = $1000 + $1000(1.04) + $1000(1.04)2 + $1000(1.04)3

= $1000 + $1040+ $1081.60 +$1124.86
= $4246.46

FutureValue
Value
Future
an
ofofan
OrdinarySimple
SimpleAnnuity
Annuity
Ordinary

Ordinary
Ordinary

10
Annuities
Annuities

10-8

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
$500

2
$500

4 Month

3
$500

$500

$500(1+.03/12)
$500(1+.03/12)2
$500(1+.03/12)3
Sum = FV of annuity

Result
Result
$ 500.00
501.25
502.50
503.76
$2,007.51

Ordinary
Ordinary

10
Annuities
Annuities

FutureValue
Value
Future
an
ofofan
OrdinarySimple
SimpleAnnuity
Annuity
Ordinary

10-9

Now imagine that you save $500 every month for the
next three years. Although the same logic applies, I
certainly dont want to do it this way!
Since your account was empty when you began
PV = 0
n = 3 yrs * 12 payments per year = 36 payments

Using the

Ordinary
Ordinary

10
Annuities
Annuities

the

FutureValue
Value
Future
an
ofofan
OrdinarySimple
SimpleAnnuity
Annuity
Ordinary

10-10

sum of the future values of all the payments

Formula
Formula

FV

= PMT [

(1+ i)n - 1

Ordinary
Ordinary

10

Solvingearlier
earlierQuestion
Question
Solving
usingAnnuities
Annuities
using

10-11

Annuities
Annuities

You vow to save $500/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.
Since your account was empty when you began

PV = 0
n = 4 payments
PMT = -500

Ordinary
Ordinary

10-12

FV Contributions
Contributions
FV

10

Contribution

10%Compounded
CompoundedAnnually
Annually
10%
FV $
FV
$10.00
14.64
$10.00

Annuities
Annuities

$10.00
$10.00

$10.00
$10.00

13.31

$10.00
$10.00

12.10

$10.00
$10.00

11.00
10.00

3
Years
Years

5 $61.05
$61.05

Ordinary
Ordinary

10
Annuities
Annuities

the

PresentValue
PresentValue
an
ofofan
OrdinarySimple
SimpleAnnuity
Annuity
Ordinary

10-13

sum of the present values of all the payments

Formula
Formula

PV

= PMT [

1-(1+ i)-n

PresentValue
Value
10-14
Present
an
ofofan
OrdinarySimple
SimpleAnnuity
Annuity
Ordinary
Assume that there are four(4) annual $1000
payments with interest at 4%

Ordinary
Ordinary

10
Annuities
Annuities

0
$1000 (1.04)-1
$1000 (1.04)

-2

$1000 (1.04)

-3

$1000 (1.04)
Sum = PV of annuity
-4

1
$1000
n=1

2
$1000

3
$1000

4 Interval

Number

$1000

n=2
n=3
n=4
the sum of the present values of all the
payments

Ordinary
Ordinary

10
Annuities
Annuities

PresentValue
Value
10-15
Present
an
ofofan
OrdinarySimple
SimpleAnnuity
Annuity
Ordinary
Assume that there are four(4) annual $1000
payments with interest at 4%

1
$1000
n=1

2
$1000

3
$1000

4 Interval

Number

$1000

$1000 (1.04)-1
n=2
$1000 (1.04)-2
n=3
$1000 (1.04)-3
n=4
$1000 (1.04)-4
PV of annuity
Sum = 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

Ordinary
Ordinary

10
Annuities
Annuities

PresentValue
Value
Present
an
ofofan
OrdinarySimple
SimpleAnnuity
Annuity
Ordinary

10-16

You overhear your friend saying the he is repaying a

loan at $450 every month for the next nine months.
The interest rate he has been charged is 12%
compounded monthly. Calculate the amount of the
loan, and the amount of interest involved.
Since you
you are
are making
making payments,
payments, not
not receiving
receiving them,
them, PMT
PMT == -450
450
Since
n = 9 payments Repaid 9 payments at $450 = $4,050

Interest
Interest -- use
use 12
12,, not
not .12
.12 when
when using
using financial
financial calculator
calculator
At the end of the loan, you dont owe any money, so FV = 0

Solve

10-17

Ordinary
Ordinary

10
Annuities
Annuities

Contribution of
Each Payment
to an
Annuitys
Present Value

Ordinary
Ordinary

10
Annuities
Annuities

PV
PV

PV Contributions
Contributions
PV

Contribution
$
9.09

$10.00
$10.00

8.20

$10.00
$10.00

$10.00
$10.00

7.51

$10.00
$10.00
$10.00
$10.00

6.83
$10.00
$10.00

10-18

3
Years
Years

6.21
5 $37.91
$37.91

Ordinary
Ordinary

10
Annuities
Annuities

LO-4

Calculating the
the
Calculating

10-19

Original Loan
Loan
Original

and aa Subsequent
Subsequent
and

Balance
Balance

The required monthly payment on

a five-year loan, bearing 8% interest,
compounded monthly, is $249.10.
a) What
What was
was the
the original
original principal
principal amount
amount of
of the
the loan?
loan?
a)
b) What
What isis the
the balance
balance owed
owed just
just after
after the
the twentieth
twentieth payment?
payment?
b)
Since you
you are
are borrowing
borrowing money,
money,you
you are
are looking
looking for
for PV
PV
Since
and
and FV
FV == 00 once
once you
you have
have repaid
repaid the
the loan!
loan!

yrs ** 12
12 payments
payments per
peryear
year == 60
60 payments
payments
nn == 55 yrs

Ordinary
Ordinary

10
Annuities
Annuities

PresentValue
Value
Present
ofofaa
DeferredAnnuity
Annuity
Deferred

10-20

Step 1 Determine PV of Annuity 10 months from now

10

11
$500

12
$500

13
$500

14 Months
$500

PVof the Annuity

PV
Step 22 -- Discount
Discount for
for10
10 months
months to
to get
get todays
todaysLoan
LoanValue
Value
Step
Hint: (Use Compound Discount)

Ordinary
Ordinary

10-21

10
Annuities
Annuities

Reid David made annual deposits of $1,000

to Fleet Bank, which pays
6% interest
compounded annually.
After 4 years, Reid makes no more
deposits.
What will be the balance in the account
10 years after the last deposit?

10-22

Ordinary
Ordinary

10

Reid David made annual deposits of $1,000 to

Fleet Bank, which pays 6% interest compounded
annually. After 4 years, Reid makes no more
deposits. What will be the balance in the account
10 years after the last deposit?

Annuities
Annuities

Step 1 Determine FV1 of Annuity 10 years from now

$1000

$1000

$1000

14 Years

$1000

FV11 of the Annuity

FV
Step 2 Determine FV using compound interest

FV22
FV

10-23

Ordinary
Ordinary

10
Annuities
Annuities

Interest
Interest
$7,992.37

$7,834.27