10-1

Ordinary
Ordinary

10

O
Ordinary A nnuities

Annuities
Annuities

Chapter 10
McGraw-Hill
McGraw-HillRyerson
Ryerson

Ordinary
Ordinary

10
Annuities
Annuities

Learning Objectives

After completing this chapter, you will be able to:

LO-1

Define and distinguish between

ordinary simple annuities and ordinary
general annuities

Calculate the
LO-2 Future Value and Present Value of
ordinary simple annuities
LO-3

McGraw-Hill Ryerson

fair market

value of a cash flow stream

that includes an annuity

10-2

Ordinary
Ordinary

10
Annuities
Annuities

Learning Objectives
Calculate the

LO-4

principal

LO-5

LO-6

McGraw-Hill Ryerson

balance owed on a loan

immediately after any payment

Present Value of and period of deferral

of a deferred annuity
Future Value and Present Value of
ordinary general annuities

10-3

10-4

Ordinary
Ordinary

Terminology

10
Annuities
Annuities

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
McGraw-Hill Ryerson

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

Ordinary
Ordinary

10

10-5

Terminology

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
McGraw-Hill Ryerson

Ordinary
Ordinary

10

10-6

Terminology

Annuities
Annuities

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

McGraw-Hill Ryerson

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

10-7

Ordinary
Ordinary

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

McGraw-Hill Ryerson

10-8

Ordinary
Ordinary

10
Annuities
Annuities

Ordinary Annuity

Ordinary
Ordinary
impleA
Annuities
nnuities
SSimple
The payment
payment interval
interval
The

==

Ordinary
Ordinary
General
eneralA
Annuities
nnuities
G
The payment
payment interval
interval
The
differs from
from
differs

the compounding
compounding
the
interval
interval
Monthlypayments,
payments,
Monthly

andinterest
interestisis
and
compoundedmonthly
monthly
compounded
McGraw-Hill Ryerson

the compounding
compounding interval
interval
the
Monthlypayments,
payments,
Monthly
butinterest
interestisis
but
compoundedsemi-annually
semi-annually
compounded

Ordinary
Ordinary

10
Annuities
Annuities

10-9

FutureValue
Value
Future
an
ofofan
OrdinarySimple
SimpleAnnuity
Annuity
Ordinary

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
McGraw-Hill Ryerson

Ordinary
Ordinary

10
Annuities
Annuities

FutureValue
Value
Future
an
ofofan
OrdinarySimple
SimpleAnnuity
Annuity
Ordinary

10-10

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
McGraw-Hill Ryerson

FutureValue
Value
Future
an
ofofan
OrdinarySimple
SimpleAnnuity
Annuity
Ordinary

Ordinary
Ordinary

10
Annuities
Annuities

10-11

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
McGraw-Hill Ryerson

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

10-12

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
McGraw-Hill Ryerson

Ordinary
Ordinary

10
Annuities
Annuities

10-13

FutureValue
Value
Future
an
ofofan
OrdinarySimple
SimpleAnnuity
Annuity
Ordinary

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.

12

Note
Note
Keys direction

FV
P/Y==
3

18810.28
120
36

500

McGraw-Hill Ryerson

Using the
the formula
formula
Using

Ordinary
Ordinary

10
Annuities
Annuities

the

sum of the future values of all the payments

Formula
Formula

McGraw-Hill Ryerson

10-14

FutureValue
Value
Future
an
ofofan
OrdinarySimple
SimpleAnnuity
Annuity
Ordinary

FV

= PMT [

(1+ i)n - 1

Ordinary
Ordinary

10
Annuities
Annuities

FutureValue
Value
Future
an
ofofan
OrdinarySimple
SimpleAnnuity
Annuity
Ordinary

10-15

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.

n
FV = PMT (1+ i) - 1
i

18810.28
37.6206
1.0025
0.0941
0.0025
1.0941

12

.03

1
1
500
McGraw-Hill Ryerson

]
36

Ordinary
Ordinary

10

Solvingearlier
earlierQuestion
Question
Solving
usingAnnuities
Annuities
using

10-16

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

McGraw-Hill Ryerson

10-17

Ordinary
Ordinary

10
Annuities
Annuities

CashFlows
Flows
Cash
..a term
term that
that refers
refers to
to payments
payments
..a
that can
can be
be either
either

that
payments received
e.g. receipts

Positives
Positives

++

McGraw-Hill Ryerson

Treated as:
as:
Treated

payments made
e.g. cheques

Negatives
Negatives

--

Therefore
Therefore

10-18

Ordinary
Ordinary

Cash Flow Sign Convention

10
Annuities
Annuities

Therefore
Therefore
when you are making payments,
or even making deposits to
savings,
these are cash outflows,

Really
Really
payments to
to
payments
the bank!
bank!
the

and therefore
the values must be negative!
Using the
McGraw-Hill Ryerson

Ordinary
Ordinary

10
Annuities
Annuities

FutureValue
Value
Future
an
ofofan
OrdinarySimple
SimpleAnnuity
Annuity
Ordinary
PV = 0 n = 4 payments PMT -500

10-19

3
Youvow
vowto
tosave
save
0
You
12
$500/monthfor
forthe
the
$500/month
FV = 2007.51
next
four
months,
next four months,
500
with
your
first
with your first
depositone
onemonth
month
deposit
fromtoday.
today.
from
4
If
your
If your
savingscan
canearn
earn
savings
We already
already have
have
We
3%converted
converted
3%
these from
from before,
before, so
so
these
monthly,determine
determine we dont have to enter
monthly,
have to enter
thetotal
totalin
inyour
your we dont
the
them again!
again!
them
account
four
account four
monthsfrom
fromnow.
now.
months
Formula solution
solution
Formula
McGraw-Hill Ryerson

Ordinary
Ordinary

10
Annuities
Annuities

10-20

Youvow
vowtotosave
save$500/month
$500/monthfor
forthe
thenext
next
You
fourmonths,
months,with
withyour
yourfirst
firstdeposit
deposit
four
onemonth
monthfrom
fromtoday.
today.IfIfyour
yoursavings
savingscan
can
one
earn3%
3% converted
convertedmonthly,
monthly,determine
determinethe
the
earn
totalin
inyour
youraccount
accountfour
fourmonths
monthsfrom
fromnow.
now.
total
n
(1+
i)
-1
Formula
FV
=
PMT
Formula

PMT = $500

n= 4
i = .03/12
= 0.0025

2007.51
4.0150
0.0100
1.0100
1.0025
0.0025
.03

12
1
1
500

McGraw-Hill Ryerson

Ordinary
Ordinary

10

Not seeing the total picture!

Annuities
Annuities

When you use formula or a

calculators financial functions to
calculate an annuitys
Future Value,

the amount
each payment
contributes to the future value
is
NOT apparent!
McGraw-Hill Ryerson

10-21

Ordinary
Ordinary

10-22

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

0
McGraw-Hill Ryerson

3
Years
Years

5 $61.05
$61.05

Ordinary
Ordinary

10
Annuities
Annuities

FutureValue
Value
Future
an
ofofan
OrdinarySimple
SimpleAnnuity
Annuity
Ordinary

10-23

You decide to save $75/month for the next four years.

If you invest all of these savings in an account
which
will pay you 7% compounded monthly,
determine:
a) the total in the account after 4 years
b) the amount you deposited
c) the amount of interest earned

Extract necessary data...

PMT = - $75
=7
= 12 n = 4 * 12 = 48
PV = 0
FV = ?
Total Deposits = $75* 48 = $3,600

Solve
McGraw-Hill Ryerson

10-24

Ordinary
Ordinary

10
Annuities
Annuities

Youdecide
decideto
tosave
save
You
$75/monthfor
forthe
the
$75/month
nextfour
fouryears.
years.
next
youinvest
invest
IfIfyou
allof
ofthese
thesesavings
savings
all
inan
anaccount
accountwhich
which
in
willpay
payyou
you7%
7%
will
compounded
compounded
monthly,determine:
determine:
monthly,
a)the
thetotal
totalin
inthe
the
a)
accountafter
after44years
years
account
b)the
theamount
amountyou
you
b)
deposited
deposited
theamount
amount
c)c)the
ofinterest
interestearned
earned
of

McGraw-Hill Ryerson

FV
P/Y==
7
12

4140.69
12
48
75

FV.. $4,140.69
Deposits... 3,600.00
Interest Earned = $ 540.69
Formulasolution
solution
Formula

Ordinary
Ordinary

10

Formula FV = PMT
Formula

Annuities
Annuities

Youdecide
decideto
tosave
save
You
$75/monthfor
forthe
the
$75/month
nextfour
fouryears.
years.
next
youinvest
invest
IfIfyou
allof
ofthese
thesesavings
savings
all
inan
anaccount
accountwhich
which
in
willpay
payyou
you7%
7%
will
compounded
compounded
monthly,determine:
determine:
monthly,
a)the
thetotal
totalin
inthe
the
a)
accountafter
after44years
years
account
b)the
theamount
amountyou
you
b)
deposited
deposited
theamount
amount
c)c)the
ofinterest
interestearned
earned
of

McGraw-Hill Ryerson

(1+ i)n - 1
i

10-25

1.005833
0.005833
55.20924
0.32205
1.32205
4140.6927
.07

12

48

1
75
FV $4,140.69 - Deposits 3,600.00

= Interest Earned $540.69

Ordinary
Ordinary

10
Annuities
Annuities

the

10-26

PresentValue
PresentValue
an
ofofan
OrdinarySimple
SimpleAnnuity
Annuity
Ordinary

sum of the present values of all the payments

Formula
Formula

McGraw-Hill Ryerson

PV

= PMT [

1-(1+ i)-n

PresentValue
Value
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

McGraw-Hill Ryerson

1
$1000
n=1

2
$1000

3
$1000

10-27

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
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

10-28

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
McGraw-Hill Ryerson

Ordinary
Ordinary

10
Annuities
Annuities

PresentValue
Value
Present
an
ofofan
OrdinarySimple
SimpleAnnuity
Annuity
Ordinary

10-29

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
McGraw-Hill Ryerson

Solve

10-30

Ordinary
Ordinary

10
Annuities
Annuities

PV = 3,918.24
Youoverhear
overhearyour
your
You
friendsaying
sayingthe
the
friend
heisisrepaying
repayingaa
he
loanat
at$450
$450every
every
loan
monthfor
forthe
thenext
next
month
ninemonths.
months.
nine
Theinterest
interestrate
ratehe
he
The
hasbeen
beencharged
chargedisis
has
8%compounded
compounded
8%
monthly. Calculate
Calculate
monthly.
theamount
amountof
ofthe
the
the
loan,and
andthe
the
loan,
amountof
ofinterest
interest
amount
involved.
involved.

McGraw-Hill Ryerson

12

450

Amount Borrowed (PV) $ 3,918.24

Repaid.. 4,050.00
Interest Paid = $

131.76

Formula solution
solution
Formula

Ordinary
Ordinary

10

PV = PMT

Formula
Formula

Annuities
Annuities

1-(1+ i)-n
i

10-31

-0.0580479
1.006667
0.006667
3,918.24
0.94195
Youoverhear
overhearyour
your
You
friendsaying
sayingthe
the
friend
heisisrepaying
repayingaa
he
loanat
at$450
$450every
every
loan
monthfor
forthe
thenext
next
month
ninemonths.
months.
nine
Theinterest
interestrate
ratehe
he
The
hasbeen
beencharged
chargedisis
has
8%compounded
compounded
8%
monthly. Calculate
Calculate
monthly.
theamount
amountof
ofthe
the
the
loan,and
andthe
the
loan,
amountof
ofinterest
interest
amount
involved.
involved.

McGraw-Hill Ryerson

.08

12

1
450
Repaid $4,050.00 - Borrowed $3,918.24

= Interest Charged $131.76

10-32

Ordinary
Ordinary

10
Annuities
Annuities

Contribution of
Each Payment
to an
Annuitys
Present Value
McGraw-Hill Ryerson

Ordinary
Ordinary

10
Annuities
Annuities

PV
PV

PV Contributions
Contributions
PV

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

McGraw-Hill Ryerson

Contribution
$
9.09

$10.00
$10.00

10-33

3
Years
Years

6.21
5 $37.91
$37.91

Ordinary
Ordinary

10-34

10
Annuities
Annuities

LO-3

of a cash flow

McGraw-Hill Ryerson

stream that includes an annuity

Ordinary
Ordinary

You have received two offers on a

building lot that you want to sell.
Annuities
Annuities

10-35

10

LO-3

Ms. Armstrongs 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
Ordinary

10
Annuities
Annuities

On what
what information
information
On
ocuwe
should
we
should
ocus?
The economic value
of a payment stream
ffocus?

10-36

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

Back to
to Offer
OfferComparison
Comparison
Back

10-37

Ordinary
Ordinary

10
Annuities
Annuities

You have received two offers on a building lot that

you want to sell. Ms. Armstrongs 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.

Ms. Armstrong
$25,000 down

Mr. Belcher
$20,000 down

plus a $100,000 lump

plus $5000 every quarter
sum payment
for five years
five
years from now
Focal Date:
Date: Today
Today
Focal
Preparing Time Lines

McGraw-Hill Ryerson

Time Lines

Ordinary
Ordinary

10
Annuities
Annuities

A $25,000 down plus a $100,000 lump sum payment

A
five years from now
BB $20,000 down plus $5,000 every quarter for five years

Years

$25,000

Ms. Armstrong

$20,000

Mr.Belcher
$5000 every quarter

$20,000
$20,000
$20,000
$20,000
$20,000
McGraw-Hill Ryerson

10-38

5
$100,000

10-39

Ordinary
Ordinary

10
Annuities
Annuities

Step 1Determine todays value of Ms. Armstrongs offer

You have received

two offers on a
building lot that you
want to sell. Ms.
Armstrongs 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

PV= 103,352.62
78352.692

todays
value
todays
todays
value
todays
ofMs.
Ms.
As
value
of
of
As
value
of
lump
sum
total
offer
lump
sum
total
offer

100,000
1

0
25,000
Step2
2
Step

10-40

Ordinary
Ordinary

10
Annuities
Annuities

Step 2 Determine todays value of Mr. Belchers offer.

You have received

two offers on a
building lot that you
want to sell. Ms.
Armstrongs 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

P/Y
C/Y
PV == 79,376.93
99,376.93
410

5
4500

20
1

20000

todays
value
todays
value
todays
todays
of
Mr.Bs
Bs
value
of
ofvalue
Mr.
of
total
lumpsum
sum
total
lump
offer
offer

10-41

Ordinary
Ordinary

10
Annuities
Annuities

TotalValue
Value
Total
eachoffer
offer
ofofeach
Ms. Armstrong
Mr.Belcher

$103,352.62
99,376.93

Difference in Offers $

3,975.69

Better off accepting Ms. Armstrongs offer!

McGraw-Hill Ryerson

Ordinary
Ordinary

10
Annuities
Annuities

LO-4

Calculating the
the
Calculating

10-42

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
McGraw-Hill Ryerson

10-43

Ordinary
Ordinary

10
Annuities
Annuities

Original Principal = PV of all 60 payments

PMT = 249.10 FV = 0

The required
required
The
monthly payment
payment
monthly
on aa five-year
five-yearloan,
loan,
on
bearing 8%
8% interest,
interest,
bearing
compounded
compounded
monthly, isis $249.10.
$249.10.
monthly,
a) What
What was
was the
the
a)
original principal
principal
original
amount of
of the
the loan?
loan?
amount
b) What
What isis the
the
b)
balance owed
owed just
just
balance
afterthe
the twentieth
twentieth
after
payment?
payment?
McGraw-Hill Ryerson

n = 5*12 = 60 i = .08/12

Originalloan
loan
Original
value
value

PV = 12,285.220

0
12

249.10
60

c=

Ordinary
Ordinary

10
Annuities
Annuities

10-44
Balance after 20 payments
= PV
of 40
PMT = 249.10
FV payments
= 0 n = 60left
- 20 = 40 i = .08

The required
required
The
monthly payment
payment
monthly
on aa five-year
five-yearloan,
loan,
on
bearing 8%
8% interest,
interest,
bearing
compounded
compounded
monthly, isis $249.10.
$249.10.
monthly,
a) What
What was
was the
the
a)
original principal
principal
original
amount of
of the
the loan?
loan?
amount
b) What
What isis the
the
b)
balance owed
owed just
just
balance
afterthe
the twentieth
twentieth
after
payment?
payment?
McGraw-Hill Ryerson

PV =

8,720.75

Newloan
loan
New
balance
balance

40
We will
will leave
leave itit to
to you
you to
to do
do
We
the algebraic
algebraic solution!
solution!
the

10-45

Ordinary
Ordinary

10
Annuities
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

10-46

Ordinary
Ordinary

10

Deferred Annuities

Annuities
Annuities

d = Number of payment intervals

Deferred
AADeferred

Annuity
Annuity

maybe
beviewed
viewedas
as
may
an
an

ordinaryannuity
annuity
ordinary
thatdoes
doesnot
notbegin
begin
that
untilaatime
time
until
interval
interval
(namedthe
theperiod
period
(named
deferral)
ofofdeferral)
haspassed
passed
has

McGraw-Hill Ryerson

in the period of deferral

Two-step procedure
procedure to
to find
find PV:
PV:
Two-step
Calculate the present value, PV1,
of the payments at the end of the
period of deferral this is just the
PV of an ordinary annuity
Calculate the present value,
PV2, of the STEP 1 amount
at the beginning of the period
of deferral

10-47

Ordinary
Ordinary

10
Annuities
Annuities

your
yourfriend
friendsaying
sayingthe
thehe
heisisrepaying
repayingaaloan
loanat
at$450
$450every
every

monthfor
forfour
fourmonths.
months. The
Theinterest
interestrate
ratehe
hehas
hasbeen
beencharged
chargedisis
month
8%compounded
compoundedmonthly.
monthly. Calculate
Calculatethe
theamount
amountof
ofthe
theloan,
loan,and
and
8%
theamount
amountof
ofinterest
interestinvolved.
involved.
the
thissame
samefriend
frienddoesnt
doesntbegin
begintotorepay
repayhis
hisloan
loan
this
foranother
another11
11months,
months,atataarate
rate$500
$500every
every
for
month
forfour
fourmonths.
months. The
Theinterest
interest
month
for
rateisisstill
still8%
8%
compoundedmonthly.
monthly.
rate
compounded
Determinethe
thesize
sizeof
ofthe
theloan
loan. .
Determine
McGraw-Hill Ryerson

Solve

Ordinary
Ordinary

10
Annuities
Annuities

10-48

PresentValue
Value
Present
ofofaa
DeferredAnnuity
Annuity
Deferred

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)

McGraw-Hill Ryerson

10-49

Ordinary
Ordinary

10
Annuities
Annuities

thissame
samefriend
friend
this
doesntbegin
begintoto
doesnt
repayhis
hisloan
loan
repay
for
for
another11
11months,
months,
another
rate$500
$500
atataarate
everymonth
month
every
forfour
four
for
months. The
The
months.
interestrate
rateisisstill
still
interest
8%
8%
compounded
compounded
monthly.
monthly.
Determinethe
thesize
size
Determine

McGraw-Hill Ryerson

PV
PV =
FV

0
12

loan
value
value
10
months
loan
value
value
10
months
today
fromnow
now
today
from

- 1967.11
1840.65
8

500

4
0

10

10-50

Ordinary
Ordinary

10
Annuities
Annuities

LO-6

The payment
payment interval
interval
The
differs from
from
differs
the compounding
compounding interval
interval
the

e.g. A typical Canadian mortgage has

Monthly payments,
but the interest is
compounded semi-annually

McGraw-Hill Ryerson

Usingcalculators
calculators

Using

10-51

Ordinary
Ordinary

10
Annuities
Annuities

Forthose
thosewho
whoare
areusing
using
For
thistype
typeof
ofcalculator,
calculator,
this
theC/Y
C/Y
the

See
following
REVIEW

worksheet
worksheet

willnow
nowbe
beused
used
will

Forthose
thosewho
whoare
areusing
usingaa
For
non-financialcalculator,
calculator,
non-financial

newformulae
formulae
new

willbe
beadded
addedtotofind
find
will
thesolution
solution
the
McGraw-Hill Ryerson

See
following

Ordinary
Ordinary

10-52

10
Annuities
Annuities

We can input the number of

compoundings per year into the
financial calculator.
This can be performed by using
the symbol
To access this symbol use:

and you will see

McGraw-Hill Ryerson

10-53

Ordinary
Ordinary

10
Annuities
Annuities

This display is referred to as the worksheet.

The12
12
The
isisaa
default
default
setting
setting

represents the number of Payments per Year

represents the number of Compoundings per Year
To access
use:

Appears
Appears
automatically
automatically

Note: You can override these values by entering

McGraw-Hill Ryerson

new ones!

Example
Example

10-54

Ordinary
Ordinary

10
Annuities
Annuities

Typical
Typical
Canadian
Canadian
mortgage
mortgage

Interest isis
Interest
compounded
compounded
semi-annually
semi-annually

P/Y ==
C/Y

Using

12.00
12.00
2.00

12
2

and
and
payments are
are
payments
each month.
month.
each

Adding New Formulae

McGraw-Hill Ryerson

10-55

Ordinary
Ordinary

10
Annuities
Annuities

Step11
Step

C
=
Step 2

Step 2

AddingNew
NewFormulae
Formulae
Adding
Determine the number of Interest

c
ompounding interval
number of interest compoundings per year
periods per

number of payments
Use

per year

c to determine i2

Use i2 = (1+i)c - 1 to calculate the equivalent

periodic rate that matches the payment interval
Step33
Step
McGraw-Hill Ryerson

Use this equivalent periodic rate as the

value for i
in the appropriate simple annuity
formula
Example
Example

Ordinary
Ordinary

10

Step11
Step

Annuities
Annuities

Typical
Typical
Canadian
Canadian
mortgage
mortgage

6% Interest
Interest isis
6%
compounded
compounded
semi-annually
semi-annually
and
and
payments are
are
payments
each month.
month.
each
Find C
C and
and ii2..
Find
2

McGraw-Hill Ryerson

10-56

To determine the number of Interest

periods per ompounding interval
number of interest compoundings per year
number of payments per year
C=

0.166666 = C

12
Step 22 Use
Step

c to determine i

10-57

Ordinary
Ordinary

Step 22 Use
Step

10
Annuities
Annuities

6% Interest
Interest isis
6%
compounded
compounded
semi-annually
semi-annually

McGraw-Hill Ryerson

i2 = (1+i)c - 1
i2 = (1+ .06/2)

Typical
Typical
Canadian
Canadian
mortgage
mortgage

and
and
payments are
are
payments
each month.
month.
each
Find C
C and
and ii2..
Find

c to determine i
.16666

-1

0.166666
0.0049 = 2
1.0049

1.03
1

another
anotherexample
example

10-58

Ordinary
Ordinary

10
Annuities
Annuities

Mortgage
Mortgage
5% interest
interest
5%
isis
compounded
compounded
monthly
monthly
and
and
payments
payments
are each
each
are
week
week

McGraw-Hill Ryerson

Step11
Step
To determine the number of
c
ompoundings
number of interest compoundings per year
number of payments per year
C=

0.23076 = C

12

52
Step 22 Use
Step

c to determine i

10-59

Ordinary
Ordinary

10
Annuities
Annuities

Step 22 Use
Step

i2 = (1+i)c - 1
i2 = (1+ .05/12)

Mortgage
Mortgage
5% interest
interest
5%
isis
compounded
compounded
monthly
monthly
and
and
payments
payments
are each
each
are
week
week

McGraw-Hill Ryerson

c to determine i

.2308

-1

1.0041667
0.0041667
0.230769
0.00096 = i2
1.00096

0.05

12

1
another
anotherexample
example

10-60

Ordinary
Ordinary

Is the following a

10

General Annuity?

Annuities
Annuities

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
Criteria

The payment
payment interval
interval
The
differs from
from
differs
the compounding
compounding interval
interval
the
As the
the Criteria
Criteria have
have been
been met,
met, therefore,
therefore,
As
we need
need to
to determine
determine C
C
we
McGraw-Hill Ryerson

Ordinary
Ordinary

10

Step11 Find
Step

10-61

Annuities
Annuities

0.1666
0.00575
1.00575
You decide to
save $50/month
12
2
for the next
three years.
Step 22 Find i2
Step
If you
invest all of
these savings in
an account
which will pay
1.035
you 7%
compounded
semi-annually,
1
determine the
total in the
account after
3 years.

McGraw-Hill Ryerson

i2 = (1+i) - 1
i2 = (1+ .07/2).1666-1
i2 = 0.00575
c

Step33 Use
Step

i2

Ordinary
Ordinary

10

Step33 Use
Step

Annuities
Annuities

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.

McGraw-Hill Ryerson

i2 in the appropriate formula

Formula FV = PMT
Formula
PMT = 50
i = .07/2

(1+ i)n - 1
i

PV = 0 n = 3*12 = 36
c = 2/12 = .16666 i2 = 0.00575

1.229255
0.229255
0.00575
1993.51
39.8702
1.00575
1

10-62

36

1
50

Solve

10-63

Ordinary
Ordinary

10
Annuities
Annuities

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.
McGraw-Hill Ryerson

P/Y=== 1993.51
C/Y
FV
12
1220
12
50
2

36
0

10-64

Ordinary
Ordinary

10

number of interest compoundings per year

number of payments per year
C=
the value for c can be a repeating decimal

Annuities
Annuities

SAVE c in memory
Improving
the
Accuracy
of
Calculated
Results

your calculator retains at least

two more digits than you see displayed!

when you need the exponent for

Simply

the c value from memory!

The value for i2 should be saved in

memory as soon you calculate it!

McGraw-Hill Ryerson

it later!

Ordinary
Ordinary

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?

McGraw-Hill Ryerson

10-65

10-66

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
McGraw-Hill Ryerson

10-67

Ordinary
Ordinary

10
Annuities
Annuities

Step 1 Determine FV1 of Annuity 10 years from now

ReidDavid
David
Reid
madeannual
annual
made
depositsof
of$1,000
$1,000toto
deposits
FleetBank,
Bank,
Fleet
thatpays
pays
that
6%
6%
interest
interest
compounded
compounded
annually.
annually.
After44years,
years,Reid
Reid
After
makesno
nomore
more
makes
deposits.
deposits.
Whatwill
willbe
bethe
the
What
balancein
inthe
the
balance
account
account

McGraw-Hill Ryerson

valueat
at
value
endof
of
end
years
44years

C/Y
P/Y
1.00
1.000
FV=== 4374.62
1

6
1

1000

0
4

Step2
2
Step

10-68

Ordinary
Ordinary

10
Annuities
Annuities

Step 2 Determine FV2 using compound interest

ReidDavid
David
Reid
madeannual
annual
made
depositsof
of$1,000
$1,000toto
deposits
FleetBank,
Bank,
Fleet
thatpays
pays
that
6%
6%
interest
interest
compounded
compounded
annually.
annually.
After44years,
years,Reid
Reid
After
makesno
nomore
more
makes
deposits.
deposits.
Whatwill
willbe
bethe
the
What
balancein
inthe
the
balance
account
account

McGraw-Hill Ryerson

FV ==

7834.27
4374.62

value14
14years
years
value
fromnow
now
from

0
10

Formula solution
solution
Formula

10-69

Ordinary
Ordinary

10

Step 1 Determine FV of Annuity 4 years from now

Annuities
Annuities

ReidDavid
David
Reid
madeannual
annual
made
depositsof
of$1,000
$1,000toto
deposits
FleetBank,
Bank,
Fleet
thatpays
pays
that
6%
6%
interest
interest
compounded
compounded
annually.
annually.
After44years,
years,Reid
Reid
After
makesno
nomore
more
makes
deposits.
deposits.
Whatwill
willbe
bethe
the
What
balancein
inthe
the
balance
account
account

McGraw-Hill Ryerson

n
(1+
i)
-1
Formula
Formula FV = PMT
i
PMT = 1000 n = 4 i = 0.06 c = 1

0.262477
1.262477
4374.62

valueat
atend
end
value
of44years
years
of

1.06
1

0.06

1000

Step2
2
Step

10-70

Ordinary
Ordinary

10

Step 2 Determine FV using compound interest

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

McGraw-Hill Ryerson

n
Formula
FV
=
PV(1
+
i)
Formula

PV =4374.62 n = 10 i = 0.06
10.262477
1.262477
.1708477
4374.62
7834.27
1.06

10

value14
14years
years
value
fromnow
now
from

10-71

Ordinary
Ordinary

10
Annuities
Annuities

Step 1 Determine FV of Annuity 4 years from now

How
much more
interest will
Reid David
accumulate
over the 14
years if his
account earns
6%
compounded
daily?

McGraw-Hill Ryerson

365

P/Y
C/Y
C/Y
FV === 4386.52
365
10

valueat
atend
end
value
of44years
years
of

1000

10-72

Ordinary
Ordinary

10
Annuities
Annuities

How
much more
interest will
Reid David
accumulate
over the 14
years if his
account earns
6%
compounded
daily?

McGraw-Hill Ryerson

Step 2 Determine FV in 10 years

using compound interest

P/Y
FV
FV=== 4386.52
7992.37
365
10

365

3650

value14
14years
years
value
fromnow
now
from

10-73

Ordinary
Ordinary

10
Annuities
Annuities

Interest
Interest
$7,992.37

McGraw-Hill Ryerson

$7,834.27

Ordinary
Ordinary

10-74

10
Annuities
Annuities

This completes Chapter 10

McGraw-Hill Ryerson