CH14 PPT

14.
1 Future Value of an Annuity

 Find the future value of:
 an annuity using the simple interest formula
 an ordinary annuity using a $1.00 ordinary annuity
future value table
 an annuity due using the simple interest formula
 an annuity due using a $1.00 ordinary
annuity future value table
 an annuity using a formula
Business Math, Eighth Edition © 2009 Pearson Education, Inc. Upper Saddle River, NJ
Cleaves/Hobbs 07458 All Rights Reserved
14.1.1 Future Value of an Annuity
 Calculate the value of a growing account
subject to periodic investments of payments.
 Some examples include:

 Retirement funds
 College education
 Vacation
 Company’s future investment in capital
expenses
Key Terms
 Annuity payment: a payment made to an
investment fund each period at a fixed interest
rate.
 Sinking fund payment: a payment made to an
investment fund each period at a fixed interest
rate to yield a predetermined future value.
 Annuity certain: an annuity paid over a
guaranteed number of periods.
Key Terms
 Contingent annuity: an annuity paid over an
uncertain number of periods.
 Ordinary annuity: an annuity for which

payments are made at the end of each period.
 Annuity due: an annuity for which payments

are made at the beginning of each period.
Future value of an annuity using
the simple interest formula
1. Find the end-of-period principal.
First end-of-period principal = annuity payment
2. For each remaining period in turn:
End-of-period principal = previous end-of-period
principal x (1 + period interest rate) + annuity
payment.
3. Identify the last end-of-period principal as the future
value.
Future value = last end-of-period principal
Look at this example
 What is the FV of an annual ordinary annuity of
$1,000 for 3 years at 4% annual interest?
 End-of-year 1 = $1,000 (no interest earned Y1)
 End-of-year 2 = $1,000 + $1,000 (1.04) = $2,040
 End of year 3 = $1,000 + $ 2,040 (1.04)
= $3,121.60
 The future value is $3,121.60.
Figure 14-2
Try this example
 Find the future value of an annual
ordinary annuity of $1,500 for four years
at 3% annual interest.
 $6,270
14.1.2 Find the FV Using a
$1.00 Ordinary Annuity FV Table
 Using Table 14-1 in your text:
1. Select the periods row corresponding to the number
of interest periods.
2. Select the rate per month column corresponding to
the period interest rate.
3. Locate the value in the cell where the periods row
intersects with the rate-per-period column.
4. Multiply the annuity payment by the table from
step 3.
FV = annuity payment
x table value
 Using Table 14-1 to find the FV of a semiannual
ordinary annuity of $6,000 for five years at 6%
annual interest, compounded semiannually.
 5 years x 2 periods per year = 10 periods
 6% annual interest rate = 3% period interest rate
2 periods per year
 See Table 14-1 for 10 periods at 3% = 11.464
 FV = $6,000 x 11.464 = $68,784
 The future value of this annuity is $68,784.
Try this example
 Find the future value of a semiannual

ordinary annuity of $ 5,000 for 10
years at 4% annual interest
compounded semiannually.
 $121,485
14.1.3 Find the FV of Annuity Due
Using the Simple Interest Formula
1. Find the first end-of-month period principal:

multiply the annuity payment by the sum of 1
and the period interest rate.
2. For each remaining period in turn, find the
next end-of-period principal = previous end
of period principal = annuity payment x 1 +
period interest rate
3. Identify the last end-of-period principal as the
future value.
 Find the total interest earned on the annuity of
$6,000 we looked at on Slide 11.
 Total invested =
$6,000 x 10 (number of payments) = $60,000
 Total interest = $68,784 - $60,000 = $8,784.
 The total interest earned on this annuity is
$8,784
Ordinary annuity
versus annuity due
 The difference between an ordinary annuity

and an annuity due is whether you made
the first payment immediately or at the
end of the first period.
Find the FV of this annuity due
 Find the FV of annuity due of $1,000 for three
years at 4% annual interest. Find the total
investment and total interest earned.
 End-of-Y 1 value = $1,000 x 1.04 = $1,040.
 End-of-Y 2 value = $2,040 x 1.04 = $2,121.60
 End-of-Y 3 value = $3,121.60 x 1.04 =
$3,246.46
 The future value of this annuity is $3,246.46
 The interest earned = $246.46
Try this example
 Find the future value of an annual annuity
due of $5,000 for three years at 4%. Find
the total investment amount and the total
interest earned.
 Total investment = $15,824.32

 Total interest earned = $824.32
14.1.4 Find the FV of an Annuity Due
Using a $1.00 Ordinary Annuity FV Table
Using Table 14-1:

 Select the periods row corresponding to the
number of interest periods.
 Select the rate-per-period column
corresponding to the period interest rate.
 Locate the value in the cell where the periods
row intersects the rate-per-period column.
(next slide)
Using a $1.00
ordinary annuity FV table
4. Multiply the annuity payment by the table value

from step 3. This is equivalent to an ordinary
annuity.
5. Multiply the amount that is equivalent to an
ordinary annuity by the sum of 1 and the period
interest rate to adjust for the extra interest that
is earned on an annuity due.
Future value = annuity payment x table value
x (1 = period interest rate)
 Using Table 14-1, find the FV of a quarterly annuity due of
$2,800 for four years at 8% annual interest, compounded
quarterly.
 8% annual interest rate ÷ 4 periods p/year = 2%
 Table 14-1 value for 16 periods at 2% = 18.639
 FV = $2,800 x 18.639 x 1.02 = $52,232.98
 The future value of this annuity is $52,232.98
Try this example
 Using Table 14-1, find the FV of
a quarterly annuity due of
$1,800 for three years at 8%
annual interest, compounded
quarterly.
 $24,624.43
14.1.5 Find the FV of an Ordinary Annuity or
Annuity Due Using a Formula
 Identify the period rate (R) as a decimal

equivalent, the number of periods (N),
and the amount of the annuity payment
(PMT).
 Substitute the values from Step 1 into the
appropriate formula.
(next slide)
14.1.5 Find the FV of an Ordinary Annuity or
Annuity Due Using a Formula
 (1  R)  1 
N
 FVord .annuity  PMT  
 R 

 (1  R) N  1 
FVannuitydue  PMT   (1  R)
 R 
(next slide)
Try this example
Find the future value of an ordinary annuity of
$100 paid monthly at 5.25% for 10 years.
 R = .0525/12 = .004375 (Period Int. Rate)
 (1.004375)120  1 
FVord .annuity  $100  
 .004375 
The future value of the ordinary annuity
is $15,737.70.
Try this example
Find the future value of an annuity due of $50
monthly at 5.75% for 5 years.
 R = .0575/12 = .0047916667 (Period Int. Rate)
 (1.0047916667)60  1 
FVannuitydue  $50   (1.0047916667)
 .0047916667 
The future value of the ordinary annuity
is $15,737.70.
14.2 Sinking Funds and the
Present Value of an Annuity
 Find the sinking fund payment using a
$1.00 sinking fund payment table.
 Find the present value of an ordinary
annuity using a $1.00 ordinary annuity
present value table.
 Find the sinking fund payment or the
present value of an annuity using a
formula.
14.2.1 Find the
Sinking Fund Payment
1. Select the periods row corresponding to the
number of interest periods.
2. Select the rate-per-period column
corresponding to the period interest rate.
3. Locate the value in the cell where the periods
row intersects the rate-per-period column.
4. Multiply the table value from step 3 by the
desired future value
Sinking fund payment = FV x Table 14.2 value
 Using Table 14-2, find the annual sinking fund
payment required to accumulate $140,000 in 12
years at 6% annual interest rate.
 Table 14-2 indicates that a 12-period value at

6% is equal to 0.0592770
 SFP = $140,000 x 0.0592770 = $8,298.78
 A sinking fund payment of $8,298.78 is

required at the end of each year for 12 years
at 6% to yield the desired $140,000.
Try this example
 Use Table 14-2 for find the annual sinking fund
payment required to accumulate $100,000 in 10
years at 4% annual interest.
 Find the number of periods: 10
 Find the table value where 10 periods and 4%
intersect: 0.0832909
 Multiply the desired FV by the table value
 The annual sinking fund payment required to
accumulate $100,000 in 10 years is $8,329.09
14.2.2 Find the PV of an
Ordinary Annuity Using
a $1.00 Ordinary Annuity PV Table
 Use Table 14-3 in your text to locate the given

number of periods and the given rate per
period.
 Multiply the table value times the periodic
annuity payment.
Present value of an annuity

= periodic annuity payment x table value
 Use Table 14-3 to find the present value of a semiannual
ordinary annuity of $3,000 for seven years at 6% annual
interest, compounded semiannually.
 6% annual interest rate ÷ 2 periods p/year = 3% period
interest rate
 PV annuity = $3,000 x 11.296 (table factor)= $33,888
 By investing $33,888 now at 6% interest, compounded
semiannually, you can receive an annuity payment of
$3,000 twice a year for seven years.
Try this example
 Roberto Santos wants to know how much he will
have to invest now to receive an annuity payment
of $5,000 twice a year for ten years. The money
will be invested at 6% annually compounded
semiannually.
 Number of periods = 20; Interest per period = 3%
 Table factor = 14.877
 5,000 x 14.877 = 74,385
 He must invest $74,385 now to receive a $5,000
annuity payment twice a year for 10 years.
14.2.3 Find the Sinking Fund Payment
or the Present Value of an Annuity
Using a Formula
 Identify the period rate (R) as a decimal

equivalent, the number of periods (N),
and the future value (FV) of the annuity.
 Substitute the values from Step 1 into the
appropriate formula.
(next slide)
14.2.3 Find the Sinking Fund Payment
or the Present Value of an Annuity
Using a Formula
  R 
PMTord .annuity  FV  
 (1  R)  1 
N

 (1  R)  1  N
PVord .annuity  PMT  N 
 R(1  R) 
(next slide)
Try this example
Find the monthly contribution to reach $100,000 in
20 years with an annuity fund that earns 5.5%
annual interest.
R = .055/12 = .0045833333; N = 240
 .0045833333 
PMTord .annuity  $100, 000  
 (1.0045833333)  1 
240
The payment required each month into the

sinking fund is $229.56.
Try this example
How much is needed in a fund that pays 5.5% to
receive $700 per month for 20 years.
R = .055/12 = .0045833333; N = 240
 (1.0045833333)  1
240

PVord .annuity  $700  240 
 .0045833333(1.0045833333) 
$85,670.56 is needed in the fund to receive
$700 each month for 20 years.
Remember!
Future
Payment
Value
Sinking Unknown Known
fund
Annuity Known Unknown

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14.

1 Future Value of an Annuity

 Some examples include:

 Ordinary annuity: an annuity for which

 Annuity due: an annuity for which payments

 Find the future value of a semiannual

1. Find the first end-of-month period principal:

 The difference between an ordinary annuity

 Total investment = $15,824.32

Using Table 14-1:

4. Multiply the annuity payment by the table value

 Identify the period rate (R) as a decimal

 Table 14-2 indicates that a 12-period value at

 SFP = $140,000 x 0.0592770 = $8,298.78

 A sinking fund payment of $8,298.78 is

 Use Table 14-3 in your text to locate the given

Present value of an annuity

 Identify the period rate (R) as a decimal

The payment required each month into the

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