Annuity Due

Fi nanci al Mat hemat i cs Annui t y Due
2010 ht t p: / / w w w .w eal l st ar t somew her e.com

1
Cal cul at i ng Fut ur e Val ue Annui t y Due

FV = R_
(1 + r)
n
- 1
r
_ (1 + r)

FV refers t o f ut ur e val ue
R refers t o t he r egul ar pay ment s per compoundi ng per i od
n refers t o t he number of compoundi ng per i ods
r refers t o t he i nt er est r at e per compoundi ng per i ods

An annuit y is a series of equal cash flows occurring at equal t ime int ervals
over a specified t ime period. Annuit y due refers t o t he fact t hat t he
regular payment s ar e being made at t he begi nni ng of each per iod, hence
t he name, annuit y due, payment is due i mmedi at el y .

Lease payment s are a really good example of an annuit y due. Lease
arrangement s are a ser ies of regular payment s at t he beginning of each
per iod occurr ing at equal t ime int ervals ( usually mont hly) over a specified
t ime ( usually unt il t he end of t he lease arr angement ) .

The following t imeline should classify what we mean when we say t hat
payment s are made at t he beginning of each period. The t imeline depict s
a 6 per iod annuit y, wit h regular $100 payment s being made at t he
begi nni ng of each per iod, occurr ing at equal t ime int ervals over a
specified t ime per iod.

You will not ice t hat t he fut ure value annuit y due formula is very similar t o
t he fut ure value ordinary annuit y formula. Because you receive a cash
flow one per iod earlier it has t ime t o accumulat e for anot her per iod y ou
i ncr ease i t s v al ue by ( 1+ r ) . Since every cash flow in t he annuit y has
moved one period ear lier, t he fut ure value of t he ent ire annuit y get s t o
accumulat e for an ext ra per iod and increases by ( 1+ r)

We will now t ake a look at some examples.


2
Ex ampl e 1
Jake rent s out a building t o an account ing pract ice. The lease arrangement is for
10 years. Every t hree mont hs Jake receives $10, 000 in rent . Payment s are
made upfront . This money goes int o an account earning 7% p. a. compounded
quart erly. What will be t he value of t he account at t he end of t he 10 year lease
arrangement if Jake never wit hdraws from it ?

I t s always best t o det ermine what you are t rying t o find. I n t his example we are
t rying t o find t he f ut ur e val ue, FV, of Jakes account at t he end of t he 10 year
lease arrangement .

The lease arrangement is for 10 years and int erest is compounded semiannually.
The number of compounding periods is 10yrs x 4 mont hs = 40.

The int erest rat e per compounding period is 0. 07 4 = 0. 0175.

Fv = R_
(1 +i)
n
-1
i
_ (1 +i)
FV = ?
R = $10, 000
r = 0. 07 4 = 0. 0175
n = 10yrs x42 = 40

Fv = $1u,uuu_
(1 + u.u17S)
40
-1
u.u17S
_ (1 +u.u17S)

Fv = $S82,SS7

At t he end of t he 10 year lease arrangement Jake will have $582, 357.


3
Ex ampl e 2
Jake is awfully greedy and decides t hat he would rat her have $800, 000 in his
lease account by t he end of t he 10 year lease arrangement . How much will Jake
have t o charge every 4 mont hs?

So what are we t rying t o find? We are t rying t o find t he amount of regular
payment s t hat Jake will charge, t hat being R, given t hat he want s t he f ut ur e
val ue of his lease account t o be $800, 000.

Fv = R_
(1 +i)
n
-1
i
_ (1 +i)

FV = $800,000
R = ?
r = 0. 07 4 = 0. 0175
n = 10yrs x 4 = 40

$8uu,uuu = R_
(1 +u.u17S)
40
- 1
u.u17S
_ (1 + u.u17S)

$8uu,uuu = R|$S7.2S4](1.u17S)

$8uu,uuu = R(S8.2S6)

R =
$8uu,uuu
$S8.2S6
= $1S,7S7

Jake will need t o charge $13, 737 in rent every 3 mont hs t o have accumulat ed
$800, 000 in t he lease account by t he end of t he 10 year lease arrangement .


4
Cal cul at i ng Pr esent Val ue Annui t i es
Due

PV = R_
1 - (1 + r)
-(n-1)
r
_ + R

PV refers t o pr esent v al ue
R refers t o t he r egul ar pay ment s per compoundi ng per i od
n refers t o t he number of compoundi ng per i ods
r refers t o t he i nt er est r at e per compoundi ng per i ods

Again you will not ice t hat t he present value annuit y due formula is very
similar t o t he present value ordinary annuit y formula. Since t he init ial
payment is made at t he beginning of each period inst ead of at t he end,
we add back t his ver y first payment , R, t o t he present value ordinar y
annuit y formula.

Ex ampl e 3
Jake is get t ing greedier and greedier each quest ion. Jake now want s t o
det ermine t odays value of t he lease agreement , if he was t o charge $13, 737
each every 3 mont hs. Assume t hat t he account is st ill 7% p. a. and is
compounded quart erly.

Pv = R_
1 -(1 +i)
-(n-1)
i
_ +R
PV = ?
R = $13, 737
r = 0. 07 4 = 0. 0175
n = 10yrs x 4 = 40

Pv = $1S,7S7_
1 -(1 +u.u17S)
-(40-1)
u.u17S
_ + $1S,7S7

Pv = $S8S,9S6 +$1S,7S7 = $S99,67S

Todays value of t he lease agreement is $399, 673.


5
Ex ampl e 4
Jake decides t hat t his is simply not enough! Jake want s t odays value of t he
lease agreement t o be $500, 000. How much will Jake have t o charge every 3
mont hs for t he present value of t he lease arrangement t o be $500, 000?

I n t his example we are t rying t o find R, t he regular payment s t hat Jake will have
t o charge per compounding period.

Pv = R_
1 -(1 +i)
-(n-1)
i
_ +R
PV = $500,000
R = ?
r = 0. 07 4 = 0. 0175
n = 10yrs x 4 = 40

$Suu,uuu = R_
1 - (1 +u.u17S)
-(40-1)
u.u17S
_ +R

$Suu,uuu = 28R +R

Fact or i se R $Suu,uuu = R (28 +1)

R =
$Suu,uuu
(28 +1)
= $17,241

Jake will need t o charge $17, 241 in rent every 3 mont hs for t he lease agreement
t o have a present value of $500, 000.

Ex ampl e 5
I f Jake does decide t o charge $17, 421 in rent every 3 mont hs, what will be t he
fut ure value of t he lease account ? Assume t hat t he account is st ill 7% p. a. and is
compounded quart erly.

Fv = R_
(1 +i)
n
-1
i
_ (1 +i)
FV = ?
R = $17, 421
r = 0. 07 4 = 0. 0175
n = 10yrs x42 = 40

Fv = $17,421_
(1 + u.u17S)
40
-1
u.u17S
_ (1 +u.u17S)

Fv = $1,u14,S2S

At t he end of t he 10 year lease arrangement t he fut ure value of Jakes lease
account will be $582, 357.

Annuity Due

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Fi nanci al Mat hemat i cs Annui t y Due

2010 ht t p: / / w w w .w eal l st ar t somew her e.com

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