Pamantasan ng Lungsod ngMaynila

College of Engineering and Technology

Engineering Economics
Chapter 3
Annuity
Prepared by:
Engr. Jenalyn Macarilay
Electronics Engineering Department
 LEARNING OUTCOMES
Explain and illustrate the cash flow diagram of annuity

Distinguish, understand, and illustrate the cash flow diagram

ordinary, deferred, annuity due and perpetuity

Solve the present or future value of annuity

Calculate the present and future value of complex cash flow

streams.

Prepare an amortization table

 ANNUITY

a series of equal payments occurring at equal

periods of time
 ANNUITY
Annuities are established for the ff. purposes
Annuities are established for the following purposes

1 2 3

To extinguish a To accumulate a
present debt by a required amount in
series of equal the future by To replace a future
payments made at depositing equal lump-sum payment
equal time intervals, amounts at equal with equal periodic
this is also known as intervals in time, such payments
amortization deposits are referred
to as sinking funds
TYPES OF ANNUITY

Ordinary Deferred
Annuity Annuity

Annuity
Perpetuity
Due
 ORDINARY ANNUITY
o Payments are made at the end of each period
( 1 + 𝑖𝑖)𝑛𝑛 −1
𝐹𝐹 = 𝐴𝐴
𝑖𝑖

( 𝟏𝟏 + 𝒊𝒊)𝒏𝒏 −𝟏𝟏
𝑭𝑭 = 𝑨𝑨
𝒊𝒊

Note: image taken from Mathalino.com

 ORDINARY ANNUITY

Cash flow occurs in consecutive interest periods

Cash flow amount is same in each interest period

P is one period ahead of first A value

Last cash flow occurs in same period as F

 ORDINARY ANNUITY
Sample Problem

Ans = $ 18, 953.93

Ans. $18,954
 Example 1:

What are the present

ORDINARY worth and the accumulated
amount of a 10 year annuity
ANNUITY paying P100,000 at the end of
each year with interest as 15%
compounded semi-annually?

Ans. P=P491,300.79
F=P2, 086,972.6
 Example 2:

A chemical engineer
wishes to set –up a special fund
by making a uniform semi-annual
end- of period deposits for 20
ORDINARY years. The fund is to provide a
$100,000 at the end of each of
ANNUITY the last five years of a 20 year
period. If interest is 8%
compounded semi-annually, what
is the required semi-annual
deposit to be made?

Ans. A = $6,193.99
 DEFERRED ANNUITY
o The first payment is made several periods after the beginning
of the annuity

Note: image taken from Mathalino.com

 DEFERRED ANNUITY

Cash flow occurs in consecutive interest periods

Cash flow amount is same in each interest period

The first A is deferred by k periods

Last cash flow occurs in same period as F

 DEFERRED ANNUITY
Sample Problem
What lumpsum amount is equal to a yearly deposit worth
$8000 from years 3 through 10 at an interest rate of 10% per
year?
Given: A= $8000
n= 8 (year 3-10)
i= 10% CA
Reqd: P
Solution:
𝟏𝟏− 𝟏𝟏+𝟎𝟎.𝟏𝟏 −𝟖𝟖 −𝟐𝟐
𝑷𝑷 = 𝟖𝟖, 𝟎𝟎𝟎𝟎𝟎𝟎 𝟏𝟏 + 𝟎𝟎. 𝟏𝟏
𝟎𝟎.𝟏𝟏

Ans = $35, 272.24

 Example 1:

If 10,000 is deposited
each year for 9 years, how
DEFERRED much annuity can a person get
annually from the bank for 8
ANNUITY years starting 1 year after the
9th deposit is made. Cost of
money is 14%

Ans. A = P34, 675

 Example 2:

A debt of P40,000 whose

interest rate is 15% compounded
semi-annually, is to be discharged by
DEFERRED a series of 10 semi-annual payment,
the first payment is to be made 6
ANNUITY months after consummation of the
loan. The first 6 payemnts will be
P6,000 each while the remaining 4
payments will be equal and of such
amount that the final payment will
liquidate the debt. What is the
amount of the last 4 payments?
Ans: A = P5,454
 ANNUITY DUE

o Payments are made at the beginning of each period

Type equation here.

𝟏𝟏 − (𝟏𝟏 + 𝒊𝒊)𝟏𝟏−𝒏𝒏 (𝟏𝟏 + 𝒊𝒊)𝒏𝒏+𝟏𝟏 −𝟏𝟏

𝑷𝑷 = 𝑨𝑨 + 𝟏𝟏 𝑭𝑭 = 𝑨𝑨 − 𝟏𝟏
𝒊𝒊 𝒊𝒊

Note: image taken from Mathalino.com

 ANNUITY DUE

Cash flow occurs in consecutive interest periods

Cash flow amount is same in each interest period

P occurs on the same period of first A value

F occurs one period after the last A value

 ANNUITY DUE
Sample Problem
What is the current and future value of a $50 payment to be made at
the beginning of each year, for three years if the prevailing rate of
interest is 7% CA?
Given: A= $50
n= 3
i= 7% CA
Reqd: P & F
Solution:
𝟏𝟏−𝟑𝟑
𝟏𝟏 − 𝟏𝟏 + 𝟎𝟎. 𝟎𝟎𝟎𝟎
𝑷𝑷 = 𝟓𝟓𝟓𝟓 + 𝟏𝟏
𝟎𝟎. 𝟎𝟎𝟎𝟎

𝟏𝟏 + 𝟎𝟎. 𝟎𝟎𝟎𝟎 𝟑𝟑+𝟏𝟏 − 𝟏𝟏

𝑭𝑭 = 𝟓𝟓𝟓𝟓 − 𝟏𝟏
𝟎𝟎. 𝟎𝟎𝟎𝟎

Ans. P=$140.40; F =$172

 Example 1:
A farmer bought a tractor
costing P12,000 if paid in cash. The
tractor may be purchased by

ANNUITY installment to be paid within 5 years.

Money is worth 8% compounded
annually. Determine the amount of
DUE each annual payment if all payments
are made:
a. At the end of each year for 5 years
b. At the beginning of each year for 5
years

Ans. a. A = P3, 005.48; b. A = P2, 782.85

 Example 1:

Yosef bought a lot worth P1, 000,000

and promised to pay in equal amount
ANNUITY every month for 3 years at 5%
compounded monthly rate. He
DUE missed 5 payments after paying his
first 12 payments. What single
amount must he pay by the time his
18th payment is due to extinguish all
his debts?

Ans. P699, 781.7

 PERPETUITY

o periodic payments continue indefinitely

𝑨𝑨 𝑨𝑨
𝑷𝑷 = 𝟏𝟏 + 𝒊𝒊 −𝒌𝒌
𝑷𝑷 = 𝒊𝒊
𝒊𝒊 if there are deferred periods

Note: image taken from Mathalino.com

 PERPETUITY

Cash flow occurs in consecutive interest periods

Cash flow amount is same in each interest period

P may occur one period ahead of first A value

P may occur several periods ahead of first A value

 PERPETUITY
Sample Problem
ABC Corporation pays an annual dividend worth $3 estimates
that they will pay the dividends indefinitely. How much are the
investors willing to pay for the dividend with a required rate of
return of 6%?
Given: A= $3
i= 6% CA
Reqd: P
Solution:

𝟑𝟑
𝑷𝑷 =
𝟎𝟎.𝟎𝟎𝟎𝟎

Ans = $ 50
 Example 1:

What amount of money

PERPETUITY invested today at 15% interest
can provide the following
scholarships; P30,000 at the
end of each year for 6 years;
P40,000 for the next 6 years
and P50,000 thereafter?

Ans. P241,277
 AMORTIZATION

oAny method of repaying debt, the principal and the

interest included, usually by a series of equal payments
at equal interval of time.
AMORTIZATION SCHEDULE
Interest due at the Principal repaid at the end
Outstanding principal at the
Period end of the Payment of payment
beginning of the period
period
1 P0=P1 I1 = P1*i*n A P.R1=A-I1
2 P2= P1-P.R1 I2 = P2*i*n A P.R2 = A-I2

: : : : :
n Pn = Pn-1-P.Rn-1 In= Pn *i*n A P.Rn=A-In
 AMORTIZATION
Sample Problem

A debt of P5,000 with interest of 12% compounded semi-

annually is to be amortized by equal semi-annual payments
over the next 3 years, the first due in 6 months. Find the semi-
annual payment and construct an amortization schedule.

Given: P=P5,000
r=12%CSA; m=2
n=2(3)=6
Solution:
𝑟𝑟 0.12
𝑖𝑖 = = = 𝟎𝟎. 𝟎𝟎𝟎𝟎
𝑚𝑚 2
5000
𝐴𝐴 = = 𝐏𝐏𝟏𝟏, 𝟎𝟎𝟎𝟎𝟎𝟎. 𝟖𝟖𝟖𝟖
1 − 1 + 0.6 −6
0.6
 AMORTIZATION
Solution

Outstanding
Interest due Principal
principal at
at the end repaid at
Period the Payment
of the the end of
beginning of
period payment
the period
1 5000.00 300.00 1016.82 716.82
2 4283.18 256.99 1016.82 759.83
3 3523.35 211.40 1016.82 805.42
4 2717.93 163.08 1016.82 853.74
5 1864.19 111.85 1016.82 904.97
6 959.22 57.55 1016.82 959.27
5000.05
 REFERENCES

oEngineering Economy,
Blank and Tarquin, 7th
Edition, McGraw-Hill,
2012
oEngineering Economy,
Hipolito Sta. Maria
oVarious online materials
THANK YOU