Engineering Economy

Ryan Jeffrey P. Curbano, Ph.D.

 ANNUITIES
• Annuity
– Consists of a series of equal payments made at
equal interval of time.
• Annuities occur in the following instances
– Payment of debt by series of equal payments at
equal interval of time
– Accumulation of a certain amount by setting equal
amount periodically.
– Substitution of a series of equal amounts periodically
in lieu of a lump sum at retirement of an individual.
 Types of Annuities
(1) Ordinary Annuity
- is one where the equal payments are made at the
end of each payment period starting from the first
period.
Four Essential Elements of an Ordinary Annuity
• The amount of all payment are equal
• The payments are made at equal interval of time
• The first payment is made at the end of the first
period all payments thereafter are made at the end
of the corresponding period.
• Compound interest is paid on all amounts in the
annuity
 Graphical Representation of Ordinary
Annuity
(P/A, i%, n) (F/A, i%, n)

0 1 2 3 N-1 n

P1.00 P1.00 P1.00 P1.00 P1.00

n
(P/A, i%, n) or P = (1+ i) – 1
i (1+ i) n

n
(F/A, i%, n) or F = (1 + i) – 1
i
 Formula
• Ordinary Annuity
n -n
P = A(P/A, i%, n) = A (1+i) – 1 or A 1 –(1+i)
n
i(1+i) i

n
F = A(F/A, i%,n) = A (1 + i) – 1
i
Where: A = amount of each payment of an ordinary
annuity
P = present value
F = future worth or accumulated amount
 Example 1.0
• What is the present worth of a 3 years annuity
paying P3,000 at the end of each year, with
interest at 8% compounded annually?
 Example 2.0
• A one bagger concrete mixer can be purchase with a down payment
of P8,000 and equal installment of P600 each paid at the end of
every month for the next 12 months. If money is worth 12%
compounded monthly, determine the equivalent cash price of the
mixer.
 Example 3.0
• Mr. Robles plans a deposit of P500 at the end of each
month for 10 years at 12% annual interest,
compounded monthly. The amount that will be
available in two years is.
 Example 4.0
• The president of a growing engineering firms wishes to
give each of 50 employees holiday bonus. How much is
needed to invest monthly for a year at 12% nominal
interest rate compounded monthly so that each
employees will received a P1,000 bonus
 Example 5.0
• A man inherited a regular endowment of P100,000 every end
of 3 months for 10 years. However, he may choose to get a
single lump sum payment at the end of 4 years. How much is
the lump sum if the cost of money is 14% compounded
quarterly.
 Example 6.0
• A machine is under consideration for investment. The cost of
the machine is P25,000. Each year it operates the machine
will generate a savings of P15,000. Given an effective annual
interest rate of 18%, what is the discounted payback period in
years on the investment in the machine?
 Example 7.0
• Because of the peso devaluation, a car costing P150,000 is to
be purchase through a finance company instead of paying
cash. If the buyer is required to pay P40,000 as down
payment and P4000 each month for four years, what is the
effective interest rate on the diminishing balance?
 Types of Annuity
(2) Deferred Annuity
- it is also ordinary annuity but the payment of the
first amount is deferred a certain number of periods
after the first.

M periods n periods
N-1
0 1 2 m 0 1 2 n

A A A A

Cash Flow diagram given A to find P

 Formula
• Deferred Annuity
P = A(P/A, i%, n)(P/F, i%, m)

-n -m
= A 1- (1+i) (1+i)
i

F = A(F/A, i%,n) (F/P, i%, m)

= A (1+i)n - 1 ( 1+i)m
i
 Example 1.0
• A lathe for a machine shop cost P60,000 if paid in cash. On
the installment plan, a purchaser should pay P20,000 down
payment and 10 quarterly installment, first due at the end of
the first year after purchase. If the money is worth 15%
compounded quarterly. Determine the quarterly installment.
 Example 2.0
• A man invest P10,000 now for the college education of his 2
year old son. If the fund earns 14% effective, how much will
the son get each year starting from his 18th to the 22nd
birthday?
 Example 3.0
• A person buy a piece of property for P100,000 down
payment and ten deferred semi annual payments of P8,000
each starting three years from now. What is the present
value of the investment is the rate of interest is 12%
compounded semi annually?
 Example 4.0
• In five years, P18,000 will be needed to pay for a building
renovation. In order to generate this sum, consisting of three
annual payments is established now. For tax purpose, no
further payments will be made after three years. What
payments are necessary if money is worth 15% per annum?
 Example 5.0
• A fund for replacement of machinery in a plant must contain
P30,000 at the end of 9 years. If the fund is invested at 3.5 %
compounded semi annually. What equal deposits should be
placed in the fund at the end of 6 months just for the first four
years?
 Types of Annuity
(3) Annuity Due
– Is one where payments are made at the start
of each period beginning from the first period.
P F

A A A
 Formula for Annuity Due
• Present Worth
n-1
P = A (1+i) - 1 + A
n-1
i (1 + i)

• Future Worth
n +1
F = A (1 +i) - 1 - A
i
 Example 1.0
• A farmer bought a tractor costing P25,000 payable in 10 semi
annual payments, each installment payable at the beginning
of each period. If the rate of interest is 26% compounded
semi-annually, determine the amount of each installment.
 Example 2.0
• As rental for the building, the owner received two offers.
(a) P50,000 a year for 8 years, the rental for each year being
paid at the start of each year.
(b) P30,000 the first year, P40,000 the second year, P50,000
the third year and P60,000 for the next 5 years with a rentals
paid at the beginning of each year.
If money is worth 12%, which is the better offer?
 Example 3.0
• A man owes P12,000 today and agrees to discharge the debt
by equal payments at the beginning of each 3 months for 8
years where these payments include all interest at 8%
payable quarterly. Find the quarterly payment.
 Example 4.0
• A man will deposit P200 with a savings and loan association
at the beginning of each 3 months for 9 years. If the
association pays interest at the rate of 5.5% compounded
quarterly. Find the sum to his credit just after the last deposit.
 Types of Annuity
(4) Perpetuity
- is one where the payment periods extend
forever or in which the periodic payments
continue indefinitely.

Formula:
P= A
i
 Example 1.0
• Find the present value in pesos of a
perpetuity of P15,000 payable
semi-annually if money is worth 8%
compounded quarterly
 Example 2.0
• It costs P50,000 at the end of each year to maintain a section
of Kennon road in Baguio city. If the money is worth 10%.
How much would it pay to spend immediately to reduce the
annual cost to P10,000.
 Example 3.0
• If the money is worth 8% compounded quarterly, compare the
present values of the following:
(a) An annuity of P1,000 payable quarterly for 50 years
(b) An annuity of P1,000 payable quarterly for 100 years
(c) A perpetuity of P1,000 payable quarterly.
 Type of Annuity
(5) Compounded Continuously
• Future Worth
F = A er n - 1
r
e -1
• Present Worth
-r n
P=A1-e
r
e- 1
 Example 1.0
• P500 is deposited each year into a savings bank account
that pays 5% nominal interest, compounded continuously.
How much will be the account at the end of 5 years
 Example 2.0
• A man borrowsP100,000 at a rate of 6% compounded
continuously for 5 years. How much must he pay annually if
money is compounded continuously
 Example 3.0
• What is the nominal rate of interest compounded
continuously for a period of 5 years of an equal payment
series if the sinking fund factor is equal to 0.180519?
 Example 4.0
• Determine the number of periods in years would it take for a
uniform payment series in an account that earns 6%
compounded continuously if the compound amount factor is
5.657797282
THANK YOU