Engineering Economy

Unit 4: Annuities (Part I)

This part of the module will give you now the ideas about annuities. Thus, it is necessary to spend a
time to understand things about meaning of annuity, occurrences of annuities, and the first two types of
annuity, the ordinary and deferred annuities.

Unit Objectives:

1. Learn the interest earned on a series of payment on a borrowed or invested capital.

Unit Outline:

A. Meaning of Annuity
B. Occurrences of Annuities
C. Ordinary Annuity
D. Deferred Annuity

Unit Content:

A. Meaning of Annuity

Annuity is defined as a series of equal payments occurring at equal interval of time. When an annuity
has a fixed time span, it is known as annuity certain.

B. Occurrences of Annuities

1. Payment of a debt by a series of equal payments at equal intervals of time. This occurs when goods are
bought on instalment plan, the payments for which are usually equal amount paid periodically, usually
monthly.
2. Accumulation of a certain amount by setting equal amounts periodically. This occurs when a person saves
equal amounts and deposits this periodically in bank; when equal amount are set aside at equal intervals
of time to take care of the depreciation of equipment and to provide for their replacement at a definite
future time. Periodic deposits in a sinking fund, equal in amount, are also annuities.
3. Substitution of a series of equal amount periodically in lieu of a lump sum at retirement of an individual.

Types of Annuities

Annuities in engineering economy are usually classified into four categories. There are: ordinary
annuity, deferred annuity and annuity due.

C. Ordinary Annuity

An ordinary annuity is a type of annuity where the payments are made at the end of each period
beginning from the first period.

1
The four essentials elements of an ordinary annuity are:

a. The amounts of all payments are equal.

0 1 2 3 4 n

A A A A A

F
A
P
Formula:

Present worth, P

A[(1 + i)n − 1]
P=
i(1 + i)n

Or

A [1 − (1 + i)− n
P=
i

Future worth, F

A[(1 + i)n − 1]
F=
i

Where:
i = interest per period
n = number of periods
A = uniform payment
P = present worth
F = future worth

[(1 + i)n − 1]
= uniform series present worth
i(1 + i)n

[(1+i)n − 1]
i
= uniform series compound amount facor

2
 Application Problems

1. A man paid 10% down payment of P200, 000 for a house and lot and agreed to pay the 90% balance on
monthly instalment for 60 months at an interest rate of 15% compounded monthly. Compute the amount
of the monthly payment.

0 1 2 3 4 5 6 7 59 60
4
A A A A A A A A A
Given:
DP = P 200, 000. 00
𝑃 200,000.00
Total Price = = 𝑃 2,000,000.00
0.10
Balance = P 2,000,000. 00 − P 200,000.00
Balance = P 1,800,000.00
n = 60 months
m = 12 (Compounded Monthly)
NR = 0.15

Required:
Monthly Payment, A

Solution:
A[(1 + i)n − 1]
P=
i(1 + i)n
P {i(1 + i)n }
A=
[(1 + i)n − 1]
0.15 0.15 60
P 1,800,000.00 { (1 + ) }
12 12
A=
0.15 60
[(1 + ) − 1]
12
𝐀 = 𝐏 𝟒𝟐, 𝟖𝟐𝟏. 𝟖𝟕

2. What is the present worth of a 3 years annuity paying P3, 000, 000 at the end of each year, with interest
at 8% compounded annually?

0 1 2 3

A A A

Given:
A = P 3,000,000.00
n = 3 years
m = 1 (Compounded Annually)
i = 0.08

3
 Required:
Present Worth, 𝑃

Solution:
A[(1 + i)n − 1]
P=
i(1 + i)n
P 3,000,000.00[(1 + 0.08)3 − 1]
P=
0.08(1 + 0.08)3
𝐏 = 𝐏 𝟕, 𝟕𝟑𝟏, 𝟐𝟗𝟎. 𝟗𝟔

3. A manufacturing firm wishes to give each 80 employees a holiday bonus. How much is needed to invest
monthly for a year at 12% compounded monthly, so that each employee will receive a P2, 000 bonuses?

0 1 2 3 4 5 6 7 8 9 10 11 12
1
A A A A A A A A A A A A

Given:
No. of employees = 80 employees
F = P 2,000.00 (80) = 𝑃 160,000.00
m = 12 (Compounded Monthly)
NR = 0.12

Required:
Monthly Investment, 𝐴

Solution:
A[(1 + i)n − 1]
F=
i
0.12
(P 160,000.00) (
A= 12 )
0.12 12(1)
[(1 + ) − 1]
12

𝐀 = 𝐏 𝟏𝟐, 𝟔𝟏𝟓. 𝟖𝟏

4. Money borrowed today is to be paid in 6 equal quarterly payments at the end of each quarter. If the
interest is 12% compounded quarterly. How much was initially borrowed if quarterly payment is P2, 000?

0 1 2 3 4 5 6

A A A A A A

Given:
A = P 2,000.00

4
 t = 1.5 years
m = 4(Compounded quarterly)
NR = 0.12

Required:
Present Worth, 𝑃

Solution:
A[(1 + i)n − 1]
P=
i(1 + i)n
0.12 1.5(4)
P 2,000.00 [(1 + 4 ) − 1]
P=
0.12 0.12 1.5(4)
4 (1 + 4 )
𝐏 = 𝐏 𝟏𝟎, 𝟖𝟑𝟒. 𝟑𝟖

5. A man borrowed P300, 000 from a lending institution which will be paid after 10 years at an interest rate
of 12% compounded annually. If money is worth 8% per annum, how much should he deposit to a bank
monthly in order to discharge his debt 10 years hence?

Given : Part 1

0 10

P F

For the compound Interest

Required:
Future Worth, F

Solution:

F = P ( 1+ I) n
F = P300,000 ( 1 +0.12)10
F = P931,754.46

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Part 2 : Effective Rate of Interest

Given:
ERI = 8% annually

Required:
NRI compounded monthly

Solution:
𝑁𝑅 12
Ie = [(1 + 12
) − 1]
𝑁𝑅 12
0.08 = [(1 + ) − 1]
12
NR = 0.07721 = 7.721% compounded monthly

Part 3 : Annuity

Given :
F = P931,754.46
NR = 7.721% compounded monthly
n = 12 x 10 = 120

1 2 3 4 5 6 7 8 119 120

A A A A A A A A A

Required:
Annuity, A

Solution:

A[(1 + i)n − 1]
F=
i
0.07721
(P 931,754.46) (
A= 12 )
0.07721 120
[(1 + 12 ) − 1]

A = P 5,172.79