Annuity and Amortization

MODULE 3
 Annuity:
 ANNUITY – it is a series of equal payments occurring at equal interval of time.
 AMORTIZATION – a method of paying debt including the principal and interest
which is done in a series of equal payments occurring at equal interval of time.
▪ Types of Annuity:
1. Ordinary Annuity – Payments are made at the end of every period
2. Annuity Due – Payments are made at the beginning of every period
3. Deferred Annuity – The first payment will be made on a future date
4. Perpetuity – Payments are made FOREVER
Example: consolidated bonds and dividend paying stocks
 Converting Nominal to Effective Interest

 12% compounded quarterly 12% yearly compounded quarterly - nominal

 12% quarterly compounded quarterly Effective
 12% 12% yearly compounded yearly - Effective
 12 % quarterly 12% quarterly compounded quarterly - Eff
 1% per month 1% monthly compounded monthly - Effective
 Converting Nominal to Effective Interest
 12% compounded monthly = 12% yearly compounded monthly

j n
i= j
n 1+i = 1+ n

Convert to monthly compounded monthly Convert to yearly compounded yearly

12% yearly compounded monthly 12% yearly compounded monthly
n
j j
i = 1+i = 1+ n
m
12
= 12 0.12
12 1 + i = 1 + 12
= 0.01
i = 0.1268
i = 1% monthly compounded monthly
i = 12.68% yearly compounded yearly
 Ordinary Annuity:
Payments are made at the end of every period
 Present Value of Ordinary Annuity: P = $1000
i = 5%
0 1 2 3 4 5
n = 5 years
Period 1 Period 2 Period 3 Period 4

$1000 $1000 $1000 $1000 $1000

Formula
$1000
= $952.38 1- (1 + i ) -n
(1.05)1 P =A
$1000
= $907.03
i
(1.05)2
$1000
(1.05)3
= $863.84
1- (1+ 0.05 )-5
P = 1000
$1000
(1.05)4
= $822.70 0.05
$1000
(1.05)5
= $783.53 = 1000(4.329477)
$4329.48 = Present Value of an ordinary = $4329.477
 Annuity:
 Future Value of Ordinary Annuity: P = $1000
i = 5% Formula
0 1 2 3 4 5 n = 5 years
Period 1 Period 2 Period 3 Period 4 (1 + i ) n- 1
F=A
$1000 $1000 $1000 $1000 $1000
i
(1+ 0.05) 5- 1
= $1000 x (1.05)0 = $1000
F = 1000
0.05
= $1000 x (1.05)1 = $1050
= $1000 x (1.05)2 = $1102.50 F = 1000(5.525631)
= $1000 x (1.05)3 = $1157.63
= $1000 x (1.05)4 = $1215.51 F = 5525.631
Future Value of an ordinary annuity = $5525.64
 Ordinary Annuity No. 1
 Reuben decide to deposit an amount every end of the year in order to buy his
dream house and lot on his retirement in 10 years. How much his yearly
deposit should be to earn PhP 40 Million at his retirement if i = 5%

0 Simple Annuity
1 2 3 4 5 10
n
A A A A A A F = A (1 + i ) - 1
i
n = 10 years
F = 40M.
(1 + 0.05 ) 10 - 1
40 = A
i = 5% yearly 0.05
40 = A (12.57789)

A = PhP 3,180,183
 Ordinary Annuity No. 2
 Mr. Ilustre is depositing PhP 10,000 at the end of every quarter. If the amount
will be compounded by 8% quarterly, how much will he receive after 5 years?
Simple Annuity

0 1 2 3 4 5 20
quarter quarter quarter quarter quarter quarter (1 + 0.02 )20 - 1
10k 10k 10k 10k 10k 10k F = 10,000 0.02

F=? (1.02)20 - 1
= 10,000
A = PhP 10,000 0.02
r = 8% compounded quarterly
= 10,000(24.2973698)
i = 0.08/4
i = 0.02 = PhP 242,973.70
n = mt
= 4(5) = 20
 Ordinary Annuity No.3
 How many quarterly payments of 40,000 at 10% compounded quarterly must
be made in order to pay a car costing PhP 680,000 by installments instead of
paying it at once.
F680k Convert to monthly compounded monthly
680k 12% yearly compounded monthly
0 1 2 3 4 5 n j
i =
m
40k 40k 40k 40k 40k 40k 40k
= 10
4
n=?
F40k
= 0.025
i = 10% compounded quarterly i = 2.5% quarterly compounded quarterly
 Cont… Problem No.3

F680k Consider at the nth quarter:

680k

0 2 F680 = F40k
1 3 4 5 n
(1 + i )n- 1
40k
680k(1+i)n = 40k
40k 40k 40k 40k 40k 40k
i
F40k 680(1.025)n = 40k (1 + 0.025)n - 1
n=?
0.025
i = 10% compounded quarterly
n = 22.41 (shift solve)
= 23.0 quarters
 Cont.. Problem No.3
 No shift solve:
(1 + 0.025) n- 1
680,000(1+.025)n = 40k
0.025
680,000(1+.025)n = 1,600,000[(1+0.025)n -1]
680,000(1.025)n = 1,600,000(1.025)n -1,600,000
920,000(1.025)n = 1,600,000
n = 22.41
Log[920,000(1.025)n)] = Log(1,600,000)
= 23 quarters
Log920,000 + nLog(1.025) = Log (1,600,000)
nLog(1.025) = Log(1,600,000) – Log 920,000
n = Log(1,600,000) – Log 920,000
Log(1.025)
 Practice Problem:
 An engineer eyeing to buy a payloader truck worth PhP 2,000,000 was given
the option to pay through a downpayment of PhP 450,000 while the remaining
amount will be paid monthly for 2 years starting immediately at the end of first
month, How much these monthly deposits be if money is worth 8%
compounded yearly. Let’s consider the i:
n=24 months F2M
i = 8% yearly compounded yearly
2.0M
4 24 months m
0 1 2 3 j jmonthly m
1+i = 1+ n = 1 + iyearly = 1+
n
A
A A A A
j 12
FA 1 + 0.08 = 1 +
12
450k
n=12 F450k
 Practice Problem:
j 12
1 + 0.08 = 1 + j
12 i =
j m
12
√ 1.08 = 1+
12 7.72
j =
12 12
12
= √ 1.08 -1
= 0.643% monthly compounded
12 monthly
j = 12 x √ 1.08 -1
= 0.00643
j = 0.077208 = 0.643%
= 7.72% yearly compounded monthly
 Practice Problem:
n=24 months F2M Let’s consider on the 24th month:
2,000,000 F2M = FA + F450k
0 1 2 3 4 24 months
n
2M(1+i)n = A (1 + i ) - 1 + 450,000(1+i)n
A i
A A A A
24 - 1
FA 2M(1+0.00643)24 =A (1 + 0.00643 ) +
450,000 0.00643
n=12 F450k
450,000(1+0.00643)24
2,332,576 = A(25.86126) + 524,829.6
A = PhP 69,901.71
2. Annuity Due
 Annuity Due:
Payments are made at the beginning of every period
 Present Value of Annuity Due: P = $1000
i = 5%
0 1 2 3 4 5 n = 5 years
Period 1 Period 2 Period 3 Period 4

$1000 $1000
Formula
$1000 $1000 $1000
$1000 -n
(1.05)0
= $1000
P =A 1- (1 + i ) (1+i)
$1000 i
= $952.38
(1.05)1
1- (1+0.05) -5
$1000 P =A (1+0.05)
= $907.03
(1.05)2
0.05
$1000
= $863.84
(1.05)3
P = 1000(4.329477)(1.05)
$1000
= $822.70
(1.05)4
P = 4545.951
$4545.95 = Present Value of an annuity due
 Annuity Due:
Payments are made at the end of every period

 Future Value of Annuity Due: P = $1000

I = 5% Formula
0 1 2 3 4 5
Period 1 Period 2 Period 3 Period 4 n = 5 years
(1 + i ) n- 1
F=A (1 + i )
$1000 $1000 $1000 $1000 $1000 i
(1+0.05) 5- 1
= $1000 x (1.05)1 = $1050 F = 1000 (1+0.05)
0.05
= $1000 x (1.05)2 = $1102.50
= $1000 x (1.05)3 = $1157.63 F = 1000(5.525631)(1.05)
= $1000 x (1.05)4 = $1215.51
= $1000 x (1.05)5 = $1276.28 F = 5801.913
Future Value of an annuity due = $5801.92
 Annuity Due No. 1
 Solve for the present value of annuity due for an investor to receive USD 12,000
semi-annually for 6 years if it will be compounded semi-annually at 8% semi-annually.
 Solution:
Given: A = USD 12,000
t = 6 years P
r = 8%
m = 2 compounded semi-annually 0 1 2 3 4 5 6
i = r/m
= 0.08/2 12k 12k 12k 12k 12k 12k
= 0.04
n = mxt n = 12 periods
= 2x6
= 12
 Annuity Due No. 1
 Solution:

-n
P = A 1- (1 + i ) (1 + i)
i
-12
P = 12,000 1- (1+0.04 ) (1 + 0.04)
0.04
P = 12,000(0.375402/0.04)(1.04)

P = USD 117,125.424
 Annuity Due No.2
 As a gift to his nephew’s 2nd birthday, John deposited an amount to a company
that offers educational plan. His nephew will received an educational fund
allowance of USD 50,000 per year for 5 years starting on his 18 th birthday. If
the money is worth 5% compounded quarterly, how much did John deposited?

n=20 years Fp Where:

P Fp = ?
np = 20 years
2 3 18 19 20 21 22 i = 5% compounded quarterly
50k 50k 50k F50 = USD 50,000
2nd 50k 50k
birthday n50 = 5 years
n = 5 years
F50k
Fp = F50k
 Annuity Due No. 2
1. Solve for “i” to become effective interest
5% yearly compounded quarterly
n=20 Fp n
j
P 1+i = 1+ n

2 3 18 19 20 21 22 0.05 4
1+i = 1+ 4
50k 50k 50k 50k 50k

F50k 1 + i = 1.05094
n=5
i = 1.05094 - 1
i = 5% compounded quarterly i = 0.05094
i = 5.094%
 Annuity Due No.2

n=20 Fp Summation of F:
Fp = F50k
P
(1 + 0.0509)5 - 1
Fp ( 1+ i)n = 50,000 ( 1+ 0.0509
2 3 18 19 20 21 22 0.0509

50k 50k 50k 50k 50k (1 + 0.0509)5 - 1

Fp ( 1+ 0.0509)20 = 50,000 0.0509
( 1.0509)

n=5
F50k Fp ( 2.699155) = 50,000 (5.817335)

Fp = 290,866.95 / 2.699155

Fp = 107,762.23
 Annuity Due No.3

 A car can be purchase by paying a downpayment of PhP 150,000 and the

balance to be paid with two installments, the first installment is to be paid after
two years, and the other, which is twice than the first installments would be
after another 3 years. If the car could be acquired by paying 12 monthly
installments of PhP 40,000 at the beginning of each month, determine the
amount of first and second installments of the first option if interest rate is 12%
compounded monthly.

Let x = the first payment i = 12% compounded monthly

2x = the second payment
150k = downpayment
 Cont… Problem No.3
 Solution: 1st Option
Summation of F vertical:
n=5 Fc
C = Price of the car?
Fc = 2x + Fx + F150k
0 1 2 3 4 5
150k
x 2x
Since the mathematical summation
n=3
Fx above has brought more than one
variable it would be difficult to solve the
n=5
F150k problem using the first statement,
x= 1st payment after 2 years hence, we will solve first the 2nd
2x = 2nd payment after another 3 years statement.
 Cont…Problem No.3
 2nd Statement: If the car could be acquired by paying 12 monthly installments
of PhP 40,000 at the beginning of each month, determine the amount of first
and second installments of the first option if interest rate is 12% compounded
monthly.
i = nominal to effective rate
n=12 Fp i = j/m
Price of the car? = 12% /12
= 1% monthly compounded monthly
0 1 2 3 4 12
40k 40k 40k 40k 40k 40k
NOTE: It's important to match the compounding
frequency specified in the statement to accurately
n=12 convert the nominal rate to the effective rate.
F40k
i = 12% compounded monthly.
 Cont…Problem No.3
 2nd Option:
n=12 Fp Summation of F:
Price of the car? (1+i)n -1 (1+i)
Fp = F40k =A n

0 1 2 3 4 12 (1 + 0.01)12 -1
40k P(1.01)12 = 40,000 (1+0.01)
40k 40k 40k 40k 40k 0.01
P (1.126825) = 40,000(12.6825)(1.01)
n=12 = 512,374.12
F40k P = 512,374.12 / 1.126825
i = 12% compounded monthly. = 454,705.034 (price of the car)
 Cont… Problem No.3
 1st Statement: A car can be purchase by paying a downpayment of PhP
150,000 and the balance to be paid with two installments, the first installment is
to be paid after two years, and the other, which is twice than the first
installments would be after another 3 years.

n=5 Summation of F vertical (5th year):

Fc
C = 454,705.034 Fc = 2x + Fx + F150k
0 1 2 3 4 5
150k
But: Fc = 454,705.034(1+i)n
x 2x
And i = 12% compounded monthly
n=3
Fx
= 12% yearly compounded yearly
n=5 F150k
 Cont… Problem No.3
 1st Option Effective rate is: 12% compounded monthly
n=5 Fc
454,705.034
j n
1+i = 1+ n
12
0 1 2 3 4 5 1 + i = 1 + 0.12
150k
2x
12
x
Fx 1 + i = (1.126825)
n=3
n=5
i = 0.126825
F150k
i = 12.68% yearly compounded yearly
 Cont… Problem No.3
 1st Option Summation of F Vertical (5th year):
Fc = 2x + Fx + F150k
P(1+i)n = 2x + x(1+i)3 + 150k(1+i)5
454,705.034(1.1268)5 = 2x + x(1.1268)3+ 150k(1.1268)5
825,969.50 = 2X + 1.43067X + 272,474.24
Rearranging:
2x + 1.43067x = 825,969.50 – 272,474.24
3.43067x = 553,495.26
x = 553,986.6 / 3.43067
= 161,480.59
2x = 2 x (161,480.59)
= 322,961.17
3. Deferred Annuity
 Deferred Annuity:
The first payment will be made on the future date
 Present Value of a Deferred Annuity

P k n

n
0 1 2 3 4 5 6 7 8
Formula
Deferral
A A A A A
1- (1+i) -n
(1+i)-k PV = A (1+i)-k
i

1- (1+i)-n
P =A
i
 Deferred Annuity:
The first payment will be made on the future date
 Present Value of Deferred Annuity: P = $1000
i = 5%
0 1 2 3 4 5 6 7 8 n = 5 years
Period 1 Period 2 Period 3 Period 4 k = 3 years
Formula
$1000 $1000 $1000 $1000 $1000
Deferral -n
$1000
= $822.70 PV = A 1- (1+j) (1+i)-k
(1.05)4

$1000
j
= $783.53
(1.05)5
$1000
= $746.22 1- (1+0.05)-5 (1+0.05)-3
(1.05)6 PV = 1000
$1000
= $710.68
0.05
(1.05)7

$1000
PV = 1000(4.3294277)(0.863838)
= $676.84
(1.05)8

$3740.30 = Present Value of a deferred annuity PV = 3739.965

 Deferred Annuity:
The first payment will be made on the future date
 Future Value of Deferred Annuity: P = $1000
i = 5%
0 1 2 3 4 5 6 7 8 n = 5 years
Period 1 Period 2 Period 3 Period 4

$1000 $1000 $1000 $1000 $1000

Deferral = $1000 x (1.05)0 = $1000

= $1000 x (1.05)1 = $1050

Formula = $1000 x (1.05)2 = $1102.50

= $1000 x (1.05)3 = $1157.63

FV = A (1+i)n -1
i = $1000 x (1.05)4 = $1215.51

Future Value of deferred annuity = $5525.64

 Deferred Annuity:
 A PhP 500,000 loan was agreed to be paid by 5 end of year payments which
will start 4 years after the loan was made. Find the amount of these payments
if the interest is 12% compounded yearly.
On the 8th year:

n=8 F500k F500k = FA

500k (1+i)n -1
500,000(1+i)n = A
i
0 1 2 3 4 5 6 7 8

Deferral 1+ 0.12)5 -1
A A A A A 500,000(1+0.12)8 = A
0.12
n=5
FA 500,000(2.475963) = A(6.352847)

i = 12% compounded yearly A = PhP 194,870.35

 Deferred Annuity:
A 30 year old employee invested in a retirement plan. He wants to received USD 10,000
every month for 10 years when he retires at age 65. How much should he invest today if
the interest during the deferral period is 8% compounded annually and 5% compounded
monthly during the payout period?
Consider at 65
FE65
E FE75 FE65 = E(1+i)n = E(1+0.08)35
30 31 32 64 65 70 75 = 14.78534E
1 2 3 4 5 6 7 8 Consider at 75
i = 8% compounded annually FE65 = F10k(75)
F10k
n = 35 years
10k every month 14.78534E(1+i)n = 10k (1+i )n - 1
Accumulation Period 30 – 65 years n = 10x12 = 120 months i 120 - 1
i = 8% compounded annually i = 0.004167 14.78534E(1+0.004167)120 = 10k (1+0.004167 )
Payout Period 65 – 75 years
0.004167
i = 5% compounded monthly 24.35256545E = 10,000(155.2856
i = 5% /12 = 0.4167% E = USD 63,765.60
 Deferred Annuity: other solution
A 30 year old employee invested in a retirement plan. He wants to received USD 10,000
every month for 10 years when he retires at age 65. How much should he invest today if
the interest during the deferral period is 8% compounded annually and 5% compounded
monthly during the payout period?
Consider at 65
FE65 FE65 = F10k(75)
E FE75
30 31 32 64 65 70 75 1- (1+j)-n
FE65(1+i)n = 10k
i
1 2 3 4 5 6 7 8
-120
i = 8% compounded annually
FE65(1+0.08)35 = 10k 1-(1+0.004167 )
0.004167
n = 35 years F10k(65) 10k every month
Accumulation Period 30 – 65 years n = 10x12 = 120 months
14.78534429E = 10,000(94.279612)
i = 8% compounded annually i = 0.004167 14.78524429E = 942,796.12
Payout Period 65 – 75 years
1- (1 + i ) -n E = USD 63,765.58
i = 5% compounded monthly
P =A
i = 5% /12 = 0.4167% i
 Deferred Annuity:
 A PhP 500,000 loan was agreed to be paid by 5 end of year payments will
start 4 years after the loan was made. Find the amount of these payments if i
is 12% compounded yearly.
On the 8th year:

n=8 F500k F500k = FA

500k (1+i)n -1
500,000(1+i)n = A
i
0 1 2 3 4 5 6 7 8

Deferral 1+ 0.12)5 -1
A A A A A 500,000(1+0.12)8 = A
0.12
n=5
FA 500,000(2.475963) = A(6.352847)

i = 12% compounded yearly A = PhP 194,870.35

 Deferred Annuity:
 A parent, on the day of their child is born wishes to determine what lumpsum
amount should have to paid into an account bearing interest of 5%
compounded annually, in order to withdraw PhP 20,000 each year of their
child’s 18th, 19th 20th and 21st birthdays. How much is the lumpsum amount?
Solution: P
PV = A 1- (1+i)-(n) (1+i)-(k)
17 18 19 20
i 21

j = r/m = 0.12/12 = 1% k =17

n = no. of payments = 4
k = period of deferral 20k 20k 20k 20k
k = (t)(m) - 1
= (18)(1) – 1 i = (r)/(m)
= 17 = (0.05)/(1)
= 0.05
Deferred Annuity:

1- (1+j) -(n)
PV = A (1+i)-(k)
j
1- (1+0.05)-(4) (1+0.05)-(17)
PV = PhP 20000 P
0.05
17 18 19 20 21
PV = PhP 20000(3.545950504)(0.436297)
k =17
PV = PhP 30,941.73)
20k 20k 20k 20k
 Deferred Annuity:
 Anna availed of cash loan that gave her an option to pay PhP 10,000 monthly
for 1 year. The first payment is due after 6 months. How much is the present
value of the loan if the interest rate is converted monthly
(1+i)-(k+n) 1- (1+i)-(k)
A = PhP 10,000 PV = A 1- -A
i i
m = 12
r = 12% 1- (1+0.01)-(5+12) 1- (1+0.01)-(5)
t = 1 = PhP 10,000 - 10,000 0.01
0.01
n = mt = 12(1) = 12
j = r/m = 0.12/12 = 1% 1- (1+0.01)-(5+12) 1- (1+0.01)-(5)
= PhP 10,000 - 10,000 0.01
k = 5 months period 0.01
= PhP 10,000 (15.5622513/0.01) - PhP 10,000(4.8534312/0.01
= PhP 107,088.21
Perpetuity
 Perpetuity
Payments are made FOREVER
Capital

0 1 2 3 4 ∞ A
P = i
A A A A A

PA Where:
Since we cannot determine the A = periodic value
timelines for perpetuity we can solve P = present value
the problem on its present value
i = interest rate
 Perpetuity No. 1
 An employee thinking of his retirement, calculated that he needs PhP 500,000
per year will be sufficient to live without the need to work. Upon his retirement,
should he invest in the bank that offers 2% interest rate to receive the said
amount every year continuously?
@ Year 0
Capital
C = P500K
0 1 2 3 4 ∞ A
But P500k =
i
500k 500k 500k 500k 500k
500,000
P500k =
0.02

P500k Capital = P500k = PhP 25,000,000

A
P = i
 Perpetuity
 An employee thinking of his retirement, calculated that he needs PhP 500,000
per year will be sufficient to live without the need to work. Upon his retirement,
should he invest in the bank that offers 2% interest rate to receive the said
amount every year continuously?
@ Year 0
Capital
C = P500K
0 1 2 3 4 ∞ A
But P500k =
i
500k 500k 500k 500k 500k
500,000
P500k =
0.02

P500k Capital = P500k = PhP 25,000,000

A
P = i
 How Does Perpetuity Works?

PhP 25,000,000 @ 2% interest rate

Jan. 1, 2025 Dec. 31, 2025 Jan. 1, 2026 Dec. 31, 2026 Jan. 1, 2027 Dec. 31, 2050
25,000,000 25,000,000 25,000,000 25,000,000 25,000,000 25,000,000

500k 500k 500k

Withdraw Withdraw Withdraw

 Perpetuity No. 2
 On the average, a construction company is spending PhP 250,000,000 to
maintain an expressway and an additional PhP 600,000,000 every 4 years for
major repairs. How much should the company invest now in a bank that offers
8% per annum to address the maintenance cost of the expressway.
Capital @ Year 0

0 1 2 3 4 5 6 7 8 9 ∞ C = P250M + P600M
A
But P250M
250M i
250M 250M 250M 250M 250M 250M 250M 250M 250M =
250,000,000
P250M =
P250M 600M 600M 0.08

A P250M = PhP 3,125,000,000

P600M P = i
 Perpetuity No. 2
Capital
@ P600M calculating the ”i”
0 1 2 3 4 5 6 7 8 9 ∞
1+i4 = (1+i1)4
250M
250M 250M 250M 250M 250M 250M 250M 250M 250M
1+i4 = (1+0.08)4
P250M 600M 600M i4 = (1+0.08)4 - 1
i4 = (1+0.08)4 - 1
P600M
i4 = 0.3605%
For P600M note that the amount is paid
every 4 years and the interest rate will
not be suited to the annual interest rate
provided by the bank.
 Perpetuity No. 2
Capital @ P600M calculating the ”i”
0 1 2 3 4 5 6 7 8 9 ∞ 600,000,000
P600M =
250M
0.3605
250M 250M 250M 250M 250M 250M 250M 250M 250M
P600M = 1,664,355,062.41
P250M 600M 600M

C = P250M + P600M
P600M
C = 3,125,000,000 + 1,664,355,062.41
For P600M note that the amount is paid
every 4 years and the interest rate will = PhP 4,789,355,062.41
not be suited to the annual interest rate
provided by the bank.
Summary?