4

Annuity
 Learning Outcomes

By the end of this chapter, you should be able to

✔ explain the term ‘ordinary annuity certain’
✔ derive the future value and the present value of
ordinary annuity certain
✔ find the future value of annuity
✔ find the present value of annuity
✔ solve for annuity payment R, the number of
payments n, and the interest rate i, and

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 Learning Outcomes (Cont.)

✔ identify the problems where the present value

and the future value of annuity formula can be
appropriately applied.

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 4.1 Introduction

q Annuity is a series of (usually) equal payments

made at (usually) equal intervals of time.
q Examples: shop rentals, insurance policy
premiums, annual dividends received and
instalment payments.
q In each case, equal payments are deposited or
paid periodically over time.

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 4.1 Introduction (Cont.)

q In ordinary annuity certain, payments are

made at the end of the payment period. The
interest and payment period are the same
intervals.
q Note that unless specified, money invested
every period is understood to mean money
invested at the end of every period.

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 4.2 Future Value of an Ordinary
Annuity Certain

q Future value (or accumulated value) of an

ordinary annuity certain is the sum of all the
future values of the periodic payments.

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 4.2 Future Value of an Ordinary
Annuity Certain (Cont.)

q Let periodic payments = R,

interest rate per interest period = i%
term of investment = n interest periods, and
future value of annuity at end of n interest periods = S.

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 4.2 Future Value of an Ordinary
Annuity Certain (Cont.)

q Summing up the terms, we get

 (1  i ) n  1
S=R 
 1


or

 (1  i ) n  1
S = R sni with sni = 
i

 
 (1  i ) n  1
q The expression, sni = is the future value

 i


of annuity of 1 per payment interval for n
intervals. Interest earned, I, from investing in
annuity is given by I = S – nR.
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 4.2 Future Value of an Ordinary
Annuity Certain (Cont.)

Example 4.1
RM100 is deposited every month for two years seven
months at 12% compounded monthly. What is the future
value of this annuity at the end of the investment period?
How much interest is earned?
Solution

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 4.2 Future Value of an Ordinary
Annuity Certain (Cont.)

Here,
R = RM100
12%
i = 12 = 1%
n = 2 ×12 + 7 = 31

 (1  i ) n  1
From S = R  1  , we get
 (1  1%)31  1
S= 100  1% 

= RM3,613.27.

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 4.2 Future Value of an Ordinary
Annuity Certain (Cont.)

Alternatively, by using tables, we get

S = Rsn i
= 100s31 1%
= 100(36.13274045)
= RM3,613.27
Interest earned,
I = S – nR
= 3,613.27 – (31 × 100)
= RM513.27
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 4.2 Future Value of an Ordinary
Annuity Certain (Cont.)

Example 4.4
Lily invests RM100 every month for five years in an
investment scheme. She is offered 5%
compounded monthly for the first three years and
9% compounded monthly for rest of the period.
Find the accumulated amount at the end of the five
years. Hence, determine the interest earned.

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 4.2 Future Value of an Ordinary
Annuity Certain (Cont.)

Solution

q Since there are two different rates, we break the

annuity up into two streams of annuity as shown
below.

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 4.2 Future Value of an Ordinary
Annuity Certain (Cont.)
Stream 1

 5% 36 
 (1  )  1
12
Amount just after the third year = 100 5% 
 
 12 

= RM3,875.33

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 4.2 Future Value of an Ordinary
Annuity Certain (Cont.)

Amount at the end of five years

9%
= 3,875.33(1 + 12 )2

= RM4,636.50

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 4.2 Future Value of an Ordinary
Annuity Certain (Cont.)
Stream 2

Amount at the end of five years

 9% 24 
(1  )  1
= 100  12
 9% 
 
 12 

= RM2,618.85

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 4.2 Future Value of an Ordinary
Annuity Certain (Cont.)

q Hence, the amount in the account at the end of five

years
= RM4,636.50 + RM2,618.85
= RM7,255.35.
q Interest earned, I = S – nR
= 7,255.35 – (60 × 100)
= RM1,255.35

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 4.3 Present Value of an Ordinary
Annuity Return

q The present value (discounted value) of an ordinary

annuity certain is the sum of all present values of the
periodic payments.

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 4.3 Present Value of an
Ordinary Annuity Return
(Cont.)
q Summing all the terms, we obtain
1  (1  i )  n 

A = R  i


or A = Ra ni
1  (1  i )  n 
With an i =  i
 and interest

paid, I = nR – A.

1  (1  i )  n
The expression, ani = [ i ] is the present value of an
annuity of 1 per payment interval for n intervals.

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 4.3 Present Value of an
Ordinary Annuity Return
(Cont.)
Example 4.13
Good Fortune Industries decided to pay back a RM20,000
loan by making six semi-annual payments at 12%
compounded semi-annually. Find the
a) semi-annual payment.
b) interest and principal portions of the first payment.
c) the outstanding balance after the first payment.
d) the interest and principal portions of the second
payment.
e) the outstanding balance after the second
payment.
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 4.3 Present Value of an
Ordinary Annuity Return
(Cont.)
Solution
a) Here, A = RM20,000,
i = 6%,
n = 6.

1  (1  i )  n 
From A = R  i
 , we

get
1  (1  6%) 6 
20,000 = R  6%



R = RM4,067.25

The semi-annual payment is RM4,067.25.

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 4.3 Present Value of an
Ordinary Annuity Return
(Cont.)
b) Interest due after first payment
1
= 20,000 × 12% × 2
= RM1,200
Principal payment
= RM4,067.25 – RM1,200
= RM2,867.25

The interest and principal portions are RM1,200 and

RM2,867.25 respectively.

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 4.3 Present Value of an
Ordinary Annuity Return
(Cont.)
c) Outstanding balance after the first payment
= RM20,000 – RM2,867.25
= RM17,132.75
d) Interest due after second payment
1
= 17,132.75 × 12% × 2
= RM1,027.97
Principal payment
= RM4,067.25 – RM1,027.97
= RM3,039.28
The interest and principal portions are RM1,027.97 and
RM3,039.28 respectively.
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 4.3 Present Value of an
Ordinary Annuity Return
(Cont.)
e) Outstanding balance after the second payment
= RM17,132.75 – RM3,039.28
= RM14,093.47

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 4.4 Solving for R, n and i

q We shall discuss how to find the periodic

payment, R, the number of payments n, and the
interest rate per interest period, i.

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 4.4 Solving for R, n and i (Cont.)

Example 4.14
To find the periodic payment, R
Find the amount to be invested every three months at 10%
compounded quarterly to accumulate RM10,000 in three
years. Find the interest earned.
Solution

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 4.4 Solving for R, n and i (Cont.)

Here, S = RM10,000,
10%
i = 4
n = 4 × 3 = 12

1  (1  i )  n 
From S =R 
 i
 ,we
 get
 (1  2.5%)12  1
10,000 = R 
 2 . 5 %



R = RM724.90

The amount is RM724.90

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 4.4 Solving for R, n and i (Cont.)

Interest earned, I = S – nR
= 10 000 – (12 × 724.90)
= RM1,301.20

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 4.4 Solving for R, n and i (Cont.)

Example 4.16
q Rosalind borrows RM80,000 at 12% compounded
monthly for three years.
a) Find her monthly payment.
b) If she has not paid her first five monthly
payments, how much should she pay on her
sixth payment to settle all outstanding arrears?

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 4.4 Solving for R, n and i (Cont.)

c) If she wants to settle all of the loan immediately

after paying the first five monthly payments,
how much additional payment does she have to
make?
d) If she has made the first five monthly payments
and wants to settle all of the loan in the sixth
payment, how much should she pay? How
much interest is paid?

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 4.4 Solving for R, n and i (Cont.)

Solution
1  (1  i )  n 
a) From S = R i
 , we get
 
1  (1  1%) 36 
80,000 = R 
 1% 
R = RM2,657.14
b) Outstanding arrears on sixth payment
1  (1  i )  n 
= R i

 
 (1  1%) 6  1
= 2,657.14  1% 
 
= RM16,346.77
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 4.4 Solving for R, n and i (Cont.)

c) Outstanding loan
= 2,657.14a 31 1%
1  (1  1%) 31 
= 2,657.14  1 %

 
= RM70,526.57
d) Two methods can be used to find the sixth payment.
Method 1
The sixth payment = 2,657.14 + 2,657.14  a30 1%
= RM71,231.83

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 4.4 Solving for R, n and i (Cont.)

Method 2
Using the result obtained in (c), we get
The sixth payment = 70,526.57 (1 + 1%)1
= RM71,231.83
Total interest paid = [(2,657.14 × 5) + 71,231.83] –
80,000
= RM4,517.53

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 4.4 Solving for R, n and i (Cont.)

Example 4.17
A RM10,000 used car is bought for RM2,000 down
payment, fourteen payments of RM500 a month
and a final fifteenth payment. If the interest
charged is 9% compounded monthly, find the size
of the final payment.

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 4.4 Solving for R, n and i (Cont.)

Let the final payment be K.

14
 9% 
1  (1   9%
12
10,000 = 2,000 + 50  9% 

+ K(1+ 12 ) -15

 12 

K = RM1,541.98

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 4.4 Solving for R, n and i (Cont.)

Example 4.19
To find the number of payments, n
Jimmy has to pay RM443.21 every month to settle a loan
of RM10,000 at 6% compounded monthly. Find the
number of payments he has to make.
Solution

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 4.4 Solving for R, n and i (Cont.)

1  (1  i )  n 
From A = R  i  , we get
 6%  n 
1  (1  ) 
10,000 = 443.21  12

6%
 
 12 
6%
0.112 813 = 1 – (1 + 12 )–n
6%
(1 + 12 )
–n = 0.887186
6%
–n lg(1 + 12
)= lg 0.887186

n = 24 payments
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 4.4 Solving for R, n and i (Cont.)

Example 4.20
Roger borrows RM100,000 at 12% compounded
monthly. How many monthly payments of RM2,000
should Roger make? What would be the
concluding size of the final payment?

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 4.4 Solving for R, n and i (Cont.)

Solution
1  (1  i )  n 
From 
i
A = R, we get
 
1  (1  1%)  n 
100,000 = 
 1 %
 2,000

0.5 = 1 – (1 + 1%)–n
(1.01)–n = 0.5
–n lg(1.01) = lg 0.5
lg 0.5
n =  lg1.01

n = 69.7 payments
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 4.4 Solving for R, n and i (Cont.)

Roger can either pay sixty-eight payments of RM2,000

each and one concluding payment of more than
RM2,000, or sixty-nine full payments and one
concluding payment of less than RM2,000.

Method 1
Sixty-eight payments of RM2,000 each and a final payment
of more than RM2,000 on the sixty-ninth payment.

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 4.4 Solving for R, n and i (Cont.)

Let the concluding payment be K.

1  (1  1%) 68
100,000 = 1% + K(1 + 1%)–69

K = RM3,310.56

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 4.4 Solving for R, n and i (Cont.)

Method 2
Sixty-nine payments of RM2,000 each and a final
payment of less than RM2,000 on the seventieth
payment.

1  (1  1%) 68 
100,000 = 2,000  1%

 + K(1+1%)–70

K = RM1,323.66

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