Calculating Different Types of Annuities

Definition
An annuity is a series of payments required to be made or received over time
at regular intervals.

The most common payment intervals are yearly (once a year), semi-annually
(twice a year), quarterly (four times a year), and monthly (once a month).

Some examples of annuities: Mortgages, Car payments, Rent, Pension fund

payments, Insurance premiums.

TYPES OF ANNUITIES

Ordinary Annuity:
An Ordinary Annuity has the following characteristics
• The payments are always made at the end of each interval
• The interest rate compounds at the same interval as the payment
interval
For calculating the sum of a series of regular payments the following formula
should be used:

C[(1+i)n -1]
S n = -----------------
i

Example: Alan decides to set aside $50 at the end of each month for his
child’s college education. If the child were to be born today, how much will be
available for its college education when s/he turns 19 years old Assume an
interest rate of 5% compounded monthly.

Solution:
First, we assign all the terms:
C= $50
i= 0.05/12 or 0.004166
n= 18 x 12, or 216

Now substituting into our formula, we have:

C[(1+i)n -1]
S n = -------------------
i

$50[(1+0.05/12)^216 -1]
S n = --------------------------------
0.05 / 12

S n = $50(349.2020206)
S n = $17,460.10

Formula for calculating present value of a simple annuity:

C[1-(1+i)-n]
PV = --------------------
i

Calculating Different Types of Annuities

Definition
An annuity is a series of payments required to be made or received over time
at regular intervals.

The most common payment intervals are yearly (once a year), semi-annually
(twice a year), quarterly (four times a year), and monthly (once a month).

Some examples of annuities: Mortgages, Car payments, Rent, Pension fund

payments, Insurance premiums.

TYPES OF ANNUITIES

Ordinary Annuity:
An Ordinary Annuity has the following characteristics
• The payments are always made at the end of each interval
• The interest rate compounds at the same interval as the payment
interval
For calculating the sum of a series of regular payments the following formula
should be used:

C[(1+i)n -1]
S n = -----------------
i

Example: Alan decides to set aside $50 at the end of each month for his
child’s college education. If the child were to be born today, how much will be
available for its college education when s/he turns 19 years old Assume an
interest rate of 5% compounded monthly.

Solution:
First, we assign all the terms:
C = $50
i= 0.05/12 or 0.004166
n= 18 x 12, or 216

Now substituting into our formula, we have:

 C [(1+i)n-1]
S n = -------------------
i

$50[(1+0.05/12)^216 -1]
S n = --------------------------------
0.05 / 12

S n = $50(349.2020206)

S n = $17,460.10

Formula for calculating present value of a simple annuity:

C [1-(1+i)-n]
PV = --------------------
i

Example: Alan asks you to help him determine the appropriate price to pay
for an annuity offering a retirement income of $1,000 a month for 10 years.
Assume the interest rate is 6% compounded monthly.

Solution:
Substituting into our formula, we have:

C = $1,000
i = 0.06 /12 or 0.005
n = 12 x 10, or 120

$1,000[1-(1+0.005)^-120]
PV = -----------------------------------
0.005

PV = $90,073.45

Annuity Due:
In an annuity due, the payments occur at the beginning of the payment
period.

For calculating the sum of a series of regular payments the following formula
should be used:

C (1+i)[(1+i) n -1]
S n (due)= -----------------------
 i

Example: Alan wants to deposit $300 into a fund at the beginning of each
month. If he can earn 10% compounded interest monthly, how much amount
will be there in the fund at the end of 6 years.

Solution:
C = $300
i = 0.10/12 or 0.008333
n = 12 x 6 or 72

Substituting into our formula yields:

$300(1+0.10/12)[(1+0.10/12)^72-1]
S n (due) = -------------------------------------------------
0.10/12

S n (due) = $300(98.93)
S n (due) = $29,679

Formula for calculating present value of an annuity due:

C (1+i)[1-(1+i)-n]
PV(due) = -------------------------
i

Calculating Different Types of Annuities

Definition
An annuity is a series of payments required to be made or received over time
at regular intervals.

The most common payment intervals are yearly (once a year), semi-annually
(twice a year), quarterly (four times a year), and monthly (once a month).

Some examples of annuities: Mortgages, Car payments, Rent, Pension fund

payments, Insurance premiums.

TYPES OF ANNUITIES

Ordinary Annuity:
An Ordinary Annuity has the following characteristics
• The payments are always made at the end of each interval
• The interest rate compounds at the same interval as the payment
interval
For calculating the sum of a series of regular payments the following formula
should be used:

C [(1+i)^ n -1]
S n = -----------------
i

Example: Alan decides to set aside $50 at the end of each month for his
child’s college education. If the child were to be born today, how much will be
available for its college education when s/he turns 19 years old Assume an
interest rate of 5% compounded monthly.

Solution:
First, we assign all the terms:
C = $50
i= 0.05/12 or 0.004166
n= 18 x 12, or 216

Now substituting into our formula, we have:

C [(1+i)n-1]
S n = -------------------
i

$50[(1+0.05/12)^216 -1]
S n = --------------------------------
0.05 / 12

S n = $50(349.2020206)

S n = $17,460.10

Formula for calculating present value of a simple annuity:

C [1-(1+i)-n]
PV = --------------------
i

Example: Alan asks you to help him determine the appropriate price to pay
for an annuity offering a retirement income of $1,000 a month for 10 years.
Assume the interest rate is 6% compounded monthly.

Solution:
Substituting into our formula, we have:

C = $1,000
i = 0.06 /12 or 0.005
n = 12 x 10, or 120
 $1,000[1-(1+0.005)^-120]
PV = -----------------------------------
0.005

PV = $90,073.45

Annuity Due:
In an annuity due, the payments occur at the beginning of the payment
period.

For calculating the sum of a series of regular payments the following formula
should be used:

C (1+i)[(1+i)^ n -1]
S n (due)= -----------------------
i

Example: Alan wants to deposit $300 into a fund at the beginning of each
month. If he can earn 10% compounded interest monthly, how much amount
will be there in the fund at the end of 6 years.

Solution:
C = $300
i = 0.10/12 or 0.008333
n = 12 x 6 or 72

Substituting into our formula yields:

$300(1+0.10/12)[(1+0.10/12)^72-1]
S n (due) = -------------------------------------------------
0.10/12

S n (due) = $300(98.93)
S n (due) = $29,679

Formula for calculating present value of an annuity due:

C (1+i)[1-(1+i)-n]
PV (due) = -------------------------
i

Example: The monthly rent on an apartment is $950 per month payable at

the beginning of each month. If the current interest is 12% compounded
monthly, what single payment 12 months in advance would be equal to a
year’s rent?

Solution:
C = $950
i= 0.12/12 or 0.01
n= 12

Substituting into the formula gives:

$950(1+0.03)[1-(1+0.01)^-12]
PV (due) = ---------------------------------------
0.01

PV(due) = $950(11.37)
PV(due) = $10,801.50