MATH IF (MATHEMATICS OF THE MODERN WORLD)

MODULE 3
Introduction to Annuities

Section 1
Ordinary Annuity

COLLEGE OF BUSINESS AND ACCOUNTANCY

RATIONALE

The goal of the course is for students to develop the computational skills they
will need to be successful in the world of business along with a better understanding
of business concepts and situations that require a mathematical solution.
Specifically, the students are expected to understand the concepts on simple
interest, simple discount and able to apply this concept in various business
transactions in which calculation are required

INSTRUCTIONS TO USERS

Read the main content of the module under developmental activities sections and
answer the problems indicated in the closure activities.

The learners should have a good background on the following concepts

1. Whole numbers, decimals, fractions, and percent

2. Rules in manipulating equations and formulas.
3. Fluency in calculator use is required.

MODULE 1 LEARNING OBJECTIVES

1. Calculate simple interest and bank discount.

2. Manipulate simple interest and bank discount formula.
3. Apply simple interest and bank discount concepts in discounting promissory
notes.
Section 1 1 Ordinary Annuity
Section Objectives:
1. Define the basic terms involved with annuities.
2. Find the amount of an annuity via Table Factors and Future Value Formula
3. Use the formula to find the present value of an ordinary annuity.

OBJECTIVE 1 Define the basic terms involved with annuities.

In Module 2, we discussed lump sums that were invested for periods of time. In this
module, we talk about an annuity, or a series of equal payments made at regular intervals.
Monthly mortgage payments, quarterly payments by a company into an employee retirement
account, and monthly checks paid by Social Security to a retired couple are examples of
annuities. There are two basic types of annuities. One type grows as regular payments are
made and it accumulates compound interest. Regular payments into a retirement account or
college savings account are examples of this type of annuity. A second type of annuity
involves regular
payments made out of an accumulated sum. Monthly payments from a retirement fund are an
example. Retirement funds can in fact represent both types, with money being added on a
regular
basis while an employee is working, then with payments being made from the fund after the
employee retires. This section will cover annuities that accumulate funds, while Section 11.2
will include a discussion of annuities from which payments are made. The basic terms
involved
are the same for both types.
An ordinary annuity is one in which payments are made at the end of each period,
such as at the end of each month. The payment period is the length of time between
payments and
the term of the annuity is the total time needed for all payments. Interest calculations for
annuities are done using compound interest. The total amount in an annuity on a future date
is the amount, compound amount, or future value of the annuity. These terms are used
interchangeably.
 The amount an annuity grows to can be found using compound interest techniques
from
the previous module. For example, suppose a firm makes deposits of P30,000 at the end of
each year for 6 years into an investment earning 8% compounded annually. Use the
compound interest tables in module 2 for 5 years and 8% to find the future value of the first
payment as follows:
P 30,000 * 1.46933 = P44,079.9
The future value of the annuity is the sum of the compound amounts of all six
payments. The annuity ends on the day of the last payment. Therefore, the last payment,
which is made at the end of year 6, earns no interest.

The future value of the annuity is P 220, 075.9.

Find the total amount deposited in the annuity and interest earned as follows:
Total deposits = 6 years * P 300,00 per year = P180,000
Interest earned = Future value of annuity - Total deposits
=P 220,075.9 – P 180,000
= P 40,075.9
OBJECTIVE 2 Find the amount of an annuity.
The amount of an annuity can also be found using the amount of an annuity table on
the next page. The number from the table is the amount or future value of an annuity with a
payment of P 1. The amount of an annuity with any payment is found as follows.

Finding Amount of an Annuity

Amount = Payment * Table Factor from amount of an annuity table

As a check, reconsider the annuity of P 30,000 at the end of each year for 6 years at
8% compounded annually. Locate 8% at the top of the table and 6 periods in the far left (or
far right) column to find 7.33593.
Amount = P 30,000 * 7.33593 = P 220,077.9
This amount is identical to the amount calculated earlier, but sometimes the estimates from
the table differ slightly from those found using a calculator.
Table Factors for an Amount of Annuity
Example 1
A father deposits P10,000 every quarter for 5 years in a firm that pays 12%
compounded quarterly. Assuming no withdrawals are made, how much would be in his
account at the end of five years?

Solution
Deposits per quarter = 10,000
12%
Interest earned per quarter =3 % for 5 years x 4 = 20 quarters. Look across the
4
top of
the table for 3, and down the side for 20 periods to find 26.87037

Amount = P 10,000 x 26.87037= P 268,703.7

Total deposits = 20 quarters * P 10,00 per year = P 200,000
Interest earned = Future value of annuity - Total deposits
= P 268,703.7 – P 200,000
= P 68,703.7

Quick Check 1
At the end of every quarter, P 2000 is put into a educational plan that earns 6% compounded
quarterly. Find the future value in 5 years.
Future value of an ordinary annuity can also be determined using its formula and it is given
by:

Amount of an Annuity or Future Value of an Ordinary Annuity (FV OA)

(1+i)n−1
FV OA=Pmt (
i )
Where FV OA =Future value∨amount
Pmt= periodic deposit∨ payment
n=number of deposits∨ payments made i=interest rate per compounding period

Example 2
Mark Ezekiel wants to put up his Art Studio 5 years from now. If he deposits P 5,000
from his monthly salary for the next 5 years in an account that yields 12% compounded
monthly. How much does he have by that time?

Solution
Amount deposited at the end of each month is P 5000 for 5 years x 12 = 60 months
12%
Using Pmt= P5,000, n=60 and =1 %
12

(1+i)n−1
FV OA=Pmt ( i )
(1+ 0.01)60−1
FV OA=P 5,000 ( 0.01 )
=P 408,348.35(rounded)

Quick Check 2
Verify Quick Check 1 using the formula.
Objective 3. Use the formula to find the present value of an ordinary annuity.

The present value of an ordinary annuity is the total of the present values of all the
payments of the annuity. To get the present value, assume an annuity of n number of
payments at rate i per period. Calculate the present value of each payment to the start of the
annuity and take their sum. The total is the present value of the annuity.
There is also a corresponding table factor for Present Value of an Ordinary Annuity
given below.

Finding Amount of an Annuity

Present Value of Ordinary Annuity = Payment * Present Value Table Factor

Example 3
An alumnus in a certain university wants to provide a P 250,000 research fellowship
fund at the end of each year for the next five years. If the University can invest the money at
10% compounded annually, how much should a man give now to setup the fund for the
scholarship?

Solution
Annual fellowship fund = P 250,000
10 %
Interest earned per year =10 % for 5 years x 1 = 5. Look across the top of
1
the table for 10, and down the side for 5 periods to find 3.79079
Present Value = P 250,000 x 3.79079= P 947,697.5

The amount P 947, 697.5 is the lump sum need to be deposited in an investment
earning 10% compounded annually to be able to provide P 250,000 pesos every end of
the year for 5 years. At the end of the 5th year of the scholarship, the fund is fully
exhausted. The fund was able to provide P 250,000 x 5= P 1,250,000 by investing P
947, 697.5

The present value of an ordinary annuity formula can also be used and it is given by:

Present Value of an Ordinary Annuity (FVOA)

1−(1+i)−n
PV OA=Pmt ( i )
Where PV OA=Present Value of an Ordinary Annuity
Pmt= periodic deposit∨ payment
n=number of deposits∨ payments made i=interest rate per compounding period
Example 4

A company wants to purchase a machine the will require a payment of

P100,000 at the end each 6 months for the next four years. How much should the
company invest at present to cover for the semiannual payment if the money can be
invested 12% compounded semiannually?

Solution

Amount to be paid at the end of each month is P 100,000 for 4 years x 2 = 8

12%
Using Pmt= P100,000, n=8 and =6 %
2

1−(1+i)−n
PV OA=Pmt ( i )
1−(1+0.06)−8
PV OA=P 100,000 (0.06 )
=P 620,979.38( rounded)

The value can verified using the table factor for present value. Given i=6% and n=8,
the corresponding table factor is 6.20979
Present Value = P 100,000 x 6.20979= P 620, 979
The difference in decimal places is due to the limit decimal places used by the table
factor.
Section Exercises
Find the amount of the following ordinary annuities rounded to the nearest cent. Find the total interest
earned.

Amount of Time Amount of Interest

Each Deposit Deposited Rate (Years) Annuity Earned

1. P 900 annually 5% 18 __________ __________

2. P 2900 annually 8% 5 __________ __________

3. P 7500 semiannually 6% 10 __________ __________

4. P 9200 semiannually 8% 5 __________ __________

5. P 3500 quarterly 10% 7 __________ __________

Find the present value of the following annuities. Round to the nearest cent
Amount per Payment at Time Rate of Present
Payment End of Each (Years) Investment Compounded Value

P 1800 year 18 10% annually ______________

P 4100 year 7 6% annually ______________

P 2000 6 months 12 8% semiannually ______________

P 1700 6 months 14 5% semiannually ______________

P 894 quarter 6 4% quarterly ______________

Solve the following application problems.

1. Roman Rodriguez would like to know if he can retire in 35 years at age 60, when he
plan to fish a lot. Assume the total deposit into his retirement account at the
community college is P 3800 at the end of each year and that the fund earns 6, per
year. Find (a) the amount of the annuity and (b) the interest earned.

2. Monique Chaney places P 250 of her quarterly child support check into an annuity for
the education of her child. She does this at the beginning of each quarter for 8 years
into an account paying 8, per year, compounded quarterly. Find the amount of the
annuity and (b) the interest earned.

3. In 4 years, Jennifer Videtto will need to purchase a delivery van for her plumbing
company. She estimates it will require a down payment of P 10,000 with payments of
P 950 per month for 36 months. (a) Find the total amount needed in 4 years assuming
12% compounded monthly. (b) Will she have enough if she invests P 2200 at the end
of every quarter for 4 years and earns 6, compounded quarterly?

4. Jessica Thames expects to receive P 18,400 per year based on her deceased husband’s
contributions to Social Security. Assume that she receives payments for 14 years and
a rate of 4% per year, and find the present value of this annuity.
SYNTHESIS

Formula for Future Value and Present Value of Ordinary Annuity

(1+i)n−1
FV OA=Pmt ( i )
Amount = Payment * Table Factor from amount of an annuity table

1−(1+i)−n
PV OA=Pmt ( i )
Present Value of Ordinary Annuity = Payment * Present Value Table Factor
References

Ballada, Ballada, Math in the Business World, 2019, 1st edition

Ballada, Ballada, Investment Mathematics, 2012 issue

Mathematics in the Modern World

Mathematics of Investment 5th Edition by Asuncion C. Mercado Del Rosario, copyright

2011, Del Ros Publishing House

Clendenen G., Salzman S. Business Mathematics 13ed 2015, Pearson Publishing,