CHAPTER 3 ANNUITY Objectives: After completing this chapter, you will be able t 1. Define annuity. Al J 2. Discuss the importance of annuity. : 3. Classy the types of annuities. \w 4 |. Solve illustrative and classical problems of annuity. What is annuity? a series of equal payments made at equal intervals of time. It is a sum of money paid out at regular times, usually monthly or yearly. The word comes from the Latin word annus, ineaiig year Insurance policies, wills, and other documents provide for annuities. People may leave money to an heir in the form of an annuity. The inheritance will then be paid in installments instead of in a lump sum. ‘annubies fon be structured according to a wide array of details and factors, such ‘as the duration of time that payments from the annuity can be guaranteed to continue. Annuities can be created so that, upon annuitization, payments will continue so long as either the annuitant or their spouse is alive. Annuities can be structured to provide fixed periodic payments to the annuitant or variable payments. The intent of variable annuities is to allow the annuitant to receive greater payments if investments of the annuity fund do well and smaller payments if its investments do poorly. This provides for a less stable cash flow than a fixed annuity, but allows the annuitant to reap the benefits of strong returns from their fund's investments. The different ways in which annuities can be structured provide individuals seeking annuities the flexibility to construct an annuity contract that will best meet their needs. 53Chapter 3 - Annuity “Types of Annuities | 1. “Ordinary Annuity is one where the each payment period An is essentially a period of time. Straight bond coupon payments are normally referred to as ordinary annuities. An ordinary annuity is essentially a level stream of cash flows for a fixed period of time. Straight bond coupon payments are normally referred to as ordinary annuities. i \ petremee date Pid et oO 1 2 3 4 14 14 " oO 1 2 3 4 5 ae 2. is also an ordinary annuity but ‘he STARTERS is deferred a certain number of periods after the first. Problems on iffered annuity can be transformed into ordinary annuity. deferred ‘A type of annuity contract that delays payments of income, installments or a lump sum until the investor elects to receive them. This type of annuity has , the in which you and the in which the 54Engineering Economics A Simplified Approach by C. G. Duaso Earnings on a deferred annuity account are taxed only upon withdrawal, providing the annuity with a tax benefit. This type of annuity also provides a death benefit, so that the beneficiary of the annuity is guaranteed the principal and the investment earnings. 1 2 3 4 5 Te petreee date n annuity due requires payments to be made at the beginning of the period. For example, in many lease arrangements, the first payment is due immediately and each successive payment must be made at the beginning of the month. PV Reference date 55Chapter 3 - Annuity 4. 0 = a1] \Perpetuitylis an annuity where the payment periods extend forevarlor in which the periodic payments continue indefinitely. This is not as abstract a concept as you may think; the British issued bonds, called consoles, which are a great example of perpetuity. By Purchasing a consol from the British government, the bondholder is entitled to receive annual interest payments forever, Although it may seem a bit illogical, an infinite series of cash flows can have a finite present value. Because of the time value of money, each payment is only a fraction of the last. - = ae 1 2 3 4 Derivation of Formula: A. Series of Payments D whose End Sum is S rm \ Reference date Om l— si Led N w = D+D(1+i)' +D(14i)? +D(14i)? = D[1+ (1Fi)+ (ati)? +(14i 7) = D[4+6i +4747) =DZ =4+6i+4i+i 56Multiply i both sides ® a Ze =a +6 + 4 +i ‘Add 1 both sides > “V 14Ziz 1+ 41 +67 +r sit ae ee Thus: S§ =D | ~~. Generally forts] i B, Equal Series of Payments D whose Initial Sum is R R « Tete ee D D “Gee 57vez reRrene, fae] (Ut 4 See 141)" -1]Chapter 3 - Annuity Multiply by (1+ i)* both sides (ati) R = (D(1+i)? + D(1+i)? + D(1+i)? +] In general, (1+i) -1 (oi R = i(t+iy” i(1+i) Where: S$ = total end sum of the series of payments D = equal end- of -period payments in a series R = initial sum of the series of payments n= qumber of years nominal rate of interest 4. Sample Problem Deposits at the end of each year are made by a father for his son starting from his son's first birthday until the son’s 20" birthday. The son will have to withdraw equal amounts of P 20,000 for each year starting from his 21” birthday to his 24™ birthday from the deposits his father made. How much was the yearly deposit the father made if money is worth 8% compounded annually? Solution: 4 hay Ryo = W 2) i(1+7 (1+ 0.08)" -1 Rio = 20,000] —_—_—"—q i 0,08(1+0.08) \ lear Roo = P 66,242.54 FP *Pe a ss “NF How — \\ OwEngineering Economics A Simplified Approach by C. G. Duaso Thus Rao = S20 a (1+i) -1 Sto a eae i 66,242.54 = D D = P1447.5458 2. Sample Problem From the following cash flow diagram with i = 8%. Compute the equivalent series of equal year-end payments. 10,000 20,000 al o 1 2 3 4 3 10 Solution P= Be Pe +P + Pe Py CORRCERED-PmnernZ>— nea’ S Pe TT fn pens _ 5000 10,000 = 7,500 _ = 000 20, 000" / (1+008). | (140.08) (1+0.08)" (1+0.08)° "(008)" P = 4286.69 + 6805.83 + 4376.18 + 2701.34 + 9263.87 P= P 27,433.91 From equation of Annuity P=R 59Chapter 3 - Annuity . at (14° -1 sew worth R = p/p Vise | i(1+i) ) 0 \ pees cine ener i0) 0,08 (1+0.08) D = P 4088.46 3. Sample Problem Engr. Quijada bought a car with cash value of P 340,000 on the insteliment plan under the following terms: P40,000 cash upon delivery and the balance payable in 12 equal monthly payments, each payment combining an amortization installment and 2% interest on the previously unpaid balance. Solve for his monthly payment. Solution: R = — 340,00- 40,000 ees re 2 5 | (tr9.02)" cet > oma( 02(1+0.02) P 300,000 300,000 = D = P 28,367.88 4. Sample Problem The purchaser of a tractor paid P108,000 cash and agreed to pay P 30,000 at the end of 6 months for 10 years. He failed to make the first 5 payments of P3,000 each. At the end of 3 years he desires to pay the tractor by a single payment which will cancel both his accumulated liabilities and his future liabilities. What must he pay if money is worth 6% per annum compounded semi-annually? 60Engineering Economics A simplified Approach by C. G. Duaso Solution: ir) (+4) -1 =D a os i 2 6 (1.2%) a = 30,000) — : : 0.06 2 S, = P 194,052.29 i 2(7) (+5) -1 wee |B 6 7 ij 1+— 2 14 [(s.022)"-s 2 Rg = 30,000) 7-4, 0.06 0.06} L 2 Re * P 338,882.19 Thus A = S+R A = 194,052.29 + 338,882.19 = PS32,934.48 61aT go DET pe PLAN : % © vy. 2000 t co" P24 TC 43) - Nelo * ize i er & aH; pe DLO or y iene Cay = reco [( 14 0-08)!° q Oy (ite.04)* TR= 3,420. es PEF on) 2 Fen so olin aer(ui® Yoon (V4 000) ' = \o +2068] (i+ 02)*-1 dia,e4 ow 024, bec Orgerm is | e oft) sim Tar” — ° Seer sent | al 6.00 P =e heaey © Ho. Se NY isexy ? party EES nem ye —_-Azybe00(1+.12)8 A uk (i) pales 2 avonbel (HE dhs efer wmattly> 2 in wes rE > a [J01.08 cosa pce pte olcit ea ao, ‘too eda eB anit SRY neey Aa! : wy Lon Se ceca D> 132435996 /annum, “Troi canIIS :'~'S'‘sr Chapter 3 - Annuity EXERCISE No. 34 Annuity Name: Score: Course Year. Instructor:, INSTRUCTION: Answer the following problems and show the complete solution. ‘i. What is the present worth of a P 2000.00 annuity over a 10-year period, if interest rate is 8%? A. P 13420 * c.P 15340 B.P 14290 D.P 16340 ‘4X2. Abegail invested P 5000 per month on a bank that offers 694interest. How much can he get after S years? A. P334,790 CP 356,850 B.P348,850 * D. P 386,290 A house and lot can be acquired by a down payment of P 500,000 and a yearly Payment of P 100,000 at the end of each year for a period of 10 years, starting at the end of 5 years from the date of purchase. If money is worth 14% compounded annually, what is the cash price of the property? ; A.P-770,289.80 CP 808,835.92 * B.P- 785,550.30 ©. P 810,380.92 g A young engineer borrowed P 10,000 at 12% interest and paid P 2,000 per annum for the last 4 years. What does he have to pay at the end of the fifth year in order to Pay off his toan A.P6,922.93 * C.P 6,872.89 B.P 6,633.22 D. P 6,760.20 6. Aman purchased of monthly installment at P 100,000 worth of land. The interest rate is 12% nominal and payable in 20 years. What is the monthly amortization? A.P 1,101.08 * C.P 1328.30 8.P 1290.09 D. P 1590.20 62© $= 200K G0 © wv/me, $= (60,006 A= 10 yo 1s 12% compounded monty re companied worthy ms oa olen fscofeebyt On “© 69 [rd] t a ar cso ¥8)O] a Coos? 2) 2 woos = DUCHY =i] a ee oR 2 \ ¥ 2 13,486.73 | |_D> \e/e15.80 y © w=28,000/y ® ( G,s08 , bets yt eZ do Meal 43 “oe p> B80 Bae W260 ns2e &, 766 - bw \ My falance = 2, ey a 14e 5 yrs se ao(ised eg] ane arin tage Kewl tro : con = tsp0[ (1H0.00)*-1] 0% (Hoe) | Res 242,500.02 © % vf 200,000 ne? CPIEZ /conpundd monthly D> 42,€21,.¢9 ; aoeto-o toon pywet — § SBIR ye t Meo,c00-* = 42, A £213 Cir 0 yen Ae ye ,c00 (1440)" owEngineering Economics A Simplifted Approach by C. G. Duaso \\6. A manufacturing firm wishes to give each 80 employees a holiday bonus. How much is needed to invest monthly for a year at 12% nominal interest rate compounded monthly, so that each employee will receive a P 2,000 bonus? A. P 10,200.39 CP 14,289.30 B. P12,615.80 * D. P 16,289.37 XJ. An instructor plans to retire in exactly one year and want an account that will pay him P 25,000 a year for the next 15 years. Assuming a 6% annual effective interest rate, what is the amount he would need to deposit now? A. P 242,806.22 * C. P 367,290.22 B. P 256,890.20 D. P 379,390.11 \\8. Mr. Robles plans a deposit of P 500 at the end of each month for 10 years at 12% annual interest, compounded monthly. What will be the amount that will be available in two years? AP 12,345.55 C. P 13,486.73 * B.P 12,980.44 D.P 14,289.34 A small machine has an initial cost of P 20,000, a salvage value of P 2,000 and a life of 10 years. If your cost of operation per year is P 3,500 and your revenues per year is P 9,000, what is the approximate rate of return on investment? Br242%* C. 16.29% B. 20.38% D. 14.6% WA Ko Aman paid 10% down payment of € 200,000¥or a house and lot and agreed to pay the balance on monthly installments for n years at an interest rate of 15% compounded monthly. If the monthly installment was P 42,821.87, find the value of , "2 pe Ax Pe A. 3years ©. 5 years * a(n) eo * He 8. 7 years D.9 years vets wf. if a low cost house and lot worth P87,000 were offered at 10% down payment and 500 per month for 25 years, what is the effective monthly interest rate on the diminishing balance? e A. 36% C.49% * B.42% D. 54% 63@ Prise je20 ot wonky e me yo LS As ryt ee . 521 £10, 28 =/2, 40 AF ac ey Ti8 6B 536 12,000 A=2,506. ve = 7a.00'f 21,502 .2g2 D [cw ae) i Soe See O14 - ® v= 1e,coo/ye nea gis C24 , vc > 4 Tyne $> 1,000 [C14 .14)4 -1] olf C= (WO, 953.43 fen pe vee cre lets 448 of one) yl on i4( tron! G®tm CRy% D-? hr fo Ge. pepe ita Tat" re pico gh 1] ect) & DP> 16% X 280,060 DP = 38 42,000 PAL 226,000 hee te whe Dp: ? Re vllri yr] i (ri D1CHoos)* | OIE (i+ 6.0K) e Toe. © Re 12-000 iz 26% n= ay per ee ofty Sy] Nae peo = LORE] Zw DezChapter 3 - Annuity 9 12. A debt of P12,000 with interest of 20% compounded quarterly is to be amortized by E equal semi-annual payments over the next three years, the first due in 6 months. How much is the semi-annual payments? A.P2,775* C. P3125 B. P2,965 D.P 3510 ‘\13. If P10,000 is deposited each year for 9 years, how much annuity can a person get annually from the bank every year for 8 years starting 1 year after the 9" deposit is made. Cost of money is 14%, A. P34,675 * C. P 36, 903 B. P 35,950 D. P 38,250 \u4. A car dealer advertises the sale of a car model for a cash price of P 280,000. If purchased on installment, the regular down payment is 15% and balance payable in 18 equal monthly installments at an interest rate of 1.5% per month. How much will be required monthly payments? A. P12,255 C. P 15,186 * B. P 13,370 D.P 16,225, ‘5. If you obtain a foan of P 1,000,000 at the rate of 12% compounded annually in order to build a house, how much must you pay monthly i amortize the loan within a period of ten years? A.P 10,255 C.P 15, 259 B.P 13,994 * D.P 16,550 16. Find the present value of a deferred annuity of P350 for 6 years that is deferred 2 Years, if money is worth 6% compounded quarterly. ALP 394.27 * ~ ¢.451.47 8.P 417.29 D. 481.27Engineering Economics A simplified Approach by C. G. Duaso EXERCISE No. 3B Annuities Name:, Score: Course & Year, Instructor: INSTRUCTION: Select the correct answer for each of the following questions tis a series of equal payments occurring at equal interval of time. A. Annuity * C. Amortization 8. Debt 0. Deposit itis a series of equal payments occurring at equal interval of time where the first payment is made after several periods, after the beginning of the payment. A. Perpetuity C. Annuity due 8. Ordinary annuity D. Deferred annuity * A series of uniform accounts over an infinite period of time. A. Depreciation C. Perpetuity * 8. Annuity D. Inflation A type of annuity where the payments are made at the end of each payment period starting from the first period. A. Ordinary annuity* C. Deferred annuity 8. Annuity due D. perpetuity . A type of annuity where payments are made at the start of each period, beginning from the first period. A. Ordinary annuity C. Deferred annuity 8. Annuity due * D. Perpetuity As applied to a capitalized asset, the distribution of the initial cost by periodic changes to operation as in depreciation or the reduction of a debt by either periodic or irregular prearranged program is called. A. Annuity C. Annuity factor 8. Capital recovery D. Amortization * A periodic payment andi Is the interest rate, the present worth of perpetuity. A OL cov 8. oi D.D/i * 658. Annuity can be applied only to a payment of A. Monthly C. Annually 8B. Semi-annually D. All of the above * 9. The process of determining the value of certain property for specific reasons, A. Bond C. Annuity 8. Demand D. Appraisal * 10. A series of equal payments occurring at equal periods of time. A. Equity capital C. Amortization * 8. Depreciation D. Interest 11, The systematic recording of all business transactions in financial terms. A. Bookkeeping * €. Budgeting 2) B. Accounting D. Booking ~~ . 12. Which of the following is not considered an injection in the economy? A exports c B. imports * investment D. none of the above 13, Which of the following is not considered a leakage in the economy? A. Savings C. Imports B. Income taxes D. Investment spending * 14.The government's attempt to control the decisions and choices of A. Localization C. Nationalization 8. Privatization D. Regulation* 15. The opportunity cost of holding money is the A. bond rate C. dividend 3. interest rate * D. shares 16, Assets which can be easily converted to cash are called A Real assets C. Liquid assets * 8. Solvent assets D. Ideal assets 17. Which function of money represents its role as an instrument it for buying and selling goods and services? ‘A. Medium of exchange * C. Store of value 8. Unit of account D. All of the above 66 Private firms. j,. DARce rap yee Ory a (i+) wean, SY Gilvcsp, value tr yal th “physical WP ee (fe Urs