Anannuityisasequenceofequalpaymentsmadeatequalintervalsoftime.E.g.

ofannuitiesare
weeklywages,monthlyhomemortgagepayments,paymentstoarecurringdeposit,quarterlystock
dividendetc.
Thetimeperiodbetweensuccessivepaymentsiscalledpaymentperiodorpaymentinterval.Itmaybe
weekly,monthly,quarterly,annuallyetc.oranyfixedperiodoftime.Thetimefromthebeginningof
firstintervaltotheendofthelastintervaliscalledthetermordurationoftheannuity.Thesizeofeach
paymentofanannuityiscalledtheperiodicpaymentoftheannuity.Thepersonwhoreceivesthe
paymentiscalledannuitant.Thesumofallpaymentsmadeinayeariscalledannualrent.
Theamountorfuturevalueofanannuityisthetotalamountdueattheendofthetermoftheannuity.
Itisprincipalplusinterest.Thus,theamountisthesumtotalofeachinstallmentkeptoncompound
interesttilltheendoftheterm.
Presentvalueofanannuityisthecurrentvalueofasequenceofequalperiodicpaymentsmadeovera
certainperiodoftime.
Annuitiesareofthreetypes:
1.

Inannuitiescertain,theno.ofpaymentsisfixed,i.e.thepaymentsbeginandendonfixed
dates.Anexampleisthatyouborrowsomeloanfromabankandrepayitin10equalannual
installments,the1stinstallmentbeingpaid1yearafterdateofborrowing.

2.

Acontingentannuityisonewherethetermdependsuponsomeeventwhoseoccurrenceisnot
fixed.Anexampleisperiodicpaymentsoflifeinsurancepremiumswhichstopwhenthe
persondies.

3.

Aperpetualannuityisanannuitywhosetermdoesnotend,i.e.itextendstillinfinity.Thus
thereisnolastpayment;theygoonforever.Anexampleisfreeholdproperty,whereyoucan
earnrentinperpetuity.

Annuitiesarefurtherclassifiedintothreecategoriesbypaymentdates:
1.

Anordinaryannuityorimmediateannuityiswherepaymentsaremadeattheendofeach
paymentperiod,i.e.1stpaymentismadeattheendofthe1stpaymentinterval,andsoon.
Examplesarerepaymentofcarloans,housemortgageetc.

2.

Anannuitydueiswherepaymentsaremadeatthebeginningofeachperiod.Examplesarelife
insurancepremiumpayments,recurringdepositpaymentsetc.

3.

Ifthepaymentsstartafterspecifiedno.ofperiods,wegetadeferredannuity.Typical
examplesarepensionplansfloatedbyvariousinsurancecompanies.Whenanannuityisleft
unpaidforano.ofyears,itissaidtobeunpaidorforeborneforthatamountofperiod;the
totalamountfortheseintervals,alongwithinterest,iscalledamountofdeferredannuity.

AmountandPresentValueofOrdinaryAnnuities
Whenwespeakofannuitiescertain,weusuallyspeakofordinary(immediate)annuity,wherepayment
isattheendofeachpaymentinterval.Wewillusethefollowingnotationsinthisarticle:
A=amountofeachinstallment
V=presentvalueofannuity

M=(future)amountofannuity
r=rateofinterest(ononerupeeperpaymentinterval)
n=no.ofinstallments(incaseofannuitycertain)
ToFindPresentValue(V):

ToFindAmountorFutureValue(M):

Hereristheinterestperpaymentperiodandnistheno.ofinterestperiods.Ifpaymentsarenotannual,
valuesofrandnshouldbestatedcorrectly.
Observethat:
IllustrativeExamples:
Example1:Findthepresentvalueandamountofanordinaryannuityof8quarterlypayments
ofRs500each,therateofinterestbeing8%p.a.compoundedquarterly.
Solution:
Here,A=Rs500
n=8

Now,let

Now,
Let

Thus,thepresentvalueofannuityisRs3662.50andamountisRs4275.
Example2:Amanborrowedsomemoneyandreturneditin3equalquarterlyinstallmentsofRs
4630.50each.Whatsumdidheborrowiftherateofinterestwas20%p.a.compounded
quarterly?Findalsotheinterestcharged.
Solution:
Here,wehavetofindpresentvalue(V)ofanordinaryannuitycertain.
A=Rs4630.50
n=3

Thus,thesumborrowedwasRs12160
Now,totalmoneyrepaid
Therefore,interestpaid
Example3:AmanborrowsRs37500andagreestorepayinsemiannualinstallmentsofRs2250
each,thefirstduein6months.Howmanypaymentsmusthemakeifrateofinterestis6%
compoundedsemiannually?
Solution:
Here,wehavetofindthenumberofpayments,n
V=Rs37500
A=Rs2250

Weknow,

Thus,themoneymayberepaidin23installmentswith23rdinstallmentslightlymorethanRs2250,or
themoneymayberepaidin24installments,the24thinstallmentslightlylessthanRs2250.
Nowpresentvalueoffirst23installmentsofRs2250each

presentvalueof24thinstallment
Hence,amountof24thinstallment
Thus,therewillbe23installmentsofRs2250and24thinstallmentofRs1020.22.

AmountandPresentValueofAnnuityDue
Inannuitydue,paymentisdoneatthebeginningofeachpaymentperiod.Forexample,paying
monthlyhouserentinadvanceeachmonth.
Here,Presentvalue(V):

Amount(M):

Thisiseasilyobtainedfromformulaeofordinaryannuitybymultiplyingbyfactor(1+r).Thisisso
becauseallinstallmentsareshiftedfromendofperiodtobeginningofperiod,sotheyamountto(1+r)
timesmore.
Illustrativeexamples:
Example1:FindtheamountandpresentvalueofanannuitydueofRs500perquarterfor8
yearsand9monthsat6%compoundedquarterly.
Solution:
Here,rateofinterest,r=1.5%perinterestperiod=0.015
Numberofinterestperiods,
Eachinstallment,A=Rs500
Presentvalueofannuitydue,

Amountofannuitydue,

Example2:Mr.Guptahasbeenaccumulatingafundat8%effective,whichwillprovidehim
withanannualincomeofRs30000for15years,thefirstpaymentbeingpaidonhis60thbirthday.
Ifhewishestoreducethenumberofpaymentsto10,findhowmuchannualincomewillhe
receive?
Solution:

Infirstcase,wehaveannuitydueof15terms.
Itspresentvalue(asonMr.Guptas60thbirthday),

Nowifonly10paymentsaretobereceived,wehaveannuitydueof10terms.IfAistheamountof
eachannualinstallment,

Thus,

Hence,Mr.Guptawillreceiveapprox.Rs38268peryearfor10years.

AmountandPresentValueofDeferredAnnuity
Ifthepaymentsstartafteraspecifiednumberofperiods,wegetadeferredannuity.
Here,Presentvalue(V):

Sometimesweuse
Similarly,futureamount,

NotethatformulaforMissameasthatforordinaryannuitywhereasformulaforVisobtainedby
dividingformulaforannuityby

IllustrativeExamples:
Example1:FindthepresentvalueofasequenceofannualpaymentsofRs10000each,thefirst
beingmadeattheendof5thyearandthelastbeingmadeattheendof12thyear,ifmoneyis
worth6%.
Solution:
Here,wehaveadeferredannuityof8terms(n),deferredfor4terms.
Eachinstallment,A=Rs10000
Rateofinterest,r=6%=0.06
m=4,m+n=12
Usingtheformula,presentvalue

Example2:VeenaisallottedanLIGflatforwhichshehastomakeanimmediatepaymentofRs
1lacand10semiannualpaymentsofRs50000each,thefirstbeingmadeattheendof3years.If
moneyisworth10%perannumcompoundedhalfyearly,findthecashpriceoftheflat.
Solution:
Cashprice=Downpayment+Presentvalueofannuity

Here,downpaymentisRs1lac,whilewehaveanannuityof10termsi.e.n,deferredfor
5terms.
Eachinstallment,A=Rs50000
Rateofinterest,r=10%p.a.compoundedhalfyearly=0.05
m=5,m+n=15
Presentvalueofannuity,

yearsi.e.

Hence,cashpriceoftheflat=Rs100000+Rs302509=Rs402509.

SinkingFund
Acompanymayaccumulatemoneyovertheyearstodischargeafutureobligation(liability)like
repaymentofdebentures,replacingamachine,formodernization/expansionofbusinessetc.
Thus,insinkingfundmethod,thedebtororthecompanymakesequalperiodicdepositsintothisfund
sothatjustafterthelastdeposit,thefundamountstotheoriginaldebt/moneyrequired.IfasumAis
depositedaftereveryperiodandtherearensuchinstallments,andrateofinterestisr(perrupeeper
interestperiod),thentheamountofobligationwhichcanbedischargedis

IllustrativeExample:
Example1:AmachinecostingRs2lacshaseffectivelifeof7yearsanditsscrapvalueisRs
30000.Whatamountshouldthecompanyputintoasinkingfundearning5%perannumsothat
itcanreplacethemachineafteritsusefullife?AssumethataneqwmachinewillcostRs3lacs
after7years.
Solution:
Costofnewmachine=Rs3lacs
Scrapvalueofoldmachine=Rs30000
Hence,moneyrequiredfornewmachineafter7years=Rs300000Rs30000=Rs270000
IfAistheannualdepositintosinkingfund,thenwehave
Amountofannuity,M=Rs270000
Numberofperiods=7
Rateofinterestperperiod=0.05.

Thus,thecompanyhastodepositRs33161.35attheendofeachyearfor7years.

Exercise
1.

AsumofRs2522isborrowedfromamoneylenderat5%p.a.compoundedannually.Ifthis
amountistobepaidbackin3equalinstallments,findtheannualinstallment.

2.

AdealeradvertisesthatataperecorderissoldatRs450cashdownfollowedbytwoyearly
installmentsofRs680andRs590attheendofthe1styearand2ndyearrespectively.Ifthe
interestchargedis18%p.a.compoundedannually,findthecashpriceofthetaperecorder.

3.

Amanborrowedsomemoneyandpaidbackin3equalinstallmentsofRs2160each.What
sumdidheborrowiftherateofinterestchargedwas20%p.a.compoundedannually?Find
alsothetotalinterestcharged.

4.

AcompanyborrowsRs200000ontheconditiontorepayitwithC.I.at5%p.a.byannual
installmentsofRs20000each.Inhowmanyyearswillthedebtbepaidoff?

5.

Mr.XpurchasedanannuityofRs2500peryearfor15yearsfromaninsurancecompany
whichreckonstheinterestat3%compoundedannually.Ifthefirstpaymentisdueinoneyear,
whatdidtheannuitycostMr.X?

6.

CalculatetheamountofordinaryannuityofRs7000attherateof10%p.a.compounded
annuallyfor10years.

7.

FindthepresentvalueofanannuityofRs1200payableattheendofeach6monthsfor3
yearswhentheinterestisearnedat8%peryearcompoundedsemiannually.

8.

UrvashiismakingmonthlydepositsintoanannuitythatwillbeworthRs250000in30years.
Theannuityearnsanannualrateof7.2%compoundedmonthly.Whatarehermonthly
payments?

9.

ThepriceofataperecorderisRs1561.ApersonpurchaseditbypayingacashofRs300and
thebalancewithdueinterest,in3halfyearlyequalinstallments.Ifthedealerchargesinterest
attherateof10%p.a.compoundedhalfyearly,findthevalueofeachinstallment.

10. WhatamountshouldbesetasideattheendofeachyeartoamounttoRs148970attheendof
8yearsat5%p.a.compoundedannually?
11. Whatequalpaymentsmadeatthebeginningoftheyearfor3yearswillpayforahousepriced
atRs400000,ifmoneyisworth15%perannumcompoundedmonthly?

12. ApersoninvestsRs1000everyyearwithacompanywhichpaysinterestat10%perannum.
Heallowshisdepositstoaccumulatewiththecompanyatcompoundinterest.Findtheamount
standingtohiscreditoneyearafterhehasmadehisyearlyinstallmentforthetenthtime.
13. ApersonbuysahouseforwhichheagreestopayRs5000atthebeginningofeachmonthfor
5years,thefirstinstallmentbeingpaidimmediately.Ifthemoneyisworth6%perannum
compoundedmonthly,whatisthecashpriceofthehouse?Roundofftheanswertonearest
thousandrupees.
14. IfmonthlyhouserentisRs600payableinadvance,i.e.atthebeginningofeachmonth,what
isequivalentyearlyrentalpaidinadvance?Interestisreckonedat6%perannumcompounded
monthly.
15. Howmuchmustbedepositedon1stApril2000inafundpaying4%compoundedsemi
annuallyinordertobeabletomakesemiannualwithdrawalsofRs500eachbeginning1st
April2015andending1stOctober2030?
16. SheelapurchasedawashingmachinepayingRs5000downandpromisingtopayRs200
everymonthfor3years,thefirstbeingmadeattheendoffirstyear.Findthecashpriceofthe
washingmachine,assumingthatmoneyisworth9%perannumcompoundedmonthly.
17. SumanbuysamachineforRs33000andagreestomake16semiannualpayments,thefirst
paymentbeingmadeattheendof4years.Findthehalfyearlypayments,ifthemoneyis
worth7%perannumcompoundedsemiannually.
18. AmachinecostsacompanyRs525000anditseffectivelifeisestimatedtobe20years.A
sinkingfundiscreatedforreplacingthemachineattheendofitslifetimewhenitsscrap
realisesasumofRs25000only.Calculatewhatamountshouldbeprovidedeveryyearoutof
profits,forthesinkingfundifitaccumulatesaninterestof5%perannumcompounded
annually.
19. ApersonsetsupasinkingfundinordertohaveRs100000after10yearsforhischildrens
collegeeducation.Howmuchamountshouldbesetasideafterevery6monthsintoanaccount
paying5%perannumcompoundedhalfyearly?
20. AcompanysetsasideasumofRs2000attheendofeachyearfor15yearstopayoffa
debentureissueofRs40000.Ifthefundaccumulatesat12%perannum,compounded
annually,findthesurplusamountafterredemptionofdebentureissue.