Week-11-Problems

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Annuities-Problems

Formulae

 The accumulated value of an ordinary annuity is computed by

S=RX accumulation factor.

 Accumulated value of an annuity due is computed by

S=R X accumulation factor X(1+i)

 Present value of an ordinary annuity is computed by

A=RX discount factor.

 Accumulated value of an annuity due is computed by

A=RX discount factor X (1+i)

Problem1:

Find the accumulated value of an annuity of $150 invested at the end of each
month for 2 years at an annual rate of 9% compounded monthly.

Solution:

Given

R=$150,

n=12X2(payment made by by monthly)=24payments

i=0.09/12=0.0075

(Annual rate is 9%=0.09, so monthly interest rate=Annual rate/12)

accumulation factor for i=0.0075 and n=24 is 26.18847

(From table)
S=RX accumulation factor=$150X26.18847=$3928.2705

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Problem2:

The bank pays interest at the rate of 4% annually compounded quarterly. How
much money will you have in the bank at the end of 5 years if you deposits
$200 at the end of each quarter

Solution:

Given

R=$200

N=4X5-20(compounded Quartery)

i=0.04/4=0.01

The accumulation factor for i=0.01, n=20 is 22.01900

S=RX accumulation factor=$200X22.01900=4403.8

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Problem-3

Find the accumulated value of an annuity of $600 invested at the beginning of

each quarter for 5 years at an annual rate of 8% compounded quarterly.
Solution:

Accumulation factor for n=20(4X5), i=0.08/4=0.02 is=24.29737 .

Here S=RX accumulation factorX(1+i)=$600X24.29737X1.02=17348.322

(Invested at the beginning of each quarter that is why in formula (1+i) is there)
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Problem-4

Find the present value of an annuity of $300 at the end of each month for 5
years at 9% compounded monthly.
Solution:

Discount factor for n=60(12X5) and i=0.009/12=0.0075 is 48.17337.

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Problem-5

Find the present value of an annuity of $300 at the begining of each month for
5 years at 9% compounded monthly.

Solution:

From Table,Discount factor for n=60(12X5) and i=0.009/12=0.0075 is 48.17337.

A=RX discount factor X(1+i) =$300X48.17337X1.0075=14560.4011

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Problem-6

The accumulation of sinking fund in which $10000 is to accumulated in 1 year if

payments are made Quarterly into an account which pays 5% compounded
quarterly, for the above case Construct a sinking fund schedule.

Solution:

Here S=$10000

Accumulation factor for (n=1X4=4 and i=0.05/4=0.0125)=4.07563(From table)

𝑅 = 𝑆 /𝐴𝑐𝑐𝑢𝑚𝑢𝑙𝑎𝑡𝑖𝑜𝑛 𝑓𝑎𝑐𝑡𝑜𝑟 = 10000/ 4.07563 =2453.60

Sinking fund schedule

Period Initial Interest at Quarterly Increase in Final

amount 1.25% payment fund amount

1 0 0 2453.60 2453.60 2453.60

2 2453.6 0 30.67 2453.60 2483.67 4937.27

3 4937.2 7 61.71 2453.60 2515.31 7452.58

4 7452.58 93.15 2453.60 2546.75 9999.33

First we have calculate the 𝑅 value by using the formula

𝑅 = 𝑆 /𝐴𝑐𝑐𝑢𝑚𝑢𝑙𝑎𝑡𝑖𝑜𝑛 𝑓𝑎𝑐𝑡𝑜𝑟

Here given S=$10000

N=1X4=49(1 year quarterly=1X4)

i=0.05/4=0.0125(Quarterly interest rate=yearly interest rate/4 )

Accumulation factor for (n=1X4=4 )=4.07563(From table)

Sinking fund schedule

First Column:

Period here totally 4 periods(n=4)

Second Column:

Initial amount at the starting time it is 0.

Next period Initial amount=Last term Final amount

Third Column

Initialy for 0 it is 0,

second row interest=30.67 (for initial amount 2453.6 at 1.25%, ie

2453.6X1.25/100=30.67) ,

third row interest=61.71(4937.2 7X1.25=55.5)

Fourth row interest=93.15 (7452.58X1.25=93.15)

Fourth column

Quarterly payment is common to all period that is= 2453.60

Fifth column

Increase in fund = Quarterly payment + Interest at 1.25%

Sixth column

Previous period Final amount+ Present period Increase in fund

Problem-7

Construct an amortization schedule for a one and half year loan of $5000 at 6%
interest which is to repaid in quarterly installments over one and half years.

Solution:

Given A=5000

Discount factor for (n=6,i=0.06/6=0.01)=5.74601

𝑅 = 𝐴/ 𝐷𝑖𝑠𝑐𝑜𝑢𝑛t𝑓𝑎𝑐𝑡𝑜𝑟 = 5000/ 5.74601 =870.1690

Amortization schedule

Payment Payment Interest Reduction to Principa l

Number amount principal balance

- - - $5000

1 870.169 0 50 820.169 4179.831

2 870.169 0 41.79 828.379 3351.452

3 870.169 0 33.51 856.659 2494.793

4 870.169 0 24.94 845.229 1649.564

5 870.169 0 16.49 853.679 795.885

6 870.1690 7.95885 862.210 -66.325

Column I:

Payment number 1 to 6

Column II:

Payment amount (Like EMI, it is fixed)

Column III:

Present period Interest=( previous period principle balance) X(interest rate).

Here 5000X1/100=50, like wise other entries also.

Column IV:

Interest reduct from payment amount.

Here 870.169 0 -50=820.169 0 , like wise other entries also.

Column V:

principle balance=

Previous term principle balance-current period reduction to principle .

Here principle balance= 5000-820.1690=4179.831.

Like wise other entries also.

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Problem-8

Which would you prefer to receive

(i) $12000 at the end of 3 years plus $25000 at the end of 5 years, or

(ii) $2250 at the end of each quarter for the next 5 years.

Assume that money is worth 10% annually and is compounded quarterly.

Solution:

Option(i)

Quarterly pament so, n=3X4=12,i=10/100=0.025

The present value of $ 12000 , 3 years from now is

𝐴 = 𝑆/ (1+𝑖)n = 12000 /(1.025)12 = 12000/ 1.34489

 =8922.66(n=3X4=12; i=0.10/4=0.025)

Quarterly pament so n=5X4=20,i=10/100=0.025

The present value of $25000, 5 years from now is

𝐴 = 𝑆/ (1+𝑖)n = 25000/ (1.025)20= 25000 /1.63862

=15256.74(n=3X4=12; i=0.10/4=0.025)

The total present value under option(i) is $24179.4004.

Option (ii)

The present value of $2250 per quarter for 5 years is

A=Rxdiscount factor

=$2250X15.58916=$35075.61.

Option (ii) is preferable, since the present value of the money is larger.

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