Key Concepts of Simple and

Compound Interests, and Simple

and General Annuities – Part 002
General Mathematics
Objectives
At the end of this module, the learner should be able to:
• 1. Distinguish between simple and general annuities
• 2. Find the future value and present value of both simple annuities and
general annuities
• 3. Calculate the fair market value of a cash flow stream that includes an
annuity
• 4. Calculate the present value and period of deferral and deferred annuity
Motivation
• Give instances when people normally pay in installments. Ask your parent,
aunt, uncles or even brothers or sisters who have been working and have
experiences in paying for commodities or services in installment.
Simple and General Annuity
Review:
• Simple annuity is where compounding and payment period happen at the
same time.
• General annuity is where the payment is not the same as the interest
compounding period.
Terminology
• Annuity – a sequence of payments made at equal (or fixed) intervals or
periods of time.
• Payment interval – the time between successive payments
• Term of annuity (𝑡) – time between the first and the last payment.
• Regular or periodic payment (𝑅) – the amount of each payment.
• Future Value (𝐹) – sum of future values of all payments to be made during
the full term.
• Present Value (𝑃) – sum of present values of all the payments to be made
during the full term.
Simple Annuity
• Computation for the future value of simple annuity is based on the formula:

(1 + 𝑗)𝑛 −1
𝐹=𝑅
𝑗
where:
𝑅 = 𝑡𝑕𝑒 𝑟𝑒𝑔𝑢𝑙𝑎𝑟 𝑝𝑎𝑦𝑚𝑒𝑛𝑡
𝑗 = 𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑟𝑎𝑡𝑒 𝑝𝑒𝑟 𝑝𝑒𝑟𝑖𝑜𝑑
𝑛 = 𝑛𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑝𝑎𝑦𝑚𝑒𝑛𝑡
Example #1:
• Suppose your Mom would like to save Php 2,000.00 at the end of each month for
1 year in a fund that gives 12% compounded monthly. How much is the amount
or future value of her savings after the end of her term of annuity?
(1 + 𝑗)𝑛 −1
𝐹=𝑅
𝑗
𝑅 = 𝑃𝑕𝑝 2,000.00 (𝑝𝑎𝑦𝑚𝑒𝑛𝑡 𝑎𝑚𝑜𝑢𝑛𝑡)
𝑗 = 0.01 𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑟𝑎𝑡𝑒 𝑝𝑒𝑟 𝑝𝑒𝑟𝑖𝑜𝑑
𝑛 = 12 𝑛𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑝𝑎𝑦𝑚𝑒𝑛𝑡𝑠
(1 + 0.01)12 −1
𝐹 = 2,000.00
0.01
(1.01)12 −1
𝐹 = 2,000.00
0.01
0.12682503
𝐹 = 2,000.00 ×
0.01
𝐹𝑉 = 𝑃𝑕𝑝 25,365.01
Present Value
• To compute for the Present Value of payments in a simple annuity fund,
you may use the formula:

1 − (1 + 𝑗)−𝑛
𝑃=𝑅
𝑗
where:
𝑅 = 𝑡𝑕𝑒 𝑟𝑒𝑔𝑢𝑙𝑎𝑟 𝑝𝑎𝑦𝑚𝑒𝑛𝑡
𝑗 = 𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑟𝑎𝑡𝑒 𝑝𝑒𝑟 𝑝𝑒𝑟𝑖𝑜𝑑
𝑛 = 𝑛𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑝𝑎𝑦𝑚𝑒𝑛𝑡
Example 1:
Computing for the present value of the investment:

1 − (1 + 𝑗)−𝑛
𝑃=𝑅
𝑗
1 − (1 + 0.01)−12
𝑃 = 2,000.00
0.01
𝑃 = 𝑃𝑕𝑝 22,510.15
General Annuity
• In the computation for general annuity, the payment schedule is different
from the interest compounding payout. The formula is generally the same
with some adjustments on the interest rate per period.

(1 + 𝑗)𝑛 −1
𝐹=𝑅
𝑗
where:
𝑅 = 𝑡𝑕𝑒 𝑟𝑒𝑔𝑢𝑙𝑎𝑟 𝑝𝑎𝑦𝑚𝑒𝑛𝑡
𝑗 = 𝑒𝑞𝑢𝑖𝑣𝑎𝑙𝑒𝑛𝑡 𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑟𝑎𝑡𝑒 𝑝𝑒𝑟 𝑝𝑎𝑦𝑚𝑒𝑛𝑡 𝑖𝑛𝑡𝑒𝑟𝑣𝑎𝑙 𝑜𝑟 𝑝𝑎𝑦𝑚𝑒𝑛𝑡 𝑝𝑒𝑟𝑖𝑜𝑑
𝑛 = 𝑛𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑝𝑎𝑦𝑚𝑒𝑛𝑡
Example #2:
Example #2: (con’t)
• This interest rate will be used for the computation using the same formula
for a simple annuity. The equivalent interest is the computed interest for
the fund if the payment and the compounding interest payoff coincide in
schedule.
• 3. This interest rate will be used for the computation using the same
formula for a simple annuity. The equivalent interest is the computed
interest for the fund if the payment and the compounding interest payoff
coincide in schedule
Fair Market Value
• FMV computations are used a lot in the insurance industry. Insurance
agents would normally show computations to prospective clients so that
the clients may be better assisted in making an intelligent decision on
choosing a plan they would avail of.
FVM (Example)
• Your family is thinking of selling your current house to buy a bigger house
for the growing family. Several days after the advertisement of intent to
sell, your father was offered by two persons interested on buying the
property.
• Offer 1: Down payment of Php 500,000.00 and a lump sum payment of
Php 2,000,000.00 after 2 years.
• Offer 2: Down payment of Php 500,000.00 and a monthly payment of Php
100,000.00 for 18 months.
• Which of the two offers will be better to accept of the payments will have
an interest of 12% compounded monthly?
FVM (Example) (con’t)
• An initial review of the problem would most probably sway you to accept
Offer #1 as it totals Php 2,500,000.00 in payment (Php 500,000.00 + Php
2,500,000.00) while Offer #1 totals Php 2,300,000.00 (Php 500,000.00 +
Php 1,800,000.00). However, this is not enough information and figures to
help your parents make an intelligent decision.
FVM (Example) (con’t)
• Offer 1:
• Since the payments are in lump sums, you will need to use the compound
interest formula:
𝐹𝑉
• 𝑃𝑟𝑒𝑠𝑒𝑛𝑡 𝑉𝑎𝑙𝑢𝑒 = 𝑅 𝑁𝑇
1+
𝑁
2,000,000
• 𝑃𝑟𝑒𝑠𝑒𝑛𝑡 𝑉𝑎𝑙𝑢𝑒 = 0.12 12×2
1+
12

• 𝑃𝑟𝑒𝑠𝑒𝑛𝑡 𝑉𝑎𝑙𝑢𝑒 = 1,575,132.25

• 𝑃𝑟𝑒𝑠𝑒𝑛𝑡 𝑉𝑎𝑙𝑢𝑒 𝑜𝑓 𝑡𝑕𝑒 𝑜𝑓𝑓𝑒𝑟 = 𝑃𝑕𝑝 500,000.00 + 𝑃𝑕𝑝 1,575,132.25
• 𝑃𝑟𝑒𝑠𝑒𝑛𝑡 𝑉𝑎𝑙𝑢𝑒 𝑜𝑓 𝑡𝑕𝑒 𝑜𝑓𝑓𝑒𝑟 = 𝑃𝑕𝑝 2,075,132.25
FVM (Example) (con’t)
• Offer 2:
• Since the payments are in installments, you need to treat this as an
annuity. This is a simple annuity as the payment coincides with the
compounding interest rate payoff.
1−(1+0.01)−18
• 𝑃= 100,000.00 0.01
• 𝑃 = 𝑃𝑕𝑝 1,639,826.86
• 𝑃𝑟𝑒𝑠𝑒𝑛𝑡 𝑉𝑎𝑙𝑢𝑒 𝑜𝑓 𝑡𝑕𝑒 𝑜𝑓𝑓𝑒𝑟 = 𝑃𝑕𝑝 500,000.00 + 𝑃𝑕𝑝 1,639,826.86
• 𝑃𝑟𝑒𝑠𝑒𝑛𝑡 𝑉𝑎𝑙𝑢𝑒 𝑜𝑓 𝑡𝑕𝑒 𝑜𝑓𝑓𝑒𝑟 = 𝑃𝑕𝑝 2,139,826.86
• From the two computation, it shows that the better option is to accept Offer
#2 as it gives your family a higher return.
Deferred Annuity
• This is a type of annuity that does not begin until a given time interval has
passed. The period of deferral is the time between the purchase and the
start of the payments for the deferred annuity.
• the formula for the present value of a deferred annuity is:
1−(1+𝑗)−(𝑘+𝑛) 1−(1+𝑗)−𝑘
• 𝑃= 𝑅 − 𝑅
𝑗 𝑗
• where:
• 𝑅 = 𝑡𝑕𝑒 𝑟𝑒𝑔𝑢𝑙𝑎𝑟 𝑝𝑎𝑦𝑚𝑒𝑛𝑡
• 𝑗 = 𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑟𝑎𝑡𝑒 𝑝𝑒𝑟 𝑝𝑒𝑟𝑖𝑜𝑑
• 𝑛 = 𝑛𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑝𝑎𝑦𝑚𝑒𝑛𝑡
• 𝑘 = 𝑡𝑕𝑒 𝑛𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑎𝑟𝑡𝑖𝑓𝑖𝑐𝑖𝑎𝑙 𝑝𝑎𝑦𝑚𝑒𝑛𝑡𝑠