Time Value of Money – Part III

A. Annuities
• An annuity is a series of periodic payments (or receipts), usually made in equal amounts. Examples
include life insurance premiums, interest payments on bonds, and installment payments for cars, house
and lot and home appliances.
• Payment interval is the period between two successive payment dates.
• The term of an annuity is the time between the beginning of the first payment interval and the end of the
last payment interval.
• Classification of Annuities:
o According to term
▪ Annuity certain begins and ends on definite dates.
▪ Perpetuity. It is an annuity in which the term begins on a definite date, but never ends.
The term of this type of annuity is infinite.
▪ Contingent annuity. The term begins on a definite date, but the ending date is not fixed
in advance, instead, it depends on some condition happening in the future.

o According to timing of payments

▪ Ordinary Annuity. Periodic payments are made at the end of each payment interval.
▪ Annuity Due. Periodic payments are made at the beginning of each payment interval.
▪ Deferred Annuity. Periodic payments are made at the end of each payment interval.
However, the payment of the annuity does not begin until after a designated period of
time.

o According to the length of the payment interval and the interest compounding period
▪ Simple annuity. The payment interval coincides with the interest compounding period.
▪ Complex or general annuity. The payment interval does not coincide with the interest
compounding period.

B. Simple Ordinary Annuities

• Future value of a simple ordinary annuity
• Or simply ordinary annuity
• “Starts with nothing and accumulates a series of payments at compound interest to a future
amount.”
𝑖 𝑛𝑡
(1 + 𝑛) − 1
𝐹𝑢𝑡𝑢𝑟𝑒 𝑣𝑎𝑙𝑢𝑒 𝑜𝑓 𝑜𝑟𝑑𝑖𝑛𝑎𝑟𝑦 𝑎𝑛𝑛𝑢𝑖𝑡𝑦 = 𝑃𝑎𝑦𝑚𝑒𝑛𝑡 × [ ]
𝑖
𝑛
• Present value of a simple ordinary annuity
• “Used when someone wanted an account from which he could withdraw a series of equal
amounts over a period of time.”
𝑖 −𝑛𝑡
1 − (1 + 𝑛)
𝑃𝑟𝑒𝑠𝑒𝑛𝑡 𝑣𝑎𝑙𝑢𝑒 𝑜𝑓 𝑜𝑟𝑑𝑖𝑛𝑎𝑟𝑦 𝑎𝑛𝑛𝑢𝑖𝑡𝑦 = 𝑃𝑎𝑦𝑚𝑒𝑛𝑡 × [ ]
𝑖
𝑛
C. Simple Annuity Due
• An annuity for which the periodic payments are made at the beginning of each payment interval. The term
begins on the date of the first payment and ends one payment interval after the last payment is made.
• Future value of an annuity due
𝑖 𝑛𝑡
(1 + 𝑛) − 1 𝑖
𝐹𝑢𝑡𝑢𝑟𝑒 𝑣𝑎𝑙𝑢𝑒𝑜𝑓 𝑎𝑛𝑛𝑢𝑖𝑡𝑦 𝑑𝑢𝑒 = 𝑃𝑎𝑦𝑚𝑒𝑛𝑡 × {[ ][ 1 + ] }
𝑖 𝑛
𝑛
 • Present value of an annuity due
𝑖 −𝑛𝑡
1 − (1 + 𝑛) 𝑖
𝑃𝑟𝑒𝑠𝑒𝑛𝑡 𝑣𝑎𝑙𝑢𝑒 𝑜𝑓 𝑎𝑛𝑛𝑢𝑖𝑡𝑦 𝑑𝑢𝑒 = 𝑃𝑎𝑦𝑚𝑒𝑛𝑡 × {[ ] [1 + ] }
𝑖 𝑛
𝑛
D. Deferred Annuities
• The term of a deferred annuity starts at a later date. The period between now (or time zero) and the
beginning of the term of the annuity is called the period of deferment.
• No additional formula is involved since this kind of annuity is only a combination of compounding or
discounting and annuities.

E. Perpetuities
• A kind of annuity that begins on a definite date but never ends. Payments for this type of annuity continue
forever, thus making its term infinite.
• Since there is no end to perpetuity, it is impossible to determine its future value. However, the present
value of a perpetuity can be determined.
𝑃𝑎𝑦𝑚𝑒𝑛𝑡
𝑃𝑟𝑒𝑠𝑒𝑛𝑡 𝑣𝑎𝑙𝑢𝑒 𝑜𝑓 𝑎 𝑝𝑒𝑟𝑝𝑒𝑡𝑢𝑖𝑡𝑦 =
𝑖

Illustrative Problems

1. What is the future value of an ordinary annuity of ₱10,000 per year for 4 years, at 12% interest compounded annually?
₱47,793.28
2. Metro Bank is paying 12% interest compounded semiannually. Find the future value of ₱60,000 deposited at the end
of every six months, for 6 years. ₱1,012,196.47
3. Metro Bank is paying 12% interest compounded monthly. Find the future value of ₱10,000 deposited at the end of
every month, for 6 years. ₱1,047,099.31
4. Robinsons Savings Bank pays interest at the rate of 4% compounded quarterly. How much money will one have in
the bank at the end of 5 years if he/she deposits ₱2,500 at the end of each quarter? ₱55,047.51

5. How much must be deposited now at 9% compounded annually, to have an annuity payment of ₱50,000 at the end
of each year, for 10 years? ₱320,882.89
6. What is the present value of an ordinary annuity of ₱10,000 per month, for 4 years, at 12% interest compounded
monthly? ₱379,739.59

7. The Billy Playhouse wants to have ₱20,000 at the end of each 6-month theater season for stage renovations and
lighting equipment. How much must be deposited now, at 8% compounded semiannually, to yield this annuity payment
for the next 6 years? ₱187,701.48
8. Wealth Savings and Loans is paying 6% interest compounded monthly. How much must be deposited now in order to
withdraw ₱4,000 at the end of each month for 2 years? ₱90,251.46
9. Sam has saved a total of ₱1,700,000 for retirement. He has put the money in a fund which pays 9% annual interest
compounded monthly. How much should he withdraw at the end of each month in order to have enough money to last
for 15 years? ₱17,242.53
10. An office table sells for ₱6,000. As an incentive, a furniture store offers to accept ₱500 per month for one year with
no finance charge. If the actual interest rate charged by a bank is 12% compounded monthly, what is the actual cost
of the office table? ₱5,627.54
11. Tracy bought a Toyota FJ Cruiser at ₱1,798,000. She paid 20% down-payment and will pay the balance monthly for
3 years. If the interest rate is 6.24% annually, how much should she pay every end of the month?

12. Alma deposited ₱6,000 at the beginning of each month, for 2 years, at her savings account in a local bank. If the
interest rate is 12% compounded monthly, calculate for the value of her deposit after the 2-year period. ₱163,459.20

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 13. Belle invested ₱2,500 at the beginning of every 3-month period for 5 years at 8% interest compounded quarterly. How
much is Belle’s investment worth after 5 years? ₱61,958.29
14. Angelo wishes to have ₱200,000 five years from now. How much must he invest at the beginning of each year if the
first payment starts now and the interest is 10% compounded annually? ₱29,781.36
15. How much must be deposited now, at 10% compounded semiannually, to yield an annuity payment of ₱20,000 at the
beginning of each 6-month period, for 2 years? ₱74,464.96
16. If ₱10,000 must be withdraw at the beginning of each 3-month period for the next 3 years, how much must be
deposited now, at 6% compounded quarterly, to yield the annuity payment needed? ₱110,711.18

17. Arnold bought a ₱42,500 flat television and agreed to pay for it in installment of ₱5,000 at the beginning of every six
months, starting on the date of purchase. If the interest rate charged is 12% compounded semiannually, how many
installments will it take him to pay off the obligation?
18. The monthly rent for a 2-bedroom unit at SN Apartment is ₱10,000 payable at the beginning of each month. If the
current interest rate is 9%, what would be a fair amount to charge someone if they wish to pay one year’s worth of
rent now?
19. Peter owns a machine shop. One of his machines is rather old and needs to be replaced in 3 years. He estimated that
a new machine will cost ₱800,000. How much should he set aside every month starting now into a sinking fund which
pays an annual rate of 6% compounded monthly in order to accumulate the money to replace the machine?
20. Bill plans to purchase a life insurance policy which has an annual premium of ₱15,000 due at the beginning of the
year. If he elects to pay his premium in quarterly installments, how much should he pay at the beginning of each
quarter if the interest rate is 10% compounded quarterly?

21. Find the present value of an annuity of ₱1,000 payable at the end of each quarter for six payments. The interest rate
is 6% compounded quarterly, with the first payment due at the end of 9 months. ₱5,530.04
22. John purchased a dining set for ₱80,000 on May 13, 2009. She paid ₱10,000 cash and agreed to pay the balance
plus interest at 9.50% compounded annually in 14 equal payments, with the first payment due on May 13, 2012. What
is the size of each payment? ₱11,084.71
23. If ₱5,000 is deposited at the end of each month and the interest rate is 6% compounded monthly, how many monthly
payments will be required for the deposit to equal a present value of ₱450,000? The first deposit is made at the end
of six months. 125 monthly payments
24. If money is worth 5.50% compounded annually, what single payment now is equivalent to 45 annual payments of
₱35,000 each with the first payment due in five years? ₱467,516.04

25. Find the present value of a simple perpetuity of ₱5,000 payable at the end of each quarter if the interest rate is 8.00%
compounded quarterly. ₱250,000.00
26. Find the present value of a simple ordinary annuity of ₱5,000 payable at the end of each quarter if the interest rate is
8.00% compounded quarterly for (a) 20 years, (b) 25 years, (c) 250 years, (d) 1,000 years.
27. Find the present value of a simple perpetuity of ₱4,000 payable at the beginning of each month if the interest rate is
12% compounded monthly. ₱404,000.00
28. Find the present value of a simple perpetuity of ₱10,000 payable semiannually if the interest rate is 2% per six
months and the first payment is due(a) six months from now; and (b) now.

Additional Problems

29. During your 3rd birthday, your favorite aunt promised to set up a college fund for you. For the fund, she obliged
herself to deposit ₱50,000 at the end of each year for 15 years, with the first payment due one year after he made
the promise (i.e. at your 4th birthday). Today, you are now 18 years old and soon to enroll in college. You inquired
with the depository bank as to the status of the fund and learned that your aunt forgot to make the 5th and 9th
deposits. All other required payments were made on time. Given this scenario, how much is the value of your
college fund today? How much must be deposited by your aunt to the fund today in order to make up for the two
payments missed? Interest is 10% compounded annually.

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 30. Annalise plans to retire in 20 years. After her retirement, she wants to receive a monthly retirement pension of
₱50,000 for 10 years with the first receipt to happen one month after the date she retires. To realize this, she is
planning to save equal amounts every month starting one month from now for 20 years, with the last payment due
at the date of her retirement. At 8.00% compounded monthly, how much should be the balance of her retirement
fund by the time she retires? How much must the size of her monthly savings be in order to accumulate the desired
value of the fund at her retirement date?

31. Asher and Michaela got divorced. The divorce settlement stipulated that Asher pay ₱21,000 per month for their
son Michael until he turns 18, with the first payment to happen now. Michael just turned 12 years old today. How
much must Asher set aside today to meet the settlement? Interest is 6% compounded monthly.

32. Laurel is planning to buy a 54” smart television. The cash price of the TV is ₱30,000. She opted to buy the TV on
an installment basis. Under the terms of the sale, she is to pay a down payment equal to 25% of the cash price
and settle the remaining balance with four equal quarterly payments. The first payment is to be made 3 months
from now. How much is the required down payment? If the EAR of the obligation is 12%, how much must the size
of the quarterly payments be?

33. Connor wants to have a Ferrari in 5 years. The current price of his dream car is ₱10,540,000. However, this price
is expected to increase by 3.45% annually due to inflation. How much must Connor deposit at the end of every 3
months, with the first deposit to happen today, in order to have enough money to buy the Ferrari? Assume his
deposits will earn interest of 7% compounded quarterly.

34. Frank retires today. He has ₱5,000,000 in his bank account which he saved for his retirement years. He will use
this money for his daily expenses for the next 10 years and for his dream trip to New Zealand five years from now.
For the said trip, he expects to spend ₱850,000. With the foregoing, how much must Frank withdraw from the
fund every month, with the first withdrawal to be made a month from now, so that his ₱5,000,000 fund would last
for 10 years and he will be able to fulfill his dream of going to New Zealand? The fund is deposited in an account
that earns interest of 5% compounded monthly.

35. Teagan owes Connor ₱450,000. The two agreed that Teagan shall settle the obligation by paying Connor ₱25,000
monthly starting one month from now. Assuming interest is 12% compounded monthly, how many ₱25,000-sized
payments will Teagan have to make in order to settle her obligation? What must the size of the last payment be?

36. Wes just won the lottery with a ₱200 million jackpot which will pay him ₱10 million every year for 20 years, with
the first payment to happen today. An investor has offered him ₱100 million for this annuity. Wes estimates that
he can earn 10% interest compounded annually on any amount he invests. He now asks your advice on whether
to accept or reject the offer. What advice will you give him? Explain your answer with supporting computations.

37. Bonnie is planning to attend college when she graduates from high school 7 years from now. She anticipates that
she will need ₱100,000 at the beginning of each college year to pay for tuition and other fees and have some
money to spend. Bonnie has arranged with her father to do the household chores if her dad deposits ₱35,000 at
the end of each year for the next 7 years in a bank account that pays interest of 8.00% compounded annually.
Will there be enough money in the account?

38. Oliver just bought a laptop for ₱48,000. However, instead of paying upfront cash, he was given by the store
manager one year to pay. Starting today and every month for the next 11 months, he shall be paying ₱4,000. If
money is worth 8%, what is the equivalent cash price of the laptop?

39. A friend of yours is convincing you to buy one of the investment products being offered by his company, Moonlife
Financial. This investment product is priced at ₱100,000 and promises to pay ₱25,000 one year from now and for
the succeeding four years. You require a return of 9.00% from this product. Should you buy it? Provide support
for your decision.

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