APPLICATIONS OF ANNUITY

There are many topics where the principle of annuity can be applied. To mention some of
them we have the following:
1. BOND VALUE
- It is the present worth or cost of a bond or the amount being paid to own a bond.

Consider the CFD,

C

I I I I I I

0 1 2 3 4 n–1 n

P
 P = I 1 – ( 1 + i ) –n + C ( 1 + i ) – n ; I = Fr
i

Where,
P = bond value / purchase price
I = income per period through the ownership of a bond
F = face value of the bond, the amount printed on the bond
r = bond rate of interest per period/interest rate per period of the bond
i = yield of investment or the rate of interest per period/investor’s rate per
period
n = maturity period / no. of interest periods from the date of purchase to the
redemption date
C = redemption cost, the value of the bond at the end of the period

Note: C = F , if not given

 SAMPLE PROBLEM
1. A P1,000.00 face-value bonds pay dividend of P 110.00 at the end of each
year. If the bond matures in 20 years, what is the approximate bond value
at an interest of 12% per year compounded annually?

2. A P1,000.00 6% bond pays dividends semi-annually and will be redeemed

at 110% on July 1, 1975. It is bought on July 1, 1972 to yield 4%
compounded semi-annually. Find the price when it was bought.

3. To secure a return of 4%, at what price should a bond be purchased if it is

redeemable at P10,000.00 in 10 years and pays annual dividends of
P350.00
2. CAPITALIZED COST
- It is the sum of first cost (FC) and the present worth of the following costs:
a.) Annual Maintenance and Operational Cost (MC)
b.) Cost of Repair or Rework (CR)
c.) Renewal Cost/Replacement Cost (RC)
However, these 3 factors may not be all present in a certain property but
definitely at least one of the three factors will be included.
Furthermore, capitalized cost may be considered the amount of money
needed at present to purchase a property or to construct a project for continuous
service.
FORMULA:

CC = FC + MC + CR + RC
i ( 1 + i )K – 1 ( 1 + i )L – 1
Where,
L = useful life
K = interval of repair, k>1 and a factor of L
NOTES:
1. If RC is not given, use
RC = FC – SV – CR
where, SV = salvage value
2. If annual maintenance cost is not of a constant value, use the principle of
problem 2 of perpetuity in place of the term MC/i.

SAMPLE PROBLEM:
1. A P100,000.00 item is purchased. Annual maintenance and operational costs are
P 18,000.00. Using 8%, what is the capitalized cost of perpetual service?
2. A timber penstock costs P50,000.00 and whose salvage value is P2,000.00 after
10 years. If the annual maintenance cost is P1,200.00 and money is worth 10%,
find the capitalized cost.
3. A bridge has an initial cost of P600,000.00 and whose estimated life is 30 years.
The annual maintenance cost is P6,000.00 and the cost of repair is P25,000.00
every 5 years. Find the capitalized cost if the salvage value is P 30,000.00 and
cost of money is 9%.
4. Determine the capitalized cost of a motor that is worth P50,000.00, with maintenance
costs of P1,000.00 per year for the first 5 years, P1,200 per year thereafter and P5,000.00
repair every years if money is worth 12%.
Solution:
The maintenance cost is not constant, then solve for its present worth by using the
principles of annuity.
Consider the CFD,
PMC (Present worth of Maintenance Cost)

0 1 2 3 4 5 ∞

0’ 1 2 3
P 1,000 each
1- (1 + i )-n
A i P 1,200 each
PP ( 1 + i ) -n PP A/i
By equation of value at 0,

PMC = PA + PF

PMC = 1,000 1 – ( 1.12 ) -5 + 1,200 ( 1.12 ) -5

0.12 0.12

= P 9,279.04476

CC = FC + MC + CR , no replacement
i ( 1 + i ) k- 1
Use PMC in place of MC/i

CC = FC + PMC + CR so,
( 1 + i ) k- 1
CC = 50,000 + 9,279.04476 + 5,000
( 1.12 ) 5 - 1
CC = P 65,837.78359
3. UNIFORM ARITHMETIC GRADIENT
- It is a series of payments occurring at equal period or interval of time when payments
have common difference.
- In certain cases, economic analysis problems involve receipts or disbursements that
increase or decrease by a uniform amount each period. For example, maintenance
and repair expenses on specific equipment or property may increase by a relatively
constant amount each period. This is known as a uniform arithmetic gradient.

Consider the CFD, F

P
0 1 2 3 4 5 n–1 n

A
A+G
A + 2G
A + 3G A + 4G A+(n-2)G
G = common difference A + (n-1)G
FORMULAS:
P = PA + PG
WHERE,
PA = A 1 – ( 1 + i ) –n ; PG = G 1 – ( 1 + i ) –n – n ( 1 + i ) -n
i i i

F = FA + FG
WHERE,
FA = A ( 1 + i ) n - 1 ; FG = G (1+i)n –1 -n
i i i

NOTE: G – positive for increasing payments

G – is negative for decreasing payments
Suppose that the maintenance expense on a certain machine is P 1,000 at the end of
the first year and increasing at a constant rate of P 500 each year for the next four
years.
P 2500 P 3000
P 1500 P 2000
P 1000
0 1 2 3 4 5
This cash flow may be resolved into two components:
(n-1) G
A A A A A 2G 3G
0 G
+
0 1 2 3 4 5 0 1 2 3 4 5
A = P1000 n=5 G = P 500 n=5
PA PG
1. The maintenance cost for a sewing machine this year is expected to be P500.
The cost will increase by P 50 each year for the subsequent 9 years. The
interest is 8% compounded annually. What is the present worth of maintenance
for the machine over the full 10 years?
2. A man pays his debt in the following manner: P 1,000 after 1 yr., P 900 after 2
yrs., P 800 after 3 yrs. And so on up to the 6th year. Find the accumulated
amount of these payments at the rate of 15% compounded annually.
3. A loan was to be amortized by a group of four end-of-year payments forming an
ascending arithmetic progression. The initial payment was to be P 5,000 & the
difference between successive payments was to be P 400. But the loan was
renegotiated to provide for the payment of equal rather than uniformly varying
sums. If the interest rate of the loan was 15%, what was the annual payment?
4. Find the equivalent annual payment of the following obligations at 20% interest.
End of year Payment
1 P 8,000
2 P 7,000
3 P 6,000
4 P 5,000
4. GEOMETRIC GRADIENT
- It is a series of payments with common ratio occurring at equal period or interval of time.
Consider the CFD,
P

0 1 2 3 4 n-1 n
A
A (1+r) A(1+r)2
A(1+r)3

A(1+r) n - 2 A(1+r) n – 1

P = A 1 - wn ; P = An , if i = r
1+i 1-w 1+r
Where,
w = 1+r ; 1+r = rate of increase ; r = percent of increase
1+i
Note:
r = is positive for increasing payments
r = is negative for decreasing payments

SAMPLE PROBLEMS:
1.The annual maintenance costs of a generator is P 1,000 after 1 yr. and it is
estimated to increase by 10% each yr. for a period of 8 years. Find the
present worth of the maintenance costs if the rate of interest is 15%
compounded annually.
1. FIND THE PRESENT WORTH OF ALL THE CASH DISBURSEMENTS USING GRADIENT INTEREST
FORMULAS IF MONEY IS WORTH 15% PER ANNUM. ANNUAL CASH DISBURSEMENTS INCREASES BY
P 1,000.00 EVERY YEAR THEREAFTER, UNTIL THE END OF THE FOURTH YEAR. THE FIRST CASH
DISBURSEMENT AMOUNTS TO P 5,000.00.

2. THE FIRM IS CONSIDERING THE INSTALLATION OF AN AUTOMATIC DATA PROCESSING UNIT TO

HANDLE SOME OF ITS ACCOUNTING OPERATIONS. MACHINES FOR THAT PURPOSE MAY BE
PURCHASED FOR P 20,000.00, OR MAY BE LEASED FOR P 8,000.00 FOR THE FIRST YEAR AND P
1,000.00 LESS EVERY YEAR NOW AND THEN UNTIL THE END OF THE 4TH YEAR. IF MONEY IS WORTH
15%, IS IT ADVISABLE TO RENT OR BUY THE MACHINE?

3. THE MAINTENANCE ON A MACHINE IS EXPECTED TO BE P 155.00 AT THE END OF THE FIRST YEAR
AND IT IS EXPECTED TO INCREASE P 35.00 EACH YEAR FOR THE FOLLOWING 7 YEARS. WHAT SUM
OF MONEY SHOULD BE SET ASIDE NOW TO PAY THE MAINTENANCE FOR THE EIGHT YEAR PERIOD?
ASSUME INTEREST IS 6%?

4. THE MAINTENANCE OF A ROOM AIRCONDITIONER IS EXPECTED TO BE P 2,000.00 AT THE END OF

THE FIRST AND EXPECTED TO INCREASE BY P 100.00 EACH YEAR FOR THE FOLLOWING 7 YEARS.
ASSUMING RATE OF INTEREST IS 6%, COMPUTE THE EQUIVALENT UNIFORM ANNUAL
MAINTENANCE COST.

5. A NEW STORAGE TANK CAN BE PURCHASED AND INSTALLED FOR P 50,000.00 AND IS EXPECTED
TO LAST FOR 10 YEARS. HOWEVER, AN EXISTANG TANK OF EQUIVALENT CAPACITY MAY BE
CONTINUED TO BE USED PROVIDED IT IS REPAIRED. IF THIS TANK WRE REPAIRED ITS USEFUL LIFE
IS ESTIMATED TO BE 3 YEARS, AFTER WHICH THE SAME TYPE OF REPAIRS WILL HAVE TO BE DONE
AGAIN. ASSUME THAT FUTURE COSTS WILL REMAIN THE SAME AND THAT THE TANKS WILL HAVE
NO SCRAP VALUE. MONEY IS WORTH 10% COMPPOUNDED ANNUALLY. HOW MUCH CAN BE SPENT
FOR REPAIRING THE EXISTING TANK IF THE CAPITALIZED COST OF THE TWO TANKS ARE THE
SAME?