Engineering

Economy
03 – Annuities

Prep by: Engr. Buluran

Annuity (A) It is defined as a series of equal payments occurring at equal periods of time.

There are four uniform series formulas that involve A, Where A means that:

• The cash flow occurs in consecutive interest periods.

• The cash flow amount is the same in each period

The formulas relate a present worth

P to a uniform series amount A or
vice versa.
It is important to remember that in these equations, the P and the first A are value are
separated by one interest period and n is always equal to the number of A values
Sample Problem
▪ How much money should you willing to
pay now for a guaranteed $600 per
year for 9 years starting next year, at a
rate of return of 16% per year?
The other two formulas for considering the future worth and the
Annuity

The formulas relate a Future worth F

to a uniform series amount A or vice
versa.
 It is important to remember that these equation such that the last A value
occurs in the same time period as the future worth F and n is always equal to the
number of A values.
Sample Problem
▪ Formasa Plastics has major fabrication plants in Texas and Hong Kong. The president
wants to know the equivalent future worth of $1 million capital investments each year
for 8 years, starting 1 year from now. Formasa capital earns at a rate of 14% per year.
▪ A man purchased a small lot in a subdivision, paying P200,000 downpayment and promising to
pay P15,000 every 3 months for the next 10 years. The seller figured interest at 12%
compounded quarterly.

a) What was the cash price of the lot?

b) If the man missed the first 12 payments, what must he pay at the time the 13th is due to bring
him up to date?
c) After making 8 payments, the man wished to discharge his remaining indebtedness by a
single payment at the time when the 9th regular payment was due, what must he pay in
addition to the regular payment then due?
d) If the man missed the first 10 payment, what must he pay when the 11th payment is due to
discharge his entire indebtedness?
 A deferred annuity is one where the first payment is made several periods after
Deferred Annuity the beginning of the annuity.

Future amount of deferred annuity, F

Present amount of deferred annuity, P

The first payment was made at the end of the kth period and n
number of payments was made. The n payments form an
ordinary annuity.
Sample Problem
▪ On the day his grandson was born, a man deposited to a trust company
a sufficient amount of money so that the boy could receive five annual
payments of P10,000 each for his college tuition fees, starting with his
18th birthday. Interest at the rate of 12% per annum was to be paid on all
amounts on deposit. There was also a provision that the grandson could
elect to withdraw no annual payments and receive a single lump
amount on his 25th birthday. The grandson chose this option.
a) How much did the boy receive as the single payment?
b) How much did the grandfather deposit?
▪ If P10,000 is deposited each year for
9 years, how much annuity can a
person get annually from the bank
every year for 8 years starting 1
year after the 9th deposit is made.
Cost of money is 14%.
 This is defined as the one where the payments are made at the beginning of
Annuity Due each period.

*r represents rate of interest (i).

Sample Problem
▪ A man bought an equipment costing P60,000 payable in 12 quarterly payments, each
installment payable at the beginning of each period. The rate of interest is 24%
compounded quarterly. What is the amount of each payment?
 Perpetuity A perpetuity is an annuity in which the payments continue indefinitely.

Present amount of perpetuity, P

 Sample Problem
▪ What amount of money invested today at 15% interest rate can
provide the following scholarships: P30,000 at the end of each
year for 6 years; P40,000 for the next 6 years and P50,000
thereafter?
 Capitalized cost of any property is the sum of the first cost and the present worth of
Capitalized Cost all costs of replacement, operation and maintenance for a long time or forever.

Case 1:

No replacement, only maintenance and Capitalized Cost = First Cost + Present worth
or operation every period of perpetual operations and or maintenance

Case 2:

Replacement only, no maintenance and Capitalized Cost = First Cost + Present worth
or operations of perpetual replacements

Case 3:
Capitalized Cost = First Cost + Present worth of cost
Replacement, maintenance and or every of perpetual operation and or maintenance +
period Present worth of cost of perpetual operations
Sample Problem
▪ Determine the capitalized cost of a structure that requires an initial investment of P1,500,000
and annual maintenance of P150,000. Rate of interest is 15%.

▪ A new engine was installed by a textile plant at a cost of P300,000 and projected to have a
useful life of 15 years. At the end of its useful life, it is estimated to have a salvage value of
P30,000. Determine its capitalized cost if interest is 18% compounded annually.

▪ Determine the capitalized cost of a research laboratory which requires P5,000,000 for
original construction, P100,000 at the end of every year for the first 6 years and then
P120,000 each year thereafter for operating expenses, and P500,000 every 5 years for
replacement of equipment with interest at 12% per annum.
 This is any method of repaying a debt, the principal and interest included,
Amortization usually by a series of equal payments at equal interval of time.

Amortization utilizes annuity, and compound interest.

Amortization schedules is prepared to show information on the perspective of the borrower and
the lender.

Period Outstanding Interest due at end of Payment Principal repaid at end of

principal at period period
beginning of
period
Date or number Amount of debt Amount of interest Amount due Amount of debt owed at
of period. owned at the start included in the payment. each period. the end of the period.
of the period. (F/P - P) for 1 period (A/P) (Payment - Interest)
(Pbeginning - Pend)
Sample Problem
▪ A debt of P5,000 with interest at 12%
compounded semiannually is to be
amortized by equal semiannual payments
over the next 3 years. The first due is in 6
months.
▪ Find the semiannual payments
▪ Construct an amortization schedule.
 Period Outstanding Interest due at end of Payment Principal repaid at end
principal at period of period
beginning of
period
Date or Amount of debt Amount of interest Amount due Amount of debt owed at
number of owned at the start included in the payment. each period. the end of the period.
period. of the period. (F/P - P) for 1 period (A/P) (Payment - Interest)
(Pbeginning - Pend)
1 5000 300 1016.81 716.81

2 4283.19 256.99 1016.81 759.82

3 3523.37 211.40 1016.81 805.41

4 2717.96 163.08 1016.81 853.73

5 1864.23 111.85 1016.81 904.96

6 959.27 57.56 1016.81 959.25

Totals 1100.88 6100.92 4999.98

Uniform Arithmetic This is wherein the cash flow changes (increases or decreases ) by the
Gradient same amount in each period.

Where:

• G = Gradient (Amount
of change in cash
flow between two
consecutive periods.)

The equation finds the

present worth of the
gradient only.
The base amount in time
period 1 must be accounted
separately as an annuity.
 Sample Problem
▪ A loan was amortized by a group of
four end-of-year payments forming an
ascending arithmetic progression. The
initial payment was to be P5,000 and
the difference between successive
payments was to be P400. 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?
References

BASICS OF ENGINEERING ENGINEERING ECONOMY:

ECONOMY BY L. BLANK, A. APPLYING THEORY TO
TARQUIN PRACTICE BY T. ESCHENBACH