06

ANNUITY
 LEARNING OUTCOMES
By the end of this chapter, you should be able to:
01 Explain the term 'ordinary
annuity certain
02 present value of ordinary
Derive the future value and the
annuity certain
03 Find the future value of annuity
04 Find the present value of annuity
05
Solve for annuity payment,
R, the number of payments
n, and the interest rate
06 Solve for annuity payment,
R, the number of payments
n, and the interest rate
Identify the problems
where the present value
and the future value of the
annuity appropriately
applied.
INTRODUCTION
• Annuity concepts enable people to plan for the
future in terms of investments and savings.
• Annuity is a series of (usually) equal payments
made at (usually) equal intervals of time.
• It is the periodic payments to an investment or loan
paid to the compound interest account where the
payment for each period is the same, and the rate
of interest does not change throughout the entire
term.
• Examples of annuity are shop rentals, insurance
policy premiums, annual dividends received and
installment payments.
TYPES OF
ANNUITY • Annuities can be classified into many classes:
annuity due, annuity certain, general annuity,
perpetuity and others.
• Annuity certain has a specific beginning date and
also specific ending date.
• Payments in an ordinary annuity are made at the
end of each period whereas payments in an annuity
due are made at the beginning of each period.
• In this chapter, we will mainly discuss on ordinary
annuity certain where payments are made at the
end of the payment period and the interest and
payment period are of the same interval.
• Note that unless specified, money invested every
period is understood to mean money invested at the
end of every period.
WHAT’S THE
DIFFERENCE
BETWEEN
ANNUITY &
COMPOUND
INTEREST?
FUTURE VALUE
Sum of all the periodic payments for the entire period of loan or investment.

(1 + 𝑖)𝑛 −1
𝑆=𝑅
𝑖

𝑖
𝑅=𝑆
(1 + 𝑖)𝑛 −1

𝐼 = 𝑆 − 𝑛𝑅
 (1+𝑖)𝑛 −1 𝑖
𝐼 = 𝑆 − 𝑛𝑅
𝑆=𝑅 ; 𝑅=𝑆 ;
𝑖 (1+𝑖)𝑛 −1

R = periodic payments / amount of periodic

payments made at m times a year
k = annual nominal rate / the interest rate calculated
in a year
m = frequency conversion / number of times the
interest is credited in a year
i = Periodic Interest Rate / interest rate for each
𝑘
interest period ; 𝑖 = 𝑚
t = the annuity period
n = number of times payment are made ; 𝑛 = 𝑚 × 𝑡
FREQUENCY OF CONVERSION, m

Compounding Interest credited at the end Number of times

Period of each interest credited per
year, m

Annually Year 1
Semi- annually 6 months 2
Quarterly 3 months 4
Monthly Month 3
EXAMPLE
Lina pays a co-operative RM300 at the end of each quarter for 5 years. The
co-operative pays interest of 10% compounded quarterly. At the end of the
5-year period, find the
a) amount she has with the co-operative
b) the amount of interest she receives.

a) It is given that b) The interest she receives is

R = RM300, t = 5, k = 0.1 and m = 4. 𝐼 = 𝑆 − 𝑛𝑅
𝐼 = 7663.40 − (4 × 5 × 300)
0.1
(1+𝑖)𝑛 −1 (1+ 4 ) 4×5 −1 𝐼 = 𝑅𝑀1663.40
𝑆=𝑅 = 300 0.1
𝑖
4

𝑆 = 𝑅𝑀7663.40
EXAMPLE
Latifah wants to have RM12,000 in 3 years' time. To save for that
amount, she deposits the same value at the end of each month into an
account. The account earns an interest of 9% compounded monthly.
What is the value of each deposit?

Given S = 12000, t = 3, k = 0.09 and m = 12.

𝑖
To find R. then we use 𝑅 = 𝑆
(1+𝑖)𝑛 −1
0.09
12
𝑅 = 12000 0.09 (12×3)
(1+ 12 ) −1

R = RM291.60.
EXAMPLE
Nadine wants to buy a computer that costs RM3,800. She saves RM120
at the end of each month in an account. The account pays an interest of
12% compounded monthly. How long will it be before she has enough
money to buy the computer?
Given S = 3800, R = 120, k = 0.12 and m = 12
(1+𝑖)𝑛 −1
To find t, then we use 𝑆 = 𝑅 𝑖
0.12
(1+ 12 )𝑛 −1 log 1.3667 = 𝑛 𝑙𝑜𝑔 1.01
3800 = 120 0.12
12 log 1.3667
=𝑛
(1.01)𝑛 −1 𝑙𝑜𝑔(1.01)
3800 = 120 0.01 n = 27.6 ≈ 28 months
3800×0.01
+ 1 = (1.01)𝑛
120

1.3667 = (1.01)𝑛
EXERCISE
RM150 was deposited every month for 3 years 7 months at 12% interest
rate compounded monthly. What is the value of the account at the end of
the investment period? How much interest earned?
EXERCISE
Five years from today, a couple wants to have enough money to pay the
10% down-payment on a house that cost RM150000. To save for the
downpayment they decide to deposit a fixed sum at the end of 6 month
period into an account which earns an interest of 11.5% compounded
semi-annually. How much should they deposit each time?
EXERCISE
An amateur sailor wants to save RM20000 as a downpayment for a boat.
He invests RM800 at the end of every three months in a savings scheme.
The scheme pays an interest of 10% compounded quarterly. For how
many years would he need to invest before he has saved enough for the
downpayment.
 PRESENT VALUE
• The lump sum of money that must be deposited today in order
to generate the future value needed in the annuity.
• The lump sum of money that must be deposited today so that an
equal amount of money can be withdrawn at a regular interval
time until the term expires. (After the last withdrawal there will
be no money left in the account)

1 − (1 + 𝑖)−𝑛
𝐴=𝑅
𝑖
𝐼 = 𝑛𝑅 − 𝐴
𝑖
𝑅=𝐴
1 − (1 + 𝑖)−𝑛
 1− 1+𝑖 −𝑛 𝑖
𝐴=𝑅 ; 𝑅=𝐴 ; 𝐼 = 𝑛𝑅 − 𝐴
𝑖 1−(1+𝑖)−𝑛

R = periodic payments / amount of periodic payments

made at m times a year
k = annual nominal rate / the interest rate calculated
in a year
m = frequency conversion / number of times the
interest is credited in a year
i = Periodic Interest Rate / interest rate for each
𝑘
interest period ; 𝑖 =
𝑚
t = the annuity period
n = number of times payment are made ; 𝑛 = 𝑚 × 𝑡
 EXAMPLE
How much should Rahman have in his account to enable him to withdraw
RM500 at the end of every quarter for 2 years? The account pays an
interest of 11% compounded quarterly.

It is given that R = RM500, t = 2, k = 0.11 and m = 4.

1−(1+𝑖)−𝑛
𝐴=𝑅 𝑖
0.11
1−(1+ 4 )− 4×2
A = 500 0.11
4

A = 𝑅𝑀3547.15
 EXAMPLE
Saiful wants to set up a retirement fund. From this fund, Saiful can withdraw
RM1,500 at the end of each month for 20 years. The fund pays an interest
of 9% compounded monthly. Find
(a) the value of the retirement fund
(b) the interest earned by the account.

a) It is given that b) The interest she receives is

R = RM1000, t = 20, k = 0.09 and m = 12. 𝐼 = 𝑛𝑅 − 𝐴
𝐼 = 12 × 20 × 1500 − 166717.43
0.09
1−(1+𝑖)−𝑛 1−(1+ 12 )− 12×20 𝐼 = 𝑅𝑀193,282.57
𝐴=𝑅 = 1500 0.09
𝑖
12

A = 𝑅𝑀166,717.43
 EXAMPLE
A couple paid a 10% down-payment for a house that costs RM185,000
and secured a bank loan to pay the balance. In order to settle the loan,
the couple will pay monthly installments for 25 year The interest on the
loan is 11.5% compounded monthly. Find
a) the value of each installment
b) the amount of interest charged.

a) It is given that 𝑖
Cost of the House = RM 185000; 𝑅=𝐴 1−(1+𝑖)−𝑛
Downpayment (10%) = RM 18500 0.115

Amount borrowed, A = RM166500

12
𝑅 = 166500 0.09 −(12 ×25)
1−(1+ 12 )
t = 25, k = 0.115 and m = 12.
R = RM1692.42
 EXAMPLE
A couple paid a 10% down-payment for a house that costs RM185,000
and secured a bank loan to pay the balance. In order to settle the loan,
the couple will pay monthly installments for 25 year The interest on the
loan is 11.5% compounded monthly. Find
a) the value of each installment
b) the amount of interest charged.

b) The interest received

𝐼 = 𝑛𝑅 − 𝐴
𝐼 = 12 × 25 × 1692.42 − 166500
𝐼 = 𝑅𝑀341,226
 EXERCISE
Sofian wants to buy a new car that costs RM110,000. He traded in his
present car for RM50,000 and borrowed the balance from a bank. The 6
year loan which he has to pay monthly charges an interest of 10%
compounded monthly. Find the value of each monthly payment and
amount of interest charged.
 EXERCISE
A housewife purchased a vacuum cleaner by paying a deposit of RM300, to
be followed by payments of RM256 at the end of each quarter for two years.
The company selling the vacuum cleaner charged an interest of 12%
compounded quarterly. What is the list price of the vacuum cleaner?
ADDITIONAL
PROBLEMS
 EXAMPLE
a) It is given that A = 5000, t = 3, k = 0.06 and
m = 12. A lecturer receives a RM5000
𝑖 computer loan from his school.
Using 𝑅 = The loan is to be paid at the
1−(1+𝑖)−𝑛
0.06
end of each month for 3 years.
𝑅 = 5000 12 The interest charged is 6%
compounded monthly.
0.06 −(12 ×3)
1−(1+ )
12
However, after paying the 20th
R = RM152.11 installment, the lecturer
decides to settle the
outstanding balance in full
b) After paying for the 20th installment, the number of because he is going overseas
payments left is 36 – 20 = 16. to further his studies. Find

1−(1+𝑖)−𝑛
0.06 16
1−(1+ 12 )− 12× ൗ12 a) The value of each monthly
𝐴=𝑅 𝑖
= 152.11 0.06 installment
12
b) The outstanding balance
A = 𝑅𝑀2333.36 on the loan after 20th
 EXAMPLE
Ali purchased a house that cost
a) It is given that RM212,000. He paid a 10%
Cost of the House = RM 212000; downpayment and applied for a bank
Downpayment (10%) = RM 21200 loan to settle the balance of the
purchase price. The loan which is for 25
Amount borrowed, A = RM190800 years, is to be paid by monthly
t = 25, k = 0.11 and m = 12. installments at an interest of 11%
𝑖 compounded monthly.
Using 𝑅 = 1−(1+𝑖)−𝑛 (a) How much is each monthly
0.11 installment?
𝑅 = 190800 12
0.11 −(12 ×25) (b) Ali defaulted in paying 4 successive
1−(1+ 12 )
instalments. How much should he next
R = RM1870.06 instalment for his remaining
installments to be on schedule?
(b) What is the outstanding balance after
paying regular installments for 15 years?
 EXAMPLE
Ali purchased a house that cost
b) Since these payments are paid late, interest RM212,000. He paid a 10%
is charged. Thus, downpayment and applied for a bank
(1+𝑖)𝑛 −1 loan to settle the balance of the
𝑆=𝑅 𝑖 purchase price. The loan which is for 25
0.11 5 years, is to be paid by monthly
(1+ 12 )− 12× ൗ12 −1
S = 1870.06 0.11
installments at an interest of 11%
12 compounded monthly.
S = 𝑅𝑀9,523.30 (a) How much is each monthly
installment?
(b) Ali defaulted in paying 4 successive
instalments. How much should he next
instalment for his remaining
installments to be on schedule?
(b) What is the outstanding balance after
paying regular installments for 15 years?
 EXAMPLE
c) After paying for the 15 years of installment, Ali purchased a house that cost
the number of payments left is RM212,000. He paid a 10%
downpayment and applied for a bank
= (12 x 25) – (12 x 15) = 120. loan to settle the balance of the
purchase price. The loan which is for 25
years, is to be paid by monthly
1−(1+𝑖)−𝑛
Thus by using 𝐴 = 𝑅 installments at an interest of 11%
𝑖
0.11 120
compounded monthly.
1−(1+ 12 )− 12× ൗ12
A = 1870.06 0.11
(a) How much is each monthly
12 installment?
A = 𝑅𝑀135, 757.52 (b) Ali defaulted in paying 4 successive
instalments. How much should he next
instalment for his remaining
installments to be on schedule?
(b) What is the outstanding balance after
paying regular installments for 15 years?
 EXERCISE
A director buys a RM300,000 house by
paying a 20% downpayment and taking a
bank loan to settle the balance. The loan is
for 15 years and is serviced by monthly
installments. Interest is 9% compounded
monthly.
(a) Find the monthly installment for the loan.
(b) If the director defaults in paying the 88th
and 89th installment, how much should he
pay on the 90th instalment for the remaining
payments to be on schedule?
(c) After paying for 10 years, the director was
asked to declare his assets as part of an
investigation into corruption. This includes
listing the outstanding balance of the
housing loan. What is this outstanding value?
 EXERCISE
A director buys a RM300,000 house by
paying a 20% downpayment and taking a
bank loan to settle the balance. The loan is
for 15 years and is serviced by monthly
installments. Interest is 9% compounded
monthly.
(a) Find the monthly installment for the loan.
(b) If the director defaults in paying the 88th
and 89th installment, how much should he
pay on the 90th instalment for the remaining
payments to be on schedule?
(c) After paying for 10 years, the director was
asked to declare his assets as part of an
investigation into corruption. This includes
listing the outstanding balance of the
housing loan. What is this outstanding value?
 EXERCISE
A director buys a RM300,000 house by
paying a 20% downpayment and taking a
bank loan to settle the balance. The loan is
for 15 years and is serviced by monthly
installments. Interest is 9% compounded
monthly.
(a) Find the monthly installment for the loan.
(b) If the director defaults in paying the 88th
and 89th installment, how much should he
pay on the 90th instalment for the remaining
payments to be on schedule?
(c) After paying for 10 years, the director was
asked to declare his assets as part of an
investigation into corruption. This includes
listing the outstanding balance of the
housing loan. What is this outstanding value?
 EXERCISE
A student buys a motorcycle that
costs RM4,800. He pays a RM500
deposit and obtains a loan to pay
the balance. He will settle the loan
by monthly payments for 3 years.
The interest charged is 10%
compounded monthly. After paying
the monthly payments for some
time, he encounters some financial
difficulties and defaults in paying 3
continuous monthly payments. Find
(a) the monthly payment
(b) the next payment after the
defaulted payments so that the
remaining payments are on
schedule.
 EXERCISE
A student buys a motorcycle that
costs RM4,800. He pays a RM500
deposit and obtains a loan to pay
the balance. He will settle the loan
by monthly payments for 3 years.
The interest charged is 10%
compounded monthly. After paying
the monthly payments for some
time, he encounters some financial
difficulties and defaults in paying 3
continuous monthly payments. Find
(a) the monthly payment
(b) the next payment after the
defaulted payments so that the
remaining payments are on
schedule.
 EXERCISE
Cynthia buys a RM72,000 car by
trading in her previous car for
RM40,000. She takes a 5-year loan
to settle the balance of the
purchase price. The loan is to be
repaid by monthly instalments. The
interest on the loan is 12%
compounded monthly. After 4 years,
she wants to sell the car to buy
another car. She decides to settle
the outstanding balance of the loan
before selling her present car.
(a) What is the monthly installment
for the car loan?
(b) What is the outstanding balance
of the loan after paying the loan
for 4 years?
 EXERCISE
Cynthia buys a RM72,000 car by
trading in her previous car for
RM40,000. She takes a 5-year loan
to settle the balance of the
purchase price. The loan is to be
repaid by monthly instalments. The
interest on the loan is 12%
compounded monthly. After 4 years,
she wants to sell the car to buy
another car. She decides to settle
the outstanding balance of the loan
before selling her present car.
(a) What is the monthly installment
for the car loan?
(b) What is the outstanding balance
of the loan after paying the loan
for 4 years?
 END OF
CHAPTER
6