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MATH 012
(Mathematics of Investment)
Definition of Terms:
Simple Annuities- defined as an investment vehicle designed to accept, grow, and, upon
annuitization, payout a stream of income. Annuities are offered by insurance companies. The
insurance company is in charge of your money and is contractually obligated to see that you get
paid the agreed upon amounts.
Ordinary Annuity- payments are required at the end of each period. For instance, straight
bonds usually make coupon payments at the end of every six months until the bond’s maturity
date.
Since we have to add the future value of each payment, you may have noticed that if you have
an ordinary annuity with many cash flows, it would take a long time to calculate all the future
values and then add them together. Fortunately, mathematics provides a formula that serves as
a shortcut for finding the accumulated value of all cash flows received from an ordinary
annuity:
Where:
c= cash flow per period
i= interest rate
n= number of payments
Note that the one- cent difference between $5, 525.64 and $5, 525.63 is due to rounding error
in the first calculation. Each value of the first calculation must be rounded to the nearest penny-
the more you have to round numbers in calculation, the more likely rounding errors will occur.
So, the above formula not only provides a shortcut in finding the FV of an ordinary annuity, but
also gives a more accurate result.
Example 2: To obtain the total discounted value, we need to take the present value of each
payment and, as we did in example 1, add the cash flow together.
Where:
i= interest rate
n= number of payments
The formula provides us with the PV in a few easy steps. Here is the calculation of the annuity
represented in the diagram for Example 2.
$1,000x [4.33] = $4,329.48
More Examples:
1. Braden Company, a small producer of plastic toys, wants to determine the most it should
pay to purchase a particular annuity. The annuity consists of cash flows of $700 at the end of
each 5 years. The firm requires the annuity to provide a minimum return of 8%.
A- Asked: Present Value
R- Represent:
Given;
S- Solve:
= Php 2, 794.90
C- Conclusion:
Therefore, the Braden Company should pay Php 2, 794.90 to purchase a particular annuity.
2. You have an investment account that has 6% annual interest rate. At the end of each year,
you invest an additional $2000. You want to know how much will have in your investment
account over the next 5 years.
A- Asked: Future Value (FV)
R-Representation:
Given:
E- Equation
S- Solve:
= $11, 274. 19
C- Conclusion:
In this case, the future value of this annuity and the total cash value of your investment over the course of 5 years would be
$11, 274.19
Group 5 Members
ARAGON, CLARISE
CATAYAS, MARY RUSSEL
ESTOCONING, ADONIS
INVENTO, JAN BRYLE