MODULE 2

The Time Value of Money

Unit 2
Ordinary Annuity and Deferred Annuity
UNIT LEARNING OUTCOMES

 TLO 2.2: To solve problems that involve time value of money calculations and to
illustrate economic equivalence involving uniform cash flows

Crisis in the Gulf

One of the biggest man-made environmental catastrophe in American History- millions

of gallons of oil flowing unchecked into the Gulf of Mexico from an undersea well. In
response to this tragedy, British Petroleum (BP) will make payments into a fund to pay
for some of the damages to the Gulf Coast resulting from their massive oil spill in April
and following months of 2010. BP will pay $3 billion at the end of the third quarter of
2010 and another $2 billion in the fourth quarter of 2010. BP will then make payments
of $1.25 billion each quarter thereafter until a total of $ 20 billion has been paid into
the fund. If the opportunity cost of capital (interest rate) is 3% per quarter, what is
the equivalent value of this payment stream at the beginning of the third quarter of
2010? This is one type of problem you can answer after studying unit 2 of module 2.

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 An annuity is a series of equal payments occurring at equal periods of time.

Symbols and Their Meaning:

P = value or sum of money at present

F = value or sum of money at some future time
A = a series of periodic, equal amounts of money
n = number of interest period
i = interest rate per interest period F= occurs at the same time as
last A

P = occurs one period before first A

0 1 2 3 4 n-1 n

A A A A A A

1. Ordinary Annuity

An ordinary annuity is one where the payments are made at the end of each period.

(a) Finding P when A is Given

P = occurs one period before first A

0 1 2 3 4 n-1 n

A A A A A A
To derive the formula of P/A, we apply equation of values, using “0” as focal point.
∑ P = ∑ each A’s at 0
P = A(1+i)-1 + A(1+i)-2 + A(1+i)-3 + A(1+i)-4 ….+ A(1+i)-(n-1) + A(1+i)-n
*since this equation is a geometric sequence, therefore the formula for P/A is…

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 P = A (P/A, i%, n)
𝟏 − (𝟏+𝒊 )−𝒏
P=A[ ]
𝒊

The quantity in brackets is called the “uniform series present worth factor.”

(b) Finding F when A is Given

F= occurs at the same times as

last A

0 1 2 3 4 n-1 n

A A A A A A

To derive the formula of F/A, we apply equation of values, but this time using “n” as focal
point.
∑ F = ∑ each A’s at n
F = A(1+i)(n-1) + A(1+i)(n-2) + A(1+i)(n-3) + A(1+i)(n-4) ….+ A(1+i)n-n
*since this equation has a geometric sequence, therefore the formula for F/A is…

F = A (F/A, i%, n)
(𝟏+𝒊 )𝒏 −𝟏
F=A[ ]
𝒊

The quantity in brackets is called the “uniform series compound amount

factor.”

(c) Finding A when P is Given

A = P (A/P, i%, n)
𝒊
A=P[ ]
𝟏 − (𝟏+𝒊 )−𝒏

The quantity in brackets is called the “capital recovery factor.”

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 (d) Finding A when F is Given

A = F (A/F, i%, n)
𝒊
A = F [(𝟏+𝒊 )𝒏 ]
−𝟏

The quantity in brackets is called the “sinking fund factor.”

The above discussions are further clarified by the following examples. Examining the
solution to each example can give you deeper insights into the subject matter.
Example 1: What are the present worth and the accumulated amount of a 10-year annuity
paying ₱10,000 at the end of each year, with interest at 15% compounded annually?
Given: A = ₱10,000/year n = 10 yrs i = 15%/year
Required: P and F
F

0 1 2 3 9 10

₱10,000 ₱10,000 ₱10,000 ₱10,000 ₱10,000

₱10,000 (P/A, 15%, 10)

For P: ₱10,000 (F/A, 15%, 10)

P = A (P/A, i%, n) = ₱10,000 (P/A, 15%, 10)

1 − (1.15)−10
P = ₱10,000 [ ] = ₱50,188 answer
0.15

For F:
F = A (F/A, i%, n) = ₱10,000 (F/A, 15%, 10)
(1.15 )10 −1
F = ₱10,000 [ ] = ₱203,037 answer
0.15

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 Example 2: What is the present worth of ₱500 deposited at the end of every three months for
6 years if the interest rate is 12% compounded semiannually?
Given: A= ₱500/ quarter n= 6 yrs x 4Q/yr = 24 quarters r=12%CSA
Solution:
1st For i/Q : For solving for the interest rate per quarter, need to convert 12%CSA to
r%CQ and then get i%/Q
0.12 2
(1+i)4 – 1 = (1 + ) -1
2

i + 1 = (1.06)0.5
i = 0.0296 or 2.96% per quarter
2nd For P:
P = A (P/A, 2.96%, 24)
1 − (1+0.0296)−24
= ₱500 [ ]
0.0296

= ₱500 (17.0087)
P = ₱8,504 ans.

Example 3: Mr. Reyes borrows ₱600,000 at 12% compounded annually and agreeing to
pay the loan in 15 annual payments. How much of the principal is still unpaid after he has
made the 8th payment?
Given: P= ₱600,000 n= 15 years r=12%CA
Required: x= principal still unpaid after 8th payment
Solution: i = r/m= 12%/1 = 12%/year
First solve for A
𝟎.𝟏𝟐
A = 600,000 [ ] = ₱ 88,094.54
𝟏 − (𝟏+𝟎.𝟏𝟐 )−𝟏𝟓

Then solve for x:

𝟏 − (𝟏.𝟏𝟐 )−𝟕
x = 88,094.52 [ ]
𝟎.𝟏𝟐

x= ₱402,041.94

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 Example 3: M purchased a small lot in a subdivision, paying ₱200,000 down and promising
to pay ₱15,000 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 M missed the first 12
payments, what must he pay at the time the 13th is due to bring himself up to date?
Solution: i = r/m = 12%/ 4 = 3%/Q

P =Cash price

0 1 2 3 39 40 Q

A= ₱15,000/Q
₱200,000

a) Using “0” as focal point ∑ =∑

𝟏 − (𝟏.𝟎𝟑 )−𝟒𝟎
P = ₱200,000 + ₱15,000/Q [ ]
.𝟎𝟑

P = ₱ 546,721.58

b) Let x= amount to be paid at the time the 13th is due to bring M up to

date.

0 1 2 3 12 13 Q

A= ₱15,000/Q

Using “13” as focal pt

(𝟏.𝟎𝟑 )𝟏𝟑 −𝟏
X = ₱15,000/Q [ ] = ₱ 234,266.86
.𝟎𝟑

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 Example 4: A man approaches the ABC Loan Agency for ₱100,000 to be paid in 24 monthly
instalments. The agency advertises an interest rate of 1.5% per month. They proceed to
calculate the amount of his monthly payment in the following manner:
Amount Requested ₱100,000
Credit investigation 500
Credit Risk Insurance 1,000
Total ₱101,500

Interest ( ₱101,500) (24) (0.015) = ₱36,540

Total Owed: ₱101,500 + 36,540 = ₱138,040

Payment = ₱138,040 = 5,751.67

24
What is the effective rate of interest of the loan?
Solution:

₱100,000

0 1 2 3 23 24 M

A= 5,751.67
For EIR:

Using “0” as focal point

𝟏 − (𝟏+𝒊 )−𝟐𝟒
₱100,000 = 5,751.67 [ ]
𝒊

i = 0.02758/month

EIR = [ 1 + r/m]m – 1 = [ 1 + i/month ] 12 - 1

EIR = [ 1+ .02758]12 -1 = .3861 x 100 = 38.61%/ year ans

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 2. Deferred Annuity

A deferred annuity is one where the first payment is made several periods after the
beginning of the annuity.

Finding P when A is Given

P
m periods n periods

0 1 2 n-1 n
0 1 2 m

A A A A
PA (P/F, i%, m) A (PA/A, i%, n)
(P/i%, m)
PA
A
To derive the formula of P for deferred, equation of values was again used,

using “0” as focal point

P = A (P/A, i%, n) (P/F, i%, m)

𝟏 − (𝟏+𝒊 )−𝒏
P=A[ ] (𝟏 + 𝒊 )−𝒎
𝒊
(𝟏+𝒊 )𝒏 −𝟏
F=A[ ] (𝟏 + 𝒊 )𝒎
𝒊

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 The above discussions are further clarified by the following examples. Examining the
solution to each example can give you deeper insights into the subject matter.
Example 5: A debt of ₱40,000, whose interest rate is 15% compounded semiannually, is to be
discharged by a series of 10 semiannual payments, the first payment to be made 6 months
after consummation of the loan. The first 6 payments will be ₱6,000 each, while the remaining
4 payments will be equal and of such amount that the final payment will liquidate the debt.
What is the amount of the last 4 payments?
Solution: i = r/m = 15%/2 = 7.5%/ SA

₱40,000

0 1 2 3 4 5 6 7 8 9 10

A A A A
₱6,000 (P/A, 7.5%, 6)

A (P/A, 7.5%, 4) (P/F, 7.5%, 6) A (P/A, 7.5%4)

Using “0” focal date, the equation of value is

₱40,000 = ₱6,000 (P/A, 7.5%, 6) + A (P/A, 7.5%, 4) (P/F, 7.5%, 6)
𝟏 − (𝟏.𝟎𝟕𝟓 )−𝟔 𝟏 − (𝟏.𝟎𝟕𝟓 )−𝟒
₱40,000 = ₱6,000 [ ] +A[ ] (𝟏. 𝟎𝟕𝟓 )−𝟔
.𝟎𝟕𝟓 .𝟎𝟕𝟓

₱40,000 = ₱6,000 (4.6938) + A (3.3493) (0.6480)

A = ₱5,454

Or Using “10” as focal pt

₱40,000(F/P, 7.5%,10) = ₱6,000 (A/F, 7.5%, 6) (F/P, 7.5%, 4) + A (F/A, 7.5%, 4)

(𝟏.𝟎𝟕𝟓 )𝟔 −𝟏 (𝟏.𝟎𝟕𝟓 )𝟒 −𝟏
₱40,000 (𝟏. 𝟎𝟕𝟓 )𝟏𝟎 = ₱6,000 [ ] (𝟏. 𝟎𝟕𝟓 )𝟒 +A[ ]
𝟎.𝟎𝟕𝟓 𝟎.𝟎𝟕𝟓

A = ₱5,454

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 3. Annuity Due

A deferred annuity is one where the payments are made at the beginning of each
period.

Finding P when A is Given

0 1 2 3 4 n-1 n

A A A A A A

P = A + A (P/A, i%, n-1)

P = A (1 + P/A, i%, n-1)

Finding F when A is Given

0 1 2 3 4 n-1 n

A A A A A A

F = A (F/A, i%, n +1) – A

F = A [(F/A, i%, n-1) – 1]

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 The above discussions are further clarified by the following examples. Examining the
solution to each example can give you deeper insights into the subject matter.
Example 6 A man bought an equipment costing ₱60,000 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?
Solution:
24%
P = ₱60,000 n = 12 i= = 8%
3

P = A (1+P/A, 2%, n-1)

₱60,000 = A (1+ P/A, 8%, 11)

₱60,000 = A (1+ 7.1390)

A = ₱7,371.91

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 Work on the following exercise. This is an opportunity for you to practice your knowledge
and skills you acquired in this unit. Final answers are provided at the end of each problem to
serve as your guide. Write the problem and solution in a short bond paper with heading
Assignment M2.2 and submit in our Google Classroom under class work Assignment M2.2
1. A young woman, 22 years old, has just graduated from college. She accepts a good
job and desires to establish her own retirement fund. At the end of each year
thereafter she plans to deposit ₱2,000 in a fund at 15% annual interest. How old will
she be when the fund has an accumulated value of ₱1,000,000? Ans: 53 years old

2. M purchased a small lot in a subdivision, paying ₱200,000 down and promising to pay
₱15,000 every 3 months for the next 10 years. The seller figured interest at 12%
compounded quarterly.

(a) After making 8 payments, M 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?

(b) If M missed the first 10 payments, what must he pay when the 11th payment is due
to discharge his entire indebtedness?

Ans: (a) ₱300,006; (b) ₱479,948

3. A new office building was constructed 5 years ago by a consulting engineering firm.
At the time the firm obtained the bank loan for ₱10,000,000 with a 20% annual interest
rate, compounded quarterly. The terms of the loan called for equal quarterly
payments for 10-year period with the right of prepayment at any time without penalty.
Due to the internal changes in the firm, it is now proposed to refinance the loan
through an insurance company. The new loan is planned for a 20-year term with an
interest rate of 24% per annum, compounded quarterly. The insurance company has
a one-time service charge of 5% of the balance. This new loan also calls for equal
quarterly payments.
(a) What is the balance due on the original mortgage (principal) if all payments have
been through a full five years?
(b) What will be the difference between the equal quarterly payments in the existing
arrangement and the revised proposal? Ans: (a) ₱7,262,733; (b) ₱120,862
4. An asphalt road requires no upkeep until the end of 2 years when P60,000 will be
needed for repairs. After this P90,000 will be needed for repairs at the end of each
years for the next 5 years, then P120,000 at the end of each year for the next 5 years.
If money is worth 14% compounded annually, what was the equivalent uniform
annual cost for the 12-year period.
Ans. ₱79,245

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