CHAPTER 5 :

ANNUITY
5.0 Introduction
5.1 Future & Present Value of Ordinary
Annuity Certain
5.2 Amortization
5.3 Sinking Fund
5.4 Annuity with Continuous
Compounding
5.0 INTRODUCTION
Annuity Definition
Annuity is a series of (usually) equal payments
made at (usually) equal intervals of time.
Examples of annuity:
Shop rentals
Insurance policy premium
Regular deposits to saving accounts
Installment payments
5.0 INTRODUCTION
Annuity Classes
Annuity can be classified into many classes:
Annuity certain payment are made at the end of
each payment period.
Annuity due payment are made at the beginning
of each period.
General annuity
Perpetuity & others.
In this chapter we shall mainly discuss ordinary
annuity certain where payment are made at the end
of each payment periods & the interest and payment
periods are of the same interval.
5.1 FUTURE & PRESENT
VALUES ORDINARY
ANNUITY CERTAIN
Future Value of Ordinary Annuity
Certain
The formula to calculate the future value of the
annuity at the end of investment periods is
given by nn mt
The
Thesumsumof
11 ii n 11
n mt
all
allfuture
of
future
SS R
R
values
valuesofof ii r
ii r
the
theperiodic
periodic mm
payments
payments
where : R = Periodic payment
i = Interest rate per interest period
n = Term of investment
5.1 FUTURE & PRESENT
VALUES ORDINARY
ANNUITY CERTAIN
Future Value of Ordinary Annuity
Certain
11 ii 11
nn
SS R
R Rs
Rs
ii nni i

s
The expressions, n i is the future value of
annuity of 1 per payment for n intervals. Its
read as s angle n at i & its value can be
found for certain i and n in the tables.
EXAMPLE 1
1. RM 100 is deposited every month for 2 years 7 months
at 12% compounded monthly. What is the futures
value of this annuity at the end of the investment?

Solution
R 100 1 0.01 31 1
S 100
r 12%; m 12; 0 . 01
7 31 RM 3 613.27
t 2
12 12
12%
i 1%
12
31
n 12 31
12
EXAMPLE 1
2. RM 100 is deposited every 3 months for 2 years 9
months at 8% compounded quarterly. What is the
futures value of this annuity at the end of the
investment?
Solution
R 100
r 8%; m 4;
9 33
t 2
12 12
8%
i 2%
4
33
n 4 11
12
EXAMPLE 1
3. Find the amount to be invested every 3 months at 10%
compounded quarterly to accumulate RM 10,000 in 3
years.

Solution
S 10 000
r 10%; m 4;
t 3
10%
i 2. 5%
4
n 4 3 12
EXAMPLE 1
4. RM 100 was invested every month in an account that
pays 12% compounded monthly for two years. After
the two years, no more deposits was made. Calculate
the amount of the account at the end of five years.
M: 0
12% monthly M: 24 No deposit M: 60

Solution 100

R 100 Amount in the account just after 2 years:

r 12%; m 12; 1 0.01 24 1
S2 100
t1 2; t2 3 0 . 01
12% RM 2 697.35
i 1%
12 Amount in the account at the end
n1 12 2 24 of 5 years: S 2 697.351 0.01 36
5
n2 12 3 36 RM 3 859.28
EXAMPLE 1
5. Julia invested RM 100 every month for 5 years in an
investment scheme. She was offered 5% compounded
monthly for the first 3 years & 9% compounded
monthly for the rest of the period. Determine the
accumulated amount at the end of 5 years.
M: 0 M: 36 M: 60
5% monthly 9% monthly
Solution
100 100 100
R 100; m 12
r1 5%; r2 9%;
Amount of annuity just after 3rd years:
t1 3; t2 2
1 5% 36 1
5% 9% S3 100 12

i1 ; i2 0.75% 5%
12 12 12
n1 12 3 36 RM 3 875.33
n2 12 2 24
EXAMPLE 1
M: 0 M: 36 M: 60
5% monthly 9% monthly
Solution
100 100 100

R 100; m 12
r1 5%; r2 9%; Amount of annuity at the end of 5 years:

t1 3; t2 2 S5 3 875 .331 0.75%

24

5% 9% RM 4 636 .50
i1 ; i2 0.75%
12 12
n1 12 3 36 Amount of annuity for another the 2 years:
n2 12 2 24 1 0.75% 24 1
S2 100
0 . 75 %
Total
Totalamount
amountat
atthe
theend
endof
of55years
years RM 2 618 .85
==RM
RM4636.50
4636.50++RM
RM2618.85
2618.85==RM
RM7255.35
7255.35
5.1 FUTURE & PRESENT
VALUES ORDINARY
ANNUITY CERTAIN
Present Value of Ordinary Annuity
Certain
The formula to calculate the present value of the
annuity at the end of investment periods is
given by nn mt
1111 ii
nn
mt
The
Thesumsumof
all
allpresent
present
of
AA R
R
values
valuesofof ii r
ii r
the
theperiodic
periodic mm
payments
payments
where : R = Periodic payment
i = Interest rate per interest period
n = Term of investment
EXAMPLE 2
1. Lisa has to pay RM 300 every month for 24 months to
settle a loan at 12% compounded monthly.
a) What is the original value of the loan?
b) What is the total interest that she has to pay?
Solution
R 300 1 1 0.01 24
r 12%; m 12; a) A 300
0 . 01
t 2
RM 6 373.02
12%
i
12
1% b) I 300 24 6 373.02
n 12 2 24 RM 826.98
EXAMPLE 2
2. Johan won an annuity that pays RM1000 every 3
months for 3 years. What is the present value of this
annuity if the money worth 16% compounded
quarterly?
Solution
R 1000 1 1 0.04 12
r 16%; m 4; A 1000
0 . 04
t 3
RM 9 385 .07
16%
i 4%
4
n 4 3 12
EXAMPLE 2
3. Mimi intends to give scholarship worth RM 7500 every
year for 6 years. How much must she deposit now into
an account that pays 7% per annum to provide this
scholarship?
Solution
R 7500
r 7%; m 1;
t 6
7%
i 7%
1
n 1 6 6
EXAMPLE 2
4. Mariam invests RM 12 000 in an account that pays 6%
compounded monthly. She intends to withdraw her
account every month for 2 years and when she makes
her last withdrawal her account will zero. Determine
the size of these withdrawal.
Solution
A 12 000
r 6%; m 12;
t 2
6%
i 0 .5 %
12
n 12 2 24
EXAMPLE 2
5. Firdaus borrowed RM 80 000 at 12% compounded monthly for 3
years.
a) Calculate his monthly payment.
b) If he has not paid his first 5 monthly payments, how much
should he pay on his 6th payment to settle all outstanding
arrears?
c) If immediately after paying the first 5 monthly payments, he
wants to settle all the loan. How much additional payments
does he has to make?
d) If he has made the first 5 monthly payments & wants to
settle all the loan in the sixth payment, how much should
he has to pay? How much interest was paid?
A 80 000 1 1 i n
Solution r 12%; m 12; t 3 a) A R
i
12%
i 1%; n 12 3 36
12
EXAMPLE 2
A 80 000
Solution r 12%; m 12; t 3
12%
i 1%; n 12 3 36
12
b) Outstanding arrears (5 months), S =

c) Outstanding loan (after 5 months) A =

d) 6th payment (used answer in c) as P), S = P(1+i) n

Total interest paid = R(5) + 6th payment A

PRACTICE 1
1. Find the future values and the present values of the
following annuities:
a) RM6000 every year for 8 years at 12%
compounded annually.
b) RM800 every month for 2 years 5 months at 5%
compounded monthly.
c) RM950 every 3 months for 3 years 9 months at 6%
compounded quarterly.
2. Serena invested RM300 every three months for four
years. She was offered 5% compounded quarterly for
the first two years and 8% compounded quarterly for
the rest of the period. Find the accumulated amount
at the end of four years.
PRACTICE 1
3. RM500 was invested every month for twenty months in
an account that pays 5% compounded annually. After
the twenty months, no more deposit was made. Find the
amount in the account at the end of four years.
4. Find the amount that must be deposited at the end of
each month at 5.5% compounded monthly for two years
so as to accumulate RM2000.
5. Mariana borrowed RM 100 000 at 4% compounded
monthly. She has to repay the loan by making 60
monthly payments.
a) Find her monthly payments.
b) If she has not paid her first 15 monthly payments,
how much should she pay on her 16th payment to
settle all outstanding arrears?
5.2 AMORTIZATION
Amortization
Schedule
Its a table showing the distribution of
principal & interest payments for the
various of periodic payments.
EXAMPLE 3
A loan of RM 1000 at 12% compounded monthly is to be
Amortized by 18 monthly payments.
a) Calculate the monthly payment.
b) Construct an amortization schedule.

Solution
A 1000 1 1 i n
r 12%; m 12; a) A R
i
18
t 1 .5 1 1 0.01 18
12 1000 R
12% 0.01
i 1%
12 1000 R 16.3983
n 121.5 18 R RM 60.98
EXAMPLE 3
Solution b) Amortization schedule
Beginning Ending Monthly Total principal Total interest
Period balance balance payment Total paid paid paid
1 MYR 1,000.00 MYR 949.02 MYR 60.98 MYR 60.98 MYR 50.98 MYR 10.00
2 MYR 949.02 MYR 897.53 MYR 60.98 MYR 121.96 MYR 102.47 MYR 19.49
3 MYR 897.53 MYR 845.52 MYR 60.98 MYR 182.95 MYR 154.48 MYR 28.47
4 MYR 845.52 MYR 792.99 MYR 60.98 MYR 243.93 MYR 207.01 MYR 36.92
5 MYR 792.99 MYR 739.94 MYR 60.98 MYR 304.91 MYR 260.06 MYR 44.85
6 MYR 739.94 MYR 686.36 MYR 60.98 MYR 365.89 MYR 313.64 MYR 52.25
7 MYR 686.36 MYR 632.24 MYR 60.98 MYR 426.87 MYR 367.76 MYR 59.11
8 MYR 632.24 MYR 577.58 MYR 60.98 MYR 487.86 MYR 422.42 MYR 65.44
9 MYR 577.58 MYR 522.37 MYR 60.98 MYR 548.84 MYR 477.63 MYR 71.21
10 MYR 522.37 MYR 466.62 MYR 60.98 MYR 609.82 MYR 533.38 MYR 76.44
11 MYR 466.62 MYR 410.30 MYR 60.98 MYR 670.80 MYR 589.70 MYR 81.10
12 MYR 410.30 MYR 353.42 MYR 60.98 MYR 731.78 MYR 646.58 MYR 85.20
13 MYR 353.42 MYR 295.97 MYR 60.98 MYR 792.77 MYR 704.03 MYR 88.74
14 MYR 295.97 MYR 237.95 MYR 60.98 MYR 853.75 MYR 762.05 MYR 91.70
15 MYR 237.95 MYR 179.35 MYR 60.98 MYR 914.73 MYR 820.65 MYR 94.08
16 MYR 179.35 MYR 120.16 MYR 60.98 MYR 975.71 MYR 879.84 MYR 95.87
17 MYR 120.16 MYR 60.38 MYR 60.98 MYR 1,036.69 MYR 939.62 MYR 97.07
18 MYR 60.38 MYR 0.00 MYR 60.98 MYR 1,097.68 MYR 1,000.00 MYR 97.68
5.3 SINKING FUND
Sinking Fund Definition
Sinking fund is an account that is set up for
a specific purpose at some future date.
date
For example:
An individual might establish a sinking fund for
the purpose of discharging a debt at a future
date.
A company might establish a sinking fund in
order to accumulate the sufficient capital to
replace equipment that is expected to obsolete
at some future date.
EXAMPLE 4
A debt of RM 1000 bearing interest at 10% compounded
annually is to be discharged by the sinking fund method. If
5 annual deposits are made into a fund which pays 8%
compounded annually,
a) calculate the annual interest payment.
b) Determine the size of the annual deposit into sinking
fund.
c) What is the annual cost of this debt?
d) Construct the sinking fund schedule. a) I RM 1000 10% RM 100
S 1000; 1 i n 1
b) S R
Solution r1 10%; m 1; t 5 i
r2 8%; m 1; t 5 1 0.08 5 1
1000 R
8% 0.08
i 8%
1 1000 R 5.8667
n 1 5 5 R RM 170.45
EXAMPLE 4
Solution
c) Annual cost = Annual interest payment + annual deposit
= RM 100 + RM 170.45 = RM 270.45
d) End of Interest Annual Amount at the
period (year) earned deposit end of period
170.46 + 13.64 +170.46
1 MYR 0.00 MYR 170.46 MYR 170.46
2 MYR 13.64 MYR 170.46 MYR 354.55 354.55 + 28.36 +170.46
3 MYR 28.36 MYR 170.46 MYR 553.37
4 MYR 44.27 MYR 170.46 MYR 768.10
5 MYR 61.45 MYR 170.46 MYR 1,000.00

170.46 x 8%

354.55 x 8%
5.4 ANNUITY WITH
CONTINUOUS
COMPOUNDING
Future value of the Present value of the
annuity: annuity:
eektkt 11 11eektkt
SS R
R kkp AA R
R kkp
ee p 11 ee p 11

where : R = Periodic payment

k = annual continuous compounding rate
t = time in years
p = number of payments in 1 year
EXAMPLE 5
Zainal wins an annuity that pays RM1000 at the end of
every 6 months for 4 years. If money is worth 10% per
annum continuous compounding, what is
a) The future value of this annuity at the end of four
years?
b) The present value of this annuity?

Solution e 0.1 4 1
a) S 1000 0.1
e 1 2

R 1000;
S RM 9 592.63
k 10%; t 4
p2 1 e 0.1 4
b) A 1000 0.1
e 1
2

A RM 6 430.13
EXAMPLE 6
Ah Chong won an annuity that pays RM5000 at the end of
every 3 months for 5 years. If money is worth 6% per
annum continuous compounding, calculate
a) the future value of this annuity at the end of 5 years.
b) the present value of this annuity.

Solution