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Mathematics of Finance: Section 4 Present Value of An Annuity Amortization
Mathematics of Finance: Section 4 Present Value of An Annuity Amortization
Mathematics of Finance
Section 4
Present Value of an Annuity; Amortization
Present Value of an Annuity
2
Derivation of Formula
A P 1 i
n
n
P A(1 i )
3
Present Value of the
First Four Payments
3
P3 3000(1.015)
4
P4 3000(1.015)
4
Derivation of Short Cut Formula
5
Present Value of an Ordinary Annuity
n
1 (1 i)
PV PMT
i
6
Back to Our Original Problem
7
Back to Our Original Problem
1 (1 i ) n
P R
i
1 (1.015) 8
P 3000 22, 457.78
0.015
8
Interest Earned
9
Amortization Problem
10
Amortization Problem
Solution
11
Solution
(continued)
1 (1 i ) n
PV PMT
i
i
PMT PV n
1 (1 i )
12
Solution
(continued)
i
Care must be taken to perform PMT PV n
the correct order of operations. 1 (1 i )
1. enter 0.045 divided by 12 0.045
2. 1 + step 1 result PMT 50, 000 12 382.50
3. Raise answer to -180 power. 0.045 180
1 1
4. 1 – step 3 result 12
5. Take reciprocal (1/x) of step 4
result. Multiply by 0.045 and
divide by 12.
5. Finally, multiply that result by
50,000 to obtain 382.50
13
Solution
(continued)
14
Constructing an
Amortization Schedule
If you borrow $500 that you agree to repay in six
equal monthly payments at 1% interest per month
on the unpaid balance, how much of each monthly
payment is used for interest and how much is used
to reduce the unpaid balance?
15
Amortization Schedule
Solution
If you borrow $500 that you agree to repay in six
equal monthly payments at 1% interest per month
on the unpaid balance, how much of each monthly
payment is used for interest and how much is used
to reduce the unpaid balance?
Solution: First, we compute the required monthly
payment using the formula i
PMT PV
1 (1 i ) n
0.01
500
1 (1.01) 6
$86.27
16
Solution
(continued)
18
Strategy for Solving Mathematics
of Finance Problems
19
Strategy
(continued)
20