ANNUITIES

An annuity – is a stream of equal periodic cash

flows, over a specified time period. These
cash flows are usually annual but can occur at
other intervals, such as monthly rent or car
payments.

The cash flows in an annuity can be inflows

(the 3,000 received at the end of each of the next
20 years) or outflows ( the 1,000 invested at the
end of each of the next 5 years).

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There are two basic types of annuities:

1. Ordinary annuity – the cash flow

occurs at the end of each period

2. Annuity due – the cash flow occurs

are the beginning of each period.

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EXAMPLE:

Fran Abrams is evaluating two annuities. Both are 5-

year, 1,000 annuities; Annuity A is an ordinary annuity and
annuity B is an annuity due @7% interest.

To better understand between these annuities, she has

listed their cash flows. Note that the amount of each
annuity totals 5,000.

The two annuities differ only in the timing of their cash

flows: The cash flows are received sooner with annuity due
than with the ordinary annuity.4
Comparison of Ordinary Annuity and Annuity Due Cash Flows (1,000, 5 years)
Annual Cash Flow

Year Annuity A (ordinary) Annuity B (annuity due)

0 0 1,000
1 1,000 1,000
2 1,000 1,000
3 1,000 1,000
4 1,000 1,000
5 1,000 0
Totals 5,000 5,000

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 Let us assume that you invest 1,000 every year for
the next 5 years, @ 5% interest.
FVOA = CF=1,000 r= 5% n=5 FVAD = CF = 1,000 r-5% n=5
ORDINARY ANNUITY ANNUITY DUE
YEAR CASH FVIFO FUTURE YEAR CASH FVIFO FUTURE
FLOW A VALUE A VALUE
S FLOWS

0 0 1,000 +(1+.05)^5
1.2763 1276.28
1 1,000 +(1+0.05)^4 1 1,000 +(1+.05)^4
1.2155 1215.51 1.2155 1215.51
2 1,000 +(1+0.05)^3 2 1,000 +(1+.05)^3
1.1576 1157.63 1.1576 1157.63
3 1,000 +(1+0.05)^2 3 1,000 +(1+.05)^2
1.1025 1102.50 1.1025 1102.50
4 1,000 +(1+0.05)^1 4 1,000 +(1+.05)^1
1.0500 1050.00 1.0500 1050.00
5 1,000 +(1+0.05)^0 5
1.0000 1000.00 FVAD 5,801.91
FVOA
5,525.63
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PRESENT VALUE OF ORDINARY ANNUITY
Using the same example of five $1,000 payments made over
a period of five years, here is how a present value calculation
would look. It shows that $4,329.58, invested at 5% interest,
would be sufficient to produce those five $1,000 payments.

WHO CAN SOLVE FOR THE PVOA?

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 PRESENT VALUE OF ANNUITY DUE

For example, an annuity due's interest rate

is 5%, you are promised the money at the
end of 3 years and the payment is $100 per
year.

WHO CAN SOLVE FOR THE PVAD?

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9
PV OF ORDINARY ANNUITY

YR CF PVIFOA PV
1 1,000 =1/(1+.05)^1 0.9524 952.38
2 1,000 =1/(1+.05)^2 0.9070 907.03
3 1,000 =1/(1+.05)^3 0.8638 863.84
4 1,000 =1/(1+.05)^4 0.8227 822.70
5 1,000 =1/(1+.05)^5 0.7835 783.53
4329.48

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PRESENT VALUE OF ANNUITY DUE

For example, an annuity due's interest rate is 5%,

you are promised the money at the end of 3 years
and the payment is $100 per year. ANS. 285.94

0 100 =1/(1+0.05)^0 1.0000 100

1 100 =1/(1+.05)^1 0.9524 95.24
2 100 =1/(1+.05)^2 0.9070 90.70
3 285.94
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FORMULA FOR PRESENT AND FUTURE VALUES OF
ANNUITY DUE

FV Annuity Due ​= C×[i(1+i)n−1​]×(1+i)​n-1]
FV Annuity Due​​ = 1,000×[0.05(1+0.05)5−1​]
= 1,000×5.53×1.05
= 5,801.91​

PVAnnuity Due​=C×[i1−(1+i)−n​]×(1+i)​1
1
PV Annuity Due ​= 1,000×[0.05(1−(1+0.05)−5​]×(1+0.05)
= 1,000×4.33×1.05
= 4,545.95​ 12
 FORMULA:
ORDINARY ANNUITY
FUTURE VALUE
FV ORDINARY ANNUITY = C×[i(1+i)n−1​]
r
= 500 * ([1 + 0.06]^10 - 1 )/0.06
= 6,590.40
ORDINARY ANNUITY
PRESENT VALUE
PV Ordinary Annuity​=C×[i1−(1+i)−n​]​
1

PVOrdinary Annuity ​= 1,000×[0.051−(1+0.05
13
Finding the Present Value Of An Ordinary Annuity

Example:
Braden Company, a small producer of plastic
toys, wants to determine the most it should pay to
purchase a particular ordinary annuity. The
annuity consist of cash flows of 700 at the end of
each year for 5 years. The firm requires the
annuity to provide a minimum return of 8%.

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END

OF

PRESENTATION

*UPLOAD THIS PRESENTATION

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Year 0 -

Year 1 - 648.15

Year 2 - 600.14

Year 3 - 555.68

Year 4 - 514.52

Year 4 - 476.41

Present Value 2,794.90

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 Long Method of Finding the Present Value of an Ordinary
Annuity
Year (n) Cash Flow Present Value Calculation Present Value

1 700 700/(1 + 0.08)1 1,648.15

2 700 700/(1 + 0.08)2 600.14
3 700 700/(1 + 0.08)3 555.68
4 700 700/(1 + 0.08)4 514.52
5 700 700/(1 + 0.08)5 476.41
Presen
t
Value Of an Annuity 2,794.90

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ANSWER:
A B
ordinary annuity = 5,750.74 annuity due = 6,153.29

(6,153.29 – 5,750.74) /5,750.74 = 0.07 = 7% -difference

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COMPUTE FOR PRESENT VALUE OF ORDINARY ANNUITY
COMPUTE FOR PRESENT VALUE OF ANNUITY DUE

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https://www.investopedia.com/retirement
/calculating-present-and-future-value-of-
annuities/

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Formula for Annuity
FUTURE VALUE OF AN ORDINARY ANNUITY

FVOrdinary ​=C×[i(1+i)n−1​]
Annuity
where:
C=cash flow per period
i=interest rate
n=number of payments​

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 So, let's assume that you invest $1,000 every
year for the next five years, at 5% interest.

FVOrdinary Annuity​​= $1,000×[0.05(1+0.05)5−1
​ = $1,000×5.53
= $5,525.63
​

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Using the same example of five $1,000 payments
made over a period of five years, here is how a
present value calculation would look. It shows
that $4,329.58, invested at 5% interest, would be
sufficient to produce those five $1,000 payments.

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 If we plug the same numbers as above into the equatio
here is the result:

PVOrdinary Annuity ​= 1,000×[0.051−(1+0.05)−5​]
= 1,000×4.33
= 4,329.58​

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For example, if the $1,000 was invested on
January 1 rather than January 31 it would have an
additional month to grow.

The formula for the future value of an annuity due is

as follows:
FVAnnuity Due​​=C×[i(1+i)n−1​]×(1+i)​

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 TIME LINE FVn = CF X { [ (1+r) n – 1]}
r
FVs = 1,000 X { [1 + 0.07) 5 – 1 ] } = 5,750.74
0.07
1,310.80
1,225.04
1,440.90
1,070.00
1,000.00
1 1 1 1 1 1 5,750,00
0 1 2 3 4 5
End of Year
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FV Annuity Due​​= $1,000×[0.05(1+0.05)5−1​]
= $1,000×5.53×1.05
= $5,801.91​
Calculating the Present Value of an Annuity Due
Let's say you pay $1,000 a month in rent. Below, we can see what the
next five months would cost you, in terms of present value, assuming you kept
your money in an account earning 5% interest.

This is the formula for calculating the present value of an

annuity due:

PVAnnuity Due​=C×[i1−(1+i)−n​]×(1+i)​
1

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 Let’s review some concepts
Yellow Blue Red
Is the color of gold, butter and Is the colour of the clear sky Is the color of blood, and
ripe lemons. In the spectrum of and the deep sea. It is located because of this it has
visible light, yellow is found between violet and green on the historically been associated
between green and orange. optical spectrum. with sacrifice, danger and
courage.

Yellow Blue Red

Is the color of gold, butter and Is the colour of the clear sky Is the color of blood, and
ripe lemons. In the spectrum of and the deep sea. It is located because of this it has
visible light, yellow is found between violet and green on the historically been associated
between green and orange. optical spectrum. with sacrifice, danger and
courage.

37
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