Annuities

13
Due

Annuities

Chapter
McGraw-Hill Ryerson

13

13 - 1

Annuities

13
Due

Learning
Objectives

13 - 2

After completing this chapter, you will be able to:

Calculate
LO 1.

LO 2.

McGraw-Hill Ryerson

the Future Value and Present Value of

the payment size, number of
payments, and interest rate in

Annuities

13 - 3

13
Due

1stst.

th.
15th.

youlease
leaseequipment,
equipment,
IfIfyou
vehicle,or
orrent
rentproperty,
property,
aavehicle,
thetypical
typicallease
leasecontract
contract
the
requirespayments
paymentsatatthe
the
requires

beginningofofeach
each
beginning
periodofofcoverage
coverage
period
Membershipdues
duesare
areusually
usuallypaid
paidin
inadvance
advance
Membership
Onlyaasmall
smallmodification
modificationtotothe
themath
mathofofOrdinary
OrdinaryAnnuities
Annuitiesisis
Only
neededtotohandle
handle
needed
McGraw-Hill Ryerson

Annuities

Classification of
of
Classification
Annuities
Annuities

13
Due

13 - 4

Ordinary
rdinary A
Annuity
nnuity
O
Payments
Payments/ Deposits
/ Deposits

Payments
Payments/ /Deposits
Deposits

are
aremade
madeatatthe
the
end
endofofthe
theperiod
period

are
aremade
madeatatthe
the
beginning
beginningofof
the
period
the period

McGraw-Hill Ryerson

Annuities

Classification of
of
Classification
Annuities
Annuities

13
Due

Annuity
Annuity
Category
Category

Ordinary Simple

thepayment
payment
IsIsthe
atthe
theend
endor
or
at
the
atatthe
beginning
beginning
eachpayment
payment
ofofeach
interval?
interval?

Ordinary General
Simple Annuity Due

Comparethe
the
Compare
payment
payment
intervalto
tothe
the
interval
compounding
compounding
interval
interval

End

Equal

End

Not Equal

Beginning

Equal

General Annuity Due Beginning

McGraw-Hill Ryerson

1313- 5- 6

Not Equal

Annuities

13 - 6

13
Due

Formulae
Formulae

LO 1.

Formula
Formula

n
(1+
i)
-1
FVdue = PMT

Formula
Formula

-n
1-(1+
i)
PVdue = PMT

McGraw-Hill Ryerson

] * (1+ i)

]* (1+ i)

If the payments form a general annuity due,

c
use i2 = (1+i) 1 in the formula for i

Annuities

13 - 7

13
Due

Clues to help identify annuities due

Payments at the beginning of each..
Paymentsin advance
First payment made today
Payments .. starting now

McGraw-Hill Ryerson

Annuities

13

13 - 8

Due

How much will Elyse accumulate in her RRSP

by age 60 if she makes
semi-annual contributions of $1,000
starting on her 30th birthday?
Assume that the RRSP
earns 8% compounded semi-annually
and that no contribution is made
on her 60th birthday.

McGraw-Hill Ryerson

Annuities

13 - 9

13
Due

Step 1 Set your calculator to the BGN mode

How much
much
How
will Elyse
Elyse
will
accumulate in
in her
her
accumulate
RRSP by
by age
age 60
60 ifif she
she
RRSP
makes
semimakes
semiannual contributions
contributions of
of
annual
$1,000 starting
starting on
on her
her
$1,000
30th birthday?
birthday?Assume
Assume
30th
that the
the RRSP
RRSPearns
earns
that
8% compounded
compounded semisemi8%
annually and
and that
that no
no
annually
contribution isis made
made on
on
contribution
her 60th
60th birthday.
birthday.
her

McGraw-Hill Ryerson

END
BGN

BGN

Yourcalculator
calculator
Your
nowset
setfor
for
isisnow

annuity due
due
annuity

Noticethe
the
Notice
tinyBGN
BGN
tiny
abovethe
the00
above

Step2
2
Step

Annuities

13 - 10

13
Due

Step 2 Solve for the FV of the annuity due

How much
much
How
will Elyse
Elyse
will
accumulate in
in her
her
accumulate
RRSP by
by age
age 60
60 ifif she
she
RRSP
makes
semimakes
semiannual contributions
contributions of
of
annual
$1,000 starting
starting on
on her
her
$1,000
30th birthday?
birthday?Assume
Assume
30th
that the
the RRSP
RRSPearns
earns
that
8% compounded
compounded semisemi8%
annually and
and that
that no
no
annually
contribution isis made
made on
on
contribution
her 60th
60th birthday.
birthday.
her

McGraw-Hill Ryerson

ElysesRRSP
RRSP
Elyses
valueon
onher
her
value
60ththbirthday
birthday
60

BGN
FV= 247,510.31
0

1000
2

60
0

Annuities

13
Due

How much
much
How
will Elyse
Elyse
will
accumulate in
in her
her
accumulate
RRSP by
by age
age 60
60 ifif she
she
RRSP
makes
semimakes
semiannual contributions
contributions of
of
annual
$1,000 starting
starting on
on her
her
$1,000
30th birthday?
birthday?Assume
Assume
30th
that the
the RRSP
RRSPearns
earns
that
8% compounded
compounded semisemi8%
annually and
and that
that no
no
annually
contribution isis made
made on
on
contribution
her 60th
60th birthday.
birthday.
her

McGraw-Hill Ryerson

13 - 11

(1+ i) - 1
FV = PMT
* (1+ i)
i
c = 1 i = 0.08/2 PMT = 1000 n = 60

Formula
Formula

247,510.31
10.5196
9.5196

ElysesRRSP
RRSP
Elyses
valueon
onher
her
value
60ththbirthday
birthday
60

60

1.04
1
1000

0.04
1.04

Annuities

13 - 12

13
Due

A lottery offers the winner a choice between

a $300,000 cash prize, or quarterly payments
of $7,000 beginning immediately
and continuing for 20 years.
Which alternative should the winner pick
if money is worth
8% compounded
What do
do we
we have
have to
to find?
find?
What
quarterly?
Needtotofind
findthe
thePV
PVtoday
todayofofthe
thepayment
paymentalternative
alternative
Need
andcompare
comparewith
withthe
the$300,000
$300,000cash.
cash.
and
McGraw-Hill Ryerson

Annuities

13

13 - 13

Due

Step 1 Set your calculator to the BGN mode

lotteryoffers
offers
AAlottery
thewinner
winneraachoice
choice
Yourcalculator
calculator
Your
the
betweenaa$300,000
$300,000
BGN
isnow
nowset
setfor
for
between
END
BGN
is
cashprize,
prize,or
or
0
cash
annuity due
due
quarterly
payments
annuity
quarterly payments
$7,000
ofof$7,000
beginning
beginning
immediately
immediately
andcontinuing
continuing
and
for 20
20years.
years.
for
Which
Which
alternativeshould
should
alternative
thewinner
winnerpick
pick
the
ifif

McGraw-Hill Ryerson

Step2
2
Step

Annuities

13 - 14

13
Due

Step 2 Solve for the PV of the annuity due

lotteryoffers
offers
AAlottery
thewinner
winneraachoice
choice
the
betweenaa$300,000
$300,000
between
cashprize,
prize,or
or
cash
quarterlypayments
payments
quarterly
$7,000
ofof$7,000
beginning
beginning
immediately
immediately
andcontinuing
continuing
and
for 20
20years.
years.
for
Which
Which
alternativeshould
should
alternative
thewinner
winnerpick
pick
the
ifif

McGraw-Hill Ryerson

BGN
PV= 283,775.83
0

7000
8

CashValue
Value
Cash
ofthe
the
of
payment
payment
option
option

80

The $300,000
$300,000 cash
cash is
is aa better
better offer
offer
The
$16,224 more
more in
in current
current day
day
$16,224
dollars($300,000 -- $283,775.83)
$283,775.83)
dollars($300,000

Annuities

13
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13 - 15
A lottery offers the winner a choice between a
$300,000 cash prize, or quarterly
payments of $7,000 beginning immediately and
continuing for 20 years. Which alternative should
the winner pick if money is worth 8% compounded
quarterly?

-n
1-(1+
i)
PVdue = PMT

= 7000

]* (1+ i)

(1 -(1 + .08/4)-80) *(1.02)

.02

= $283,775.83
The $300,000
$300,000 cash
cash isis aa better
better offer
offer $16,224
$16,224 more
more in
in
The
current day
day dollars($300,000
dollars($300,000 -- $283,775.83)
$283,775.83)
current
McGraw-Hill Ryerson

Annuities

13 - 16

13
Due

LO 2.

Step 1 Set your calculator to the BGN mode

Step 2 Solve for the PMT of the annuity due

You have
accumulated
$104,000 in your
RRSP. Your goal is
to build it to $250,000
with equal
contributions every
6 months for the
next 7 years. If you
earn 8.5%
compounded semiannually, and start
today, find the size
of your
contributions.

McGraw-Hill Ryerson

Step 11 Step
Step 22
Step

BGN
BGN= -3,286.10
PMT

14
250000
104000

Payment
Payment
needed is
is
needed
$3286.10
$3286.10

8.5

Annuities

13

Formula
Formula

Due

You have
accumulated
$104,000 in your
RRSP. Your goal is
to build it to $250,000
with equal
contributions every
6 months for the
next 7 years. If you
earn 8.5%
compounded semiannually, and start
today, find the size
of your
contributions.

McGraw-Hill Ryerson

FVdue

= PMT[

(1+ i)n - 1

]*(1+ i)13 - 17

Extract necessary data...

c = 1 i = 0.085/2 PMT = ? n = 14
FV = 250 000 PV = 104 000
a.a. Find the FV 7 years from now
of the $104,000 already saved.
FV = 104 000(1+.085/2)14
= $186,250.84
b. Subtract this value from the
b.
$250,000 target to get
the FV of
annuity.
$250,000the
- $186,250.84

$63,749.16
== $63,749.16

Annuities

13
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13 - 18

Choose appropriate formula and Solve

(1+ i)n - 1
FV = PMT
* (1+ i)
i
c = 1 i = 0.085/2 PMT = ? n = 14
FV = $63,749.16
PV = 0

14
(1.0425)
1 * (1.0425)
63749.16 = PMT
0.0425

63749.16 = PMT(19.3997)
PMT==$3286.10
$3286.10
PMT

McGraw-Hill Ryerson

Annuities

13 - 19

13
Due

Purchase
Price

A car sells for $27,900. The manufacturer

offers an interest rate of 1.8%
compounded monthly on a three year lease.
If the residual value is $14,500,
find the lease payments assuming a $2,500
down payment.
Down
Present Value of Present Value of
Payment = Lease Payments + Residual Value

$27,900

$25,400

$2,500

McGraw-Hill Ryerson

Present Value of
Lease Payments

Present Value of
Lease Payments

Present Value
of $14,500

Present Value
of $14,500

Annuities

13 - 20

13
Due

Step 1 Set your calculator to the BGN mode

Step 2 Solve for the PMT of the annuity due
A car sells for
$27,900.
The
manufacturer
offers an interest
rate of 1.8%
compounded
monthly on a three
year lease.
If the
residual value is
$14,500, find the
lease payments
assuming a $2,500

McGraw-Hill Ryerson

Step 11 Step
Step 22
Step
12

BGN=
PMT
36
14500
25400

Payment
Payment
needed is
is
needed
$322.50
$322.50

1.8

BGN
332.50
0

Annuities

13

13 - 21

Due

Extract necessary data...

c = 1 i = 0.018/12 PMT = ? n = 36
A car sells for a.a. Find the PV of the $14,500
$27,900.
residual value
The
PV = 14 500(1+.018/12)-36
manufacturer
= $13,738.32
offers an interest
rate of 1.8%
b. PV annuity =
compounded b.
monthly on a three
SP DP PV of residual value
year lease.
= $27,900 - $2500 - $13,738.32
If the
residual value is
$11,661.68
== $11,661.68
$14,500, find the
lease payments
See Next
assuming a $2,500

McGraw-Hill Ryerson

Annuities

13 - 22

13

Choose appropriate formula and Solve

Due

-n
1-(1+
i)
PVdue = PMT

]* (1+ i)

c = 1 i = 0.018/12 PMT = ? n = 36
FV = 0

PV = $11,661.68

-36
11661.68 = PMT 1 - (1.0015)
0.0015

* (1.0015)

11661.68 = PMT (35.0722)

PMT==$332.50
$332.50Lease
LeasePayment
Payment
PMT

McGraw-Hill Ryerson

Annuities

13 - 23

13

How long
long will
will itit take
take to
to accumulate
accumulate
How
$1 million
million in
in an
an RRSP
RRSPifif the
the first
first quarterly
quarterly payment
payment
$1
of $2000
$2000 isis made
made today?
today? Assume
Assume the
the RRSP
RRSP
of
earns 6%
6% compounded
compounded quarterly.
quarterly.
earns

Due

PV = $0
Step 11
Step

n =? FV = $1 000 000 i = .06/4

Step 22
Step

BGN
N
=
6

2000
1 000 000

McGraw-Hill Ryerson

BGN
142.9
0

143
143
Quarterly
Quarterly
payments
payments
35.75 years
years
35.75

Annuities

13 - 24

13
Due

using the algebraic method to

determine

Number of Payments

Formulae
Formulae

FVdue * i
ln 1 +
PMT

ln 1
n

McGraw-Hill Ryerson

ln 1 i

]
]

PVdue * i
PMT
ln 1 i

Annuities

13
Due

13 - 25

How long
long will
will itit take
take to
to accumulate
accumulate
How
$1 million
million in
in an
an RRSP
RRSPifif the
the first
first quarterly
quarterly payment
payment
$1
of $2000
$2000 isis made
made today?
today? Assume
Assume the
the RRSP
RRSP
of
earns 6%
6% compounded
compounded quarterly.
quarterly.
earns
PV = $0

Formula
Formula

n=

n=

n =?

FV = $1000000 i = .06/4

FVdue * i
ln 1 +
PMT
ln 1 i

ln 1+ 1,000,000 * .015
2000(1.015)
ln (1.015)

142.9 i.e.
i.e. 143
143 quarterly
quarterly payments
payments
== 142.9
McGraw-Hill Ryerson

]
= 2.1269
0.0149
or 35.75
35.75 years
years
or

Annuities

13 - 26
A $100,000 life insurance policy requires an
annual premium of $420 or a monthly premium of $37.
In either case, the premium is due at the beginning of
the period of coverage. What is the effective rate of
interest charged to those who pay monthly?

13
Due

Set to

BGN mode

P/Y===
C/Y
I/Y

12
12
1

BGN
13.04
1201

420

37
0
Effective Interest
Interest rate
rate on
on the
the
Effective
monthly payment
payment plan
plan == 13.04%
13.04%
monthly

McGraw-Hill Ryerson

Annuities

13 - 27

13
Due

This completes Chapter 13

McGraw-Hill Ryerson