MODULE 2

Annuity, Perpetuity
and Cost
 LESSON 3

Annuity

Annuity is a series of uniform payments made at equal intervals of time.

Annuities are established for the following purposes:
1. As a payment of a debt by a series of equal payment at equal time intervals, also
known as amortization.
2. To accumulate a certain amount in the future by depositing equal amounts at equal
time intervals. These amounts are called sinking fund.
3. As a substitute periodic payment for a future lump sum payment.

Types of Annuity
A. Ordinary Annuity. The payment is made at the end of each period starting from from
the first period, as the diagram shown below.

Future worth of A
A [(1+i)¿¿ n−1]
F= ¿
i
where:
A – periodic payment
F or S – future worth or sum of all the periodic payment after the
last payment is made.
(1+i)n −1
– known equal-payment-series compound-amount
i
factor

Value of A with known F (sinking fund)

Fi
A=
(1+i)n −1
i
n – known equal-payment sinking-fund factor
(1+i) −1
Present worth of A
F A [(1+i)¿¿ n−1]
P= n =
¿
(1+i) (1+i)n i
 (1+i)n −1
– known as equal-payment-series present-worth-factor
(1+ i)n i

Value of A with known P (capital recovery)

P(1+i)n i
A=
(1+i)n −1
(1+ i)n i
– known as equal-payment-series-capital-recovery fac.
(1+i)n −1

B. Deferred Annuity – the first payment is deferred a certain number of periods after
the first.

A [(1+i)¿¿ n−1]
F= ¿
i
note: n is number of payments after the first
A [(1+i)¿¿ n−1]
P= ' ¿
( 1+i)n i
note: n’ – number of payments

C. Annuity Due. If the payment is made at the beginning of each period starting from
the first period, it is annuity due.

From the diagram shown

A¿
F= ¿
i

A [(1+i)¿¿ 6−1] A [(1+i)¿¿ n−1]

P= 5
¿= ' ¿
(1+i) i (1+ i)n
where:
n – number of payments
n’ – number of periods from zero period up to the last payment
SAMPLE PROBLEM

1. A man paid a 10% down payment of P200,000 for a house and lot and agreed to pay
the balance on monthly instalments for 5 years at an interest rate of 14% compounded
monthly. What was the monthly instalment in pesos?

Solution
Cost of house = x
0.10x = 200,000
x = 2,000,000
Balance = 1,800,000
0.1 4
i= = 0.0116
12
n = 5(12) = 60
A [(1+i)¿¿ n−1]
P= ¿`
(1+i)n i
A [(1.0125)¿¿ 60−1]
1,800,000 = ¿
( 1.0125 )60( 0.0125)
A = P42,821.87

2. A construction equipment with no salvage value is to be replaced at the end of 12

years from now at a cost of P800,000. To prepare for this, a sinking fund is created
which a regular deposit at the end of every 6 months. If the fund earns 15%
compounded semi annually how much should the deposit be?
Solution
n = 12(2) = 24
0.15
i= = 0.075
2
A [(1+i)¿¿ n−1]
F= ¿
i
A [(1.075)¿¿ 24−1]
800,000 = ¿
0.075
A = P 12,840.00

3. A man invested P100,000 every end of the year for 10 years, then waited for another
10 years for this money to grow. If his investment earned 8x, after tax, compounded
annually, what would be the sum of his investment and earnings at the end of the 20th
year.
Solution
A [(1+i)¿¿ n−1] 10000[(1.08)¿¿ 10−1]
F= ¿ = ¿ = P144, 865.62
i 0.08
S = F(1 + i)n = 144865.62(1.08)10 = P3,127, 540
4. A boy is entitled to 10 yearly endowments of P30000 each starting at the end of the
eleventh year from now. Using an interest rate of 8% compounded annually, what is the
value of these endowment now?
Solution
A [(1+i)¿¿ n−1] 30000[(1.08)¿¿ 10−1]
P1 = ¿ = ¿ = 201, 302.44
n
(1+i) i (1.08 )10 (0.08)
P1 201302.44
P= n = 10 = P93, 231.98
(1+i) (1.08)

5. Find the difference between the sums of an annuity due and an ordinary annuity for
the following data:
Periodic payment = P10,000
Payment interval = 1 year
Term = 20 years
Interest rate = 12% compounded annually
Solution
Difference = A[(1 + i)n – 1] = 10000[(1.12)20 – 1] = P86, 462.00

6. An engineer is entitled to receive P25,000 at the beginning of each year for 18 years.
If the rate of interest is 4% compounded annually.
a. What is the present value of this annuity at the time he is supposed to
receive the first payment?
b. What is the sum of this annuity at the end of 18th year?
c. Find the difference between the sums of the annuity which is paid at the
beginning of each year (annuity due) and ordinary annuity (annuity paid at
the end of each year).
Solution
A [(1+i)¿¿ n−1] 25000[(1.04)¿¿ 17−1]
a. P = ¿ +A= ¿ + 25000 =
n
(1+i) i (1.04 )17 (0.04)
P325,142
A [(1+i)¿¿ n−1] 25000[(1.04)¿¿ 19−1]
b. F = ¿ –A= ¿ – 25000 = P666,
i 0.04
780.73
c. Diff. = A[(1 + i)n – 1] = 25000[(1.04)18 – 1] = P25,645.41
 LESSON 4

PERPETUITY

Perpetuity is an annuity where the payment period extend forever or the periodic
payments continue indefinitely, If the payment is made at the end of each period starting
from the first period, the present worth of perpetuity is

A
P =
i

SAMPLE PROBLEM

1. If money is worth 8% determine the present value of a perpetuity of P1,000 payable

annually, with the first payment due at the end of 5 years.

Solution

The worth of perpetuity at the end of the 5th year is

A 1000
P’ = = = P12,500.00
i 0.08
The present worth of P’ is

P' 12500
P= = = P 9,187.87
i (0 .08)4

Arithmetic Gradient

The present worth is:

n
A [(1+i)¿¿ n−1] G (1+i) −1 n
P= ¿ + [ - n]
(1+i)n i i i(1+i)n (1+i)
The future worth is

A [(1+i)¿¿ n−1] G (1+i)n −1

F = P(1 + i)n = ¿ + i
[ – n]
i i

Geometric Gradient

1+ r
let ɯ =
1+i

Present worth

If ɯ ≠ 1

A [(1+i)¿¿ n−1] G n
P= ¿ + [ 1−ω ]
(1+i)n i 1+ i 1−ω

If ɯ = 1 (for r = 1)

A [(1+i)¿¿ n−1] Gn
P= ¿ +
(1+i)n i 1+ r

Future worth

F = P(1 + i)n

SAMPLE PROBLEMS

1. Annual maintenance for a machine are P28,000 this year and are estimated to
increase 10% each year every year. What is the present worth of the maintenance cost
for 6 years if interest is 8%?
Solution

1+ r 1+ 0.10
ɯ= = = 1.018 ≠ 1
1+i 1+ 0.08
 A [(1+i)¿¿ n−1] G 1−ω n
P= ¿ + [ ]
(1+i)n i 1+ i 1−ω

0[(1.08)¿¿ 6−1] 28000 1−1.0186

P= ¿ + [ ] = P162, 937.5
( 1.08 )6 (0.08) 1.08 1−1.018

2. Annual maintenance cost for a machine are P25,000 for six years. Interest rate is 6%.
a. What is the present worth of all the maintenance cost?
b. If maintenance cost is P25,000 this year and are estimated to increase
10% each year every year, what is the present worth of all the
maintenance cost?
c. If maintenance cost is P25,000 this year and are estimated to increase
P3,000 each year every year, what is the present worth of all the
maintenance cost?
Solution
A [(1+i)¿¿ n−1] 25000[(1.06)¿¿ 6−1]
a. P= ¿ = ¿ = P 122, 933.00
n
(1+i) i ( 1.06 )6 (0.06)

1+ r 1+ 0.10
b. ɯ= = = 1.03774 ≠ 1
1+i 1+ 0.06
A [(1+i)¿¿ n−1] G 1−ω n
P= ¿ + [ ]
(1+i)n i 1+ i 1−ω
25000 1−1.03746
P=0 +
1.06 [ 1−1.0374 ] = P 155, 550.00
n
A [(1+i)¿¿ n−1] G (1+i) −1 n
c. P=
(1+i) in
¿ + i
[ n - (1+i)n
]
i(1+i)
6
25000[(1.06)¿¿ 6−1] 3000 (1.06) −1 6
P= 6
¿ + 0.06 [ 6 - 6]
( 1.06 ) (0.06) 0.06(1.06) (1.06)
P = P 157,311
 LESSON 5

CAPITALIZED AND ANNUAL COST

Capitalized Cost, K is an application of perpetuity. The capitalized cost of a project or
structure is the sum of the first cost (FC) and the present worth of all future payments
and replacements which is assumed to continue forever. If a project requires a first cost,
annual operation and maintenance (OM) for n years, and a replacement cost (RC) after
every end of n years, then the capitalized cost is
OM RC −SV
K = FC + +
i (1+i)n −1
If RC is not specified, use RC = FC
Capitalized cost may also be defined as the first cost plus present worth of annual
maintenance and operation cost plus the present worth of depreciation assumed to
continue forever.
Annual Cost, AC of a project is
AC = Annual interest on investment + Annual Operation and Maintenance
+ Annual Depreciation Cost
( RC−SV ) i
AC = Ki = (FC)i + OM +
(1+i)n−1
SAMPLE PROBLEM
A machine costs P 300,000.00 and must be replaced at the end of each 15 years. If the
annual maintenance required is P5,000.00, find the capitalized cost is money is worth
5% and the final salvage value id P 50,000.
OM RC−SV
Solution K = FC + + n
i (1+i) −1
5000 300000−50000
K = 300,000 +
0.05 + (1.05)15−1 = P 631,711.44
Cost Comparison of Different Alternatives
If two or more different articles are available for the same purpose, they are equally
economical if the corresponding present worth, annual cost or capitalized cost are the
same.
SAMPLE PROBLEM
A certain equipment costs P 150,000 lasts for 6 years and has a salvage value of
P30,000. How much could an investor afford to pay for another machine for the same
purpose, whose life is 10 years and salvage value is P40,000, if money is worth 5%?
Solution For the first machine
 OM RC −SV
K = FC + + n
i (1+i) −1
150000−30000
K = 150000 + 0 + = P 502,841.92
(1.05)6−1
For the second machine
OM RC −SV
K = FC + +
i (1+i)n −1
FC −40000
502,841.92 = FC + 0 + 10
(1.05) −1
FC = P 218, 696.41