ANNUITY

Topic Objectives
At the end of the lesson, you must have:

Understood the concept of annuity;

Identified the different kinds of annuities; and
Solved problems relating to annuity.

List the keywords in Lesson 3.

Let’s Learn!

4.1 Basic Concepts and Definitions

All of the situations we have considered so far, whether simple interest, simple discount, or
compound interest, have had something in common. In every case, a sum of money is lent and then
the loan is repaid in full all at once at the maturity date. While the terminology and formulas have
varied, timelines for any of these loans have looked like:

However, there are many financial situations where this sort of timeline is far too simple. For example
if you take a car loan. Suppose you borrow P725,000 at 8% compounded monthly for 5 years to buy
a car. The deal is unlikely to be that you get the P725,000 up front, do nothing for 5 years, and then
repay the entire loan at the end, all in a single lump sum. Such an arrangement would not make sense
either to you or to the lender. Instead, the usual arrangement requires you pay off the loan by making
payments every month. A timeline for your car loan would instead look more like this:
This loan’s consistent and regular payments are an example of an annuity.

If the payment for each period is fixed and the compound interest rate is fixed over a specified time
the payment is called an annuity payment. Accounts associated with streams of annuity payments
are called annuities.

An annuity is a sequence of payments, usually equal, made at regular intervals. Some

examples of annuities are quarterly payments of a lot’s amortization, premiums on insurance,
periodic pensions, and monthly payments on instalment purchases, educational plan, rental payment
among others.

The payment interval or conversion period is the time between successive payments of an
annuity. The term of an annuity is the time between the first payment interval and the last payment
interval. The periodic payment is the size of amount of each payment.

For instance, in an annuity that pays P1,000 every six months for 5 years, the payment
interval is 6 months, the term of an annuity is 5 years and the periodic payment is P1,000.

4.2 Types of Annuity

Annuity certain – it is an annuity with definite term. The first and last payment
intervals have definite dates.
o Example: payment on installment of household appliances and home
mortgage
Annuity uncertain – it is an annuity with an indefinite term. The first payment
interval has a definite date, but the last payment interval cannot be determined.
o Example: pensions and insurances

4.3 Kinds of Annuity Certain

Simple annuity - is an annuity in which the payment interval is the same as the
interest period.
o Example: An annuity for which the interest rate is compounded annually
and payments are also made every year.
 Rhea deposited 30,000 every year for 10 years at 7% per year
compounded annually. The 30,000 was deposited every year and
it is compounded annually. The compounding period is similar to
the payment interval.
 General Annuity - payment intervals are not the same as the interest period,
however it can be converted to simple annuity by making the payment period the
same as the compounding period by concept of effective rates.
o Example: An annuity for which the interest rate is compounded
quarterly while payments are made yearly.
 A ten-year lease agreement between Pure G Corporation
indicates that, Mae pays the company 150,000 at the end of
every year if the agreed interest rate is 5% compounded
quarterly.

4.4 Classification of Simple Annuity

Ordinary annuity – an annuity in which the payments are made at the end of each
payment interval. Four essential elements of ordinary annuity:
 Amounts of all payments are equal
 Payments are made at equal intervals of time.
 First payment is made at the end of the first period and all payments
thereafter are made at the end of the corresponding period.
Annuity due – an annuity where the periodic payments are made at the beginning of
the payment interval.
Deferred annuity – an annuity in which the periodic payment is not made at the
beginning nor at the end of each payment interval but some later date.

4.5 Annuity Formulas

1. Finding the Remaining Balance
RB = SP- DP
where: RB = remaining balance
SP= Selling price
DP = Down payment
2. Finding Monthly Periodic Payments
PPₘ = (RB x IR + RB )/AT
where: PPₘ = monthly periodic payments
RB = remaining balance
IR = interest rate
AT = annuity term
3. Finding Quarterly Periodic Payments
PPQ = [ (RB x IR + RB)/AT ] x Q
where: PPQ = quarterly periodic payments
RB = remaining balance
IR = interest rate
 AT = annuity term
Q = quarter
4. Finding Bi-Annual Periodic Payments
PPB = [ (RB x IR + RB)/AT ] x B
where: PPB = biannual periodic payments
RB = remaining balance
IR = interest rate
AT = annuity term
B = biannual (6 months)
5. Finding Annual Periodic Payments

PPA = [ (RB x IR + RB)/AT ] x A

where: PPA = annual periodic payments

RB = remaining balance

IR = interest rate
AT = annuity term
A = annual (12 months)
6. Finding Full Payment for Monthly Periodic Payments
FP = (PP) (AT)
where: FP = full payment
PP = monthly equal payments or periodic payments
AT = annuity term
7. Finding Full Payment for Quarterly Periodic Payments
FPQ = (PPQ) (ATTQ)
where: FPQ = full payment for quarterly periodic payments
PPQ = quarterly periodic payments
ATTQ = quarterly annuity term total
8. Finding Full Payment for Annual Periodic Payments
FPA = (PPB) (ATTB)
where: FPB = full payment for bi-annual periodic payments
PPB = bi-annual periodic payments
ATTB = bi-annual annuity term total
9. Finding Full Payment for Annual Periodic Payments
FPA = (PPA) (ATTA)
where: FPA = full payment for annual periodic payments
PPA = annual periodic payments
ATTA = annual annuity term total
10. Finding the Total Cost
TC = FP + DP
where: TC = total cost
 FP = full payment
DP = down payment

Illustration 1:

Suppose your mother purchased a Cleopatra narra sala set worth P 55,000. She paid P10,000
as down payment and the remaining balance will be paid in 24 monthly equal payments or periodic
payments at 12% interest rate.

a. How much is the remaining balance?

b. How much are her monthly equal payments or periodic payments?
c. How much did she pay in 24 months as annuity term in all?
d. How much is the total cost of the Cleoparta narra sala set including down payment?

Solution:

a. Finding the remaining balance

RB = SP- DP where: RB = remaining balance; SP= Selling price; DP = Down payment

RB = P 55,000 – P10,000

= P 45,000

b. Monthly periodic payments

PPₘ = (RB x IR + RB )/AT where: PPₘ = monthly periodic payments
RB = remaining balance
IR = interest rate
AT = annuity term
PPₘ = (P45,000 x .12 + 45,000)/24
= P2,100

c. Finding Full Payment

FP = (PP) (AT) where: FP = full payment
PP = monthly equal payments or periodic payments
AT = annuity term
FP = (2,100) (24)
= P50,400
 d. Finding the Total Cost
TC = FP + DP where: TC = total cost
FP = full payment
DP = down payment

TC = 50,400 + 10,000
= P60, 400

Illustration 2:

Suppose your father purchased a welding equipment for P150,000 to be used in his machine
shop. He paid P50,000 as down payment and the remaining balance will be paid in quarterly periodic
payments for 2 years at 20% interest rate.

a. How much is the remaining balance?

b. How much are the periodic payments or quarterly equal payments?
c. How much did he pay in 2 years as annuity term in all?
d. How much is the total cost of the welding machine including the down payment?

Solution:

a. RB = SP- DP
= 150,000 – 50,000
= P100,000

b. Finding quarterly periodic payments

PPQ = [ (RB x IR + RB)/AT ] x Q where: PPQ = quarterly periodic payments
RB = remaining balance
IR = interest rate
AT = annuity term
Q = quarter
Given:
RB = P100,000
IR = 20% = .2
AT = 2 years = 24 months
Q = 3 (a year has 3 quarters)

PPQ = [ (100,000 x .20 + 100,000)/24] x 3

= 5,000 x 3
= P15,000
 c. Finding full payment for quarterly periodic payments
FPQ = (PPQ) (ATTQ)
where: FPQ = full payment for quarterly periodic payments
PPQ = quarterly periodic payments
ATTQ = quarterly annuity term total
Given:
PPQ = P15,000
ATTQ = 8 (2 years or 24 months/3 months per quarter = 8)

Solution:
FPQ = (PPQ) (ATTQ)
= (15,000) (8)
= P120,000

d. TC = FPQ + DP
= 120,000 + 50,000
= P 170,000

Illustration 3:

Mayor Yorme bought a brand new car for P2, 500,000. He paid P150,000 as down payment
and the remaining balance will be paid in biannual periodic payments for 3 years at 25% interest
rate.

a. How much are the biannual periodic payments?

b. How much did he pay in 3 years as annuity term in all?

Solution:

a. Finding biannual periodic payments

PPB = [ (RB x IR + RB)/AT ] x B where: PPB = biannual periodic payments
RB = remaining balance
IR = interest rate
AT = annuity term
B = biannual (6 months)
RB = 2,500,000 – 150,000
= P2,350,000
Given:
RB = P2,350,000
IR = 25% = .25
AT = 3 years or 36 months
B = 36 months/6 months in biannual = 6
 PPB = [ (2,350,000 x .25 + 2,350,000)/36 ] x 6
= (587,500 + 2,350,000)/36 ] x 6
= (2,937,500/36) x 6
= P489, 583.33

b. FPB = (PPB) (ATTB)

= (489, 583.33) (6)
= P2,937,499.98

Illustration 4:

Suppose Mr. You bought a commercial building and a lot for P10,000,000. He paid P1,000,000
as down payment and the remaining balance will be paid annually for 10 years at 25% interest rate.

a. How much are the annual periodic payments?

b. How much did he pay in 10 years as annuity term in all?

Solution:

a. Finding annual periodic payments

PPA = [ (RB x IR + RB)/AT ] x A where: PPA = annual periodic payments

RB = remaining balance
IR = interest rate
AT = annuity term
A = annual (12 months)

RB = P10,000,000 - P1,000,000

= P9,000,000

Given:

RB = P9,000,000

IR = 25% = .25

AT = 10 years or 120 months

A = 12 months
 PPA = [ (9,000,000 x .25 + 9,000,000)/120 ] x 12

= P2,250,000 + 9,000,000)/120 ] x 12

= (11,250,000/120) 12

= (93,750) (12)

= P1,125,000

b. Finding Full Payment for Annual Periodic Payments

FPA = (PPA) (ATTA)
= (1,125,000) (10)
= P11,250,000

References:

Aduana, N. L. (2012). Mathematics of Investment: Procedural Approach.

C & E Publishing, Inc.

Calmorin, L.P., Malubay, H.A. & Deloso, M. P. (2012. Mathematics of

Investment with computer application. Rex Book Store, Inc.