Annuities

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Annuities

Chapter
Chapter 13
13
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 Annuities

Learning Objectives
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After completing this chapter, you will be able to:

Calculate

LO 1. … the Future Value and Present Value of

LO 2. …the payment size, number of

payments, and interest rate in

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 Annuities
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1stst. IfIfyou
youlease
leaseequipment,
equipment,
aavehicle,
vehicle,or
orrent
rentproperty,
property,
thetypical
the typicallease
leasecontract
contract
requirespayments
requires paymentsatatthe
the
15th.
th.
beginningof
beginning ofeach
each
periodofofcoverage
period coverage
Membershipdues
Membership duesare
areusually
usuallypaid
paidin
inadvance
advance

Onlyaasmall
Only smallmodification
modificationtotothe
themath
mathofofOrdinary
OrdinaryAnnuities
Annuitiesisis
neededtotohandle
needed handle
McGraw-Hill Ryerson©
 Classification of
of
Annuities

13
13 Classification 13 - 4

Due Annuities
Annuities

Ordinary
O Annuity
rdinary A nnuity

Payments
Payments/ Deposits
/ Deposits Payments
Payments/ /Deposits
Deposits

are
aremade
madeatatthethe are
aremade
madeatatthe
the
end
endofofthe
theperiod
period beginning
beginningofof
the period
the period
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 Annuities

13
13 Classification of
Classification of 13 - 5
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Annuities
Annuities

Annuity
Annuity IsIsthe
thepayment
payment Comparethe
Compare the
Category atthe
at theend
endor
or payment
payment
Category atthe
the intervalto
tothe
the
at interval
beginning
beginning compounding
compounding
ofofeach
eachpayment
payment interval
interval
interval?
interval?
Ordinary Simple End Equal
Ordinary General End Not Equal
Simple Annuity Due Beginning Equal
General Annuity Due Beginning Not Equal
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 Annuities
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Formulae
Formulae
LO 1.

Formula
Formula FVdue = PMT [
(1+ i) n
-1
i
] * (1+ i)

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

i
]* (1+ i)
If the payments form a general annuity due,
c
McGraw-Hill Ryerson© use i2 = (1+i) – 1 in the formula for i
 Annuities
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Clues to help identify annuities due

“Payments at the beginning of each…..”

“Payments…in advance”

“First payment … made today”

“Payments ….. starting now”

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 Annuities
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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.

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Step 1 – Set your calculator to the “BGN mode”

How much
How much
Yourcalculator
Your calculator
will Elyse
will Elyse
accumulate in
accumulate in her
her END
BGN BGN
0 isisnow
nowset
setfor
for
RRSP by by age
age 6060 ifif she
she annuity due
annuity due
RRSP
makes
makes semi-
semi-
annual contributions
annual contributions of of
$1,000 starting
starting onon herher Noticethe
Notice the
$1,000
30th birthday?
30th birthday? tiny BGN
tinyBGN
Assume that
Assume that the
the RRSP
RRSP abovethe
above the00
earns 8%
earns 8% compounded
compounded
semi-annually and
semi-annually and that
that
no contribution
no contribution isis made
made
on her
on her 60th
60th birthday.
birthday. Step2…
Step 2…
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 Annuities
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Step 2 – Solve for the FV of the annuity due

How much
How much
will Elyse
will Elyse Elyse’sRRSP
Elyse’s RRSP
accumulate in
accumulate in her
her FV= 247,510.31
BGN
0 valueon
value onher
her
RRSP by
RRSP by age
age 6060 ifif she
she 60ththbirthday
60 birthday
makes
makes semi-
semi-
annual contributions
annual contributions of of 1000 60
$1,000 starting
$1,000 starting onon herher
30th birthday?
30th birthday? 2 8 0
Assume that
Assume that the
the RRSP
RRSP
earns 8%
earns 8% compounded
compounded
semi-annually and
semi-annually and that
that
no contribution
no contribution isis made
made
on her
on her 60th
60th birthday.
birthday.
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 Annuities
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[
(1+ i) -1
]
n
13 Formula
Formula FV = PMT * (1+ i)
Due
i
c = 1 i = 0.08/2 PMT = 1000 n = 60
How much
How much Elyse’sRRSP
RRSP
will Elyse
Elyse Elyse’s
will 247,510.31 valueon onher
her
accumulate in
accumulate in her
her 10.5196
9.5196 value
60ththbirthday
60 birthday
RRSP by
RRSP by age
age 6060 ifif she
she
makes
makes semi-
semi-
annual contributions
contributions of of 1.04 60
annual
$1,000 starting
$1,000 starting onon herher
1 0.04
30th birthday?
30th birthday?
Assume that
Assume that the
the RRSP
RRSP
earns 8%
earns 8% compounded
compounded 1000 1.04
semi-annually and
semi-annually and that
that
no contribution
no contribution isis made
made
on her
on her 60th
60th birthday.
birthday.
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 Annuities
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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
What do we
we have
have to
to find?
find?
quarterly?
Needtotofind
Need findthe
thePV
PVtoday
todayofofthe
thepayment
paymentalternative
alternative
andcompare
and comparewith
withthe
the$300,000
$300,000cash.
cash.

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 Annuities
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Step 1 – Set your calculator to the “BGN mode”

AAlottery
lotteryoffers
offers
thewinner
the winneraachoice
choice Yourcalculator
calculator
betweenaa$300,000
$300,000 Your
between END
BGN BGN
0 isisnow
nowset
setfor
for
cash prize, or
cash prize, or
quarterlypayments
quarterly payments annuity due
annuity due
of$7,000
of $7,000
beginning
beginning
immediately
immediately
andcontinuing
and continuing
for 20
for 20years.
years.

Which
Which
alternativeshould
alternative should
thewinner
the winnerpick
pick
Step2…
Step 2…
ifif
money is worth
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 Annuities
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Step 2 – Solve for the PV of the annuity due

AAlottery
lotteryoffers
offers
CashValue
Cash Value
thewinner
the winneraachoice
choice
betweenaa$300,000
$300,000 PV= 283,775.83
BGN
0 ofthe
of the
between
cashprize,
cash prize,or
or payment
payment
quarterlypayments
quarterly payments option
of$7,000
$7,000 option
of 7000 80
beginning
beginning
immediately
immediately 8 0
4
andcontinuing
and continuing
for 20
for 20years.
years.
The $300,000
The $300,000 cash
cash is
is aa better
better offer
offer
…$16,224 more
…$16,224 more in
in current
current day
day
Which
Which
alternativeshould
should dollars…($300,000 -- $283,775.83)
dollars…($300,000 $283,775.83)
alternative
thewinner
the winnerpick
pick
ifif
money is worth
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 Annuities
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$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?
PVdue = PMT 1-(1+ i)
[-n

i
]* (1+ i)
= 7000 [ ]
(1 -(1 + .08/4)-80) *(1.02)
.02
= $283,775.83

The $300,000
The $300,000 cash
cash isis aa better
better offer…
offer… $16,224
$16,224 more
more in
in
current day
current day dollars…($300,000
dollars…($300,000 -- $283,775.83)
$283,775.83)
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 Annuities
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LO 2. Step 1 – Set your calculator to the “BGN mode”

Step 2 – Solve for the PMT of the annuity due
You have Step 11 Step
Step Step 22
accumulated
$104,000 in your BGN= -3,286.10
PMT BGN
0
RRSP. Your goal is
to build it to $250,000 2
with equal 14 8.5
contributions every 250000
6 months for the
next 7 years. If you
earn 8.5% 104000
compounded semi-
annually, and start Payment
Payment
today, find the size needed is
needed is
of your $3286.10
$3286.10
contributions.
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 = PMT[ ]*(1+ i)
Annuities
Formula FVdue (1+ i)n - 1 13 - 17
13
13 Formula
Due i
Extract necessary data...
c = 1 i = 0.085/2 PMT = ? n = 14
You have FV = 250 000 PV = 104 000
accumulated
$104,000 in your a.a. Find the FV 7 years from now
RRSP. Your goal is of the $104,000 already saved.
to build it to $250,000 FV = 104 000(1+.085/2)14
with equal = $186,250.84
contributions every
6 months for the b. Subtract this value from the
b.
next 7 years. If you $250,000 target to get
earn 8.5% the FV of
compounded semi-
annually, and start $250,000the
- $186,250.84
annuity.
today, find the size
of your == $63,749.16
$63,749.16
contributions.
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 Annuities
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FV = PMT [
(1+ i)n - 1
i ]
* (1+ i)
c = 1 i = 0.085/2 PMT = ? n = 14
FV = $63,749.16 PV = 0

63749.16 = PMT [
(1.0425) 14

0.0425 ]
– 1 * (1.0425)

63749.16 = PMT(19.3997)

PMT==$3286.10
PMT $3286.10

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 Annuities
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How long will
will itit take
take to
to accumulate
accumulate
$1 million
$1 million in
in an
an RRSP
RRSP ifif thethe first
first quarterly
quarterly payment
payment
of $2000
of $2000 isis made
made today?
today? Assume
Assume the the RRSP
RRSP
earns 6%
earns 6% compounded
compounded quarterly.quarterly.
PV = $0 n =? FV = $1 000 000 i = .06/4
Step 11
Step Step 22
Step 143
143
=
BGN
N 142.9
0
BGN Quarterly
Quarterly
payments
payments
4 6 0 35.75 years
35.75 years
2000
1 000 000

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…using the algebraic method to determine

Number of Payments

n
[
ln 1 +
FVdue * i
PMT  ]
ln 1  i
Formulae
Formulae
n
[
ln 1
PVdue * i
PMT  ]
ln 1 i

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 Annuities
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13 How long
How long will
will itit take
take to
to accumulate
accumulate
Due
$1 million
$1 million inin an
an RRSP
RRSP ifif thethe first
first quarterly
quarterly payment
payment
of $2000
of $2000 isis made
made today?
today? AssumeAssume the the RRSP
RRSP
earns 6%
earns 6% compounded
compounded quarterly.quarterly.
PV = $0 n =? FV = $1000000 i = .06/4

Formula
Formula n=
[
ln 1 +
FVdue * i
PMT  ]
ln 1  i

n=
[
ln 1+ 1,000,000 * .015
2000(1.015)
]
ln (1.015) = 2.1269
0.0149
== 142.9
142.9 i.e.
i.e. 143
143 quarterly
quarterly payments
payments or 35.75
or 35.75 years
years

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 Annuities
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This completes
This completes Chapter
Chapter 13
13

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