ANNUITY

Definition
A sequence of payments made at equal intervals of time
A sum of money or an investment that is paid at regular intervals
A stream of fixed cash flows, i.e. payments or receipts, that occurs
periodically, over time.
An account earning compound interest from which periodic
withdrawals are made
A contract between you and an insurance company in which you
make a lump sum payment or series of payments and, in return,
obtain regular disbursements beginning either immediately or at
some point in the future
Examples of annuity
Saving money for
a vacation, or
fees for your child’s school education

Payment of
housing loan,
life insurance premium,
Monthly rent, etc.
Monthly salary
CALCULATING THE AMOUNT OF ANNUITY
There are two types of annuity formula

i. Ordinary Annuity
ii. Annuity Due
Differences between ordinary annuity and annuity due
based on timing
BASIS FOR COMPARISON ORDINARY ANNUITY
Meaning Ordinary annuity is one in
which the inflow or outflow of
cash fall due for payment at
the end of each period.
Payment Belongs to the period
preceding its date.
Appropriate for Payments
Example Housing loan, payment of
mortgage, coupon bearing
bonds, Monthly salary etc.
ANNUITY DUE
Annuity due is described as
the series of cash flows
occurring at the beginning of
each period.
Belongs to the period
following its date.
Receipts
Rental lease payments, life
insurance premium, etc.
 ORDINARY ANNUITY

 Defined as a series of regular payments or receipts; that occurs at

regular intervals over a specified number of periods (also known as
annuity regular or deferred annuity).
Ordinary annuity payments are made at the end of each period and
the frequency of the payments is the same as the frequency of the
compound interest

Note
Ordinary annuity payment is made on a monthly, quarterly, semi-
annual or annual basis
FUTURE VALUE OF ORDINARY ANNUITY

Where,
PMT = Period cash payment (the amount of money that has been
deposited )
r = interest per period (Written in decimal)
n = total number of Compounded periods (number of times the account
will compound in one year)
t = time taken(years) the account is active
 = Future value of the Ordinary annuity (the money in the account at
the end of a time or period or in the future)

Compounding periods n
Annually 1
Semi-Annually 2
Quarterly 4
 Monthly 12
Daily 365
Weekly 52
Bi-Weekly 26
Example1
Find the future value of an ordinary annuity with a term of 25 years,
payment period is monthly with payment size of Tsh50,000. Annual
interest is 6%.
Solution
Given t = 25 years, n(monthly) = 12, rate, r = 6% = 0.06, PMT =
Tsh 50,000

Using the formula

We have

Interpretation

We put only Tsh50,000 each month for One year will have
Tsh600,000 and after 25 years we will have deposited
Tsh600,000x25 years = Tsh15,000,000 thus the interest will be
Tsh19,649,698.12
Example 2
You have travel enthusiasm and curious to visit Asia but cannot afford
the lump sum amount of Tsh 800,000. Currently, from your salary, you
can save only Tsh150,000 per month and you are searching for a source
which would provide you the sum after 5 years to enjoy a trip to Asia. For
this, you consider buying an annuity contract with 7% interest rate
annually.
Solution
Given:
t = 5 years,
n = annually = 1,
r = 7% = 0.07,
PMT = Tsh150,000
From

We have

=
=
Example 3
Suppose Tsh150,000 is deposited at the end of each year for the
next 6 years in an account paying 8% interest compounded
annually. Find the ordinary future value of annuity
Solution
Given
t = 6 years
n = annually = 1,
r = 8% = 0.08,
PMT = Tsh150,000
From

We have,
=

Therefore the future value is Tsh 1,100,389.35

PRESENT VALUE OF ORDINARY ANNUITY
Present value for ordinary annuity is given by

Where,
PMT is cash payment during specific period of time
r is interest rate during a period
n is a total number of periods
Example 1
You have inherited Tsh2,000,000 from your father and you wish to
purchase a contract that will provide you a steady income for next 10 year.
Currently, banks are paying 12% compound interest on the annual basis.
How much would you be able to receive on yearly basis?

Solution
Givens:
Time, t = 10 years
 n = annually = 1,
rate, r = 12% = 0.12,
PMT = ?,
2,000,000
From

Thus,
=

Then, you would receive

Example 2
Ms. Smith buys a car Costing Tsh20,300,000. She agrees to make
payment at the end of each monthly period for 6 years. she pays
9.65% interests compounded monthly. What is the amount of each
payment, Find the total Interest?
Solution
Givens:
Time, t = 6 years
n =Monthly = 12,
rate, r = 9.65% = 0.0965,
PMT = ?,
Tsh20,300,000
From
,
We have

8
Then, you would receive

Total interest =
=
=

 Thus Ms. Smith will pay a total Interest of = Tsh6519,856

Test your understanding
Problem 1. (Three different ways of asking the same question)
Find the present value of ordinary annuity which has payments of Tsh200,000 per
month for 5 years at 4.1% Compounded monthly
(Answer

Problem 2
Find the PV of an ordinary annuity which has deposited of Tsh10,279 semiannually
for 5 years at 7.6% Compounded semiannually
(Answer
 ANNUITY DUE
 Is an annuity where the payment is made at the beginning of each period
 receives one more period of compounding than the ordinary annuity
(a)Future value of annuity Due is given by

(b)The present value of Annuity Due is given by

Example 1
Suppose you want to save money for your child’s college expenses let’s
suppose you deposit Tshs 100,000 at the beginning of each year for 18
years at an interest rate of 5%. How much is available for your child when
he/she start the school

Solution
Given: PMT= Tshs100,000, r = 5% = 0.05, t=18 years, n = annually =1
asked to find future value of annuity due
From
Therefore, you will have Tshs 29,539,900.40 at age of 18years of your child
Example 2
Suppose for an annuity due, you want to have Tshs 30,000,000 in the bank after 20
years. Assuming you make deposit at the beginning of each year at an interest rate of
4%. How much would you have to deposit at the start of year assuming each deposit
is the same amount

Solution
PMT =? r = 4% = 0.04, t=20 years, n = annually =1,
 Divide by both sides

Therefore, you would have to deposit

 PERIODIC PAYMENTS
The periodic payment (annuity) may be associated may be associated either with the
• amount of annuity or
• present value of annuity

Formula

Periodic payment for future value of annuity

Periodic payment for present value of annuity

when we have a present value
Example 1
Find the periodic payment whose amount of annuity is shs 2,500,000, if
money is worth 16% compounded annually for 5 years
Solution
 From

Example 2
Find the periodic payment whose present value is Tshs 500,0000, if money is
worth 15% compounded quarterly for 6 years
Solution
Example 3
On October 2005 , a wise father , deposited Tshs 1,200,000 in his son’s account
who is studying a two year diploma at CBE Dar-es-salaam so as to allow his son
to withdraw a certain amount of money as his pocket at the end of each month
for two years. If the account pays interest at 25% compounded monthly , what
is the size of each monthly withdraw his son can take ?
Solution
Here,