11

nnuities
OArdinary

Chapter 11
McGraw-Hill
McGraw-HillRyerson
Ryerson

11-1

Learning Objectives

11

After completing this chapter, you will be able to:

LO-1

Calculate the
payment size in ordinary and
deferred annuities

LO-2

number of payments in ordinary

and deferred annuities

LO-3

interest rate in ordinary annuities

McGraw-Hill Ryerson

11-2

11-3

11

Using your financial calculator

solve for payment number or
size or interest rate using the
same steps as before
we need to reorganize the formulae to solve
algebraically
McGraw-Hill Ryerson

11-4

11

Finding the Payment Size.

PMT
McGraw-Hill Ryerson

Finding Payment Size

11

11-5

of an
Ordinary Simple Annuity
Your life partner somehow convinced you that you cant
afford the car of your dreams, priced at $28800. You are
advised to Save up for 4 years and then buy the car for
cash. How much would you
have to save each month, if
PMT
you could invest with a return of
10% compounded monthly?
You need to decide if this situation involves
a PV or a FV and then use the appropriate formula...

As you have to save up the $28,800, i.e. in the future,

FV = $28,800
Assume you have no savings PV = 0
McGraw-Hill Ryerson

11

Finding Payment Size

11-6

of an
Ordinary Simple Annuity

Your life partner

somehow convinced you
that you cant afford the
car of your dreams,
priced at $28800. (At least
not right now). You are
advised to
Save up for 4 years and
then buy the car for cash.
How much would you
have to save each month, if
you could invest with a
return of 10%
compounded monthly?
McGraw-Hill Ryerson

PMT =

- 490.44

12

10
28800

0
48

Formula solution

11-7

11

Which Formula?
Algebraic Method of Solving for PMT

PV = PMT

1-(1+ i)-n
i

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

1. (a) If the payments form a Simple Annuity go directly to 2.

(b) If the payments form a General Annuity, find c and i2
2.

If the annuitys
PV is known,
substitute values
of PV, n, and i
into PV formula.

If the annuitys
FV is known,
substitute values
of FV, n, and i
into FV formula.

3.
McGraw-Hill Ryerson

&

4.

11-8

11

Which Formula?
Algebraic Method of Solving for PMT

PV = PMT

1-(1+ i)-n
i

3.

Calculate the quantity within the square brackets.

4.

Rearrange the equation to solve for PMT.

Applying Method

McGraw-Hill Ryerson

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

11

Finding Payment Size

11-9

of an
Ordinary Simple Annuity

Which Formula?

Your life partner

2. As the annuitys FV is known,
somehow convinced you
that you cant afford the
therefore, the FV formula is used
car of your dreams,
priced at $28800. (At least
n -1
(1+
i)
not right now). You are
FV = PMT
advised to
i
Save up for 4 years and
Extract necessary data...
then buy the car for
cash.
How much would you FV = 28800 PV = 0 n = 4*12 = 48
have to save each month,
i
= .10/12 c = 1 PMT = ?
if you could invest with a
return of 10%
compounded monthly?

McGraw-Hill Ryerson

11

Your life partner

somehow convinced you
that you cant afford the
car of your dreams,
priced at $28800. (At least
not right now). You are .10
advised to
Save up for 4 years and
then buy the car for
cash.
How much would you
have to save each month,
if you could invest with a
return of 10%
compounded monthly?
McGraw-Hill Ryerson

Formula FV = PMT (1+ i)n - 1

i
FV = 28800 PV = 0 n = 4*12 = 48
i = .10/12 c = 1 PMT = ?

11-10

58.7225
0.4894
1.4894
490.44
1.0083
0.0083
12

48

1
28800
another example

11-11

11

The
McGraw-Hill Ryerson

11-12

11

Your parents are discussing the terms of the

$100 000 mortgage that they have offered to
hold in the purchase of your first home.
They are considering an
interest rate of 5% compounded monthly.
If you were to take 20 years
to repay the mortgage,
find the size of the monthly payment.

PV = $100000

PMT =

12
5
0
McGraw-Hill Ryerson

FV = 0

240

n =12*20 = 240
-659.96
100 000

Formula solution

11

Your parents are

discussing the terms of
the 100 000 mortgage
that they have offered to
hold in the purchase of
your first home. They
are considering an
interest rate of 5%
compounded monthly.
If you were to take 20
years to repay the
mortgage, find the size
of the monthly payment.
McGraw-Hill Ryerson

11-13

Extract necessary data...

PV = $100000

i = .05/12
n =12*20 = 240
FV = 0
C =1

11-14

11

Choose appropriate formula and Solve

2. As the annuitys PV is known, the PV formula is used

Formula PV = PMT 1-(1+ i)-n

n =12*20 =240

PV = $100000 i = .05/12
-0.6314
0.3686
1.0042
0.0042
659.96
0.0015
151.53

12

.05

240

Size of monthly
mortgage
payment

1
100 000

McGraw-Hill Ryerson

11-15

11

How much interest will you pay your

parents over the 20 year period?

Amount
$

Monthly Payment x Number of Payments

659.96
240
158,390.40
Amount Borrowed

Total Interest Paid

McGraw-Hill Ryerson

100,000.00

58,390.40

11-16

11

As this amount
of interest
shocks you,
you discuss the
possibility of
making payments
of $700/month,
to save some time
and interest costs.
Determine the time
it will take you to
repay your
mortgage
at this new rate.

PMT
N
= = 217.52
-700
700

218 payments = 18 yrs 2months

Formula solution
McGraw-Hill Ryerson

11

Formula

i = .05/12

PV * i
PMT

ln 1
n

ln (1+ i)

PV = $100,000 PMT = $700 C = 1

-0.4048
-0.9045
0.5952
0.0042
1.0042
-217.52
217.52
12

.05

1
100 000

700

218 payments = 18 yrs 2months

McGraw-Hill Ryerson

11-17

11

Formula

ln 1
n

PV * i
PMT

11-18

ln (1+ i)

Developing the Formula

1. Base formula
2. To isolate n, divide both
sides by PMT

[
[

PV = PMT
PV = PMT
PMT PMT

PV
=
PMT

1- (1+ i)-n

]
]

1- (1+ i)-n

1- (1+ i)-n

Continue
McGraw-Hill Ryerson

11

from 2.

PV
=
PMT

1- (1+ i)-n

11-19

3. Continue to isolate n.

(a) Multiply both sides by i

(b) Reorganize equation

PV*i = 1- (1+ i) -n *i
i
PMT
PV *i 1- (1+ i) -n
=
PMT
PV*i
-n
1
+
=
i)
(1
PMT

[
[[

]
i i]

(c) Now Take the natural logarithm -n* ln (1+ i) = ln 1 - PV*i

PMT
(ln or lnx) of both sides
(d) Solving for n
divide both sides by ln(1+i)
McGraw-Hill Ryerson

PV
PV
**
1
ln
1
-n* ln(1+ i) = ln
PMT
PMT
n
ln (ln(1+i)
1 + i)
ln(1+i)

11-20

11

Approximately how much money do you save

in interest charges by paying $700/month,
rather than $659.91/month?
Amount
$

Monthly Payment x Number of Payments

659.96
240
158,390.40
700.00

217.52

Total Interest Saved

McGraw-Hill Ryerson

152,264.00

6,126.40

11-21

11

If you could
see your way to a
further increase
of $25/month,
(a) how much
faster would you
pay off the
mortgage, and
(b) approximately
how much less
interest would be
involved?

PMT
N
= =

205.62
-725

725

Paying $725
206 payments = 17 yrs 2months

Formula solution
McGraw-Hill Ryerson

11

Formula

i = .05/12

PV * i
PMT

ln 1
n

ln (1+ i)

PV = $100,000 PMT = $725 C = 1

-205.52
-0.8550
-0.4253
0.0042
1.0042
205.52
0.5747
12

.05

1
100 000

725

206 payments = 17 yrs 2months

McGraw-Hill Ryerson

11-22

11

11-23

Amount
$

Monthly Payment x Number of Payments

700.00
217.52 or 218
152,264.00
725.00
205.62 or 206
149,074.50
12
(a) Payments Saved
(b)Total Interest Saved
3,189.50

McGraw-Hill Ryerson

11

McGraw-Hill Ryerson

11-24

Finding Payment Size

11

11-25

in a

Deferred Annuity
York Furniture has a promotion on a bedroom set
selling for $2250. Buyers will pay
no money down and no payments for 12 months.
The first of 24 equal monthly payments is due
DEFERRAL
12 months from the purchase date.
What should the
monthly payments be if York Furniture
PMT
earns 10% compounded monthly on its account receivable
during both the deferral period
and
the repayment period?

Since you want the furniture now, this involves a PV

PV = $2250 Once you repay the loan, FV = 0
Payments are deferred for 11 months.
McGraw-Hill Ryerson

York Furniture has a promotion on a

bedroom set selling for $2250. Buyers will pay
no money down and no payments for 12 months.
The first of 24 equal monthly payments is
due 12 months from the purchase date.
What should the monthly payments be if York
Furniture earns 10% compounded monthly
on its account receivable during both the deferral
period and the repayment period?

11

In effect, York furniture has

given a loan to a buyer of $2,250

on the day of the sale!

When the payments begin, the buyer owes $2,250

plus accrued interest!

McGraw-Hill Ryerson

11-26

11-27

11

11

$2250

12

PMT PMT
n = 24
PVAnnuity

d = 11
i = 0.10/12

$2250

McGraw-Hill Ryerson

13

FV

35 36 Months
PMT Payments
PV of the payments at
the end of month 11

=
FV of the $2,250 loan
at the
end of month 11

11

Finding Payment Size

11-28

in a

Deferred Annuity
York Furniture
has a promotion
on a bedroom set selling
for $2250. Buyers will pay
no money down and no
payments for 12 months.
The first of 24 equal
monthly payments is due
12 months from the
purchase date. What
should the monthly
payments be if York
Furniture earns 10%
compounded monthly on
its account receivable
during both the deferral
period and
the repayment period?
McGraw-Hill Ryerson

Find the amount owed

after 11 months:
FV =
12

2,465.06

10

11

2250

$2,465.06 is the PV of the annuity

11

Finding Payment Size

11-29

in a

Deferred Annuity
York Furniture
has a promotion
on a bedroom set selling
for $2250. Buyers will pay
no money down and no
payments for 12 months.
The first of 24 equal
monthly payments is due
12 months from the
purchase date. What
should the monthly
payments be if York
Furniture earns 10%
compounded monthly on
its account receivable
during both the deferral
period and
the repayment period?
McGraw-Hill Ryerson

Now find the PMT of the annuity

PMT
113.75
FV = =
PV
- 2,465.06
2,465.06
2465.06
24

24 monthly payments of $113.75

will repay the loan.
Formula solution

11

Finding Payment Size

11-30

in a

Deferred Annuity
York Furniture
has a promotion
on a bedroom set selling
for $2250. Buyers will pay
no money down and no
payments for 12 months.
The first of 24 equal
monthly payments is due
12 months from the
purchase date. What
should the monthly
payments be if York
Furniture earns 10%
compounded monthly on
its account receivable
during both the deferral
period and
the repayment period?
McGraw-Hill Ryerson

Find the amount owed

after 11 months:
Formula FV = PV(1 + i)n
FV = 2250(1 + 0.10/12)11
= $2,465.06

PV = PMT

1- (1+ i)-n

2465.06 = PMT [1-(1+.10/12)-24]

.10/12
PMT = $113.75
24 monthly payments of $113.75
will repay the loan.

11-31

11

i.e....Number Of Payments

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11

Finding Number Of Payments

in a

Deferred Annuity
$20,000 is invested in a fund
earning 8% compounded quarterly.
The first quarterly withdrawal
of $1,000 will be taken from the fund
DEFERRAL
five years
from now.
How manyNwithdrawals will it take to
deplete the fund?
The FV of $20,000 after the deferral, becomes the
PV of the annuity ...

Payments are deferred for 19 quarters

McGraw-Hill Ryerson

11-32

11-33

11

PMT = $1000

i = 0. 08/4 = .02
Years

4.75

$20,000
PV1 d = 19
The $20000
earns
interest for 4
years 9
months

McGraw-Hill Ryerson

Payments of $1000/quarter
FV1

n=?
This FV1 then becomes the PV of the
annuity of $1000/quarter

11

Finding Number Of Payments

11-34

in a

Deferred Annuity
$20,000 is
invested
in a fund
earning 8%
compounded
quarterly.
The first quarterly
withdrawal
of $1000 will be
taken from the
fund five years
from now.
How many
withdrawals
will it take to
deplete the fund?
McGraw-Hill Ryerson

Find the FV of
$20,000 in 4.75 years
FV = 29,136.22

19

20000

$29,136.22 is the PV of the annuity

11

Finding Number Of Payments

11-35

in a

Deferred Annuity
$20,000 is
invested
Now find the PMT of the annuity
in a fund
earning 8%
compounded
quarterly.
FV== - 29,136.22
PV
N
29136.22
44.1
The first quarterly
withdrawal
of $1000 will be
1000
29136.22
taken from the
fund five years
0
from now.
How many
44.1 quarterly payments will deplete the
withdrawals
fund(44 full payments and 1 partial)
will it take to
deplete the fund?
Formula solution
McGraw-Hill Ryerson

11

11-36

Finding Number Of Payments

in a

Deferred Annuity
$20,000 is
Find the FV of
invested
$20,000 in 4.75 years
in a fund
earning 8%
Formula FV = PV(1 + i)n
compounded
quarterly.
FV = 20000(1 + 0.08/4)19
The first quarterly
= $29,136.22
withdrawal
of $1000 will be
taken from the
PV *i
ln
1
fund five years
PMT
n
from now.
ln (1+ i)
How many
withdrawals
29136.22 *.02
ln
will it take to
1= 44.1 payments
1000
deplete the fund?
or 11 years
ln(1.02)

McGraw-Hill Ryerson

11-37

11

When
number of compoundings per year

number of payments per year

McGraw-Hill Ryerson

11-38

11

Since you get paid

every second
Thursday you
decide to pay $350
every two weeks
to make your
budgeting easier.
Find the new term
of your mortgage if
the interest charges
remain at 5%
compounded
monthly.
McGraw-Hill Ryerson

C/Y=
N = = = 414.74
12
P/Y
PMT
-350
26
350
26

12

415 bi-weekly
payments or
15 yrs 11.4 months
Formula solution

11-39

11

Step 1 Determine c
Since you get paid
every second
Thursday you
decide to pay $350
every two weeks
to make your
budgeting easier.
Find the new term
of your mortgage if
the interest charges
remain at 5%
compounded
monthly.
McGraw-Hill Ryerson

number of compoundings per year

C = number of payments per year

C= 12 / 26 = .4615
Step 2

Use c to determine i2

i2 = (1+i)c - 1
i2 = (1+ .05/12) .4615-1
i2 = 0.0019
Step 3

11-40

11

Step 3

Use this rate i2 = 0.0019 as the value for

i in the appropriate annuity formula

Formula

PV * i
PMT

ln 1
n

ln (1+ i)

-0.7828
-0.4571
-414.74
0.5428
1.0019
0.0019
1

100 000

350

415 payments or 15 yrs 11.4 months

McGraw-Hill Ryerson

$100,000 Twenty-year
Mortgage
Interest 5% per annum

11

Scenario

Terms

11-41

Payment
Amount

# of
Payments

Total Cost

1.

Per
month

$659.96

240

$158,390.40

2.

Per
month

$700.00

218

$152,264.00

3.

Per
month

$725.00

206

$149,074.50

4.

Every
two
weeks

$350.00

415

$145,250.00

McGraw-Hill Ryerson

Best Scenario

11-42

11

N =
You are now
considering delaying
the purchase
of your first house to
allow for a larger
down payment. If
you save $350 per pay,
how long would it take
to have an additional
$15000, if you can
earn 8% compounded
monthly on your
savings?

26

8
0

40.32

350
15000

12
= FV

New Formula required

McGraw-Hill Ryerson

11-43

11

Step 1 Determine c

You are now

considering delaying
the purchase
of your first house to
allow for a larger
down payment. If
you save $350 per
pay, how long would
it take to have
an additional $15000,
if you can earn 8%
compounded monthly
on your savings?
McGraw-Hill Ryerson

number of compoundings per year

C = number of payments per year

C= 12 / 26 = .4615
Step 2

Use c to determine i2

i2 = (1+i)c - 1
i2 = (1+ .08/12) .4615-1
i2 = 0.0031
Step 3

FV * i
ln 1 +
PMT

11

Formula
You are now
considering delaying
the purchase
of your first house to
allow for a larger
down payment. If
you save $350 per
pay, how long would
it take to have
an additional $15000,
if you can earn 8%
compounded monthly
on your savings?
McGraw-Hill Ryerson

11-44

ln (1+ i)

0.1316
1.0031
1.1316
0.0031
0.1237
40.3
1
15000
350

40.3 bi-weekly payments

= approx 1yr 7months

11

Formula

FV * i
ln 1 +
PMT

11-45

ln (1+ i)

Developing the Formula

1. Base formula
2. To isolate n, divide both
sides by PMT

[
[

FV = PMT
FV = PMT
PMT PMT

FV
=
PMT

(1+ i) n - 1

]
]

i
(1+ i) n - 1

(1+ i) n - 1

continued
McGraw-Hill Ryerson

11

from 2.

3. Continue to isolate n
(a) Multiply both sides by i

FV
=
PMT
FV*i
=
PMT
FV*i
=
PMT

(b) Reorganize equation

(c) Now Take the natural logarithm

(ln or lnx) of both sides
(d) Solving for n
divide both sides by ln(1+i)
McGraw-Hill Ryerson

(1+ i) n - 1

[
[

(1+ i) n - 1

11-46

] *i
]

(1+ i) n - 1

(1+ i) n = 1 + FV*i
PMT

[
[[

]
]

FV * i
1
+
n ln (1+ i) = ln
PMT
FV * i
1
+
*i
= ln1 + FV
n ln (1+ i)ln
PMT
PMT
n
ln(1+i)
ln(1+i)
ln (1 + i)

11-47

11

Already
entered

You already have

$10000 saved
for your down
payment. If you
save $350 per pay,
how long would it take
to have an additional
$15000? Assume
you can earn 8%
compounded monthly
on all of your savings.
McGraw-Hill Ryerson

N=

8
26

37.25
350
25000

10000
12

37.5 bi-weekly payments

= approx 1 yr 5months

11-48

11

Already
entered

You already have

$10000 saved
for your down
payment. If you
save $350 per pay,
for the next 2 years,
find the size of your
available down
payment. Assume
you can earn 8%
compounded monthly
on all of your savings.
McGraw-Hill Ryerson

FV =

31430.12

8
26

350
52
12

10000

Formula solution

11

You already have

$10000 saved
for your down
payment. If you
save $350 per pay,
for the next 2 years,
find the size of your
available down
payment. Assume
you can earn 8%
compounded monthly
on all of your savings.
McGraw-Hill Ryerson

Formula Solution

11-49

This is more complicated

to solve when using
algebraic equations!
3 Steps
1.

Find the FV of the $10 000 in 2 years

2.

Find the FV of the $350 per pay

3.

Add totals together

The $10 000 continues to earn

interest during the new savings period!

11

Formula Solution
1.

Formula FV = PV(1 + i)n

= 10000(1 + 0.08/12) 24
= $11,728.88
(1+ i) n - 1
FV = PMT

11-50

3.

$
You already have
11,728.88
$10000 saved
for your down
2.
payment. If you
i
c
i2 = (1+i) - 1
save $350 per pay,
= (1+ .08/12).4615-1
for the next 2 years,
find the size of your
= 0.0031
available down
= 350 [(1+.0031)52 1]
payment. Assume
you can earn 8%
.0031
= $19701.24
19,701.24
compounded monthly
Total 31,430.12
on all of your savings.

McGraw-Hill Ryerson

11

McGraw-Hill Ryerson

11-51

11

11-52

A life insurance company advertises that

$50,000 will purchase a 20-year annuity
paying $341.13 at the end of each month.
What nominal rate of return does the annuity
investment earn?

C/Y
I/Y =

5.541

12
240
1

50000

341.13
0

The annuity earns 5.54% pa

McGraw-Hill Ryerson

11-53

11

to solve for i without

a financial calculator

McGraw-Hill Ryerson

11-54

11

This completes Chapter 11

McGraw-Hill Ryerson