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    Time Value of Money Annuities

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    Ratul Hasan
    Annuities provide a stream of equal cash flows that occur at regular intervals. They can be ordinary annuities where payments occur at the end of each period or annuities due where payments occur at the beginning of each period. Annuity due payments will always be greater than ordinary annuity payments due to the additional period of compound interest. This document discusses how to calculate the future and present value of ordinary and due annuities using the future and present value of annuity factors from financial tables. It also covers applications such as determining deposit amounts needed to reach a future sum, loan amortization schedules, finding interest rates, and calculating the number of periods for an annuity.

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    Time Value of Money Annuities

    Uploaded by

    Ratul Hasan
    106 views26 pages
    Annuities provide a stream of equal cash flows that occur at regular intervals. They can be ordinary annuities where payments occur at the end of each period or annuities due where payments occur at the beginning of each period. Annuity due payments will always be greater than ordinary annuity payments due to the additional period of compound interest. This document discusses how to calculate the future and present value of ordinary and due annuities using the future and present value of annuity factors from financial tables. It also covers applications such as determining deposit amounts needed to reach a future sum, loan amortization schedules, finding interest rates, and calculating the number of periods for an annuity.

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    Annuities provide a stream of equal cash flows that occur at regular intervals. They can be ordinary annuities where payments occur at the end of each period or annuities due where payments occur at the beginning of each period. Annuity due payments will always be greater than ordinary annuity payments due to the additional period of compound interest. This document discusses how to calculate the future and present value of ordinary and due annuities using the future and present value of annuity factors from financial tables. It also covers applications such as determining deposit amounts needed to reach a future sum, loan amortization schedules, finding interest rates, and calculating the number of periods for an annuity.

    Copyright:

    © All Rights Reserved
    Download as PDF, TXT or read online from Scribd
    Download as pdf or txt
    106 views26 pages

    Time Value of Money Annuities

    Uploaded by

    Ratul Hasan
    Annuities provide a stream of equal cash flows that occur at regular intervals. They can be ordinary annuities where payments occur at the end of each period or annuities due where payments occur at the beginning of each period. Annuity due payments will always be greater than ordinary annuity payments due to the additional period of compound interest. This document discusses how to calculate the future and present value of ordinary and due annuities using the future and present value of annuity factors from financial tables. It also covers applications such as determining deposit amounts needed to reach a future sum, loan amortization schedules, finding interest rates, and calculating the number of periods for an annuity.

    Copyright:

    © All Rights Reserved
    Download as PDF, TXT or read online from Scribd
    Download as pdf or txt
    of 26

    Annuities

    ⦿ Annuities are equally-spaced cash flows of


    equal size.
    ⦿ Annuities can be either inflows or outflows.
    ⦿ An ordinary (deferred) annuity has cash flows
    that occur at the end of each period.
    ⦿ An annuity due has cash flows that occur at the
    beginning of each period.
    ⦿ An annuity due will always be greater than an
    otherwise equivalent ordinary annuity because
    interest will compound for an additional period.
    Compounding frequency
    given no. of year(2) interest (10%)
    □ Annual (m=1) 2*1=2 .10/1=
    □ Semi annual (m=2) 2*2=4 .10/2=
    □ Quarterly (m=4) 2*4=8 .10/4=
    □ Monthly (m=12) 2*12=24 .10/12=
    □ Weekly (m=52) 2*52=104 .10/52=
    □ Daily (m=365) 2*365=730 .10/365=

    FV=PV (1+i/m)mn
    Finding the Future Value of an Ordinary
    Annuity

    ⦿ Fran Abrams wishes to determine how much


    money she will have at the end of 5 years if he
    chooses annuity A, the ordinary annuity and it
    earns 7% annually. Annuity a is depicted
    graphically below:
    Future Value of an Ordinary Annuity: Using
    the FVIFA Tables
    FVA = $1,000 (FVIFA,7%,5)
    = $1,000 (5.751)
    = $5,751

    FINANCIAL TABLE
    Annuity (Ordinary & Due)
    Future Value of an Annuity Due: Using the
    FVIFA Tables
    Simply multiply the Table factor with (1+i)
    Here Table factor is 5.751
    FVA = $1,000 (FVIFA,7%,5) (1+ i)
    = $1,000 (5.751) (1+.07)
    = $6154
    Present Value of an Ordinary Annuity
    ⦿ Braden Company, a small producer of plastic toys,
    wants to determine the most it should pay to purchase a
    particular annuity. The annuity consists of cash flows of
    $700 at the end of each year for 5 years. The required
    return is 8%.
    Present Value of an Ordinary Annuity: Using
    PVIFA Tables
    PVA = $700 (PVIFA,8%,5)
    = $700 (3.993)
    = $2,795.10
    FINANCIAL TABLE
    Present Value of an Annuity Due : Using
    PVIFA Tables
    Simply multiply the Table factor with (1+i)
    Here Table factor is 3.993
    PVA = $700 (PVIFA,8%,5) (1 + i)
    = $700 (3.993) (1+ .08)
    = $3018.40
    Future Value of a Mixed Stream

    Frey Company, a shoe manufacturer is going to


    get this amount of money for the next five years.
    What would be its equivalent future value after the
    last years cash flow, based on an 8% interest rate?
    Future Value of a Mixed Stream
    Future Value of a Mixed Stream
    ⦿ This situation is depicted on the following time
    line.
    Present Value of a Mixed Stream

    Frey Company, a shoe manufacturer, has been offered an


    opportunity to receive the following mixed stream of cash flows
    over the next 5 years. What is the most amount that he should
    pay now to accept this offer, If the firm must earn at least 9%
    on its investments?
    Present Value of a Mixed Stream
    Present Value of a Mixed Stream
    ⦿ This situation is depicted on the following time
    line.
    Special Application of Time Value

    1. Determining Deposits Needed to


    Accumulate a Future Sum

    2. Loan Amortization

    3. Finding Interest or Growth Rate

    4. Finding an Unknown Number of Periods


    Determining Deposits Needed to Accumulate a
    Future Sum

    You want to buy a house after 5 years from now on. The
    initial down payment for that house after 5 years is 30000.
    what may be the Equal annual payment at the end of the
    every 5 year. Annual interest of 6%

    Finding Cue:
    a) FV is there, b) Equal Annual end of the year ( Ordinary
    Annuity), c) Interest 6%.

    So, we have to find out PMT…


    Determining Deposits Needed to Accumulate a
    Future Sum
    FINANCIAL TABLE

    The equation:
    FVA = PMT x (FVIFA) in

    Since we should know for the payment, we can


    break up the equation like this:

    Now, find the values from the table and substitute


    those values in the equation.
    Determining Deposits Needed to Accumulate a
    Future Sum
    FINANCIAL TABLE

    The equation:
    FVA = PMT x (FVIFA) in

    PMT = FVA / FVIFA

    = 30000 / 5.637
    = 5321.98
    Loan Amortization

    The loan amortization process involves finding the


    future payments, over the term of the loan, whose
    present value at the loan interest rate equals the
    amount of initial principal borrowed.

    Problem:
    Your are receiving 6000 as a loan from X Bank.
    Interest is 10%, expecting to repay the loan at the
    end of the year within the upcoming 4 years.
    Loan Amortization

    Clearly, this is a problem of Present Value annuity.

    Finding Cue: we have to find out the future annual


    equal payments (annuity).

    The equation is :
    PVA = PMT x PVIFA

    We need to find out the payment or PMT


    Loan Amortization
    FINANCIAL TABLE

    The equation is :
    PMT = PVA / PVIFA

    = 6000 / 3.170

    = 1892.74
    Loan Amortization Schedule (Table)

    Beginning of Loan Interest Princip End of


    End of Year Payment [0.1 * (1) ] al [2-3] Year
    Year Principal (1) (2) (3) (4) Principal

    1 6000 1892.74 600 1292.744707.26

    2 4707.26 1892.74 470.23 1422.013285.25

    3 3285.25 1892.74 328.53 1564.211721.04

    4 1721.04 1892.74 172.1 1720.64


    Finding The interest rate

    S can borrow 2000 to be repaid in equal annual end


    of the year amounts of 514.14 for the next five years.
    He wants to find out the interest rate.

    Equation is :
    PVA = PMT x PVIFA

    PVIFA = PVA / PMT

    Then, look at the table….


    Finding The interest rate
    FINANCIAL TABLE

    PVIFA = PVA / PMT


    = 2000 / 514.14
    = 3.890

    Then, look at the table year is 5 (given) …. So


    interest would be 9%
    Finding an unknown number of periods

    S can borrow 25000, at an 11% annual rate, equal


    annual end of year payment 4800 required. He
    knows all the factors other than the time period. He
    wants to know the time period required to pay the
    25000 loan.
    FINANCIAL TABLE

    Equation is :
    PVA = PMT x PVIFA

    PVIFA = PVA / PMT


    Then, look at the table….

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