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SECTION 3.5 Determining the Term of an Annuity

In some problems the accumulated value S or the discounted value A, the periodic payment R, and the rate i are
specified. This leaves the number of payments n to be determined. Formulas (10) and (11) may be solved for n
by the use of logarithms. Normally, when given a value of S or A, R, and a rate i, you will not find an integer
time period n for the annuity. Algebraically this means that there is usually no integer n such that or
. It is necessary to make the concluding payment different from R in order to have equivalence. One of
the following procedures is followed in practice.

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Procedure 1: The last regular payment is increased by a sum that will make the payments equivalent to the
accumulated value S or the discounted value A. This increase is sometimes referred to as a balloon payment.

Procedure 2: A smaller concluding payment is made one period after the last full payment. This smaller
concluding payment is sometimes referred to as a drop payment. Sometimes, when a certain sum of money is to
be accumulated, a smaller concluding payment will not be required because the interest after the last full
payment will equal or exceed the balance needed (see Example 1).

CALCULATION TIP:

Unless specified otherwise, we shall use Procedure 2 throughout this book. Procedure 2 is more often used in
practice.

EXAMPLE 1A couple wants to accumulate $10  000 by making payments of $800 at the end of each half-year
into an investment account that earns interest at j2 = 4.5%. Calculate the number of full payments required and
the size of the concluding payment using both Procedures 1 and 2.

SolutionWe have S = 10  000, R = 800, i = 2.25%, and we want to calculate n. Substituting in equation (10) we
obtain:

Thus there will be 11 full deposits of $800, plus a final payment, needed to reach the $10  000 goal.

Procedure 1 Let X be the balloon payment that will be added to the last regular payment to make the payments
equivalent to the accumulated value S = 10  000. We arrange the data on a time diagram below.

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Using time 11 as a focal date, we obtain the equation of value for unknown X:

Thus the 11th deposit will be $800 + $140.07 = $940.07.

Procedure 2 Let Y be the size of a smaller concluding payment (drop payment) made a half-year after the last
full deposit. We arrange the data on a time diagram below.

Using time 12 as the focal date we obtain the equation of value for unknown Y:

The negative value of Y indicates that there is no concluding payment required (that is, Y = 0); the interest after
the last full payment has increased the accumulated balance past the $10  000 goal by $81.78.

EXAMPLE 2A man dies and leaves his wife an estate of $50  000. The money is invested at j12 = 6%. How
many monthly payments of $750 would the widow receive and what would be the size of the concluding
payment?

SolutionWe have A = 50  000, R = 750, i = 0.5%. Substituting in equation (11) we obtain:

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Thus the widow will receive 81 full payments of $750 and one smaller concluding payment, say $Y, 1 month
after the last full payment. We arrange the data on a time diagram below.

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Using time 82 as the focal date, we obtain the equation of value for unknown Y:

Using time 0 as the focal date, we obtain the equation of value

If the widow wanted to withdraw all remaining funds at the time of the last full $750 withdrawal, then let X be
the balloon payment, made at time 81. Using time 0 as the focal date, we obtain

The final withdrawal is $750 + $220.97 = $970.97.

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Using a Financial Calculator to Determine n

We illustrate the required entries for the BA-II Plus calculator.

In Example 1, the steps are as follows:

In Example 2, the steps are as follows:

Using a Computer Spreadsheet to Determine n

In some instances, a computer spreadsheet has built-in functions that allow you to calculate certain answers
more quickly. Calculating the value of n for an annuity is a situation where a financial function can be used.

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We will illustrate this using Microsoft Excel and the financial function NPER(i, -PMT, PV, FV, type) where,

i = effective rate per compounding period (typed as a decimal)

type = 0 (ordinary annuity) or 1 (annuity due)

In Example 1, you would type NPER(0.0225, -800, 0, 10  000, 0), which would result in the answer
11.13839916 half-years.

In Example 2, you would type NPER(0.005, -750, 50  000, 0, 0), which would result in the answer 81.2955857
months.

Exercise 3.5 Part A

1. A debt of $4000 bears interest at j2 = 8%. It is to be repaid by semi-annual payments of $400. Determine
the number of full payments needed and the final smaller payment after the last full payment.

Answers

2. Melissa takes her inheritance of $25  000 and invests it at j12 = 6%. How many monthly payments of $250
can she expect to receive and what will be the size of the concluding payment? Use both Procedure 1 and
Procedure 2.

3. A couple wants to accumulate $10  000. If they deposit $250 at the end of each quarter-year in an account
paying j4 = 6%, how many deposits must they make and what will be the size of the final deposit? Use
both Procedure 1 and Procedure 2.

Answers
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4. A firm buys a machine for $30  000 and pays $5000 down and $5000 at the end of each year. If interest is
at j1 = 10%, how many full payments must the firm make and what will be the size of the concluding
smaller payment?

5. A fund of $20  000 is to be accumulated by n annual payments of $2500 plus a final smaller payment made
one year after the last regular payment. If interest is at j1 = 4%, determine n and the final irregular
payment.

Answers

6. A loan of $10  000 is to be repaid by monthly payments of $400, the first payment due in one year's time.
If j12 = 12%, determine the number of regular monthly payments needed and the size of the final smaller
payment.

7. A fund of $8000 is to be accumulated by semi-annual payments of $2000. If j2 = 5%, determine the

number of full deposits required and the final smaller payment.

Answers

8. On July 1, 2014, Shannon has $10  000 in an account paying interest at . She plans to withdraw
$500 every three months with the first withdrawal on October 1, 2014. How many full withdrawals can
she make and what will be the size and the date of the concluding withdrawal?

9. A parcel of land, valued at $350  000, is sold for $150  000 down. The buyer agrees to pay the balance with
interest at j12 = 9% by paying $5000 monthly as long as necessary, the first payment due 2 years from
now.

1. Determine the number of full payments needed and the size of the concluding payment one month
after the last $5000 payment.

2. Determine the monthly payment needed to pay off the balance by 36 equal payments, if the first
payment is 1 year from now and interest is at j12 = 12%.

Answers

10. From July 1, 2005, to January 1, 2010, a couple made semi-annual deposits of $500 into an investment
account paying j2 = 7%. Starting July 1, 2014, they start making semi-annual withdrawals of $800.

1. How many withdrawals can they make and what is the size and date of the last withdrawal?

2. If the couple decided to exhaust their savings with equal semi-annual withdrawals from July 1,
2014, to July 1, 2024, inclusive, how much will they get each half-year?

11. In October 2011, an industrialist gave your school $30  000 to be used for future scholarships of $4000 at
each fall convocation starting the year the industrialist dies. If the industrialist died May 2014, and the
money earns interest at j1 = 8%, for how many years will full scholarships be awarded?

Answers
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12. A debt of $18  000 is to be repaid in annual instalments of $3000 with the first instalment due at the end of
the second year and a final instalment of less than $3000. Interest is 9% per year compounded annually.
Calculate the final payment.

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Part B

1. Antonio is accumulating a $10  000 fund by depositing $100 each month, starting September 1, 2014. If
the interest rate on the fund is j12 = 4% until May 1, 2017, and then it drops to j12 = 3%, determine the
time and amount of the reduced final deposit.

Answers

2. A widow, as beneficiary of a $100  000 insurance policy, will receive $20  000 immediately and $1800
every 3 months thereafter. The company pays interest at j4 = 6%; after 3 years, the rate is increased to j4 =
7%.

1. How many full payments of $1800 will she receive?

2. What additional sum paid with the last full payment will exhaust her benefits?

3. What payment 3 months after the last full payment will exhaust her benefits?

3. On his 25th birthday, Yves deposited $4000 in a fund paying j1 = 5% and continued to make such deposits
each year, the last on his 49th birthday. Beginning on his 50th birthday, Yves plans to make equal annual
withdrawals of $20  000.

1. How many such withdrawals can be made?

2. What additional sum paid with the last withdrawal will exhaust the fund?

3. What sum paid one year after the last full withdrawal will exhaust the fund?

Answers

4. A couple bought land worth $300  000. They paid $50  000 down and signed a contract agreeing to repay
the balance with interest at j1 = 4% by annual payments of $50  000 for as long as necessary and a smaller
concluding payment one year later. The contract was sold just after the 3rd annual payment to an investor
who wants to realize a yield of j1 = 5%. Determine the selling price.

5. A loan of $20  000 is to be repaid by annual payments of $4000 per year for the first 5 years and payments
of $4500 per year thereafter for as long as necessary. Determine the total number of payments and the
amount of the smaller final payment made one year after the last regular payment. Assume an annual
effective rate of 7.5%.

Answers

6. Solve the equation for n.

7. Solve the equation for n.

Answers

8. A friend agrees to lend you $2000 on September 1 each year for 4 years to help with education costs. One
year after the last payment you are expected to start annual repayments of $800 for as long as necessary.
Interest on the loan is . Determine the number of repayments needed, and the amount of the final
payment.

9. A car loan of $20  000 at j12 = 9% is being paid off by n payments. The first (n - 1) payments are $498.00
per month. The final monthly payment is $480.79. Determine n.
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Answers

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