Engineering Economy

ANNUITIES
• Annuity
– Consists of a series of equal payments made at
equal interval of time.
• Annuities occur in the following instances
– Payment of debt by series of equal payments at
equal interval of time
– Accumulation of a certain amount by setting equal
amount periodically.
– Substitution of a series of equal amounts periodically
in lieu of a lump sum at retirement of an individual.
 Types of Annuities
(1) Ordinary Annuity
- is one where the equal payments are made at
the end of each payment period starting from the
first period.
Four Essential Elements of an Ordinary Annuity
• The amount of all payment are equal
• The payments are made at equal interval of time
• The first payment is made at the end of the first
period all payments thereafter are made at the
end of the corresponding period.
• Compound interest is paid on all amounts in the
annuity
 Graphical Representation of Ordinary
Annuity
(P/A, i%, n) (F/A, i%, n)

0 1 2 3 N-1 n

P1.00 P1.00 P1.00 P1.00 P1.00

n
(P/A, i%, n) or P = (1+ i) – 1
i (1+ i)n
n
(F/A, i%, n) or F = (1 + i) – 1
i
 Formula
• Ordinary Annuity
n -n
P = A(P/A, i%, n) = A (1+i) – 1 or A 1 –(1+i)
n
i(1+i) i

n
F = A(F/A, i%,n) = A (1 + i) – 1
i
Where: A = amount of each payment of an ordinary
annuity
P = present value
F = future worth or accumulated amount
 Example 1.0
• What is the present worth of a 3 years
annuity paying P3,000 at the end of each
year, with interest at 8% compounded
annually?
 Example 2.0
• A one bagger concrete mixer can be purchase with a
down payment of P8,000 and equal installment of
P600 each paid at the end of every month for the next
12 months. If money is worth 12% compounded
monthly, determine the equivalent cash price of the
mixer.
 Example 3.0
• Mr. Robles plans a deposit of P500 at the
end of each month for 10 years at 12%
annual interest, compounded monthly. The
amount that will be available in two years
is.
 Example 4.0
• The president of a growing engineering
firms wishes to give each of 50 employees
holiday bonus. How much is needed to
invest monthly for a year at 12% nominal
interest rate compounded monthly so that
each employees will received a P1,000
bonus
 Example 5.0
• A man inherited a regular endowment of
P100,000 every end of 3 months for 10
years. However, he may choose to get a
single lump sum payment at the end of 4
years. How much is the lump sum if the
cost of money is 14% compounded
quarterly.
 Example 6.0
• A machine is under consideration for
investment. The cost of the machine is
P25,000. Each year it operates the
machine will generate a savings of
P15,000. Given an effective annual
interest rate of 18%, what is the
discounted payback period in years on the
investment in the machine?
 Example 7.0
• Because of the peso devaluation, a car
costing P150,000 is to be purchase
through a finance company instead of
paying cash. If the buyer is required to pay
P40,000 as down payment and P4000
each month for four years, what is the
effective interest rate on the diminishing
balance?
 Types of Annuity
(2) Deferred Annuity
- it is also ordinary annuity but the payment of the
first amount is deferred a certain number of periods
after the first.

M periods n periods
N-1
0 1 2 m 0 1 2 n

A A A A
Cash Flow diagram given A to find P
 Formula
• Deferred Annuity
P = A(P/A, i%, n)(P/F, i%, m)

--n -m
= A 1- (1+i) (1+i)
i

F = A(F/A, i%,n) (F/P, i%, m)

n m
= A (1+i) - 1 ( 1+i)
i
 Example 1.0
• A lathe for a machine shop cost P60,000 if
paid in cash. On the installment plan, a
purchaser should pay P20,000 down
payment and 10 quarterly installment, first
due at the end of the first year after
purchase. If the money is worth 15%
compounded quarterly. Determine the
quarterly installment.
 Example 2.0
• A man invest P10,000 now for the college
education of his 2 year old son. If the fund
earns 14% effective, how much will the
son get each year starting from his 18th to
the 22nd birthday?
 Example 3.0
• A person buy a piece of property for
P100,000 down payment and ten deferred
semi annual payments of P8,000 each
starting three years from now. What is the
present value of the investment is the rate
of interest is 12% compounded semi
annually?
 Example 4.0
• In five years, P18,000 will be needed to
pay for a building renovation. In order to
generate this sum, consisting of three
annual payments is established now. For
tax purpose, no further payments will be
made after three years. What payments
are necessary if money is worth 15% per
annum?
 Example 5.0
• A fund for replacement of machinery in a
plant must contain P30,000 at the end of 9
years. If the fund is invested at 3.5 %
compounded semi annually. What equal
deposits should be placed in the fund at
the end of 6 months just for the first four
years?
 Types of Annuity
(3) Annuity Due
– Is one where payments are made at the start
of each period beginning from the first period.
P F

A A A
 Formula for Annuity Due
• Present Worth
n-1
P = A (1+i) - 1 + A
n-1
i (1 + i)

• Future Worth
n +1
F = A (1 +i) - 1 - A
i
 Example 1.0
• A farmer bought a tractor costing P25,000
payable in 10 semi annual payments, each
installment payable at the beginning of
each period. If the rate of interest is 26%
compounded semi-annually, determine the
amount of each installment.
 Example 2.0
• As rental for the building, the owner received two
offers.
(a) P50,000 a year for 8 years, the rental for
each year being paid at the start of each year.
(b) P30,000 the first year, P40,000 the second
year, P50,000 the third year and P60,000 for the
next 5 years with a rentals paid at the beginning
of each year.
If money is worth 12%, which is the better offer?
 Example 3.0
• A man owes P12,000 today and agrees to
discharge the debt by equal payments at
the beginning of each 3 months for 8 years
where these payments include all interest
at 8% payable quarterly. Find the quarterly
payment.
 Example 4.0
• A man will deposit P200 with a savings
and loan association at the beginning of
each 3 months for 9 years. If the
association pays interest at the rate of
5.5% compounded quarterly. Find the sum
to his credit just after the last deposit.
 Types of Annuity
(4) Perpetuity
- is one where the payment periods extend
forever or in which the periodic payments
continue indefinitely.

Formula:
P= A
i
 Example 1.0
• Find the present value in pesos of a
perpetuity of P15,000 payable semi-
annually if money is worth 8%
compounded quarterly
 Example 2.0
• It costs P50,000 at the end of each year to
maintain a section of Kennon road in
Baguio city. If the money is worth 10%.
How much would it pay to spend
immediately to reduce the annual cost to
P10,000.
 Example 3.0
• If the money is worth 8% compounded
quarterly, compare the present values of
the following:
(a) An annuity of P1,000 payable quarterly for
50 years
(b) An annuity of P1,000 payable quarterly for
100 years
(c) A perpetuity of P1,000 payable quarterly.
 Type of Annuity
(5) Compounded Continuously
• Future Worth
rn
F=Ae -1
r
e -1
• Present Worth
-r n
P=A1-e
r
e- 1
 Example 1.0
• P500 is deposited each year into a
savings bank account that pays 5%
nominal interest, compounded
continuously. How much will be the
account at the end of 5 years
 Example 2.0
• A man borrowsP100,000 at a rate of 6%
compounded continuously for 5 years.
How much must he pay annually if money
is compounded continuously
 Example 3.0
• What is the nominal rate of interest
compounded continuously for a period of 5
years of an equal payment series if the
sinking fund factor is equal to 0.180519?
 Example 4.0
• Determine the number of periods in years
would it take for a uniform payment series
in an account that earns 6% compounded
continuously if the compound amount
factor is 5.657797282