General Mathematics

Quarter 2 - Module 4:
Annuities
General Mathematics
Alternative Delivery Mode
Quarter 2 - Module 4: Annuities
First Edition, 2020

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 What I Need to Know

This module was designed and written with you in mind. It is here to help you master
the lesson about Annuities. The scope of this module permits it to be used in many
different learning situations. The language used recognizes the diverse vocabulary level
of students. The lessons are arranged to follow the standard sequence of the course.
But the order in which you read them can be changed to correspond with the textbook
you are now using.
The module is divided into two lessons, namely:
 Lesson 1 - General Annuity
 Lesson 2 - Deferred Annuity

Lesson
General Annuity
1
What’s In

General Annuity - an annuity where the length of the payment interval is not
the same as the length of the interest-compounding period.
General Ordinary Annuity - a general annuity in which the periodic payment is
made at the end of the payment interval.
EXAMPLE 1. Monthly payments of ₱2 000 where interest is 6%, compounded
monthly. Here, the payment interval and the interest interval are the same – 1 month.
This is an example of an ordinary annuity, like those in previous lessons.
Suppose there are monthly payments of ₱2 000, but the interest is
6%, compounded semi-annually. Here, the payment interval is 1 month, but the
interest period is 6 months. They are not the same. This type of annuity is called
a general annuity.
Examples of situations or problem of general annuity:
1. Monthly installment payment of a car, lot, or house with an interest rate
that is compounded annually.
2. Paying a debt semi-annually when the interest is compounded monthly.

What’s New

FORMULA:
Future and Present Value of a General Ordinary Annuity
The future value F and present value P of a general ordinary annuity is
given by:
ሺ1+𝑗ሻ𝑛 −1 1− ሺ1+𝐽ሻ−𝑛
𝐹 = 𝑅ቂ ቃ and 𝑃 = 𝑅 ቂ ቃ
𝑗 𝑗

where R is the regular payment;

j is the equivalent interest rate per payment interval converted from the
interest rate per period; and
n is the number of payments.

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 What is it

The formulas for F and P are the same as those in the previous lesson. The extra step
occurs in finding j: the given interest rate per period must be converted to an equivalent
rate per payment interval.
EXAMPLE 1. Cris started to deposit ₱1 000 monthly in a fund that pays 6%
compounded quarterly. How much will be in the fund after 15 years?
GIVEN. R = 1,000, n = 12(15) = 180 payments, i(4) = 0.06m = 4 Find F
SOLUTION.
(1) Convert 6% compounded quarterly to its equivalent interest rate for monthly
payment interval.
F1 = F2
12𝑡 4𝑡
𝑖 12 𝑖4
𝑃 (1 + ) = 𝑃 (1 + )
12 4
12
𝑖 12 0.06 4
(1 + ) = (1 + )
12 4
12
𝑖 12
(1 + ) = ሺ1.015ሻ4
12
𝑖 12 1
1+ = [ሺ1.015ሻ4 ]ሺ12ሻ
12
𝑖 12 1
= ሺ1.015ሻ3 − 1
12
𝑖 12
= 0.000497521
12
𝑗 = 0.00497521
Thus, the interest rate per monthly payment intervals is 0.000407521 or 0.497521%
(2) Apply the formula finding the future value of an ordinary annuity using the
computed equivalent rate.
ሺ1+𝑗ሻ𝑛 −1 ሺ1+0.000497521ሻ180 −1
𝐹=𝑅 𝑗
= 1000 0.000497521
= 290, 082. 51

Thus, Cris will have ₱290 082.51 in the fund after 20 years.

Note: When solving for an equivalent rate, say j = (1.015)1/3 - 1 in Example 1, six or more decimal places will be
used. If you use fewer or more decimal places, your answers may be differ from that which is provided in the text.
You can ignore these discrepancies, but it is suggested that you use at least six decimal places or exact value.

EXAMPLE 2. Mr. Remoto would like to buy a television (TV) set payable for 6 months
starting at the end of the month. How much is the cost of the TV set if her monthly
payment is ₱ 3, 000 and interest is 9% compounded semi-annually?
GIVEN. R = ₱3 000 i2 = 0.09 m=2 n = 6 payments
SOLUTION.
(1) Find the cost (present value) at the beginning of the term P
F1 = F2
12𝑡 2𝑡
𝑖 12 𝑖2
𝑃 (1 + ) = 𝑃 (1 + )
12 2
12
𝑖 12 0.09 2
(1 + ) = (1 + )
12 2

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 12
𝑖 12
(1 + ) = ሺ1 + 0.045ሻ2
12
12
𝑖 12
(1 + ) = ሺ1.045ሻ2
12

𝑖 12 1
1+ = [ሺ1.045ሻ2 ]ሺ12ሻ
12
𝑖 12 1
= ሺ1.015ሻ6 − 1
12
𝑖 12
= 0.00736312
12
𝑗 = 0.00736312
Thus, the interest rate per monthly payment interval is 0.00736312 or 0.736312%
(2) Apply the formula in finding the present value of an ordinary annuity
using the compounded equivalent rate j = 0.00736312.
1− ሺ1+𝑗ሻ−𝑛 1− ሺ1+0.00736312ሻ−6
𝑃=𝑅 = 3, 000 = 17, 545. 08
𝑗 0.00736312

Thus, the cost of the TV set is ₱17 545.08

A cash flow is a term that refers to payment received (cash inflows) or payments or deposited made (cash outflows).
Cash inflows can be represented by positive numbers and cash outflows can be represented by negative numbers.

The fair market value or economic value of a cash flow (payment stream) on a particular date refers to a single
amount that is equivalent to the value of the payment stream at that date. This particular date is called the focal date.

EXAMPLE 3. Mr. Ribaya received two offers on a lot that he wants to sell. Mr.
Ocampo has offered ₱50 000 and a ₱ 1 million lump sum payment 5 years from
now. Mr. Cruz has offered ₱50 000 plus ₱40 000 every quarter for five years.
Compare the fair market value of the two offers if the money can earn 5%
compounded annually. Which offer has a higher market value?
GIVEN. Mr. Ocampo’s Offer Mr. Cruz’s Offer
₱50 000 down payment ₱50 000 down payment
₱1 000 000 after 5 years ₱40 000 every quarter for 5 years
SOLUTION.
(1) Find the fair market value of each offer. Choose a focal date and determine the
values of the two offers at that focal date. For example, the focal date can be the
date at the start of the term.
Since the focal date is at t = 0, compute for the present value of each offer.

Mr. Ocampo’s offer: Since ₱50 000 is offered today, then its present value is still ₱50
000. The present value of ₱1 000 000 offered 5 years from now is:
𝑃 = 𝐹 ሺ1 + 𝑗ሻ−𝑛 = ₱1,000,000ሺ1 + .05ሻ−5 = ₱𝟕𝟖𝟑, 𝟓𝟐𝟔. 𝟐𝟎
Fair Market Value (FMV) = Down payment + Present Value
FMV = ₱50 000 + ₱783 526.20
FMV = ₱833 526.20

Mr. Cruz’s offer: We first compute for the present value of a general annuity with
quarterly payments but with annual compounding at 5%.
Solve the equivalent rate, compounded quarterly, at 5% compounded annually.

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 F1 = F2
ሺ4ሻሺ5ሻ ሺ1ሻሺ5ሻ
𝑖4 𝑖1
𝑃 (1 + ) = 𝑃 (1 + )
4 1
20
𝑖4 0.05 5
(1 + ) = (1 + )
4 1
𝑖4 1
1+ = ሺ1.05ሻሺ4ሻ
4
𝑖4
= ሺ1.05ሻ1/4 − 1
4
𝑖4
= 0.012272
4
𝑗 = 0.012272
The present value of an annuity is given by
1 − ሺ1 + 𝑗ሻ−𝑛 1 − ሺ1 + 0.012272ሻ−20
𝑃=𝑅 = ₱40,000 = ₱𝟕𝟎𝟓, 𝟓𝟕𝟐. 𝟕𝟎
𝑗 0.012272
Fair Market Value (FMV) = Down payment + Present Value
FMV = ₱50 000 + ₱705 572.70
FMV = ₱755 572.70
Hence, Mr. Ocampo’s offer has a higher market value. The difference between the market
values of the two offers at the start of the term is:

Note: There is an Alternate Solution by using

₱33 526.20 - ₱755 572.70 = ₱77 953.50 end of the term as focal date

EXAMPLE 4. Mahal has just purchased a house for ₱1 000 000. He borrows the money
and will repay it in monthly installments over 5 years. The interest rate is 8.4%/a,
compounded semi-annually. Find the monthly payment.
GIVEN. F = ₱1 000 000 i = 0.084 m = 12 n = (5)(12) = 60.
SOLUTION.
F1 = F2
12
𝑖 12 0.084 2
(1 + ) = (1 + )
12 2
𝑖 12 1
1+ = ሺ1.042ሻሺ6ሻ
12
𝑖 12
= ሺ1.042ሻ1/6 − 1
12
𝑖4
= 0.006881
4
𝑗 = 0.006881
Find the periodic payment R of an ordinary annuity using j = 0.006881
𝐹 1000000
𝑅= 𝑛 = = ₱13,518.71  The monthly payment of Mahal is
ሺ1 + 𝑗ሻ − 1 ሺ1 + 0.006881ሻ60 − 1
₱13 518.71
𝑗 0.006881

What’s More

EXERCISES. Answer the following exercises: (Show your solutions)

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1. Janus deposits ₱2000 annually in a bank that earns 6.85% compounded annually.
Due to a change in employment, these deposits stopped after 10 years, but the
account will continue to earn interests until Janus retires 25 years after the last
deposit is made. How much is in the account when Betty retires?
2. Jomy has just purchased a new car for ₱800 500.00. He borrowed the money and
will repay it in monthly installments over 6 years. The interest rate is 7.8%/a,
compounded quarterly. Find the monthly payment.
3. The investment in Siomai J is ₱50 000 at the end of 5 years plus ₱6 000 annually
for 4 years afterwards. While the investment in Dette’s Milk tea offers ₱80 000
semi-annually and ₱10 000 every 5 months after 10 years. Assume that money is
worth 9% compounded annually. Which investment would you preferred?

What I Have Learned

1. Based on your own understanding, differentiate general annuity and general

ordinary annuity.
________________________________________________________________________________
_________________________________________________________________________________

2. How do you find the market fair value?

_________________________________________________________________________________
_________________________________________________________________________________

What I Can Do

The twins JR and JM both will save ₱2 000 at 12% compounded annually. JR begins at
age 20 and deposits ₱2 000 a year until age 29, for a total of 10 deposits, then does
nothing till retirement at age 65 (36 years). How much will JR have at age 65? JM begins
at age 29 depositing ₱2 000 a year until retirement at age 65 (37 deposits). How much
will JM have at retirement? After knowing the retirement money of JR and JM, what
have you learned on this problem?

Lesson

2 Deferred Annuity

What’s In

Deferred Annuity - an annuity that does not begin until a given time interval has
passed.

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Period of Deferral - time between the purchase of an annuity and the start of the
payments for the deferred annuity.
A deferred annuity is a financial transaction where annuity payments are delayed until
a certain period of time has elapsed. Usually the annuity has two stages, as depicted in
this figure.

1. Accumulation Stage. A single payment is allowed to earn interest for a specified

duration. There are no annuity payments during this period, which is commonly
referred to as the period of deferral.
2. Payments Stage. The annuity takes the form of any of the four annuity types and
starts at the beginning of this stage as per the financial contract. Note that the
maturity value of the accumulation stage is the same as the principal for the
payments stage.

The interest rate on deferred annuities can be either variable or fixed. However,
since deferred annuities are commonly used to meet a specific need, fixed interest rates
are more prevalent since they allow for certainty in the calculations.
https://math.libretexts.org/Bookshelves/Applied_Mathematics/Book%3A_Business_Math_(Olivier)/12%3A_Compound_I
nterest_Special_Applications_Of_Annuities/12.01%3A_Deferred_Annuities

What’s New

FORMULA:
Present Value of a Deferred Annuity
The present value P of a deferred annuity is given by:
1 − ሺ1 + 𝑗ሻ−ሺ𝑘+𝑛ሻ 1 − ሺ1 + 𝑗ሻ−𝑘
𝑃=𝑅 −𝑅
𝑗 𝑗
where R is the regular payment;
j is the interest rate per period;
n is the number of payments; and
k is the number of conversion periods in the deferral

What is It

EXAMPLE 1. On his 40th birthday, Mr. Ramos decided to buy a pension plan for
himself. This plan will allow him to claim ₱10 000 quarterly for 5 years starting 3 months
after his 60th birthday. What one-time payment should he make on his 40th birthday
to pay off this pension plan, if the interest rate is 8% compounded quarterly?
GIVEN. R=10,000 m=4 𝑖 4 = 0.08 Find: P

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SOLUTION. The annuity is deferred for 20 years and it will go on for 5 years. The first
payment is due three months (one quarter) after his 60th birthday, or at the end of the
81 conversion period.
Thus, there are 80 artificial payments.
Number of artificial payments: k = mt = 4(20) = 80
Number of actual payments: n = mt = 4(5) = 20
𝑖4 0.08
Interest rate per period: 𝑗 = 𝑚
= 4
= 0.02
If you assume that there are payments in the period of deferral, there would be a total
of k + n = 80 + 20 = 100
Thus, the present value of a deferred annuity can be solved as:

1 − ሺ1 + 𝑗ሻ−ሺ𝑘+𝑛ሻ 1 − ሺ1 + 𝑗ሻ−𝑘
𝑃=𝑅 −𝑅
𝑗 𝑗

1 − ሺ1 + 0.02ሻ−ሺ80+20ሻ 1 − ሺ1 + 0.02ሻ−80
𝑃 = 10000 − 10000
0.02 0.02
P = ₱430 983.516401 – 397 445.135917 P = ₱33 538.38
Therefore, the present value of these monthly pensions is ₱33,538.38
EXAMPLE 2. To find the period of deferral in the deferral annuity
(a) Monthly payments of ₱ 50,000 for 3 years that will start 8 months from now.
Answer: The first payment is at time 8. The period of deferral is from time 0 to 7,
which is equivalent to 7 periods or 7 months.
(b) Annual payments of ₱ 2,500 for 24 years that will start 12 years from now.
Answer: The first payment is at time 12. The period of deferral is from time 0 to 1,
which is equivalent to 11 periods or 11 years.
(c) Quarterly payments of ₱ 300 for 9 years that will start 1 year from now.
Answer: The first payment is at time 4 because there are 4 quarters in 1 year. The
period of deferral is from time 0 to 3, which is equivalent to 3 periods or 3 quarters.

What’s More

EXERCISES: A. Find the present value of each of the following deferred annuity (Show
your solutions).
Payment Made Rate Term Deferred for Annuity
1 ₱5 000 6%; m = 4 6 years 2 years
2 ₱12 000 9%; m = 2 3 years 4 years
3 ₱10 000 10.5%; m = 12 8 years 5 years
4 ₱4 000 12%; m = 4 2 years 1 year
5 ₱250 000 8%; m = 12 10 years 3 years

B. Find the periodic payment in each of the following deferred annuity (Show your
solutions)

Deferred Conversion Periodic

Payment Value Term Rate
for Period Payment
1 ₱11 000 2 years 1 year 5% Annually
2 ₱30 000 5 years 2 years 10% Semi-annually
3 ₱8 000 3 years 1
year 6% Annually
2
4 ₱18 000 6 years 1.5 years 7.5% Quarterly
5 ₱100 000 8 years 3 years 5% Monthly

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 What I Have Learned

Fill the blank with correct word or words to complete the statement.

1. A deferred annuity is an annuity that does not _____ until a given time interval
has passed.
2. A ______________ is a financial transaction where annuity payments are
delayed until a certain period of time has elapsed. Usually the annuity has
two stages:
2.1 _____________ A single payment is allowed to earn interest for a
specified duration. There are no annuity payments during this period of
time, which is commonly referred to as the ______________.
2.2 _______________. The annuity takes the form of any of the four types and
starts at the beginning of this stage as per the financial contract. Note that
the maturity value of the accumulation stage is the same as the principal for
the payments stage.
The interest rate on deferred annuities can be either variable or fixed. However,
since deferred annuities are commonly used to meet a specific need, fixed interest rates
are more prevalent since they allow for certainty in the calculations.

What I Can Do

Solve the following problems.

1. An investment in milk tea will yield no operating profit until the end of 1 year,
when the investor will receive ₱150 000 at the end of each year for 5 more years.
Find the present value of this income if money is worth 8% converted annually.

2. To buy a laptop for his son for the online class, Mr. Ibarra borrows ₱20 000 from
his company and will pay back the loan with interest at 9% per year in 5 annual
payments. What will the payments be?

3. JR has made semi-annual deposits of ₱2 000 for 5 years into a savings funds
paying interest at 12%, m = 2. What semi-annual deposits for the next 3 years
will it take to have a total funds of ₱50 000?

11