General Annuity Lesson

What I need to know…

At the end of the lesson, the learner will be able to:

✓ Illustrate general annuities
✓ Find the future and present values of general annuities
and compute the periodic payment of a general annuity
✓ Calculate the fair market value of a cash flow stream
that includes an annuity.

What’s in…

REVIEW

In the previous lessons, you learned to illustrate a Simple Annuity and

you solve the present and future values of simple Annuity. You also compute
for the periodic payment of simple annuity. As well as solve problems involving
real life situations on simple Annuities.

What’s new…

❖ GENERAL ANNUITY
A GENERAL ANNUITY is 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.

Examples of General annuity:

1. Monthly installment payment of a car, lo or house with an interest rate
that is compounded annually.
2. Paying a debt semi-annually when the interest is compounded monthly.

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:

�� = �� [(1+����)����−1 �� ]
�� ��
1− (1+�� ��
] and �� = �� [ ��)
−����

��
Note: j = ��, n = mt
Where: R = is the regular payment
j = is the equivalent interest rate per payment interval
converted from the interest rate per period
n = the number of payments

EXAMPLE 1:

Cris started to deposit P1,000 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:
The Cash Flow for this problem is shown in the diagram below.

Cash Flow
F
1,000 1,000 1,000 . . . . . . . . . . . 1,000 1,000

0 1 2 3 . . . . . . . . . . . . . 179 180

(1) Convert 6% compounded quarterly to its equivalent interest rate for

monthly payment interval.
F1 = F 2
12�� 4��
12) = P (1 +��44)
P (1 +��12

12��
12) = (1 +��44)4��
(1 +��12
12
12) = (1 +0.06
(1 +��12 4)
4

12
12) = (1.015)4
(1 +��12

12) = ((1.015)4)112
(1 +��12

(1 +��12
12) = ((1.015) 3
1

12= (1.015)13 − 1
 12
��

12
��

12= 0.00497521 = j
Thus, the interest rate per monthly payment interval is 0.00497521%.

(2) Apply the formula in finding the future value of an ordinary annuity
using the computed equivalent rate.

�� = �� [(1+ ��)��−1
��]

�� = 1,000 [(1+ 0.00497521)180−1

0.00497521 ]

�� = ������, ������. ����

Thus, Cris will have P290,082.51 in the fund after 20 years.

EXAMPLE 2:
Ken borrowed an amount of money from Kat. He agrees to pay the principal
plus interest by paying P38, 973.76 each year for 3 years. How much money
did he borrow if the interest is 8% compounded quarterly?

GIVEN: R = 38,973.76, i(4) = 0.08, m = 4, n = 3 payments

Find P, Present Value

SOLUTION
The Cash Flow for this problem is shown in the diagram below.

Cash
Flow
P = ? R = 38,973.76 R = 38,973.76 R = 38,973.76 0 1 2 3

(1) Convert 8% compounded quarterly to its equivalent interest rate for each
payment interval
F1 = F2
1��
P (1 +��11) = P (1 +��44)4��
(1 +��11)1�� = (1 +��44)4��
(1 +��11)1 = (1 +0.08
4
4)

(1 +��11)1 = (1.02)4

(1 +��11) = ((1.02)4)1

(1 +��11) = ((1.02)4
1
��

1= (1.02)4 − 1
1
��

1= 0.082432 = j = 8.24%
Thus, the interest rate per payment interval is 0.082432 or 8.24%.
(2) Apply the formula in finding the present value of an ordinary annuity
using the computed equivalent rate j = 0.082432.

�� = �� [1−(1+ ��)−��
��]

�� = 38,973.76 [1−(1+0.082432)−3
0.082432 ]

�� = 38,973.76 [1−(1+0.082432)−3
0.082432 ]

�� = 38,973.76 [1−0.7284462444
0.082432 ]

�� = 38,973.76 [0.2715537556
0.082432 ]

�� = 38,973.76[2.565829711]
P = 100,000
Hence, Ken borrowed P100,000 from Kat
 A cash flow is a term that refers to payments received (cash inflows)
or payments or deposits 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 focal date.

EXAMPLE 3:
Mr. Ribaya received two offers on a lot that he wants to sell. Mr. Ocampo has
offered P50,000 and a P1million lump sum payment 5 years from now. Mr.
Cruz has offered P50,000 plus P40,000 every quarter for five years. Compare
the fair market value of the two offers if money can earn 5% compounded
annually. Which offer has a higher market value?
Mr. ocampo’s Offer Mr. Cruz’s Offer

P50,000 down payment P50,000 down payment

P1,000,000 after 5 years P40,000 every quarter for 5 years

Find the market value of each offer.

SOLUTION:

We illustrate the cash flows of the two offer using time diagram
 Mr. Ocampo’s

Offer

50,000 1 million

012345

Mr. Cruz’s Offer

50,000 40,000 40,000 40,000 . . . . . . . .. . 40,000

0 1 2 3 . . . . . . . . . . . . . . . . 20

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 P50,000 is offered today, then its present value is
still P50,000. The present value of P1,000,000 offred 5 years from now is
 P = F (1 + j)-n

P = 1,000,000 (1 + 0.05)-5

P = P783, 526.20

Fair Market value (FMV) = DOWNPAYMENT + PRESENT VALUE

FMV = 50,000 + 783, 526.20

FMV = P833,526.20
Mr. Cruz’s Offer: We first compute for the present value of a general annuity
with quarterly payments but with annual compounding period at 5%.
Solve the equivalent rate, compounded quarterly of 5% compounded

annually. F1 = F2
4(5)
P (1 +��44) = P (1 +��11)1(5)
(1 +��44)20 = (1 +��41)5
(1 +��44)20 = (1 +0.05
5
1)

(1 +��44)20 = (1.05)5-1

(1 +��44) = (1.05)5(120)-1

(1 +��44) = 0.012272234
The present value of an annuity is given by

�� = �� [1−(1+ ��)−��
��]

�� = 40,000 [1−(1+0.012272)−20
0.01227222 ]

P = 705,572.70

FAIR MARKET VALUE (FMV) = DOWNPAYMENT + 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
833,526.20 – 756,572.70 = P77,953.50

What is it…
 Activity 1: Question and Answer

Directions: Answer the questions briefly. Write your answers in a separate

sheet of paper.

1. Differentiate General Annuity and General Ordinary Annuity?

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2. What is a General Ordinary Annuity?

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3. Express the process in finding the Present and future value of General
ordinary annuity.

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4. What is the formula in finding the Fair Market Value?

5. Express the process in finding the Fair Market Value.

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