ENGINEERING

ECONOMICS
ES 219|| Engineering Economics Part
2
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Annuity
is an equal and annual series of payments
made over a predetermined time period.
Annuities can be used for a variety of
purposes, but the most common one is
providing a steady income for retirees.
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In the case of retirees, a lump sum of money or

assets is exchanged for a series of smaller
payments in the future. This payment is often
guaranteed for the life of the beneficiary, meaning
that, for a fee, the seller of an annuity assumes
the longevity risk, or the risk that the beneficiary
will outlive the amount paid.
THERE ARE THREE DIFFERENT TYPES OF
ANNUITY

Ordinary Annuity
Annuity Due
Deferred Annuity
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1.
Ordinary Annuity
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Ordinary Annuity
An annuity due is one where the
payments are made at the end of each
period.

P = value or some of money at present

P=A =A
F = value or sum of money at some future
time
F=A A = a series of periodic, equal amounts of
money
n = number of interest periods
i = interest rate per interest period
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Example #1

How much money will you accumulate by the end of

year 10 if you deposit P3,000 each for the next ten
years in a savings account that earns 5% per year?

F=A
= 3, 000
F = P 37, 740
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Example #2

Suppose you would like to have P25,000 saved 6 years from

now to pay towards your down payment on a new house. If
you are going to make equal annual end-of-year payments to
an investment account that pays 7 percent, how big do these
annual payments need to be?

F=A

25, 000 = A

The Present Value of an Ordinary A = P3,495.03

Annuity measures the value today
of a stream of cash flows occurring
in the future
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Example #3

What is the value today or lump sum equivalent of receiving

P3,000 every year for the next 30 years if the interest rate is
5%?

P=A
= 3, 000
P = P46,117.35
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Example #4

What are the present worth and the accumulated amount of a

10-year annuity paying P10, 000 at the end of each year, with
interest at 15% compounded annually.

P = A = 10, 000 = P50, 188

F=A = 10, 000 = P203, 037

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Example #5

What is the present worth of P500 deposited at the end of

every three months for 6 years if the interest rate is 12%
compounded semi-annually?

P = A = 500 = P8,504
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2.
Annuity Due
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Annuity Due
Annuity due is an annuity in which
all the cash flows occur at the beginning
of the period.

P=A +A P = value or some of money at present

F = value or sum of money at some future
F=A -A
time
A = a series of periodic, equal amounts of
money
n = number of interest periods
i = interest rate per interest period
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Example #6

A man bought an equipment costing P60,000 payable in 12

quarterly payments, each installment payable at the beginning
of each period. The rate of interest is 24% compounded
quarterly. What is the amount of each payment?

P=A +A n = 12 i = = 8%
60, 000 = A + A

A = P7, 371.91
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Example #7
A certain property is being sold and the owner received two bids. The
first bidder offered to pay P400, 000 each year for five years. Each
payment is to be made at the beginning of each year. The second
bidder offered to pay P240, 000 first year, P360, 000 the second year
and P540, 000 each year for the next year three years, all payments
will be made at the beginning of each year. If money is worth 20%
compounded annually, which bid should the owner of the property
accept?
Let = present worth of the first bid
= A + A = 200, 000 + 400, 000
= P1,435,480
Let = present worth of the second bid
= 240, 000 + 360, 000 + 540, 000 (1+0.20)
= P1, 487, 875

The owner of the property should accept the second bid.

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3.
Deferred Annuity
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Deferred Annuity
A deferred annuity is one where
the first payment is made several
periods after the beginning of the
annuity.

P=A P = value or some of money at present

F = value or sum of money at some future
time
A = a series of periodic, equal amounts of
money
n = number of interest periods
i = interest rate per interest period
m = deferred periods
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Example #8
On the day his grandson was born, a man deposited to a trust company a sufficient amount of
money so that the boy could receive five annual payments of P10, 000 each for his college
tuition fees, starting with 18th birthday. Interest at the rate of 12% per annum was to be paid
on all amounts on deposit. There was also a provision that the grandson could elect to
withdraw no annual payments and receive a single lump amount on his 25th birthday. The
grandson chose this option.
a) How much did the boy receive as the single payment?
b) How much did the grandfather deposit?
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4.
Perpetuity
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Perpetuity
A perpetuity is an annuity that continues
forever or has no maturity. For example, a
dividend stream on a share of preferred stock.

There are two basic types of perpetuities:

P=  Growing perpetuity in which cash
flows grow at a constant rate, g, from
period to period.
 Level perpetuity in which the
payments are constant rate from
period to period.
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GRADIENT
FORMULAS
The previous discussions involved cash flows of the same
magnitude A in each interest period. Sometimes the cash
flows that occur in consecutive interest periods are not the
same amount (not an A value), but they do change in a
predictable way. These cash flows are known as gradients,
and there are two general types: arithmetic and geometric.
ARITHMETIC GRADIENT

Arithmetic gradients
change by the
same amount each
period.
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Example #9
The present worth of $400 in year 1 and amounts increasing by $30 per year through year 5
at an interest rate of 12% per year is closest to: (A) $1532 (B) $1,634 (C) $1,744 (D) $1,829
GEOMETRIC GRADIENT

Geometric gradients
change by the same
percentage each
period
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Example #10
Find the present worth of $1,000 in year 1 and amounts increasing by 7% per year through
year 10. Use an interest rate of 12% per year. (a) $5,670 (b) $7,333 (c) $12,670 (d) $13,550
Try for yourself
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