Lecture 3

LECTURE-3
PV and FV of Annuity Due

An annuity due is a repeating payment that is made at the beginning of each period. The
distinction between an ordinary annuity and annuity due is that payments made under
an ordinary annuity occur at the end of the period while payments made under an annuity
due occur at the beginning of the period.
The future value and present value of annuity due is as follows:
If compounding is done many times in a year e.g. m times;
Illustration-7
Find the future value of an investment if ksh150,000 is deposited at the beginning of each
year for 9 years and the interest rate is 7.2% pa, compounded annually.
Illustration-8
An individual plans to save for his new car's down payment that he will need five years from
now. He plans to make five deposits of ksh.200,000 per year. He will start the first deposit
right away.
Required:
How much will he have as the down payment for his car if he can earn 10% interest rate on
the saving?
Page 1 of 5
Illustration-9
Find the future value of an investment if ksh12,500 is deposited at the beginning of each
month for 9 years and the interest rate is 16% pa , compounded monthly.
Illustration-10
What amount must you invest today at 6% interest rate compounded annually so that you can
withdraw 60,000 at the beginning of each year for the next 5 years?
Illustration-11
What amount must you invest today at 6% interest rate compounded monthly so that you can
withdraw 5,000 at the beginning of each month for the next 5 years?
Present value of a perpetuity
Future value of a perpetuity

There is no end date, so there is no future value formula. To find the FV of a
perpetuity would require setting a number of periods which would mean that
the perpetuity up to that point can be treated as an ordinary annuity.
Present value of a growing annuity

The formula for the present value of a growing annuity is used to calculate the present value
of a series of cash flows, or payments, that grow at a proportionate rate. A growing
annuity may sometimes be referred to as an increasing annuity.
Where:
 A or C1 = the first payment,

 r = interest rate per period, and
 g = a constant growth rate.
Page 2 of 5
Illustration-12
An investment company just issued a security which will provide 10 payments, starting next
year for ksh.100,000 and increasing 5% per year after that.
Required:
How much is this security worth if the appropriate required return is 10%?
Future value of growing annuity
Present value of a growing annuity into perpetuity
Loan Amortization
Loan amortization uses the annuity formula to establish the loan repayment amounts. In this
case, the amount of the loan represents the present value and the repayments/installments
represent the annuity itself. The interests may be compounded annually, quarterly, monthly
(common with most loans) or in any period that is suitable to the investor and the loan
provider.
The amortization schedule is developed after computing the loan installment as follows:
If there many compounding periods in a year, then the formula is adjusted as follows:
Page 3 of 5
Illustration-13
Kimani takes a 5-year bank loan of ksh 600,000 from Equity bank under the terms that
provide for an interest of 14% p.a. on a reducing balance, compounded monthly.
Required:
a) Calculate the loan repayment amount per month

b) Determine the total interest amount that he will have paid upon maturity
c) Prepare an 8-month amortization schedule for this loan
Solution:
a) Repayment amount per month
A =13,961
The loan installments are ksh 13,961 per month
b) Total interest amount over the period of the loan
Total amount paid to maturity = 13961 x 60 periods =ksh. 837,657
Therefore;
Total interest = total repayment -loan amount = 837,657 -600,000 =ksh. 237,657
Page 4 of 5
c) Amortization schedule for 8-months from the beginning of the loan;
Month Balance b/f Interest Amount Repayment Balance c/f
1 600,000 7,000 607,000 13,961 593,039
2 593,039 6,919 599,958 13,961 585,997
3 585,997 6,837 592,834 13,961 578,873
4 578,873 6,754 585,626 13,961 571,665
5 571,665 6,669 578,335 13,961 564,374
6 564,374 6,584 570,958 13,961 556,997
7 556,997 6,498 563,495 13,961 549,534
8 549,534 6,411 555,946 13,961 541,985
Page 5 of 5

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LECTURE-3

PV and FV of Annuity Due

The future value and present value of annuity due is as follows:

If compounding is done many times in a year e.g. m times;

Present value of a perpetuity

Future value of a perpetuity

Present value of a growing annuity

 A or C1 = the first payment,

Future value of growing annuity

Present value of a growing annuity into perpetuity

a) Calculate the loan repayment amount per month

a) Repayment amount per month

The loan installments are ksh 13,961 per month

b) Total interest amount over the period of the loan

Total amount paid to maturity = 13961 x 60 periods =ksh. 837,657

Month Balance b/f Interest Amount Repayment Balance c/f

1 600,000 7,000 607,000 13,961 593,039

2 593,039 6,919 599,958 13,961 585,997

3 585,997 6,837 592,834 13,961 578,873

4 578,873 6,754 585,626 13,961 571,665

5 571,665 6,669 578,335 13,961 564,374

6 564,374 6,584 570,958 13,961 556,997

7 556,997 6,498 563,495 13,961 549,534

8 549,534 6,411 555,946 13,961 541,985

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