This preview has intentionally blurred sections. Sign up to view the full version.
View Full Document
Unformatted text preview: CM 426  Time Value of Money  ANNUITIES The formula for determining the future value of an annuity (a stream of equal payments made at equal intervals compounding at a
single interest rate) is represented by the following: ‘ FV of Annuity = Payment * [((1+Periodic Interest Rate)ANumber of Periods  1) / Periodic Interest Rate] (“Pansyt m: mm—
FK/A : PMT Per‘fwf: Pfﬁiobic INTEREST RATE
P6r__ir\+ N = Numeea at rations This formula assumes that the ﬁrst payment into the annuity will be made at the END of the ﬁrst period, and the ﬁnal payment will be
made at the END of the ﬁnal compounding period. Note that in this case, the last payment made will not accrue any interest because it
is made at the END of the ﬁnal period. When your calculator is in the END mode, this is what happens. Problem: Jim will make regular payments of $100 every six months for four years into an account that pays 10%, compounded
semiannually. He will begin payments in six months. How much will he have in this account exactly four years
from today? To make the problem more understandable and to help you as you enter the known variables into your calculator (HPlOB), it is my
suggestion that you ﬁrst diagram the information using a time line with arrows indicating the cashflow directions, and then make some
notes. For the problem stated above, a time line will look something like this: CF} of ‘15» EW
Tao», E"D Ar E012. 15sz 'I
W 4".) 100 Ioo r —Ioo —/00 .100 /00 eloo Now, to program the information into your calculator, do the following: 1. In ﬁnancial problems that involve payments, the ﬁrst step is to indicate how many payments per year (P/Y R) there will be.
For the problem above, enter 2, then SWITCH (YELLOW, ORANGE OR BLUE button on your calculator), and ﬁnally
P/Y R. 2. The next step is be sure your calculator is in END mode (because the payments in this problem will be made at the end of the
periods)  or BEGIN mode (if the payments are to be made at the beginning of the periods). 3. Now key in the ANNUAL interest rate (I/Y R) of 10%. Because you have already programmed the number of payments per
year (2), your calculator will automatically understand that the periodic interest rate is actually 5% (10% per year divided by 2
= 5%). 4. Next, enter the amount of the regular periodic payments (PMT). Key in 35—100 (remember that payments are going 9111, as
indicated by the down arrows in your diagram); then enter PMT. Don’t forget that annuities have several characteristics that
must be met: equal garments made at equal intervals compounded at an equal periodic interest rate. 5. Key in the number of periods (N). In this case, there are eight periods (four years of semiannual payments). You can do this
by simply entering 8 and then N; or you can take a shortcut and enter 4 (the number of years), SWITCH, and ﬁnally XP/Y R.
My suggestion for most problems is to let the calculator do the “thinking” for you. Because you have already “told” your
calculator that there are two payments per year the calculator automatically does the math: 4 years times 2 periods per year =
8 N. 6. A ﬁnal step (not necessary, but a good idea) is to indicate the present value of your annuity; that is, how much money there is
in this account today (PV). Of course, in this case, there is nothing. So enter 0, then PV. If you don’t enter anything for PV,
the default by the calculator is that PV = 0. Aﬁer entering this information (see below), you should be able to call for the future value (FV) calculation. The answer is $954.91. 7. Now, if you were making your ﬁrst payment into this account at the beginning of the ﬁrst period, instead of at the end of the
ﬁrst period, you would simply toggle your calculator to BEGIN mode instead of END mode. Do this by entering SWITCH,
BEG/END. You should see the word begin in your register. If you enter SWITCH, BEG/END again, you will not see anything in the
register and would be in END mode. After you have toggled to BEGIN mode, ask for the future value (FV), and the answer will be $1,002.66. 2 E] m ‘L/M : ,0 N ; Lf [ilk$22;
: END ..  .
PM‘ ' SINKING FUND The formula for determining the payment required for a sinking fund  a stream of equal payments made at equal intervals
compounding at a single interest rate that will yield a specified future value  is the same as that used to determine the future value of
an annuity; only in this case the future value is known, so we solve for the payment. Payment = FV / [ ((1+Periodic Interest Rate)"Number of Periods  1) / Periodic Interest Rate] FVA M “‘1 PMT : (1+ Pen“) I
/, per, ‘m‘l’ This formula assumes that the ﬁrst payment into the sinking fund will be made at the END of the ﬁrst period, and the ﬁnal payment
will be made at the END of the ﬁnal compounding period. Note that in this case, the last payment made will not accrue any interest
because it is made at the END of the ﬁnal period. When your calculator is in the END mode, this is what happens. (See time line for
annuity in END mode.) Problem: Jim predicts that he will need $1,000 three years from today and is willing to make equal deposits (payments) every
three months into an account that pays 8%, compounded quarterly for the next three years. He will make his ﬁrst
deposit in three months. How much will his payments have to be in order to have $1,000 in this account exactly
three years from today? To make the problem more understandable, and to help you as you enter the known variables into your calculator, it is my suggestion
that you make some notes. For example: 1. First write down 4 periods per year (4 SWITCH P/YR) 2. Next, write down END to be sure your calculator is in the END mode (Payments are going to be made at the end of the
periods) 3. Next, list the known variables. You can do this in any order. Future Value is $1,000; Interest per year is 8% (so periodic interest would be 2% (8% / 4 periods per year); Number of periods = 12 (Regular payments every three months for 3 years)
Or better: N = 3 SWITCH XP/Y R 4. Payments = Unknown After entering this information, you should be able to call for the Payment calculation. The answer is $74.56. If the question called for the payments to be made at the beginning of each period (see time line below), you would key in BEGIN
mode instead of END mode, and your calculator should compute an answer of $73.10. ...
View
Full
Document
This note was uploaded on 01/11/2012 for the course CM 426 taught by Professor Markhutchings during the Winter '12 term at BYU.
 Winter '12
 markhutchings

Click to edit the document details