What is ANNUITY in Finance Concept?
______________________________________________________If you would like to copy the content, please get permission by emailing val@starcresto.com. Thank you!
______________________________________________________
A lot of my students get confused with the concepts of annuity. So what exactly is annuity?
You can see annuity as a fixed amount of cash-flow that you will be getting or paying over a fixed interval.
For instance, getting $100 in year 1, year 2 and year 3. $100 is the fixed amount of cash-flow and 1 year apart is the fixed interval.
Having said that, getting $100 in year 1, year 3 and year 4 for instance is no longer an annuity as the interval is no longer one year apart since year 2 is being skipped. The interval is not limited to year, it can be monthly, weekly, 2 years interval etc as long as the same cash-flow is paid over same interval.
There are a few types of annuity as follow:
1. Annuity Due - cash inflow or outflow that occurs immediately
2. Ordinary Annuity - cash inflow or outflow that occurs at the end of the year
3. Deferred Annuity - cash inflow or outflow that occurs only after a few years
4. Perpetuity Annuity - cash inflow or outflow that occurs forever
Consider the questions as follow:
1. John
has just been employed by a prestigious firm, drawing an annual salary of
$300,000, paid at the end of each year. He plans to work for five years before
retiring. He buys a new luxury home with mortgage repayments of $5,000 per
month for the next 20 years (payable at the end of each month), and donates
$10,000 per annum forever to his favourite charity. What annual amount, in
present value terms, can John withdraw for the first five years of his
retirement from the remainder of his savings? Assume an annual interest rate of
6% p.a.
- Is there annuity?
- What is the first step to tackling this question?
- Do you know what you are supposed to find?
2. Kristy
has to make rental payments of $1,000 at the start of every month, throughout
the four-year duration of her university course. Her university fees are $4,000
to be paid at the start of each year. She earns $1,500 per month (paid at the
end of each month) from a part-time job. Assume an interest rate of 8% p.a. and
that she keeps the part-time job for the next four years. How much money, in
present value terms, can she withdraw each month for the next four years?
- What are the different annuity involved?
- Can you draw the timeline?
** If your school allows you to use financial calculator, please make use of your financial calculator to help you solve your annuity problem.
The next post will be on uneven cash flow. Stay Tune!
Having problem with your finance? Fret not! We have a team of well-trained finance academic consultant and tuition teachers who can help you simplify the steep learning curve. Contact us for lessons by:
No comments:
Post a Comment
Note: Only a member of this blog may post a comment.