Question

Find the present value of an annuity due that pays $4000 at the beginning of each quarter for the next 7 years. Assume that money is worth 6.2%, compounded quarterly. If $90,000 is invested in an annuity that earns 5.4%, compounded quarterly, what payments will it provide at the end of each quarter for the next 7 1/2 years?

Answer 1

Explanation:

From the first question:

We are to find PV of the annuity.

Using the formula:

Present value of Annuity = Annuity Amount × Present Value Annuity Factor i.e. PVAF (n , r)

Where , Annuity Amount = $4,000

n = No. of periods = 7 years × 4 quarters per year = 28 periods but since the first payment is at beginning of the quarter, Then, n = 27 when considered for PVAF

r = 6.2% / 4 quarters = 1.55%,

PVAF(n0,r) when first payment is at beginning of n i.e. n0 = 1 + { [1-(1+r)^ -n0 ]/r }

= 1 + { [1-(1+0.0155)^ {-27}]/0.0155 }

= 1 + [ (1 - 0.66015 ) ] / 0.0155]

= 1 + 21.926

= 22.926

PVAF(28,1.55%) = 22.926

Thus , Present Value of Annuity = $4,000 × 22.926 = $91704.00

2. Present value of Annuity due = Annuity Amount × Present Value Annuity Factor i.e. PVAF (n , r)

Present Value of Annuity = $90,000

n = No. of periods = 7.5 years × 4 quarters per year = 30 periods

r = 5.4% / 4 quarters = 1.35%,

PVAF(n,r) = [1-(1+r)^-n]/r

PVAF(n,r) = [1-(1+0.0135)^ -30]/0.0135

PVAF(30,1.35%) = (1 - 0.6688)/0.0135

PVAF(30,1.35%) = 0.3312/0.0135

PVAF(30,1.35%) = 24.53

Hence ;

$90,000 = Annuity Amount × 24.53

Annuity amount = $90,000/24.53 = $3,668.48