Ordinary Annuity Formula

Formula to Calculate PV of Ordinary Annuity

Ordinary Annuity Formula refers to the formula that is used in order to calculate present value of the series of equal amount of payments that are made either at the beginning or end of period over specified length of time and as per the formula, present value of ordinary annuity is calculated by dividing the Periodic Payment by 1 minus 1 divided by 1 plus interest rate (1+r) raise to the power frequency in period (in case of payments made at the end of period) or raise to the power frequency in period minus one (in case of payments made at the beginning of period)  and then multiplying the resultant with rate of interest.

The formula is given below

Present Value of Ordinary Annuity (Beg) = r * P / {1 – (1+r)-(n-1)}

Present Value of Ordinary Annuity (End) = r * P / {1 – (1+r)-(n)}

Ordinary-Annuity-Formula

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For eg:
Source: Ordinary Annuity Formula (wallstreetmojo.com)

Where,

  • P is the Periodic Payment
  • r is the interest rate for that period
  • n will be a frequency in that period
  • Beg is Annuity due at the beginning of the period
  • The end is Annuity due at the end of the period

Explanation

The present value of ordinary annuityOrdinary AnnuityAn ordinary annuity refers to recurring payments of equal value made at regular intervals for a fixed period. The frequency of these consecutive payments can be weekly, monthly, quarterly, half-yearly or yearly.read more takes into account the three major components in its formula. PMTPMTPMT function is an advanced financial function to calculate the monthly payment against the simple loan amount. You have to provide basic information, including loan amount, interest rate, and duration of payment, and the function will calculate the payment as a result.read more, which is nothing but r*P, which is the cash payment, then we have r, which is nothing, but prevailing market interest rate P is the present value of initial cash flow, and finally, n is the frequency or the total number of periods. Then there two types of payment one annuity, which due at the beginning of the period, and the second one is due at the end of the period.

Both the formulas have a slight difference that is in one, we compound by n, and in another, we compound by n-1; that’s because the payment 1st that is made will be made today, and hence no discounting is applied to the 1st payment for the beginning annuity.

Examples

You can download this Ordinary Annuity Formula Excel Template here – Ordinary Annuity Formula Excel Template

Example #1

Keshav has inherited $500,000 as per the agreement. However, the agreement stated that the payment would be received in equal installments as an annuity for the next 25 years. You are required to calculate the amount that shall be received by Keshav, assuming the interest rate prevailing in the market is 7%. You can assume that annuity is paid at the end of the year.

Solution

Use the following data can be used for calculation

  • Present Value of Lumpsum Amount (P): 10000000
  • Number of Period (n): 25
  • Rate of Interest (r): 7%

Therefore, the calculation of the ordinary annuity (end) is as follows

Ordinary Annuity Formula Example 1.1
  • =500,000* 7% /{1-(1+7%)-25}

Ordinary Annuity Value (end) will be –

Example 1.2

Example #2

Mr. Vikram Sharma has just settled in his life. He got married to a girl he wished for and also got the job he was looking for a long time. He has done his graduation from London, and he has also inherited $400,000 from his father, who is his current savings.

He and his wife are looking to buy a house in the town worth $2,000,000. Since they don’t own that much funds, they have decided to take a bank loan whereby they will be required to pay 20% from their own pocket, and the rest would be taken care of by the loan.

The Bank charges an interest rate of 9%, and the installments need to pay monthly. They decide to go for 10 years loan and have confidence that they shall repay the same sooner than the estimated 10 years.

You are required to calculate the present value of the installments that they will be paying monthly starting at the month.

Solution

Use the following data for calculation of ordinary annuity due at a beginning period

  • House Value: 2000000
  • Loan Ratio: 80%
  • Present Value of Lumpsum Amount (P): 1600000
  • Number of Period (n): 10
  • Number of Period in Months: 120
  • Rate of Interest (r): 9%
  • Rate of Interest Monthly: 0.75%

Here, Mr. Vikram Sharma and his family have taken a housing loan, which equals $2,000,000 * (1 – 20%) to $1,600,000.

  • Now we know the present value of the lump sum amount that shall be paid, and now we need to calculate the present value of monthly installments using the below start of the period formula.
  • The interest rate per annum is 9%. Therefore the monthly rate shall be 9%/12 is 0.75%.

Therefore, the calculation of the ordinary annuity (Beg) is as follows

Example 2.1
  • = 0.75%*1,600,000/{1-(1+0.75%)-119}

Ordinary Annuity Value (Beg) will be –

Ordinary Annuity Formula Example 2.2

Example #3

Motor XP has been recently made available in the market, and in order to promote its vehicle, the same has been offered a rate of 5% for the initial three months of launch.

John, who is aging 60 years now, is eligible for an annuity that he purchased 20 years ago. Wherein he made the lump sum amount of 500,000, and the annuity will be paid yearly till 80 years of age, and the current market rate of interest is 8%.

He is interested in buying the model XP motor and wants to know whether the same would be affordable for the next 10 years if he takes it on EMI payable yearly? Assume that the price of the bike is the same as the amount he invested in the annuity plan.

You are required to advise John where his annuity will meet the EMI expenses?

 Assume both are incurred at the end of the year only.

Solution

In this case, we need to calculate two annuities one is a normal one, and another one is a loan annuity.

ParticularsAnnuityBike
Present Value of Lumpsum Amount (P)500000500000
Number of Period (n)2010
Rate of Interest (r)8.00%5.00%

Annuity

Therefore, the calculation of the ordinary annuity (end) is as follows

Ordinary Annuity Formula Example 3.1
  • = 500,000 * 8%/{1-(1+8%)-20}

Ordinary Annuity Value (end) will be –

Ordinary Annuity Formula Example 3.2

Motor XP

Therefore, the calculation of the ordinary annuity (end) is as follows

Example 3.3
  • =  5%*500,000/{1-(1+5%)-10}

Ordinary Annuity Value (end) will be –

Ordinary Annuity Formula Example 3.4

There is a gap of 13,826.18 between Annuity payment and Loan payment, and hence either John should be able to take out of from pockets, or he should extend the EMI till 20 years, which is the same as an annuity.

Relevance and Uses

Ordinary annuities real-life examples could be interest payments from issuers of the bond and those payments are generally paid monthly, quarterly, or semi-annually and further dividends that are paid quarterly by a firm that has maintained payout which is stable for years. PV of an ordinary annuity will be majorly dependent upon the current market interest rate. Due to the TVMTVMThe Time Value of Money (TVM) principle states that money received in the present is of higher worth than money received in the future because money received now can be invested and used to generate cash flows to the enterprise in the future in the form of interest or from future investment appreciation and reinvestment.read more, in case of rising interest rates, the present value will decrease, while in the scenario of declining interest rates, it shall lead to an increase in the annuities present value.

Recommended Articles

This has been a guide to the Ordinary Annuity Formula. Here we discuss the formula to calculate the present value of ordinary annuity along with a downloadable excel template. You can learn more about financing from the following articles –

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