Present Value of an
Ordinary Annuity

We can use present value calculations to determine the number of periods (or payments) in an ordinary annuity if we know the other components: present value, interest rate, and the amount of each recurring payment. Exercises 7 and 8 below demonstrate how to solve for the number of periods (or payments).



Exercise #7. Janine has an investment account with a present value of $5,053. The account earns interest at 6% per year compounded annually. She intends to withdraw $500 at the end of each year. Assume that the present time (period 0) is January 1, 2006 and the first withdrawal will take place on December 31, 2006. How many withdrawals can Janine make before her account balance shrinks to $0?

PVOA=	$5,053
	$500	$500	$500	$500			$500
						.....
	← 1 year →	← 1 year →	← 1 year →	← 1 year →			← 1 year →
1/1/06	12/31/06	12/31/07	12/31/08	12/31/09			12/31/??
0	1	2	3	4			n=??
n = ?? years;  i = 6% per year

Calculation of Exercise #7 using the PVOA Table
Solving for n (the number of periods/payments in an ordinary annuity) is done with the following equation:

	PVOA   =	PMT times [ PVOA factor = for n = ?? years; i = 6% per year ]
	$5,053   =	$500 times [ PVOA factor = for n = ?? years; i = 6% per year ]
	$10,152 / 5.076   =	[ PVOA factor = for n = ?? years; i = 6% per year ]
	10.106   =	[ PVOA factor = for n = ?? years; i = 6% per year ]
	10.106   =	PVOA factor = for n = 16 years; i = 6% per year

Let's review this calculation. We insert into the equation the components that we know: the present value, the interest rate, and the recurring payment amount. In line four, we calculate our factor to be 10.106. We now know both the PVOA factor (10.106) and the interest rate (6%). We go to the PVOA Table and look down the 6% interest column until we come to the factor 10.106. Tracking across the row, we see that at this point, n = 16. Since the periods in question are annual periods, the answer is 16 years.

Here is the proof of this calculation:

Investment Account Activity

W/D No.	Date	Interest Added	Withdrawal	Account Balance
	Jan. 1, 2006			$ 5,053.00
1	Dec. 31, 2006	$ 303.18	$ 500.00	$ 4,856.18
2	Dec. 31, 2007	291.37	500.00	4,647.55
3	Dec. 31, 2008	278.85	500.00	4,426.40
4	Dec. 31, 2009	265.58	500.00	4,191.99
5	Dec. 31, 2010	251.52	500.00	3,943.51
6	Dec. 31, 2011	236.61	500.00	3,680.12
7	Dec. 31, 2012	220.81	500.00	3,400.92
8	Dec. 31, 2013	204.06	500.00	3,104.98
9	Dec. 31, 2014	186.30	500.00	2,791.28
10	Dec. 31, 2015	167.48	500.00	2,458.76
11	Dec. 31, 2016	147.53	500.00	2,106.28
12	Dec. 31, 2017	126.38	500.00	1,732.66
13	Dec. 31, 2018	103.96	500.00	1,336.62
14	Dec. 31, 2019	80.20	500.00	916.81
15	Dec. 31, 2020	55.01	500.00	471.82
16	Dec. 31, 2021	28.31	500.00	0.13

Exercise #8. Jeremy borrows $4,461 at an interest rate of 8% per year, compounded semiannually on each July 1 and January 1. He plans to make a $600 loan payment at the end of each semiannual period. Assuming that the present time (period 0) is January 1, 2006 and the first loan payment will take place on July 1, 2006, when will the loan balance be $0?

PVOA=	$4,461
	$600	$600	$600	$600			$600
						.....
	← 6 months →	← 6 months →	← 6 months →	← 6 months →			← 6 months →
1/1/06	7/1/06	1/1/07	7/1/07	1/1/08			??
0	1	2	3	4			n=??
n = ?? semiannual periods;  i = 4% per semiannual period

Calculation of Exercise #8 using the PVOA Table
The number of semiannual periods/payments in the ordinary annuity can be computed with the PVOA equation:

	PVOA   =	PMT times [ PVOA factor = for n = ?? semiannual periods; i = 4% per semiannual period ]
	$4,461   =	$600 times [ PVOA factor = for n = ?? semiannual periods; i = 4% per semiannual period ]
	$4,461 / $600   =	[ PVOA factor = for n = ?? semiannual periods; i = 4% per semiannual period ]
	7.435   =	[ PVOA factor = for n = ?? semiannual periods; i = 4% per semiannual period ]
	7.435   =	PVOA factor = for n = 9 semiannual periods; i = 6% per semiannual period

Let's review this calculation. We insert into the equation the components that we know: the present value, the interest rate, and the recurring payment amount. In line four, we calculate our factor to be 7.435. We now know both the PVOA factor (7.435) and the interest rate (4%). We go to the PVOA Table and look down the 4% interest column until we come to the factor 7.435. Tracking across the row, we see that at this point, n = 9. Since the periods in question are semiannual periods, the answer is 9 semiannual periods.

The question we were asked is "when will the loan balance be $0?" The answer is July 1, 2010. Here is the proof of this calculation:

   Loan Amortization Schedule
   (For $4,461 at 8% per year with 9 semiannual payments.)

Pmt No.	Date	Total Payment	Interest Payment*	Principal Payment**	Principle Balance
	Jan. 1, 2006				$ 4,461.00
1	July 1, 2006	$ 600.00	$ 178.44	$ 421.56	4,039.44
2	Jan. 1, 2007	600.00	161.58	438.42	3,601.02
3	July 1, 2007	600.00	144.04	455.96	3,145.06
4	Jan. 1, 2008	600.00	125.80	474.20	2,670.86
5	July 1, 2008	600.00	106.83	493.17	2,177.70
6	Jan. 1, 2009	600.00	87.11	512.89	1,664.80
7	July 1, 2009	600.00	66.59	533.41	1,131.39
8	Jan. 1, 2010	600.00	45.26	554.74	576.65
9	July 1, 2010	600.00	23.07	576.93	(0.28)

   * Interest payment equals 4% of the previous principal balance.
   ** Principal payment equals $600 minus interest payment.

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