Deferred Annuities (uniform series)

Until now, we have assumed ordinary

annuities. The first cash flow is at the end of
the first period.

If the cash flows do not start until some later

time period, the annuity is known as deferred
annuity.

If the annuity is deferred (J<N) periods, we

have the following cash flow diagram.
 Present Value of Deferred Annuity
If an annuity is deferred J periods, where J < N
Finding P given A for an ordinary annuity is
expressed by:
P = A ( P / A, i%,N )

This is expressed for a deferred annuity by:

A ( P / A, i%,N - J ) at end of period J

This is expressed for a deferred annuity by:

A ( P / A, i%,N - J ) ( P / F, i%, J )
as of time 0 (the present time )
 Summary
To Find Given Factor Factor Symbol
Name
Single payment (F/P, i%, N)
F P (1+i)N compound amount

Single payment (P/F,i%,N)

P F 1/(1+i)N present worth
Uniform series (F/A,i%N)
F A [(1+i)N-1]/i compound
amount
[(1+i)N-1]/[i(1+i)N] Uniform series (P/A,i%,N)
P A present worth
Sinking fund (A/F,i%,N)
A F i/[(1+i)N-1]
A P [i(1+i)N]/[(1+i)N-1] Capital recovery (A/P,i%,N)
Figure 4-10 Example 4-16 for Calculating the
Equivalent P, F, and A Values
 Figure 4-11 Spreadsheet Solution, Example 4-16

For Turkish Excel:

PMT function is =
DEVRESEL_DEME
Figure 4-12 Cash-Flow Diagram for Example 4-18
 Sometimes cash flows change by a constant
amount each period.
We can model these situations as a uniform
gradient of cash flows. The table below
shows such a gradient.
End of Period Cash Flows
1 0
2 G
3 2G
: :
N (N-1)G
Cash Flow Diagram for a Uniform Gradient
Increasing by G Dollars per period

i = effective interest rate (N-1)G

(N-1)G
per period
(N-2)G
(N-3)G

3G
2G
G
..
1 2 3 4 N-2 N-1 N
End of Period
It is easy to find the present value of
a uniform gradient series.

Similar to the other types of cash flows, there is a

formula (albeit quite complicated) we can use to find
the present value, and a set of factors developed for
interest tables.
 We can also find A or F
equivalent to a uniform gradient
series.
The annual equivalent of this series End of Year Cash Flows ($)
of cash flows can be found by
considering an annuity portion of the 1 2,000
cash flows and a gradient portion.
2 3,000
3 4,000
4 5,000
End of Year Annuity ($) Gradient ($)
1 2,000 0
2 2,000 1,000
3 2,000 2,000
4 2,000 3,000
Figure 4-14 Breakdown of Cash
Flows for Example 4-21
 Sometimes cash flows change by
a constant rate each period--this
is a geometric gradient series.

This table presents a geometric gradient

series. It begins at the end of year 1 and
End of Year Cash Flows ($)
has a rate of growth, , of 20%. 1 1,000
2 (x1,20) 1,200

3 (x1,20) 1,440
4 (x1,20) 1,728
We can find the present value of a geometric
series by using the appropriate formula
below.

P=

P=

Where is the initial cash flow in the series.

 Finding F and A given A1 and f
Once P is found A and F can be computed
using P

A=P(A/P,i%,N)

F=P(F/P,i%,N)
Interest rates that vary with time
We have assumed that the interest rate is constant
throughout the planning period

If it is estimated that the interest rate will change in

different periods, we have to use the appropriate
rate for the corresponding period.
The present equivalent of a cash flow occurring at
the end of period N can be computed with the
equation below, where ik is the interest rate for the
kth period.

If F4 = $2,500 and i1=8%, i2=10%, and i3=11%, then

Nominal and effective interest rates.
More often than not, the time between
successive compounding, or the interest period, is
less than one year (e.g., daily, monthly, quarterly).
The annual rate is known as a nominal rate.
A nominal rate of 12%, compounded monthly,
means an interest of 1% (12%/12) would accrue
each month, and the annual rate would be
effectively somewhat greater than 12%.
The more frequent the compounding the greater
the effective interest.
 The effect of more frequent
compounding can be easily
determined.
Let r be the nominal, annual interest rate and M the
number of compounding periods per year. We can
find, i, the effective interest per year by using the
formula below.
Converting Annual Percentage
Rate (APR) to period of interest
Converting Annual Percentage Rate
(APR) to period of interest

Source: Systems Life Cycle Costing: Economic Analysis,

Estimation and Management, John Vail Farr, Taylor and
Francis, 2011
 Example
APR = %10; Calculate effective annual intesest
rate ieff and monthly interest rate imonth
m = 12 months in a year

Source: Systems Life Cycle Costing: Economic Analysis,

Estimation and Management, John Vail Farr, Taylor and
Francis, 2011
 Compounding More Often than Once per Year
The effective interest rate for k periods is:
r k
i (1 ) 1
M
Example: For an 18% nominal rate compounded quarterly,
effective interest for 9 months is found as follows (two methods):
First method:
M = 4 (quarters in one year) ; k = (9 months = 3 quarter)
Efective annual interest rate = i(eff) = (1 + (0,18/4))4 - 1= 0,1925
Effective 9 month interest = i(9month) = (1 + i(eff))3/4 1 =
= ( 1 + 0,1925)3/4 1 = 14,12%
or by simply using the formula above:
0.18 3
i9 month (1 ) 1 14.12%
4
 Finding effective interest rates.

For an 18% nominal rate, compounded quarterly, the

effective (annual) interest is.

For a 7% nominal rate, compounded monthly, the

effective (annual) interest is:
 r M
i (1 ) 1
M
Efective annual interest rate = i(eff) = (1 + (0,06/4))4 - 1= 0,0614 = 6,14%
Example for Equivalent Annual
Value Comparison
Example

Source: Systems Life Cycle Costing: Economic Analysis,

Estimation and Management, John Vail Farr, Taylor and
Francis, 2011
Source: Systems Life Cycle Costing: Economic Analysis,
Estimation and Management, John Vail Farr, Taylor and
Francis, 2011