In view of the coronavirus pandemic, we are making LIVE CLASSES and VIDEO CLASSES completely FREE to prevent interruption in studies
Time Value of Money

Annuities and Sinking Funds

Annuities and sinking fund, are different from one another. When the fund credit happens for a specific reason, then it is called a sinking fund. Furthermore, an annuity is paying or receiving money, generally a fixed amount for a specific time period. The annuity formula and sinking fund formula will make the facts more clear.

Suggested Videos

Play
Play
Play
Play
Arrow
Arrow
ArrowArrow
Compound Interest
Annuity and Its types
Positive and Negative Correlation
Time Series: Trend Values by Moving Averages
Slider

 

Sinking Fund

As mentioned earlier, whenever there is a fund credit for a specific purpose then it is called a sinking fund. The credits take place periodically and happen over a constant time period at a fixed rate of interest. Furthermore, at the end of every period, the calculation of interest takes place.

annuity formula

To calculate the size of the sinking fund, one can use the formula.

A = P.A (n,i)

Where,

A = Saving amount
P = Periodic payment
n = Period of payment

Browse more Topics under Time Value Of Money

Annuity

An annuity is something that we see happening even at our home. Most of the times, we see our parents paying up an amount on a regular basis. The amount remains the same mostly and the payment takes place either monthly or yearly.

Furthermore, for example: If you live in a rented house, then your parents are likely to pay the rent every month. Other examples include paying for insurance, house loan, vehicle loan, etc. In all of the cases, your parents pay an equal amount for each and every month. However, the time period between the payments may vary. It can either be one month or even a year.

Similarly, in some of the cases, people receive a constant amount of cash, for example, pension. This is where the annuity formula comes in picture. An annuity is nothing but a fixed sum of money that one receives or pays over a period for a fixed time. Generally, the annuity formula helps to understand the process.

Therefore, an annuity is nothing but a payment system that takes place periodically over some specified time period. Furthermore, a special version of annuity is known as the perpetuity. In perpetuity, there is an involvement of receipts that takes place for more than the usual time.

For an annuity, these are the features for more than one payment.

  1. For the whole span of annuity, the amount of money paid and received is likely to remain the same.
  2. Between two successive payments, the time interval must remain constant.

Types of Annuity

An annuity is of two types:

  • Annuity Regular
  • Annuity Due or Annuity Immediate.

I. Annuity Regular

In this type of annuity, first regular payment generally happens during the end of the first year. Here is a table that will explain it better.

Year Payments
1 15,000
2 15,000
3 15,000
4 15,000
5 15,000

Therefore, from the table, we can conclude the fact that the very first payment happens by the end of the first year. Hence, it is an annuity regular.

II. Annuity Due or Annuity Immediate

In this type of annuity, the first payment is usually made in the start i.e. start of the annuity. This is called annuity immediate or annuity due. Here is a table to make things clear.

Beginning Year Payments
1 50,000
2 50,000
3 50,000
4 50,000
5 50,000

Therefore, from the table, it is evident that the first payment is done at the start of the first year. Hence, we call such an annuity as an annuity due or annuity immediate.

Solved Examples on Annuity Formula

Sinking Fund

Example: Calculate the needed amount that must be invested every year so that the total amount sums up to Rs. 3,00,000 by the end of 10 years. The rate of interest is 10%, compounded annually.

Solution:  Here, A = Rs. 3,00,000; n = 10; i = 0.1. We know that,

A = P.A (n,i)
3,00,000 = P.A(10, 0.1)
= P * 15.9374248
∴ P = 3,00,000/15.9374248
= Rs. 18,825.62

Note: You can also use the formula for future value of annuity regular to calculate the final amount.

Share with friends

Customize your course in 30 seconds

Which class are you in?
5th
6th
7th
8th
9th
10th
11th
12th
Get ready for all-new Live Classes!
Now learn Live with India's best teachers. Join courses with the best schedule and enjoy fun and interactive classes.
tutor
tutor
Ashhar Firdausi
IIT Roorkee
Biology
tutor
tutor
Dr. Nazma Shaik
VTU
Chemistry
tutor
tutor
Gaurav Tiwari
APJAKTU
Physics
Get Started

Leave a Reply

avatar
  Subscribe  
Notify of

Stuck with a

Question Mark?

Have a doubt at 3 am? Our experts are available 24x7. Connect with a tutor instantly and get your concepts cleared in less than 3 steps.
toppr Code

chance to win a

study tour
to ISRO

Download the App

Watch lectures, practise questions and take tests on the go.

Get Question Papers of Last 10 Years

Which class are you in?
No thanks.