Annuities
An engineer retires with $650,000 available for investment. She invests the money in
a portfolio which is expected to have an average return of 5% per annum. She wants
to have the account pay a monthly income to her and asks the accountant to assume
that the income must last for 20 years. What income can be withdrawn?
The
PV
for this problem is negative because, from the point of view of
the engineer, the money flow is outward from her to the investment
portfolio. The value of the regular payment, which has been solved for
on the right, is positive as it is being paid from the portfolio to her. We
also assume that the future value
FV
is to be zero since the income is
only to last for 20 years. The value of
N
is 240, representing 20 years of
monthly payments. On this basis the monthly annuity can be $4289.71
Loan calculations
You wish to purchase a car by taking out a loan. The current interest rate is 6.5%
and you can afford to make monthly payments of $300. You want to take out the
loan over a period of 6 years and to still owe $10,000 at the end of that period (you
expect an investment to mature at that time to pay the final amount). How much can
you borrow?
In this case, from your point of view, the payments and the
FV
final
residual are outgoing (negative) since they are made to the bank. The
present value (the loan) is positive.
N
is set to 6 years of monthly
payments.
to find the
PV
and this is the amount that can be
borrowed. It will be positive since it is going from the bank to you. In this case it is clear that you can afford to
borrow $24,624.29.
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