# 5.4 Calculating the Payment

## LEARNING OBJECTIVES

- Calculate the payment for an annuity.

Whether you are acquiring merchandise, property or saving up toward some future goal such as retirement, you will deal with annuity payments. When you graduate college and land that promising entry-level position with your employer, a lot of demands are going to get placed on your limited income. If you do not already own a place of your own, perhaps you will get one. This means the purchase of a starter home for which you will make monthly mortgage payments. To fill that home, acquiring some furniture and electronics might take you to The Brick, Sleep Country Canada, Best Buy, or The Home Depot. Then you may be staggered by all the home maintenance items you need. If you make a lot of purchases all at once, you will probably take advantage of various payment plans. These place even more demands on your monthly income. Do not forget that you will need some wheels too. You can either lease or purchase a car. Great, another payment to make! Finally, you remember what your math instructor taught you about the importance of getting started early on your RRSP, so you should begin making those monthly contributions soon, too.

Similarly, businesses also make annuity payments for a wide variety of purposes, such as saving up for future corporate goals or acquiring products and property, businesses have regular bills, too. Marketers develop payment plans for their consumers. Financial agents make investments involving periodic payments. Companies issue marketable bonds that require regular interest payments to investors. Human resource personnel look after employee benefits, including RRSP contributions and pension plan payments. Production departments need expensive machinery, so they must keep payment plans within operating budgets. No matter your choice of profession, as a business manager you will encounter annuity payment calculations.

You need to calculate an annuity payment in many situation:

- Figuring out loan or mortgage payments.
- Determining membership or product payment plans.
- Calculating lease payments.
- Determining the periodic payment necessary to achieve a savings goal.
- Determining the maximum payment that an investment annuity can sustain over period of time.

## Using a Financial Calculator

Recall that the annuity payment, PMT, is one of the variables in the future value and present value formulas for annuities. Calculating the payment requires you to determine which formula to use (depending on the type of annuity and whether you have the future value or present value), and then rearranging the formula to solve for PMT.

As we have seen, a financial calculator can quickly find the payment amount. You use the financial calculator in the same way as described previously, but the only difference is that the unknown quantity is PMT (the payment). You must still load the other six variables into the calculator, set the calculator to the correct payment setting, and apply the cash flow sign conventions carefully.

## USING THE TI BAII PLUS CALCULATOR TO FIND AN ANNUITY PAYMENT

- Set the calculator to the correct payment setting (END or BGN).
- Enter values for the known variables (PV, FV, N, I/Y, P/Y and C/Y), paying close attention to the cash flow sign convention for PV and FV.
- After all of the known quantities are loaded into the calculator, press CPT and then PMT to solve for the payment.

### NOTES

- Ensure that the calculator is set to the required payment setting. The payment will be different for END and BGN.
- The values you enter for PV and FV must adhere to the cash flow sign convention.

_{Ordinary Annuity Calculations (PV, PMT, FV) by Joshua Emmanuel [4:31] (transcript available).}

_{BAII Plus Down Payment Questions|PV and PMT by Joshua Emmanuel [3:54] (transcript available).}

## EXAMPLE

Morgan wants to consolidate a lot of smaller debts into a single three-year loan for $25,000. If the loan is charged interest at 7.8% compounded monthly, what is her payment amount at the end of every month?

**Solution:**

The timeline for the loan appears below.

PMT Setting |
END |

N |
[latex]12 \times 3=36[/latex] |

PV |
[latex]25,000[/latex] |

FV |
[latex]0[/latex] |

PMT |
? |

I/Y |
[latex]7.8[/latex] |

P/Y |
[latex]12[/latex] |

C/Y |
[latex]12[/latex] |

[latex]PMT=\$781.10[/latex]

To pay off her consolidated loan, Morgan’s month-end payments for the next three years are $781.10.

## EXAMPLE

You plan to retire in 20 years. When you do, you want to have saved $200,000 in an RRSP. To accomplish this goal, you will make quarterly payments into an RRSP that earns 3.1% compounded semi-annually.

- Calculate the size of the quarterly payments.
- How much interest does the RRSP earn?

**Solution:**

**Step 1: ** Calculate the quarterly payments.

PMT Setting |
END |

N |
[latex]4 \times 20=80[/latex] |

PV |
[latex]0[/latex] |

FV |
[latex]200,000[/latex] |

PMT |
? |

I/Y |
[latex]3.1[/latex] |

P/Y |
[latex]4[/latex] |

C/Y |
[latex]2[/latex] |

[latex]PMT=\$1,816.29[/latex]

**Step 2:** Calculate the interest.

[latex]\begin{eqnarray*} I & = & FV-n \times PMT \\ & = &200,000- 80 \times 1,816.29 \\ & = & \$54,696.80 \end{eqnarray*}[/latex]

You need to make quarterly payments of $1,816.29 to accomplish your goal. You will earn $54,696.80 in interest over the 20 years.

## EXAMPLE

Franco has placed $10,000 into an investment fund with the goal of receiving equal amounts at the beginning of every month for the next year while he backpacks across Europe. If the investment fund can earn 5.25% compounded quarterly, how much money can Franco expect to receive each month?

**Solution:**

The timeline for the vacation money appears below.

PMT Setting |
BGN |

N |
[latex]12 \times 1=12[/latex] |

PV |
[latex]-10,000[/latex] |

FV |
[latex]0[/latex] |

PMT |
? |

I/Y |
[latex]5.25[/latex] |

P/Y |
[latex]12[/latex] |

C/Y |
[latex]4[/latex] |

[latex]PMT=\$853.40[/latex]

While backpacking across Europe, Franco’s annuity will pay him $853.40 at the beginning of every month.

## TRY IT

To save approximately $30,000 for a down payment on a home four years from today, what amount needs to be invested at the end of every month at 4.5% compounded semi-annually?

**Click to see Solution**

PMT Setting |
END |

N |
[latex]48[/latex] |

PV |
[latex]0[/latex] |

FV |
[latex]30,000[/latex] |

PMT |
? |

I/Y |
[latex]4.5[/latex] |

P/Y |
[latex]12[/latex] |

C/Y |
[latex]2[/latex] |

[latex]PMT=\$572.08[/latex]

## EXAMPLE

Kingsley’s financial adviser has determined that when he reaches age 65, he will need $1.7 million in his RRSP to fund his retirement. Kingsley is currently 22 years old and has saved up $10,000 already. His adviser thinks that his RRSP will average 9% compounded annually throughout the years. To meet his RRSP goal, how much does Kingsley need to invest every month starting today?

**Solution:**

The timeline for Kingsley’s RRSP contributions appears below.

PMT Setting |
BGN |

N |
[latex]12 \times 43=516[/latex] |

PV |
[latex]-10,000[/latex] |

FV |
[latex]1,700,000[/latex] |

PMT |
? |

I/Y |
[latex]9[/latex] |

P/Y |
[latex]12[/latex] |

C/Y |
[latex]1[/latex] |

[latex]PMT=\$233.24[/latex]

To meet his retirement goals, Kingsley needs to invest $233.24 at the beginning of every month for the next 43 years.

## EXAMPLE

The production department just informed the finance department that in five years’ time the robotic systems on the production line will need to be replaced. The estimated cost of the replacement is $10 million. To prepare for this purchase, the finance department immediately deposits $1,000,000 into a savings annuity earning 6.15% compounded semi-annually, and it plans to make semi-annual contributions starting in six months. How large do those contributions need to be?

**Solution:**

The timeline for the machinery fund appears below.

PMT Setting |
END |

N |
[latex]2 \times 5=10[/latex] |

PV |
[latex]-1,000,000[/latex] |

FV |
[latex]10,000,000[/latex] |

PMT |
? |

I/Y |
[latex]6.15[/latex] |

P/Y |
[latex]2[/latex] |

C/Y |
[latex]2[/latex] |

[latex]PMT=\$751,616.87[/latex]

To have adequate funding for the production line machinery replacement five years from now, the finance department needs to deposit $751,616.87 into the fund every six months.

## TRY IT

Sinclair does not believe in debt and will only pay cash for all purchases. He has already saved up $140,000 toward the purchase of a new home with an estimated cost of $300,000. Suppose his investments earn 7.5% compounded monthly. How much does he need to contribute at the beginning of each quarter if he wants to purchase his home in five years?

**Click to see Solution**

PMT Setting |
BGN |

N |
[latex]20[/latex] |

PV |
[latex]-140,000[/latex] |

FV |
[latex]300,000[/latex] |

PMT |
? |

I/Y |
[latex]7.5[/latex] |

P/Y |
[latex]4[/latex] |

C/Y |
[latex]12[/latex] |

[latex]PMT=\$3,943.82[/latex]

## EXAMPLE

Over the next 15 years, you will invest $900 every month into an RRSP that earns 4.3% compounded semi-annually. At the end of the 15 years, you plan to retire and will transfer the money in the RRSP to a RIF earning 2.9% compounded quarterly. Over the next 20 years, you will receive quarterly payments from the RIF. Calculate the size of the quarterly RIF payments.

**Solution: **

**Step 1: ** Calculate the future value at the end of the RRSP.

PMT Setting |
END |

N |
[latex]12 \times 15=180[/latex] |

PV |
[latex]0[/latex] |

FV |
? |

PMT |
[latex]-900[/latex] |

I/Y |
[latex]4.3[/latex] |

P/Y |
[latex]12[/latex] |

C/Y |
[latex]2[/latex] |

[latex]FV=\$226,289.88...[/latex]

**Step 2:** Calculate the payment for the RIF. The future value from the RRSP becomes the present value for the RIF: [latex]PV=\$226,289.88...[/latex]

PMT Setting |
END |

N |
[latex]4 \times 20=80[/latex] |

PV |
[latex]-226,289.88...[/latex] |

FV |
[latex]0[/latex] |

PMT |
? |

I/Y |
[latex]2.9[/latex] |

P/Y |
[latex]4[/latex] |

C/Y |
[latex]4[/latex] |

[latex]PMT=\$3,737.74[/latex]

You will receive quarterly payments of $3,737.74 from the RIF.

## EXAMPLE

When you retire, you want to receive beginning-of-month payments of $750 for 30 years from a RIF earning 4.1% compounded quarterly. To plan for this, you want to make beginning-of-quarter payments for the next 25 years leading up to your retirement into your RRSP that earns 2.7% compounded semi-annually. What payments do you need to make to your RRSP?

**Solution: **

**Step 1: ** Calculate the present value at the start of the RIF.

PMT Setting |
BGN |

N |
[latex]12 \times 30=360[/latex] |

PV |
? |

FV |
[latex]0[/latex] |

PMT |
[latex]750[/latex] |

I/Y |
[latex]4.1[/latex] |

P/Y |
[latex]12[/latex] |

C/Y |
[latex]4[/latex] |

[latex]PV=\$156,005.04...[/latex]

**Step 2:** Calculate the payment for the RRSP. The present value from the RIF becomes the future value for the RRSP: [latex]FV=\$156,005.04...[/latex]

PMT Setting |
BGN |

N |
[latex]4 \times 25=100[/latex] |

PV |
[latex]0[/latex] |

FV |
[latex]156,005.04...[/latex] |

PMT |
? |

I/Y |
[latex]2.7[/latex] |

P/Y |
[latex]4[/latex] |

C/Y |
[latex]2[/latex] |

[latex]PMT=\$1,091.40[/latex]

You will need to make quarterly payments of $1,091.40 into the RRSP.

## TRY IT

The Kowalskis’ only child is eight years old. They want to start saving into an RESP so that their son will be able to receive $5,000 at the end of every quarter for four years once he turns 18 and starts attending postsecondary school. When the annuity is paying out, it is forecast to earn 4% compounded monthly. While they make contributions at the end of every month to the RESP, it will earn 8% compounded semi-annually. What is the monthly contribution payment by the Kowalskis?

**Click to see Solution**

PMT Setting |
END | END |

N |
[latex]16[/latex] | [latex]120[/latex] |

PV |
[latex]\textcolor{blue}{-73,569.219...}[/latex] | [latex]0[/latex] |

FV |
[latex]0[/latex] | [latex]73,569.219...[/latex] |

PMT |
[latex]5,000[/latex] | [latex]\textcolor{blue}{405.06}[/latex] |

I/Y |
[latex]4[/latex] | [latex]8[/latex] |

P/Y |
[latex]4[/latex] | [latex]12[/latex] |

C/Y |
[latex]12[/latex] | [latex]2[/latex] |

[latex]\displaystyle{PMT=\$405.06}[/latex]

**Exercises**

- In 5 years, Joan wants to have $25,000 in her savings account. What beginning-of-month payments does she need to make if the account earns 8.25% compounded monthly? How much interest does the account earn over the 5 years?

**Click to see Answer**$335.72, $4,856.80

- You have $500,000 in an investment fund that earns 5.9% compounded semi-annually. Over the next 15 years, you will receive quarterly payments from the fund. Calculate the size of the payments. How much interest does the fund pay?

**Click to see Answer**$12,580.44, $254,826.40

- You retire today with $1,000,000 saved up in your RRSP. You immediately transfer the funds to an RIF earning 4.75% compounded semi-annually. You will receive beginning-of-month payments from the RIF for 25 years. What is the size of the monthly payments you will receive?

**Click to see Answer**$5,652.40

- How much does Alex need to deposit ever year into his savings account if he wants to have $1,500,000 in 35 years? The savings account earns interest at 9% compounded annually.

**Click to see Answer**$6,953.76

- You purchase a $58,000 car. You pay $4,500 as a down payment and take out a loan for the balance at 3.65% quarterly. You repay the loan with monthly payments for 6.5 years. What is the size of your monthly loan payment? How much interest did you pay to buy the car?

**Click to see Answer**$771.25, $6,657.50

- Your business needs to save up for a major capital expense planned in 4 years that will cost $5,000,000. Currently the business has $450,000 saved in an investment fund earning 4.35% compounded monthly. How much does the business need to deposit into the fund at the end of every year to have enough money saved for the project?

**Click to see Answer**$1,044,548.68

- At age 60, Tiger has managed to save $850,000 and decides to retire. He wants to receive equal payments at the beginning of each month for the next 25 years. The annuity can earn 5.4% compounded quarterly.
- If he plans on depleting the annuity, how much are his monthly payments?
- If he wants to have $50,000 left over at the end of the annuity, how much are his monthly payments?

**Click to see Answer**a. $5,133.93; b. $5,054.93

- To purchase his new $50,000 car, Scooby-Doo pays $10,000 down and obtains a six-year loan for the balance at 8.8% compounded semi-annually.
- Determine the monthly payments required on the loan.
- How much interest does he pay on the loan?

**Click to see Answer**a. $713.95; b. $11,404.40

- Gold’s Gym wants to offer its clients a monthly payment option on its annual membership dues of $490. If the gym charges 7.75% compounded quarterly on its membership fee, what beginning-of-month payments should it advertise?

**Click to see Answer**$42.29

- Carling Industries needs to acquire some real estate to expand its operations. In negotiations with the Province of Nova Scotia, it will be allowed to purchase the $15 million parcel of land today and start making payments at the end of every six months for the next 10 years. If interest will be charged at 7.6% compounded semi-annually, what will be the required payments? (Round to the nearest dollar.)

**Click to see Answer**$1,084,268

- You want to have saved $100,000 in your savings account in 12 years. For the first 5 years, when the account earns 2.3% compounded monthly you make monthly payments of $235. For the last 7 years the account earns 3.62% compounded quarterly. What monthly payments do you need to make during the last 7 years to accomplish your goal? How much interest does your savings account earn?

**Click to see Answer**$846.83, $14,766.28

- In ten years, your daughter will go to university. During the four years she is in university, you want the RESP you set-up for your daughter to pay her $3,000 at the start of every six months. What beginning-of-month deposits do you need to make into the RESP over the next ten years if the RESP earns 3.89% compounded semi-annually?

**Click to see Answer**$153.16

- For the next 20 years, you deposit $1500 every quarter into your RRSP that earns 2.67% compounded semi-annually. At the end of the 20 years, you retire and convert the money saved in your RRSP to a RIF that earns 3.52% compounded quarterly. You want to receive monthly payments from the RIF for 25 years. What are the size of the monthly RIF payments?

**Click to see Answer**$790.63

- Santana wants his retirement money to pay him $3,000 at the beginning of every month for 20 years. He expects the annuity to earn 6.15% compounded monthly during this time. If his RRSP can earn 10.25% compounded annually and he contributes for the next 30 years, how much money does he need to invest into his RRSP at the end of every month? He has already saved $15,000 to date.

**Click to see Answer**$62.65

#### Attribution

“11.4: Annuity Payment Amounts” from Business Math: A Step-by-Step Handbook Abridged by Sanja Krajisnik; Carol Leppinen; and Jelena Loncar-Vines is licensed under a Creative Commons Attribution-NonCommercial-ShareAlike 4.0 International License, except where otherwise noted.

“11.4: Annuity Payment Amounts” from Business Math: A Step-by-Step Handbook (2021B) by J. Olivier and Lyryx Learning Inc. through a Creative Commons Attribution-NonCommercial-ShareAlike 4.0 International License unless otherwise noted.