Future value of ordinary annuity = payment (compound interest factor)?
Posted by MarkAug 3
CAN SOMEONE EXPLAIN IN DETAIL THE CONCEPT OF FUTURE VALUE OF ORDINARY ANNUITY = PAYMENT (COMPOUND INTEREST FACTOR). Also I would like the correct formula.
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OK, here goes nothing……
By definition an annuity is equal payments that earn some interest rate over a period of time. That means that if you make equal monthly payments for 10 years you will earn interest on top of interest because of compounding. The interest compounds because interest is paid in the form of money and then interest is earned on top of interest. The trick and easy thing about an annuity is that all payments must be the same to work, otherwise it is not an annuity.
The formula for an ordinary annuity is (from memory)
FV=PMT(1+int/number of compounding periods in a year)^n-1
———————————————
(int/number of compounding periods in a year)
or
300,000= 201.3(1+.08/12)^360-1
———-
(.08/12)
PMT= payment
FV= future value
n= number of compounding periods
int= interest rate
In the example above we used a future value of $300000 and we wanted to know what our payment would have to be to get to 300000 if we were making payments every month for 30 years and earned a return of 8%. In this case we learned that we would need to put $201.30 per month to achieve that goal.
I hope this helps
email me if not
what u pays is what u get. If u want to have an annuity of such value, u would have to pay for it with such price. but since $1 now is worth more than $1 in the future, the interest compounding has to be taken into account when calculating how much payments r required.
I would explain this myself, but it will take forever to type.
Investopedia has a great explanation with examples. Follow the link or cut and paste.
http://www.investopedia.com/articles/03/101503.asp
Goodluck!