MATH 217_MATHEMATICS OF INVESTMENT
MODULE 5
AMORTIZATION AND SINKING FUND
CONTENT
INTRODUCTION
Amortization is the gradual extinguishment of any amount over a period of time, that is, the extinction of a
dept, principal and interest by means of a sequence of equal periodic payments or installment payments due at the
end of equal intervals of time. Usually the equal payments from an annuity whose present value is the original
principal of the loan. Payments made could either be by ordinary, due or deferred annuity. (Formulas in the previous
chapter).
Amoritization Schedule is a table, which shows how much is applied to reduce the principal and how much
portion is paid for interest to show the outstanding principal or remaining liabilities after each payment period. In this
book, we shall discuss amortization schedules with regular periodic payments and with irregular final payment.
Sinking Fund is a savings fund, productively invested into which equal periodic payments are made. It is
designed to accumulate a specific sum of money within a specified date. A sinking fund is created with a defined end
in view, such as big expenses in the future.
Amortization of a Debt
When a dept is amoriztized by equal payments at equal intervals the debt becomes the present value of an
annuity. The formula is:
For the present value: (A)
Table 6
Table 3
For the periodic payment: (R)
or
Table 6
Table 7 Table 3
Let us work on the following examples to illustrate the above.
Illustrative Examples
1. A loan of P 40,000 is to be amortized by equal payments at the end of each quarter for 18 months. If interest
is 10% compounded quarterly, find the periodic payment and construct an amortization schedule.
1
Given: A=P 40,000 r=10 % ,m=4 t=18 mos .∨1 yrs.
2
MATH 217_MATHEMATICS OF INVESTMENT
Solution:
18
i=10 % ÷ 4 n= =1.5
12
¿ 2.5 %=1.5 ×× 4
¿ .025=6
Table 6 Table 3
Table 7
P 40,000
P 40,000
P 40,000
¿
5.508125
¿ P 7,262.00
Amortization Schedule
Payment Number Unpaid Balance Interest Paid Periodic Paid Principal Repaid
1 P 40,000 P 1,000 P 7,262 P 6,262
2 33,738 843.45 7,262 6,418.55
3 27,319.45 682.99 7,262 6,579.01
4 20,740.44 518.51 7,262 6,743.49
5 13,996.95 349.92 7,262 6,912.08
6 7,084.87 177.12 7,262 7,084.88
P 3,571.99 P 43,572 P 40,000.01
Note:
a. As to be expected the interest paid decreases each payment(since the debt is getting smaller), and the
payment towards reduction of the obligation increases correspondingly.
b. The total principal repaid is equal to the original loan, if in case of more or less P .05 different repeat the
process.
2. A loan of 6 semi-annual payments of P 4,500 are to be made to pay for a loan at 9% compounded semi-
annually. Find the value of the loan and prepare an amortization schedule.
Given: R=P 4,500 r=9 % , m=2n=6
Solution:
i=9 % ÷2
1
¿4 %
2
¿ .045
Table 6
Table 3
MATH 217_MATHEMATICS OF INVESTMENT
¿ P 4,500 ¿
¿ P 23,210.42 ¿ P 23,210.44
Amorization Schedule
Payment Outstanding Principal Interest Paid Periodic Payment Principal Repaid
Number
1 P 23,210.42 P 1,044.47 P 4,500 P 3,455.53
2 19,754.89 888.97 4,500 3,611.03
3 16,143.86 726.47 4,500 3,773.53
4 12,370.33 556.66 4,500 3,943.34
5 8,426.99 379.21 4,500 4,120.79
6 4,306.20 193.78 4,500 4,306.22
P 3,789.56 P 27,000 P 23,210.44
3. An obligation of P 240,000 is to be extinguished by sime-annual payments of P 38,000 each as long as
necessary. If the interset rate is 14% converted semi-annually, find the number of regular payments needd
and the concluding payment if necessary and prepare an amortization schedule.
Given: A=P240,000 R=P 38,000 i=14 %
Solution:
i=14 % ÷ 2
¿7%
¿ .07 %
Solve for n
log ( 1−Ai / R )
n=
log ( 1+i )
log (1−P 240,000× .07÷ P 38,000 )
¿
log ( 1.07 )
¿ 8.625
8 regular payments and smaller payment on the 9th.
Amortization Schedule
Payment Outstanding Balance Interest Paid Periodic Payment Principal Repaid
Number
1 P 240,000.00 P 16,800.00 P 38,000 P 21,200.00
2 218,800.00 15,316.00 38,000 22,684.00
3 196,116.00 13,728.12 38,000 24,271.88
4 171,844.12 12,029.09 38,000 25,970.91
5 145,873.21 10,211.12 38,000 27,788.88
6 118,084.33 8,265.90 38,000 29,734.10
7 88,350.23 6,184.52 38,000 31,815.48
8 56,534.75 3,957.43 38,000 34,042.57
9 22,492.18 1,574.45 24,066.63 22,492.18
P 88,066.63 P 328,066.63 P 240,000.00
MATH 217_MATHEMATICS OF INVESTMENT
Finding the Outstanding Principal
Both the borrower and the lender must be updated on the status of any obligation, that is, they should know
the remaining liabilities or outstanding principal (OP) before or after any given number of transactions.
In the preceding section, we illustrated the amorization schedule showing the outsatanding principal, the
breakdown of the periodic payment into interest and repayment of principal after any given payment. However, when
the number of payments is too large, constructing an amorization schedule becomes laborious and tendious. Hence,
short cut methods are adopted.
In tis book, we shall consider two methods in deternining the outstanding principal (OP) or ramianing
liability, namely:
a. Prospective Method
b. Retrospective Method
Prospective Method
This method uses the future history of the debt. With this method the remaining liability or outstanding
principal is equivalent to the present value of all payments, which remain to be made. When all the payments
including the last one are the same, it is usually simpler to apply this method and we apply this formula:
Table 6
Where:
OP = outstanding principal
R = periodic payment
i = periodic rate
n = total number of payments
k = number of past payments
n–k =number of future payments that remain to be made.
Let us work on the following examples to illustrate the application of the above.
Illustrative Examples
1. A loan is to be amortized by equal payments of P 5,000 each at the end of each six months for 10 years. If
the interest is based on 7%, m=2, find:
a. The present value of loan;
b. The outstanding principal just after the 8th payment;
c. The remaining liability after 8 years.
Given: R=P 5,000 r =7 % , m=2 t=10 yrs.
Solution:
i=7 % ÷2 n=10× 2
1
¿ 3 %=20
2
¿ .035
Table 6
MATH 217_MATHEMATICS OF INVESTMENT
¿ P 5,000 ( 14.212403 )
¿ P 71,062.02
b., n=20 k=8 n−k=20−8
¿ 12
Table 6
12
¿ P 5,000 ( 9.663334 )
¿ P 48,316.67
c.n=20 k=8× 2 n−k=20−16
¿ 16=4
¿ P 5,000 ( 3.673079 )
¿ P 18,365.40
2. An obligation of P 80,000 will be amortized by payments at the end of each quarter for 8 ¾ years. If money is
worth 5%, m=4. Find:
a. the periodic payment;
b. the outstanding principal after 6 years;
c. the remaining liability after the 30th payment.
3
Given: A=P80,000 r =5 % , m=4 t=8 years
4
Solution:
MATH 217_MATHEMATICS OF INVESTMENT
3
i=5 % ÷ 4 n=8 × 4
4
1
¿ 1 %=35
4
¿ .0125
Table 6
P 80,000
¿
28.207858
¿ P 2,836.09
b. n=35 k=6 ×4 n−k=35−24
Table 6
11
¿ P 2,836.09 ( 10.217803 )
¿ P 28,978.61
c. n=35 k=30 n−k =35−30
¿5
Table 6
11
¿ P 2,836.09 ( 4.817835 )
¿ P 13,663.81
MATH 217_MATHEMATICS OF INVESTMENT
Retrospective Method
This method uses the past history of the debt. With this method, the outstanding principal is equivalent to
the difference between the accumulated value of the loan and the accumulated value of the past payments. When all
the periodic payments, excluding the last one, are the same, it is appropriate to use this method by applying formula:
OP=( Accum. Valueof A−Accum .Value of past payments )
Or
Table 2
Where: Table 5
OP = outstanding principal
A = present value of the loan
R = periodic payment
i = periodic rate
k =number of past payments
Let us work on the following examples to illustrate the above.
Illustrative Examples:
1. A loan of P 60,000 with interest at 6% compounded quarterly is to be amortized by payments of P 2,000 at
the end of each three months for as long as necessary, find:
a. The outstanding principal at the end of 4 years;
b. The remaining liability just after the 30th payment;
c. The final or concluding payment.
Given: A=P60,000 R=P2,000 r =6 % , m=4
Solution:
i=6 % ÷ 4
1
¿1 %
2
¿ .015
a. k =4 ×4
¿ 16
Table 2
Table 5
¿ P 60,000 ( 1.268986 )−P 2,000 ( 17.932370 )
¿ P 76,139.16−P 35,864.74
¿ P 40 , 274.42
b. k =30
MATH 217_MATHEMATICS OF INVESTMENT
¿ P 93,784.80−P 75,077.36
¿ P 18,707.44
c. The final or concluding payment.
Step 1: Determine n using formula
n=
[
−log 1−
A ×i
R ]
log ( 1+ i )
¿
[
−log 1−
P 60,000× .015
P 2,000 ]
log ( 1.015 )
¿ 40,153977∗¿
This means the last regular payment will be the 40th, and the final or concluding payment on the 41st payment.
Step 2: Determine the outstanding principal just after the last regular payment of R.
k =40
¿ P 60,000 ( 1.814018 ) −P2,000 ( 54.267894 )
¿ P 108,841.10−P 108,535.79
¿ P 305.31
Step 3: Solve for the interest by multiplying the OP by the periodic rate.
I =OP × i
¿ P 305.31×.015
¿ P 4.58
Step 4: Solve for the final payment (Fp) by adding OP + I
F=OP+ I
¿ P 305.31+ P 4.58
¿ P 309.89
2. A debt of P 250,000 with interest 8%, m=2, will be settled by payments of P 18,000 at the end of each six
months for as long as needed. Find the concluding or final payment.
Given: A=P250,000 R=P 18,000 r =8 % , m=2
MATH 217_MATHEMATICS OF INVESTMENT
Solution:
i=8 % ÷2 n=?
¿4 %
¿ .04
Step 1: Solve for n
n=
[
−log 1−
A ×i
R ]
log ( 1+ i )
n=
[
−log 1−
0,00025 ×.04
18,000 ]
log ( 1+ .04 )
n=¿ 20,676070∗¿
*20 regular payments and final payment on the 21st.
Step 2: Solve for OP. k =20
¿ P 250,000 ( 2.191123 ) −P18,000 ( 29.778079 )
¿ P 547,780.75−P 536,005.42
¿ P 11,775.33
Step 3: Solve for I
I =OP × i
¿ P 11,775.33× .04
¿ P 471.01
Step 4: Solve for Fp
Fp=OP + I
¿ P 11,775.33+ P 471.01
¿ P 12,246.34
Sinking Fund
Sinking Fund is a saving fund productively invested in anticipation for future expenses. The amount in the
fund at any given period is the total of the periodic deposits already made including the interest earned.
The deposits to a sinking fund may be unequal at an unequal interval of period. However, the most common
and systematic practice is to accumulate the fund by equal deposits at equal interval s of periods. Each periodic
deposit is invested on a specified date and allowed to accumulate until the maturity value needed is reached.
MATH 217_MATHEMATICS OF INVESTMENT
In this textbook, we will assume that the accumulation of sinking fund is by equal deposits at equal interval
of time. Thus, equal periodic deposits form an ordinary annuity in which the amount in the fund at any time is the
amount of the annuity formed by the deposits. We apply the formula of Ao.
or
S S I
or or
s s
Table 5 Table 2 Table 7
A Sinking Fund Schedule is a table showing the gradual growth of money deposited to create a fund. It also
shows how much interest is earned every period, and the amount before and after periodic deposits.
Let us work on the following examples to illustrate the above.
Illustrate Examples:
1. The sum of P 35,000 will be needed at the end of 3 years. If money can be invested at 5%, m=2, find:
a. The semi-annual deposit;
b. Construct a sinking fund schedule.
Given: S=P 35,000 r=5 % , m=2 t=3 yrs .
Solution:
i=5 % ÷ 2 n=3× 2
1
¿ 2 %=6
2
¿ .025 R=?
S S I
or or
s s
Table 5 Table 2 Table 7
P 35,000 P35,000 = I
=
s s
=
P 35,000 P 35,000
¿ = =P35,000 ( .156550 )
6.387737 6.387737
¿ P 5,479.25 ¿ P 5,479.25 ¿ P 5,479.25
b. Sinking Fund Schedule
Period Periodic Deposit Interest in Fund Increased in Fund Amount in Fund
1 P 5,479.25 P------- P 5,479.25 P 5,479.25
2 5,479.25 136.98 5,616.23 11,095.48
3 5,479.25 277.39 5,756.64 16,852.12
MATH 217_MATHEMATICS OF INVESTMENT
4 5,479.25 421.30 5,900.55 22,752.67
5 5,479.25 568.82 6,048.07 28,800.74
6 5,479.25 720.02 6,199.27 35,000.01
*Sometimes the final amount is lesser or greater by a few centavos than what it should be, due to rounding errors.
2. A sinking fund is to be created by depositing P 7,500 at the end of 2 years in a bank that pays 7 ½, m=4. Fund the
amount in the fund at the end of the term by constructing a sinking fund schedule.
1
Given: R=P 7,500 r =7 %, m=4 t=2 yrs .
2
Solution:
1
i=7 %÷ 4 n=2× 4
2
7
¿ 1 %=8
8
¿ .01875 S=?
Rs or
Table 5
Table 2
¿ P 7,500 ( 8.545156 )=P 7,500 ( 8.545156 )
¿ P 64,088.67 ¿ P 64,088.67
Sinking Fund Schedule
Period Number Amount in Fund at the Interest Earned Periodic Deposit Amount in Fund at
Beginning of the Period the End of the
Period
1 P------ P----- P 7,500.00 7,500.00
2 7,500.00 140.62 7,500.00 15,140.62
3 15,140.62 283.89 7,500.00 22,924.51
4 22,924.51 429.83 7,500.00 30,854.34
5 30,854.34 578.52 7,500.00 38,932.86
6 38,932.86 729.99 7,500.00 47,162.85
7 47,162.85 884.30 7,500.00 55,547.15
8 55,547.15 1,041.51 7,500.00 64,088.66
Analysis:
The schedule is made this way: the fund deposit of P 7,500 in the 1st period is also the amount of the fund at
the end of the 1st period since no interest has been earned yet. This amount P 7,500 is also the amount at the
7
beginning of the 2nd period which will earn interest at 1 % of P 7,500=P 140.62 . then this interest plus the
8
periodic deposit plus he amount in fund at the start of the period is the amount in the fund at the end of the 2nd period.
Fund at the end of 2nd deposit
¿ P 7,500+ P140.62+ P 7,500=P 15,140.62
This process is repeated up to the end of the last deposit or to the maturity value needed.
MATH 217_MATHEMATICS OF INVESTMENT
