FAIR

GENERAL
MATHEMATICS
MARKET
Quarter 2 VALUE &
DEFFERED
ANNUITY
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 Objectives:
After going through this lesson, you are expected to:

1. Calculates the fair market value of a cash flow stream that

includes an annuity.
2. Calculate the present value and period of a deferred annuity
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 A Cash flow and
Fair Market Value (FMV)
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 A cash flow is a term that refers to payments received (cash
inflows) or payments or deposits made (cash outflows). Cash
inflows can be represented by positive numbers and cash outflows
can be represented by negative numbers. It is also the amount of
cash and cash-equivalents being transferred into and out of
the business.

The fair market value or economic value of a cash flow

(payment stream) on a particular date refers to a single amount that
is equivalent to the value of the payment stream at that date. This
particular date is called the focal date. In its simplest sense, fair
market value (FMV) is the price that an asset would sell for
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on the open market.

 Illustrative Example:
Example #1: Mr. Dela Torre received two offers on a lot that he wants to sell.
Mr. Lopez has offered ₱50,000 and 1 million lump sum payment after 5 years
from now. Mr. Calayag has offered ₱50, 000 plus ₱40, 000 every quarter for five
years. Compare the fair market values of the two offers if money can earn 5%
compounded annually. Which offer has a higher market value?

Solution: Mr. Lopez’s offer Mr. Calayag’s offer

₱50, 000 down payment ₱50, 000 down payment
₱1, 000, 000 after 5 years ₱40,000 every quarter for 5 years

Steps in Finding fair market value.

(1) Illustrate the cash flows of the two offers using time diagrams
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(2) Choose a focal date and determine the values of the two offers at the
focal date.
 Solution: Mr. Lopez’s offer Mr. Calayag’s offer
₱50, 000 down payment ₱50, 000 down payment
₱1, 000, 000 after 5 years ₱40,000 every quarter for 5 years

Find: fair market value of each offer

(1) Illustrate the cash flows of the two offers using time diagrams

Mr. Lopez’s offer:

Mr. Calayag’s offer:

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 (2) Choose a focal date and determine the values of the two offers at
that focal date.

Solution 1: Choose the focal date to be the start of the term. Since the focal date

is at t = 0, compute for the present value of each offer.

Mr. Lopez’s offer:
Since P50, 000 is offered today, then the present value is still P50,
000. The present value of P1, 000, 000 offered 5 years from now is:

= 1, 000. 000(1 + 0.05

P = P783, 526.17
Fair Market Value (FMV) = Down Payment + Present Value
= P50, 000 + 783, 526. 17
FMV = P833,526. 17
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 (2) Choose a focal date and determine the values of the two offers at
that focal date.

Solution 1: Choose the focal date to be the start of the term. Since the focal date

is at t = 0, compute for the present value of each offer.

Mr. Calayag’s offer:
We first compute for the present value of a general annuity with
quarterly payments but with annual compounding at 5%.
Formula: P = = P40, 000 = P705, 588. 40

Fair Market Value (FMV) = Down payment + Present Value

= 50, 000 + 705, 588.40
(FMV) = P755, 588.40
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 (2) Choose a focal date and determine the values of the two offers at
that focal date.

Solution 1: Choose the focal date to be the start of the term. Since the focal date

is at t = 0, compute for the present value of each offer.

Mr. Lopez’s offer:
P = ₱783, 526.17
FMV = ₱50, 000 + ₱783, 526.17 = ₱833, 526.17

Mr. Calayag’s offer:

P = ₱705, 572.68
FMV = ₱50, 000 + ₱705, 572.68 = ₱755, 572.68

Difference: ₱833, 526.17 – ₱755, 572.68

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= ₱77,953.49
 Hence, Mr. Lopez’s offer has a higher market
value. The difference between the market values
of the two offers as the start of the term is

P833, 526. 17 – P755, 588.40 = P77, 937.77

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 Alternate solution (Focal date at the end of the term):

Mr. Lopez’s offer:

The future value of ₱1,000,000 at the end of the term at 5% compounded
annually is given by

F=

= 50,000 (1 + 0.05
= 63,814.08

The fair market value of this offer at the end of the term is 63,814.08 plus
₱1,000,000 amounting to ₱ 1,063,814.08.
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 Mr. Calayag’s offer:

The future value of this ordinary general annuity is given by

F=

=
= 900,489.71

The future value of 50,000 at the end of the term is ₱63,814.08, which was
already determined earlier.

Fair Market Value (FMV) = 900,489.71 + 63,814.08 = ₱ 964,303.79

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 As expected, Mr. Lopez’s offer still has a higher market
value, even if the local date was chosen to be at the end of
the term. The difference between the market values of the
two offers at the end of the term is

1,063814.08 – 964,303.79 = ₱ 99,510.29

You can also check that the present value of the difference
is the same as the difference when the focal date was at
the start of the term:
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𝑃 = 99,510.29 (1 + 0.05 = ₱ 77,968.92

 Example #2: Company A offers ₱150, 000 at the end of 3 years plus ₱300, 000
at the end of 5 years. Company B offers ₱25, 000 at the end of each quarter for
the next 5 years. Assume that money is worth 8% compounded annually. Which
offer has a better market value.

i. Illustrate the cash flows of the two offers using time diagrams.
ii. Choose a focal date and determine the values of the two offers
at that focal date. Suppose that selected focal date is the start
of the term.
iii. Since the focal date is the start of the term, compute
for the preset value of each offer.
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 Company A Offer:
The Present value of P150, 000 three years from
Company A offers ₱150, 000 now is
at the end of 3 years plus
₱300, 000 at the end of 5 =
years. = 150, 000
= P119, 074.84

The present value of P300, 000 years from now is

=
= 300, 000
= P204, 174.96

Fair Market Value (FVM) =

= P119, 074.84 + 204, 174. 96
= P323, 249.80
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 Company B Offer:
Compute for the present value of a general
Company B offers ₱25, 000 annuity with quarterly payments but with
at the end of each quarter annual compounding at 8%.
for the next 5 years. Assume
that money is worth 8% (Note: )
compounded annually.
Formula: P =
= P25, 000
𝑃 = ₱ 411, 043.27

Fair Market Value (FMV) = ₱ 411, 043.37

Therefore, Company B offer is preferable since its market value is

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larger.
 Seatwork:
Problem:

Kat received two offers for investment. The first one is

₱150,000 every year for 5 years at 9% compounded
annually. The other investment scheme is ₱12,000 per
month for 5 years with the same interest rate. Which
fair market value between these offers is preferable?
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 DEFERRED
ANNUITY
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 WHAT WOULD YOU LIKE TO DO ON
YOUR 18TH BIRTHDAY?
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 Sophia, who is celebrating her 17th birthday today, does not
want an extravagant party for her 18th birthday. Instead, she
asks her parents if she could receive P500 per month until
her 21st birthday. Sophia's mom decided to save today so
that she can provide extra allowance every month after
Sophia's 18th birthday. But how much should the mother
save today so that she will have P200 every month for 3
years which is due exactly one year from now?
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 Annuity in Real life:
1. If you will buy an appliance, some big stores or appliances center
offers deferred payment.
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 Annuity in Real life:
 A credit card company offering its clients to purchase today
but to start paying monthly with their choice of term after 3
months.
 A real estate agent is urging a condominium unit buyer to
purchase now and start paying after 3 years when the
condominium is ready for occupancy.

 A worker who has gained extra income now and wants

to save his money so that he can withdraw his money
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monthly starting on the day of his retirement from work.

 Definition of Terms:
Deferred Annuity -
 An annuity that does not begin until a given time interval has
passed.
 Is one in which the first payment is made not at the
beginning or end of the first period, but at some later date.

Period of Deferral -
Time between the purchase of an annuity and the start of the
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payments for the deferred annuity.

 FORMULA:
The present value of a deferred annuity is given by

 
Where:
 
R = Periodic payment of the deferred annuity
i = Periodic interest rate
n = number of payments in the annuity
k = number of conversion periods in the deferral or number of artificial
payments
m = number of conversion period per year
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r = Nominal interest rate

 NOTE: To compute the number of deferred payment
periods use the following:
a) If the periodic payment is b) If periodic payments is due
made on the succeeding year, at the end of the deferment
multiply the number of years, then multiply the
deferred years by m. number of deferred years by m
Example: and subtract 1.
The semi-annual payment of example:
the annuity is deferred for 3 The first semi-annual
years, then, payments is due at the end of
4.5 years
k = 2(3) = 6 in the number of deferred years =4.5, m = 2
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deferred periods. deferred periods k = 2(4.5) – 1

= 9-1 = 8
 EXAMPLE 1. On his 40th birthday, Mr. Ramos decided to buy a
pension plan for himself. This plan will allow him to claim
P10,000 quarterly for 5 years starting 3 months after his 60th
birthday. What one-time payment should he make on his 40th
birthday to pay off this pension plan, if the interest rate is 8%
compounded quarterly?

Given:
R = 10,000
r = 0.08
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t=5
m=4
 Solution:
The annuity is deferred for 20 years and it will go on for 5 years. The first
payment is due three months (one quarter) after his 60th birthday, or at the
end of the 81st conversion period. Thus, there are 80 artificial payments.

= 33, 538.38
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 EXAMPLE 2.
A credit card company offers a deferred payment
option for the purchase of any appliance. Rose plans
to buy a smart television set with monthly payments
of P4,000 for 2 years. The payments will start at the
end of 3 months. How much is the cash price of the
TV set if the interest rate is 10% compounded
monthly?
Given: R = 4,000, r = 0.10, t = 2, m = 12
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 Solution

The first payment is due at the end of 3 months, or at the end of the 3rd
conversion period. Thus, there are 2 artificial payments.
No. of artificial payments: k = 2
No. of actual payments: n = mt = 12(2) = 24
Interest rate per period: i = r/m = 0.10 /12 = 0.00833

= 85, 260.53
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Therefore, the cash price of the TV set is P85,260.53

 FORMULA:
The periodic payment of a deferred annuity is given by

 
Where:
 
R = Periodic payment of the deferred annuity
i = Periodic interest rate
n = number of payments in the annuity
k = number of conversion periods in the deferral or number of artificial
payments
m = number of conversion period per year
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r = Nominal interest rate

 EXAMPLE
A man borrowed P24, 000 from the SSS calamity
loan with interest at 12% compounded monthly. At
the end of 3 months he made the first payment of 24
monthly payments which fully discharged his debt.
Find the monthly payment.

Given:
P(def) = P24, 000 i = = 0.01
r = 12%
n = 24
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k=2
 Find the period of deferral in the deferred annuity

1. 2.
Monthly payments of Annual payments of P2,500
P50,000 for 3 years that will for 24 years that will start 12
start 8 months from now years from now

Solution Solution
The first payment is at time The first payment is at time 12.
8. The period of deferral is The period of deferral is from
from time 0 to 7, which is time 0 to 11, which is equivalent
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equivalent to 7 periods or 7 to 11 periods or 11 years.

months.
 Seatwork:
Find the period of deferral in each of the following deferred annuity
problem (one way to find the period of deferral is to count the number
of artificial payments)

1. Monthly payments of P2,000 for 5 years that will start 7 months

from now
2. Annual payments of P8,000 for 12 years that will start 5 years from
now
3. Quarterly payments of P 5,000 for 8 years that will start two years
from now.
4. Semi-annual payments of P60,000 for 3 years that will start 5 years
from now
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5. Payments of P3,000 every 2 years for 10 years starting at the end of

6 years
 THANK YOU

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