Question

Suppose your parents decide to give you $10,000 to be put in a college trust fund that will be paid in equally quarterly installments over a 5 year period. If you deposit the money into an account paying 1.5% per quarter, how much are the quarterly payments (Assume the account will have a zero balance at the end of period.)

Answer 1

The quarterly annuity payment is $582.46.

What is an ordinary annuity?

An ordinary annuity in case of investment is the one that pays its end-of-the period cash flows rather than at the beginning as it is case of annuity due.

The applicable formula in this case is the present value formula of an ordinary annuity as shown below:

PV=quarterly payment*(1-(1+r)^-N/r

PV=initial investment=$10,000

quarterly payment=unknown(assume it is X)

r=quarterly interest rate=1.5%

N=number of quarterly payments in 5 years=5*4=20(there are 4 quarterly payments in a year)

$10,000=X*(1-(1+1.5%)^-20/1.5%

$10,000=X*(1-(1.015)^-20/0.015

$10,000=X*(1-0.742470418223773)/0.015

$10,000=X*0.257529581776227/0.015

X=$10,000/(0.257529581776227/0.015)

X=quarterly payment=$582.46

Note that the unknown in this case is the annuity payment, the present value can also be the unknown as well.

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