Annuity Function in Excel

What is annuity function?

The term annuity refers to the sectors, which includes banking, financial sectors, and other business requirement based on the future value of the particular investment. Calculating the periodic payments or series of equal amounts for a specified period is done using the annuity function. It calculates the future value of an asset or the number of regular payments to achieve future discounts.

Uses of annuity function in Excel

The several uses of the annuity function in Excel are as follows:

• Banking Process: The person working in banking needs to be fluent in loan payment and money-related topics. To be good knowledge in these topics, the annuity function in Excel is used to perform calculations.
• Investment and Retirement: The annuity function calculates the future value of the current asset in the specified period. This helps one to know the amount of money available in the future. The concept of retirement helps to calculate how much money will return after the retirement period. It determines how much money needs to be saved to attain retirement savings.
• Regulating the budget plan: The budget created using the annuity function is used to know one's regular expenses like housing loans, household expenses, etc. The amount that needs to be spent every month is calculated quickly.

What is called the Present value of an annuity?

The present value of the annuity is defined as the series of payments done at regular intervals where a new amount is produced in the future. The concept time value of money is explained here.

For example, if a dollar purchased today is worth more than the dollar purchased in the future regarding its purchasing power.

Key Points for Present Value of the Annuity

• The present value of the annuity determines how much money required which is used to fund future annuity payments.
• It predicts the current value of future payments, which gives a particular rate of return or discount rate. The higher the discount rate, the lower the present value of the annuity.
• As the concept of the time value of money is involved here, the sum invested today is higher the worth in the future.
• It helps to predict whether the investor can get massive money by taking a large amount of money at present or the annuity extended over the years.

Formula to calculate the present value of the annuity

Excel provides the procedure to calculate the current value of the annuity. It solves the complex calculations in the given data.

The syntax of the formula is as follows,

=PV (RATE, NPER, PMT, [fv], [type]).

The formula is explained as follows,

• Rate -Defines the discount rate or interest rate.
• NPER- Number of periods with that discount rate
• PMT- Amount of payment that is paid at regular intervals
• Fv -Defined as the future value of the annuity
• Type - Defines the timing of the payment

How to calculate the present value of an annuity using a formula?

To steps to calculate the present value of an annuity for the given problem is as follows,

Example 1: Calculate the present value of a future annuity with an interest rate of 5% for 11 years with an annual payment of $11000.

To calculate the present value,

1. Select a new cell and enter the formula as =PV (0.05, 11, 11000)
2. Press Enter. The procedure returns the presence of the annuity for the given data.

The formula returns the current value of the annuity as -91,370.56.

Calculating the present value formula for a single payment

Here is an example to calculate the current value for a single price.

Example: A person won a gift prize of amount 1,000. He is given the option to get either 1,000 at present or 11,00 after a year.

To decide which option is best, the person needs to calculate the present value of the amount where he receives in the future (1100). To calculate the interest rate, one needs to know how much the person will get in the future to inverse the current amount.

The required information to calculate the data is as follows,

1. No. of years (C3)-1
2. Annual Interest Rate (C2)-7%
3. Future Value (C4) -11, 00

The formula to calculate the present value of the investment is,

=PV (C2, C3, C4)

Here C2, C3, and C4 are called cell values.

The data entered in Excel is,

1. Select a new cell, C6, and enter the formula as = PV (C2, C3, C4).
2. Press Enter. The present value is calculated for the given data.
   
3. The amount of 1028.04 is greater than the present value (1000), which needs to be inverse to get the future value. Hence the best option is to choose the amount of 1100 the person receives after one year.

In the above example, the interest is calculated for the year. To calculate the rate of interest per month, the rate of interest is divided by 12, and the number of years is multiplied by 12. The formula is modified as,

=PV (C2/12, C3*12, C4)

From the calculated compound interest, the future value is greater than the compound interest value.

Necessary formulas to calculate the Present value of the annuity

To calculate the periodic interest rate (rate), the correct formulas are,

1. To calculate monthly interest rate= annual interest rate/12
2. To calculate quarterly interest rate= annual interest rate/4
3. To calculate semi-annual interest rate= annual interest rate/ 2

To calculate the total number of periods (per), the formulas are as follows,

1. For monthly nper= number of years*12
2. For quarterly nper=number of years*4
3. For semi-annual nper= number of years* 2

Different annuity types

The various types of annuities are as follows,

1. PMT Function
2. PV Function
3. FV Function
4. NPER Function

These annuity types are controlled by the fifth argument present in the formula, which is optional.

1. Ordinary
2. Annuity due

Here is an example to find the difference between the ordinary and annuity due.

Enter the data in the spreadsheet as follows,

1. Annual Interest-B2
2. No. of years-B3
3. Payment amount-B4
4. Annuity type-B5
5. Periods per year-B6

To calculate a regular annuity, enter the annuity type as 0. The formula entered is,

=PV (B2/B6, B3*B6, B4,, B5)

Here in the data, the future value is not entered.

The annuity due is calculated with the annuity type as 1. The formula entered is,

=PV (B2/B6, B3*B6, B4,,B5)

There occurs a difference between both the ordinary and annuity due.

Summary

Calculating the annuity function is essential to the financial and banking sectors. It is a versatile tool widely used in many organizations and companies. The formula to calculate the present value of the annuity is explained in this tutorial.