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Compound Interest vs. Annuity

As a financial planner a client comes to you for investment advice. After meeting with him and understanding his needs, you offer him the following two investment options:

Option 1: Invest $20,500 in a savings account at 5.4% interest compounded quarterly.

Option 2: Invest into an ordinary annuity where $4,500 is deposited each year into an account that earns 7.9% interest compounded annually.


Set up the formula for compound interest for Option 1 and the formula for Future Value of an Annuity for Option 2 in an Excel spreadsheet to calculate the amount earned at the end of 5 years. Be sure to label all variables in your spreadsheet.


After creating the spreadsheet with the two different investment options, write a memo that addresses the following points for your client:

?Explain to your client what compound interest is.
?Explain to your client what an annuity is.
?From the calculations in the Excel spreadsheet for Option 1 and Option 2, explain which investment option is better for your client and why.

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Solution Preview

Please see the attached excel file for the problem


Compound interest arises when interest is added to the principal, so that from that moment on, the interest that has been added also earns interest. A loan, for example, may ...

Solution Summary

The solution is detailed and explains the concepts very well. The solution is very easy to understand as well. All the steps are clearly shown which makes it very easy for anyone to follow. Overall, an excellent response to the question being asked.