MATHEMATICS FOR MANAGEMENT / BUSINESS

MATHEMTICS

Course title: Mathematics for Management

Course Number: MMGT 2072
Cr. Hours: 3
Course Description:
The course Mathematics for management is designed most
importantly, to provide students with fundamental concepts of
mathematics and their managerial applications. The course will
hopefully enable students identify the basic concepts underlying
mathematical formulations of business problems and how
mathematical methods can lead to precise solutions to managerial
problems.
Course Objectives:
Up on accomplishing of this course student should be able to:
 Describe linear equations and their applications in business
 Apply the concept of breakeven analysis to solve problems of
merchandising and manufacturing business problems
 Understand the idea of calculus and its applications in
business.
 Understand the matrix operations and properties of matrices.
 Define the relation ship between matrices and system of
linear equations
 Apply the concepts of Markov chains
 Understand optimization ideas and techniques to solve
optimization problems
 Measure the value of money through the application of
finance models
 Understand the idea of calculus and its applications in
business.

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Chapter 1:
Introduction to Linear equations and basic concepts
Session learning objective:
 At the end of this session students’ will have a better
understanding about the meaning and concepts of linear
equations.

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1.1 Linear Equations

Equation:
Equation: - A mathematical statement, which indicates two algebraic expressions are
Equal.
Example: Y = 2X + 3

Algebraic expressions:
expressions: - A mathematical statement indicating that numerical quantities
are linked by mathematical operations.
Example: X + 2

Linear equations: - are equations with a variable & a constant with degree one.
- Are equations whose terms (the parts separated by +, -, = signs)
- Are a constant, or a constant times one variable to the first power

Example: 2X – 3Y = 7
- the degree (the power) of the variables is 1
- the constant or the fixed value is 7
- the terms of the equation are 2X and 3Y separated by – sign

However 2X + 3XY = 7 isn’t a linear equation, because 3XY is a

constant times the product of 2 variables.

* No X2 terms, No X/Y terms, and no XY terms are allowed.

- Linear equations are equations whose slope is constant throughout the line.
- The general notion of a linear equation is expressed in a form Y = mx + b where
m = slope, b = the Y- intercept, Y = dependent variable and X = independent
variable.

If Y represents Total Cost, the cost is increased by the rate of the amount of the slope m.

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Slope (m) = if X1  X2

Slope measures the steepness of a line. The larger the slope the more steep (steeper) the
line is, both in value and in absolute value.

Y Y m = undefined
+ive slope
m=0
-ve slope
X X

- A line that is parallel to the X-axis is the gentlest of all lines i.e. m = 0
- A line that is parallel to the Y-axis is the steepest of all lines i.e. m = undefined or
infinite.

The slope of a line is defined as the change-taking place along the vertical axis relative to
the corresponding change taking place along the horizontal axis, or the change in the
value of Y relative to a one-unit change in the value of X.

1.2 Developing equation of a line

Session learning objectives:
 At the end of this discussion students will develop a better sill
of developing equation of a line
Discussion issues:
Students are encouraged to participate in the class based on their
previous reading about developing equation of a line. (10 minutes)
 Major types of developing equation of a line
 Models to develop the equations

1. The slope-intercept form

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This way of developing the equation of a line involves the use of the slope & the
intercept to formulate the equation.

Often the slope & the Y-intercept for a specific linear function are obtained directly from
the description of the situation we wish to model.

Example # 1

Given Slope = 10
Y-intercept = +20, then
Slope-intercept form: the equation of a line with slope = m and Y-intercept b is
Y = mx + b
Y = 10X + 20

INTERPRETATIVE EXERCISES
#2 Suppose the Fixed cost (setup cost) for producing product X be br. 2000. After setup
it costs br. 10 per X produced. If the total cost is represented by Y:
1. Write the equation of this relationship in slope-intercept form.
2. State the slope of the line & interpret the number
3. State the Y-intercept of the line & interpret the number

#3. A sales man has a fixed salary of br. 200 a week In addition; he receives a sales
commission that is 20% of his total volume of sales. State the relationship between the
sales man’s total weekly salary & his sales for the week.
2. The slope point form
The equation of a non-vertical line, L, of slope, m, that passes through the point (X 1, Y1)
is; defined by the formula Y – Y1 = m (X – X1)
Y – Y1 = m (X – X1)

Example #1  Y – 2 = 4 (X – 1)
Given, slop = 4 and Y – 2 = 4X - 4
Point = (1, 2) Y = 4X – 2

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#2 A sales man earns a weekly basic salary plus a sales commission of 20% of his total
sales. When his total weekly sales total br. 1000, his total salary for the week is 400.
derive the formula describing the relationship between total salary and sales.
Answer Y = 0.2X + 200

#3 If the relationship between Total Cost and the number of units made is linear, & if
costs increases by br. 7.00 for each additional unit made, and if the Total Cost of 10 units
is br. 180.00. Find the equation of the relationship between Total Cost (Y) & number of
units made (X)
Answer: Y = 7X + 110

1. The slope-intercept form

This way of developing the equation of a line involves the use of the slope & the
intercept to formulate the equation.

Often the slope & the Y-intercept for a specific linear function are obtained directly from
the description of the situation we wish to model.

Example # 1

Given Slope = 10
Y-intercept = +20, then
Slope-intercept form: the equation of a line with slope = m and Y-intercept b is
Y = mx + b
Y = 10X + 20

INTERPRETATIVE EXERCISES
#2 Suppose the Fixed cost (setup cost) for producing product X be br. 2000. After setup
it costs br. 10 per X produced. If the total cost is represented by Y:
 Write the equation of this relationship in slope-intercept form.
 State the slope of the line & interpret the number
 State the Y-intercept of the line & interpret the number

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#3. A sales man has a fixed salary of br. 200 a week In addition; he receives a sales
commission that is 20% of his total volume of sales. State the relationship between the
sales man’s total weekly salary & his sales for the week.

2. The slope point form

The equation of a non-vertical line, L, of slope, m, that passes through the point (X 1, Y1)
is; defined by the formula Y – Y1 = m (X – X1)
Y – Y1 = m (X – X1)
Example #1  Y – 2 = 4 (X – 1)
Given, slop = 4 and Y – 2 = 4X - 4
Point = (1, 2) Y = 4X – 2

#2 A sales man earns a weekly basic salary plus a sales commission of 20% of his total
sales. When his total weekly sales total br. 1000, his total salary for the week is 400.
derive the formula describing the relationship between total salary and sales.
#3 If the relationship between Total Cost and the number of units made is linear, & if
costs increases by br. 7.00 for each additional unit made, and if the Total Cost of 10 units
is br. 180.00. Find the equation of the relationship between Total Cost (Y) & number of
units made (X)
Answer: Y = 7X + 110

1.3 Developing equation of a line (continued discussion)

Sessions learning objective:
 At the end of this discussion students will develop a better
skill of developing equation of a line
Discussion issues:
Students are encouraged to participate in the class based on their
previous reading about developing equation of a line. (10 minutes)
 Major types of developing equation of a line
 Models to develop the equations
Two-point form

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Two points completely determine a straight line & of course, they determine the slope of
the line. Hence we can first compute the slope, then use this value of m together with
either point in the point-slope form Y – Y 1 = m (X – X1) to generate the equation of a
line.
 By having two coordinate of a line we can determine the equation of the line.

Two point form of linear equation: (Y – Y1) =

Example #1 given (1, 10) & (6, 0)

First slope = , then

Y – Y1 = m (X – X1)  Y – 10 = -2 (X – 1)
Y – 10 = -2X + 2
Y = -2X + 12
#2 A salesman has a basic salary &, in addition, receives a commission
which is a fixed percentage of his sales volume. When his weekly sales
are Br. 1000, his total salary is br. 400. When his weekly sales are
500.00, his total salary is br. 300. Determine his basic salary & his
commission percentage & express the relationship between sales &
salary in equation form.

#3 A printer costs a price of birr 1,400 for printing 100 copies of a report & br. 3000 for
printing 500 copies. Assuming a linear relationship what would be the price for printing
300 copies?

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1.4 Business applications of Linear equations

Sessions learning objective:
 At the end of this discussion students will be able on how to
apply the concepts learned so far for business organizations
problems.
Discussion issues:
Students are encouraged to participate in the class based on their
previous reading about applications in business areas. (10 minutes)
 Revenue functions
 Cost and Profit functions

Application of linear equations

Linear cost output relationships – VC, FC, TC, AC, MC, TR, :

TR/TC profit TR TC = TVC + TFC

Or TP region TR = PQ
TC TP = TR - TC
Loss T
region E BEP = PQ – (VC + FC)
TVC H
A F G FC = PQ – [Link] - TFC
TC
TFC = Q (P – VC) - FC
B C D G(No of units)
Where Q = units
product & units
sold in revenue
TC = Total Cost
FC = Fixed Cost
VC = Unit variable
Cost

Interpretation of the graph:

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1. The vertical distance between AB, FC, GD is the same because Fixed Cost is the
same at any levels of output.

2. There is no revenue without sales (because Total Revenue function passes

through the origin), but there is cost without production (because of Fixed Cost)
& the TC function starts from A & doesn’t pass through the origin

3. Up to point T, Total Cost is greater than Total Revenue  results in loss. While at
point T, (Total Revenue = Total Cost) i.e. Breakeven. (0 profit), & above point T,
TR > TC  +ve profit.
4. TFC remains constant regardless of the number of units produced. Given that
there is no any difference in scale of production.
5. As production increases, Total Variable Cost increases at the same rate and
Marginal cost is equal with Unit Variable Cost (MC
(MC = VC) only in linear
equations.
6. As production increases TC increases by the rate equal to the AVC = MC
(average cost equal to marginal cost)
7. AVC is the same through out any level of production, however Average Fixed
Cost (AFC) decreases when Quantity increases & ultimately ATC decreases when
Q increases because of the effect of the decrease in AFC.
8. As Quantity increases TR increases at a rate of P. and average revenue remains
constant.

AR = = P  AR = P in linear functions

1.5 Breakeven analysis

Sessions learning objective:
 At the end of this discussion students will be able on how to
apply the concept of break-even analysis to business
problems.

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Discussion issues: Students are encouraged to participate in the

class based on their previous reading about break-even analysis. (10
minutes)
 Meaning and definition
 Operational implications of breakeven point
Breakeven Analysis
Break-even point is the point at which there is no loss or profit to the company. It can be
expressed as either in terms of production quantity or revenue level depending on how
the company states its cost equation.

Manufacturing companies usually state their cost equation in terms of quantity (because
they produce and sell) where as retail business state their cost equation in terms of
revenue (because they purchase and sell)

CASE 1: MANUFACTURING COMPANIES

Consider a Company with equation
TC = VC + FC / Total cost = Variable cost + Fixed cost
TR = PQ/ Total Revenue = Price x Quantity

At Break-even point, TR = TC i.e TR – TC = 0

PQ = VC + FC where Qe = Breakeven Quantity
PQ – VC.Q = FC FC = Fixed cost
Q (P – VC) = FC P = unit selling price

Qe = VC = unit variable cost

TR
TC/TR TC

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Qe =

Example #1 A manufacturing Co. has a Total Fixed Cost of Br. 10,000 & a Unit Variable
Cost of Br. 5. if the co. can sell .What it produces at a price of Br. 10,

a) Write the Revenue, cost & Profit functions

b) Find the breakeven point in terms of quantity and sales volume
c) Show diagrammatically the Total Revenue, Total Cost, Total Profit, Fixed Cost
and Variable Costs.
d) Interpret the results

 The effect of changing one variable keeping other constant

Assume for the above problem FC is decreased by Br. 5000, Citrus Paribus (other things
being constant)

TC = 5Q + 5000  Qe = = 1000 units

TR = 10Q

Therefore, FC   Qe  FC & Qe have direct relationship

FC   Qe 

Assume for the above problem UVC decreased by 1 br. Citrus Paribus (keeping other
thing constant)

TC = 4Q + 10000  Qe =

TR = 10Q

Therefore, VC   Qe  VC & Qe have direct relationship

VC   Qe 

Assume for the above problem selling price is decreased by br. 1, Citrus Paribus,

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TC = 5Q + 10,000  Qe =

TR = 9Q
Therefore P   Qe  Price and breakeven point have indirect relationship
P   Qe 

In the above example a company has the following options (to minimize its breakeven
point and maximize profit).

- decreasing FC
- decreasing unit VC
- increasing the unit selling price
And if the organization is between option 2 & 3, it is preferable to decrease the unit
variable cost because if we increase the selling price, the organization May loose its
customers & also decreasing the FC is preferable.
FINDING THE QUANTITY LEVEL WHICH INVOLVES PROFIT OR LOSS
BEP = , any Q is related to the cost , profit----

 = TR – Tc Where: BEP = breakeven point

 = PQ – (VC.Q + FC)  = Profit
 = (P.Q – VC.Q) – FC TR = Total revenue
 = Q (P – VC) – FC TC = Total cost

Q = Quantity

C = Unit variable cost

Example #1 For the above manufacturing co. if it wants to make a profit of 25000 br.
What should be the quantity level?

TR = 10Q Q= when there is , the quantity produced &

sold have to be greater than the
Breakeven quantity
TC = 5Q + 10,000

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 = 25,000
Q=?

If it expects a loss of br. 5000 what will be the quantity level.

Q= * when there is loss, the qty produced & sold

should be less than the BEQ

1.6 Breakeven analysis in relation to merchandising firm

Sessions learning objective:
 At the end of this discussion students will be able on how to
apply the concept of break-even analysis to Merchandising
firm.
Discussion issues:
Students are encouraged to participate in the class based on their
previous reading about breakeven analysis in relation to
merchandising firms.(10 minutes)
 Breakeven quantity
 Breakeven revenue

CASE 2 MERCHANDISING /RETAIL BUSINESS

Breakeven Revenue = BEQ X P

Assume a bus. Firm with product A has the following cost & revenue
items.
Variable cost of A = 100 br.
Selling price = 150 br.

Markup = Selling price – Variable cost = 150 – 100 = 50

i. as a function of cost, the markup is 50/100 = 50%

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ii. as a function of retail price, the markup is 50/150 = 33.3 % it is also called margin.
Margin Cost of goods sold

The cost of goods sold = 100% - 33.3 % = 66.6%  67%

Selling price CGS
Given other selling expense = 1%of the selling price i.e. 0.01X

So, the TC equation becomes:

Y = 0.68X + FC
Where: X is sales revenue
Y is total cost
Out of 100% selling price 68% is the variable cost of goods purchased & sold

Example Suppose a retail business sale its commodities at a margin of 25% on all items
purchased & sold. Moreover the company uses 5% commission as selling expense & br.
12000 as a Fixed Cost.

Find the Breakeven revenue for the retail business after developing the equation

Break even revenue is obtained by making sales revenue & cost equals
At breakeven point TC = TR Y = mx + b
i.e. Y = X then, unit variable cost

0.8X + 12000 = X 

-0.2X = -12000
X = 60,000 br.  When the co. receives br. 60,000 as sales revenue,
there will be no loss or profit.

The Breakeven revenue (BER = ) method is useful, because we can use a single

formula for different goods so far as the company uses the same amount of profit margin

for all goods. However, in Breakeven quantity method or BEQ = it is not

possible and hence we have to use different formula for different items.

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Example It is estimated that sales in the coming period will be br. 6000 & that FC will
be br. 1000 & variable costs br. 3600, develop the total cost equation & the
breakeven revenue.

* When the breakeven revenue equation is for more than one item it is impossible to find
the breakeven quantity. It is only possible for one item by Qe = Xe/P
Where Xe = Break even revenue
P = selling price
Qe = Breakeven quantity
To change the breakeven revenue equation in to Breakeven quantity, we have to multiple
price by the coefficient of X. likewise, to change in to breakeven revenue from Break-
even quantity, we have to divide the unit VC by price.

1.7 Graphical analysis on Breakeven concepts.

Sessions learning objective:
 At the end of this discussion students will be able on how to
analyze the concept of break-even through the use of Graph.
Discussion issues:
Students are encouraged to participate in the class based on their
previous reading about Graphic analysis on breakeven concepts. (10
minutes)
 Total Revenue, Total Cost, Total Profit, and Breakeven point.
Example
A manufacturing Co. has a Total Fixed Cost of Br. 10,000 & a Unit
Variable Cost of Br. 5. If the co. can sell what it produces at a price of
Br. 10,

e) Write the Revenue, cost & Profit functions

f) Find the breakeven point in terms of quantity and sales volume

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g) Show diagrammatically the Total Revenue, Total Cost, Total

Profit, Fixed Cost and Variable Costs.
h) Interpret the results

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Chapter Two:
Introducing the basic concepts of matrices
Sessions learning objective:
 At the end of this discussion students will be able on how to
analyze the concept of break-even through the use of Graph.
Discussion issues:
Students are encouraged to participate in the class based on their
previous reading about matrix algebra. (10 minutes)

Algebra is a part of mathematics, which deals with operations (+, -, x,

). A matrix is a rectangular array of real numbers arranged in m rows
& n columns. It is symbolized by a bold face capital letter enclosed by
a bracket or parentheses.

eg. in which ajj

are real numbers

Each number appearing in the array is said to be an element or

component of the matrix. Element of a matrix are designated using a
lower case form of the same letter used to symbolize the matrix itself.
These letters are subscripted as a ij, to give the row & column location
of the element with in the array. The first subscript always refers to the
raw location of the element; the second subscript always refers to its
column location. Thus, component a ij is the component located at the
intersection of the ith raw and jth column.

The number of rows (m) & the number of columns (n) of the array give
its order or its dimension, M x n (reads “M” by “n”)

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Eg. The following are examples of matrices

1 7 element
a12 = 7
A= 5 3 this is 3 x 2 matrix a 21
=5
4 2
a32 = 2

X= 1 5 9 15 This is a 4 x 4 matrix
2 6 10 20 Element X 44 = 45
3 7 11 30 X 34 = 30
4 8 12 45 X 42 = 8
X32 = 7

Matrix operations and properties.

Sessions learning objective:
 At the end of this discussion students will be able to perform
the different types of matrix operations and understand the
types of matrices.
 Matrix addition, Matrix subtraction, and Matrix multiplication
Discussion issues:
Students are encouraged to participate in the class based on their
previous reading about matrix operations and properties. (10 minutes)

There are different types of matrices. These are

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1. Vector matrix – is a matrix, which consists of just one row or just one
column. It is an m x 1 or 1 x n matrix.

1.1 Row vector is a 1 x n matrix i.e. a matrix with 1 row

eg. W= -1 0 6 1x3
1.2. Column vector: is an m x 1 matrix i.e. a matrix with one column
only

eg. 0
Z= 20
5 3x1
2. Square matrix: - a matrix that has the same number of rows &
columns. It is also called n-th order matrix
eg. 2 x 2 , 3 x 3, nxn X= 1
2
3
4 2x2

3. Null or zero matrix: - is a matrix that has zero for every entry.
It’s generally denoted by Om x n eg. Y = 0 0
0 0

4. Identity (unit) matrix: - a square matrix in which all of the primary

diagonal entries are
ones & all of the off diagonal entries are zeros. Its denoted by I.

eg. I2 = 1 0 1 0 0
0
0 1 2x2 I2 = 0 1 0
0

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0 0 1
0
0 0 0
1 4x4

N.B. Each identity matrix is a square matrix

* Primary diagonal represents: a11, a22, a33, a44---------ann entries
element
A x I = A & I x A = A that is, the product of any given
matrix & the identity matrix is the given matrix itself. Thus, the identity
matrix behaves in a matrix multiplication like number 1 in an ordinary
arithmetic.

5. Scalar matrix: - is a square matrix where elements on the primary

diagonal are the same.

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Matrix operations (Addition, Subtraction, Multiplication)

Matrix Addition/ Subtraction

Two matrices of the same dimension are said to be CONFORMABLE

FOR ADDITION. Adding corresponding elements from the two matrices
& entering the result in the same raw-column position of a new matrix
perform the addition.

If A & B are two matrices, each of site m x n, then the sum of A & B is
the m x n matrix C whose elements are:

Cij = aij +bij for i = 1, 2 --------m C 11 = a11 + b11

j = 1, 2 ---------n C 22 = a22 + b22
C12 = a12 + b12 etc

eg. 1 3 7 9 8 12
2 4 + 8 -10 = 10 –6

eg. –2 7 2 8 7 These
two matrices aren’t
4 6 9 + 6 4 =
conformable for addition
because
they aren’t of the
same
dimension.

Laws of matrix addition

The operation of adding two matrices that are conformable for addition
has these two basic properties.

1. A + B = B + A  The commutative law of matrix addition

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2. (A + B) + C = A + (B + C)  the associative law of matrix addition

 The laws of matrix addition are applicable to laws of matrix

subtraction, given that the two matrices are conformable for
subtraction A – B = A + (-B)

eg.A= 1 2 B= 0 1
3 4 2 5

A–B= 1 1

1 -1
Matrix Multiplication

a) By a constant (scalar multiplication)

A matrix can be multiplied by a constant by multiplying each

component in the matrix by a constant. The result is a new
matrix of the same dimension as the original matrix.
If K is any real number & A is an M x n matrix, then the product KA is
defined to be the matrix whose components are given by K times the
corresponding component of A; i.e.

KA = Kaij (m x n)

eg. If X= 6 5 7 , then 2X = (2 x 6) (2 x 5)
(2 x 7)

2X = 12 10
14

Laws of scalar multiplication

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The operation of multiplying a matrix by a constant (a scalar) has the

following basic properties. If X & Y are real numbers & A & B are m x n
matrices, conformable for addition, then

1. XA = AX 3. X (A + B) = XA + XB
2. (X + Y) A = XA + YA 4. X (YA) = XY (A)

b ) Matrix by matrix multiplication

If A & B are two matrices, the product AB is defined if and only if the
number of Columns in A is equal to the number of rows in B, i.e.
if A is an m x n matrix, B should be an n x b.

If this requirement is met., A is said to be conformable to B for

multiplication. The matrix resulting from the multiplication has
dimension equivalent to the number of rows in A & the number
columns in B

If A is a matrix of dimension n x m (which has m columns) & B is a

matrix of dimension p x q (which has p rows) and if m and p aren’t the
same product A.B is not defined. That is, multiplication of matrices is
possible only if the number of columns of the first equals the number
of rows of the second.

If A is of dimension n x m & if B is of dimension m x p, then the product

A.B is of dimension n x p

eg. A= 2 3 4 B= -1 7
6 9 7 2x3 0 8
5 1 3x2

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AB = (2x – 1) + (3 x 0) + (4 x 5) (2 x 7) + (3 x 8) + (4 x 1)
= 18 = 42
(6x – 1) + (9 x 0) + (7 x 5) (6 x 7) + (9 x 8) +
(7 x 1)
= 29 = 121

 AB = 18 42
29 121

Find BA =
B= -1 7 A= 2 3 4
0 8 6 9 7 2x3
5 1
3x2
B A
3 x 2 2 x 3 result 3 x
3 matrix

Conformable

BA = (-1 x 2) + (7 x 6) (-1 x 3) + (7 x 9) (-1 x 4) + (7 x 7)

=40 60 45

(0 x 2) + (8 x 6) (0 x 3) + (8 + 9) (0 x 4) + (8 x 7)
= 48 72 56

(5 x 2) + (1 x 6) (5 x 3) + (1 x 9) (5 x 4) + (1 x 7)
16 24 27

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BA = 40 60 45
48 72 56
16 24 27

Multiplicative inverse of a matrix

Sessions learning objective:
 At the end of this discussion students will be able to find the
inverse of matrix.
Discussion issues:
Students are encouraged to participate in the class based on their
previous reading about matrix operations and inverse of matrices. (10
minutes)

The multiplicative inverse of a matrix

If A is a square matrix of order n, then a square matrix of its inverse (A -
) of the same order n is said to be the inverse of A, if and only if A x A -1
1

= I = A-1 x A

Two square matrices are inverse of each other, if their product is the
identity matrix.
AA-1 = A-1 A = I

Not all matrices have an inverse. In order for a matrix to have an

inverse, the matrix must, first of all, be a square matrix.

Still not all square matrices have inverse. If a matrix has an inverse, it
is said to be INVERTIBLE OR NON-SINGULAR. A matrix that doesn’t
have an inverse is said to be singular. An invertible matrix will have

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only one inverse; that is, if a matrix does have an inverse, that inverse
will be unique.

Note: i. Inverse of a matrix is defined only for square matrices

ii. If B is an inverse of A, then A is also an inverse of B
iii. Inverse of a matrix is unique
iv. If matrix A has an inverse, A is said to be invertible & not all.
Square matrices are invertible.

Finding the inverse of a matrix

Lets begin by considering a tabular format where the square matrix A
is AUGMENTED with an identity matrix of the same order as A / I i.e.
the two matrices separated by a vertical line

Now if the inverse matrix A-1 were known, we could multiply the
matrices on each side of the vertical line by A -1 as
AA-1 / A-1 I

Then because AA-1 = I & A-1I = A-1, we would have I / A-1. We don’t
follow this procedure, because the inverse is not known at this
juncture, we are trying to determine the inverse. We instead employ a
set of permissible row operations on the augmented matrix A / I to
transform A on the left of the vertical line in to an identity matrix (I). As
the identity matrix is formed on the left of the vertical line, the inverse
of A is formed on the right side. The allowable manipulations are called
Elementary raw operations. ELEMENTARY ROW OPERATIONS: are
operations permitted on the rows of a matrix.
In a matrix Algebra there are three types of row operations

Type 1: Any pair of rows in a matrix may be interchanged / Exchange

operations

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Type 2: a row can be multiplied by any non-zero real number /

Multiple operation
Type 3: a multiple of any row can be added to any other row. / Add A-
multiple operation

eg.1. A= 4 3 2 B= -2 6 7 
interchanging
-2 6 7 4 3 2
rows

2. A= 4 3 2 B= 8 6 4
-2 6 7 –2 6 7

3. A= 4 3 2 B= 4 3 2
-2 6 7 6 12 11
Multiplying the first row by 2 and add to the second row. This case
there is no change to the first row.
Theorem on row operations
A row operation performed on product of two matrices is equivalent to
row operation performed on the pre factor matrix.

AB = C

Pre factor post factor product

Matrix matrix matrix

eg. A= 1 2 3 B= 1 2 C= 9
13

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2 3 4 2x3 1 1 13
19 2 x 2
2 3 3x2
2x3 3x2

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Interchange row1 (R1) with row-2 (R2)

A= 2 3 4 B= 1 2 C= 13
19
1 2 3 1 1 9
13
2 3

Multiplicative inverse of a matrix

Sessions learning objective:
 At the end of this discussion students will be able to find the
inverse of matrix applying different approaches.
Discussion issues:
Students are encouraged to participate in the class based on their
previous reading and discussion in the previous class about inverse of
a matrix. (10 Min.)

Basic procedures to find the inverse of a square matrix

1. To set ones first in a column & next zeros (with in a given
column)
2. To set zeros first in a matrix & next ones.
Ones first method
Find the inverse of the following matrix
A= 3 2
1 1

augment A 3 2 1 0
with the same dimension  1 1 0 1
identity matrix first

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Interchange rows (row 1 with row 2)

1 1 0 1
3 2 1 0
Multiply R1 by –3 & add to R2
(-3R1 + R2) i.e. No change to R1
1 1 0 1
0 -1 1 -3

Multiply R2 by –1 = (-R2)
1 1 0 1
0 1 -1 3

Multiply R2 by –1 & add to R1 Ones first:

first: try to set ones first in a column and then
1 0 1 -2 zeros of the same column. Goes from left to right
0 1 -1 3
Therefore inverse of A is
A-1 = 1 –2
-1 3
Zeros first method
A= 3 2
1 1

Find inverse of A
Augmentation  3 2 1 0
1 1 0 1
-2R2 + R1
1 0 1 -2

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1 1 0 1

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-1R1 + R2 Therefore, inverse of A

1 0 1 -2 i.e. A-1 = 1 -2
0 1 -1 +3 -1 3

Exercise: Find the inverse for the following matrices (if exist)

1. A= -2 2 3 A-1 = 1/3 –4 –5 3
1 -1 0 -4 –8 3
0 1 4 1 2 0

2. B= 2 -17 11 B-1 = 1 1 2
-1 11 -7 2 4 -3
0 3 -2 3 6 -5

3. 1 1 2 4. What do you conclude from question 2 and 3?

C= 2 4 -3
3 6 -5

5. D = 2 7 1
-3 -9 2

Application of matrix.
Sessions learning objective:
 At the end of this discussion students will be able to apply the
concept of matrices so as to solve business related problems.
Discussion issues:
Students are encouraged to participate in the class based on their
previous reading about application areas of a matrix. (10 minutes)

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 Linear equations in matrix form

 Using the inverse technique to solve system of linear
equations

Solving Systems of Linear Equations

I. n by n systems
Systems of linear equations can be solved using different methods. Some are:
i. Estimation method – for two (2) variable problems (equation)
ii. Matrix method
- Inverse method
- Gaussian method

Inverse method:
Steps 1. Change the system of linear equation into matrix form. The result will be 3
different matrices constructed using coefficient of the variables, unknown values
and right hand side (constant) values

2. Find the inverse of the coefficient matrix

3. Multiply the inverse of coefficient matrix with the vector of constant, and the
resulting values are the values of the unknown matrix.

eg. 2X + 3Y = 4 Given this system of linear equation applying

X + 2Y = 2 inverse method we can find the unknown values.

Step 1. Change it into matrix form

- Using coefficient construct one matrix i.e. coefficient matrix

1 3 = Coefficient matrix
1 2

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- Using the unknown variables construct unknown matrix & it is a column vector (a
matrix which has one column)
X = vector of unknown
Y

-Using the constant values again construct vector of constant

4 = vector of constant
2

Step 2. Find inverse of the coefficient matrix

Now we are familiar how to find an inverse for any square matrix. Assuming once first
method find the inverse for matrix 2 3
1 2

Its inverse become 2 -3

-1 2

Step 3. Multiply the coefficient inverse with the vector of constant

2 -3 4 = 2
-1 2 2 0

Therefore the resulting matrix that is 2 is

0

the value for the unknown variables i.e. X = 2

Y 0

Then X = 2 and Y = 0 that is unique solution

* The logic is this given three matrices, coefficient matrix, unknown matrix and vector of
constant in the following order.
AX = B A = coefficient matrix

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Given this we can apply different X = vector of unknown

Operations, say multiply both sides B = vector of constant
Of the expression by A-1
A-1AX = A-1B
IX = A-1B
X = A-1B this implies that multiplying inverse of the coefficient matrix will gives
us the value of the unknown matrix

Limitations of inverse method

- It is only used whenever the coefficient matrix is square matrix
- In addition to apply the method the coefficient matrix needs to have an inverse
- It doesn’t differentiate between no solution and infinite solution cases.

Solving systems of linear equations

Sessions learning objective:
 At the end of this discussion students will be able to apply the
concept of matrices so as to solve business related problems.
Discussion issues:
Students are encouraged to participate in the class based on their
previous reading about application areas of a matrix. (10 minutes)
 Linear equations in matrix form
 Using the Gaussian method to solve systems of linear
equations
Gausian method
It is developed by a mathematician Karl F. Gauss (1777-1855). It helps to solve systems
of linear equations with different solution approaches i.e. unique solution, No solution
and infinite solution cases.
“n” by “n” systems

Step: 1. Change the system of linear equation into a matrix form

2. Augument the coefficient matrix with the vector of constant.

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3. Change the coefficient matrix into identity form by applying elementary row
operation and apply the same on the vector of constant.
4. The resulting values of the vector of constant will be the solution or the value of
the unknown

Example: 2X + 3Y = 4
X + 2Y = 2
Step 1. Change it into matrix form

2 3 X = 4
1 2 Y 2

Coefficient unknown vector of

Matrix matrix constant

Step: 2. Augmentation
2 3 4
1 2 2

Step: 3. Change the coefficient matrix into identity form by applying elementary row
operation (use ones first method)
2 3 4
1 2 2

Change first the primary diagonal entry from the first row into positive one. Possible
operation is exchange row one with row two.
1 2 2
2 3 4

Next change the remaining numbers in the first column into zero, this case number 2
Now multiply the 1st row by –2 & add the result to row –2

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1 2 2
0 -1 0

Then proceed to column 2 and change the primary diagonal entry i.e. –1 into 1
Multiply the 2nd row by –1 (-1R2)
1 2 2
0 1 0
Now change the remaining number with in the same column (column –2) into zero i.e.
number 2

Multiply 2nd row by –2 and add the result to the 1st row
1 0 2
0 1 0

Therefore X = 2 and Y = 0

Example 2. X+Y=2
2X + 2Y = 4

Step-1
1 1 X = 2
2 2 Y 4

Step-2 1 1 2
2 2 4

Multiply Row-1 by –2 & add the result to raw-1 (-2R1 + R2)

1 1 2
0 0 0

The next step is changing the primary diagonal entry in the 2nd row to 1. But there is no
possible operation that can enable you to change it in to number 1

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Therefore the implication is that you can’t go further but we can observe something from
the result. And it is implying an infinite solution case

Example 3. X+Y=5
X+Y=9

Step 1. 1 1 X = 5
1 1 Y 9

Step 2 1 1 5
1 1 9

Change the encircled number above in to zero

Multiply the first row by –1 & add the result to the 2nd row.
1 1 5
0 0 4
0 = 4 no solution

There is no possible operation that we can apply in order to change the primary diagonal
entry in the 2nd column without affecting the first column structure. Therefore stop there,
but here we can observe something i.e. it is no solution case.

Therefore, Gaussian method makes a distinction between No solution & infinite solution.
Unlike the inverse method.

* Summarizing our results for solving an “n” by “n” system, we start with the matrix.
(A/B), & attempt to transform it into the matrix (I/C) one of the three things will result.
1. an “n” by “n” matrix with the unique solution.

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eg.
1 0 0 10
0 1 0 -5
0 0 1 3

2. A row that is all zeros except in the constant column, indicating that there are no
solutions,

eg. 1 0 0 3
0 1 0 -5
0 0 0 7

3. A matrix in a form different from (1) & (2), indicating that there are an unlimited
number of solutions. Note that for an n by n system, this case occurs when there is a row
with all zeros, including the constant column.

Eg. 1 0 2 5
0 1 3 -3
0 0 0 0

Reference Exercise
1. X + 2Y – 3Z = 11 2. X + Y + Z = 4 3. X + Y + Z = 4
3X + 2Y + Z = 1 5X – Y + 7Z = 25 5X – Y + 7Z =20
2X + Y - 5Z = 11 2X – Y + 3Z = 8 X – Y + 3Z = 8

4. 2X + 6Y – Z = 18
Y + 3Z = 9
3X – 5Y + 8Z = 4

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Solving System of linear equations (continued).

Sessions learning objective:
 At the end of this discussion students will be able to apply
Gaussian method to solve different system of linear
equations.
Discussion issues:
Students are encouraged to participate in the class based on their
previous reading about solving systems of linear equations. (10
minutes)
 Solving systems of linear equation using Gaussian method
 “m” by “n” systems

II) M by n linear systems

The m x n linear systems are those systems where the number of rows (m) and number of
columns (n) are unequal or it is the case where the number of equations (m) & the
number of variables (n) are unequal. And it may appear as m > n or m < n.

Linear equation where m > n

To solve an m by n system of equations with m > n, we start with the matrix (A/B) and
attempt to transform it into the matrix (I/C).

One of the three things will result:

1. An m by n identifying matrix above m – n bottom rows that are all zeros, giving the
unique solution:
1 0 0 3 3X1 + 2X2 + X3 = 23
0 1 0 -5 X1 + 3X2 + 2X3 = 26
0 0 1 4 2X1 + X2 + 2X3 = 10
0 0 0 0 4X1 + 5X2 + 3X3 = 49

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3. A row that is m – n bottom raw is all zeros except in the constant column,
indicating that there are no solutions

eg. 1 0 0 3 2X1 + X2 = 30
0 1 0 -5 X1 + 2X2 = 24
0 0 1 7 4X1 + 5X2 = 72
0 0 0 1

3. A matrix in a form different from (1) & (2), indicating that there are an unlimited
number of solutions

eg. 1 0 2 -4 3X1 + 2X2 + X3 = 6

0 1 3 8 6X1 + 4X2 + 3X3 = 12
0 0 0 0 9X1 + 6X2 + 3X3 = 18
0 0 0 0 15X1 + 10X2 + 5X3 = 30

Linear Equations where m < n

Our attempts to transform (A/B) into (I/C) in the case where m < n will result in:

1. A raw which is all zeros except in the constant columns, indicating that there are no
solutions, or

2. A matrix in a form different from number one above indicating that there are an
unlimited number of solutions.
“Every system of linear equations has either No solution, Exactly one
solution or infinitely many solutions.”
solutions.”

Example - Solve the following systems of linear equations

1) 4X1 + 6X2 – 3X3 = 12

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6X1 + 9X2 – 9/2X3 = 20

No solution
X1 + 3X2 + X3 = 6
-X1 + X2 + X3 = 2

Unlimited solution
m by n system where m <n
i.e. number of equations are less than # of variables
1) 4X1 + 6X2 – 3X3 = 12
6X1 + 9X2 – 9/2X3 = 20

2) X1 + 3X2 + X3 = 6
-X + X2 + X3 = 2

As a summary:
“M” by “n” linear systems
The m x n linear systems are those systems where the number of rows (m) and number of
columns (n) are unequal or it is the case where the number of equations (m) & the
number of variables (n) are unequal. And it may appear as m > n or m < n.
Linear equation where “m” > “n”

Solving Word problems

Steps
1. Represent one of the unknown quantities by a letter usually X & express other
Unknown quantities if there is any in terms of the same letter like X1 X2 etc
2. Translate the quantities from the statement of the problem in to algebraic form & set
up an equation
3. Solve the equation (s) for the unknown that is represented by the letter & find other
unknowns from the solution

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[Link] the findings according to the statement in the problem

Solving Word problems (continued)

Sessions learning objective:
 At the end of this discussion students will develop more skills
on how to solve word problems.
Discussion issues:
Students are encouraged to participate in the class based on their
previous practice about solving word problems. (10 minutes)

Markov Chains
Sessions learning objective:
 At the end of this discussion students will have the basics of
Markov chains and its principles
Discussion issues:
Students are encouraged to participate in the class based on their
previous reading about Markov chains. (10 minutes)
 Meaning and Definition of Markov chains
 Basic assumptions of the chain
Markov Chains
This model is a forecasting model. It is probabilistic (stochastic) model.
A Russian Mathematician called Andrew Markov around 1907 develops
this model.
Markov chains are models, which are useful in studying the evolution
of certain systems over repeated trials. These repeated trials are often
successive time periods where the state (outcome condition) of the
systems in any particular time period can’t be determined with
certainty. Therefore, a set of transition probabilities is used to describe
the manner in which the system makes transition from one period to

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the next. Hence,. We can predict the probabilities of the system being
in a particular state at a given time period. We can also talk about the
long run or equilibrium or steady state.

The necessary assumptions of the chain:

[Link] system condition (outcome) state in any given period depends

on its state in the
Preceding period & on the transition probabilities

2. The transition probabilities are constant overtime

3. Change in the system will occur once & only once each period
eg. If it’s a week, its only once in a week

4. The transition period occurs with regularities

* if we start with days, we use the day until we reach our end.

How to use Markov chain to forecast the future

Sessions learning objective:
 At the end of this discussion students will develop a good skill
in forecasting the future using the Principles of Markov chains.
Discussion issues:
Students are encouraged to participate in the class based on their
previous reading and discussions in the class about Markov chains. (10
minutes)

Information flow in the analysis

The Markov model is based on two sets of input data
 The set of transition probabilities
 The existing or initial or current conditions or states

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The Markov process, therefore, describes the movement of a system

from a certain state in the current state/time period to one of n
possible states in the next stage. The system makes in an uncertain
environment, all that is known is the probability associated with any
possible move or transition. This probability is known as transition
probability, symbolized by Pij. It is the likelihood that the system which
is currently in state i will move to state j in the next period. From these
inputs the model makes two predictions usually expressed as vectors.

1. The probabilities of the system being in any state at any given

future time period
2. The long run (equilibrium) or steady state probabilities.

The set of transition probabilities are necessary for both prediction

(time period n, & steady state), but the initial state is needed for only
the first prediction.

Input data prediction

(outcome)

Set of transition Steady states

Probabilities Or long run states

about the past

Currently / initial The probability of

States The system being in
about today
Any sate at any give
time
Example
Currently its known that 80% of customers shop at store 1 & 20% shop at store 2. In
reviewing a past data suppose we find that out of all customer who shopped at store 1 in a
given week 90% remain loyal for the next week (store one again), 10% switch to store 2.

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On the other hand, out of all customers who shopped at store 2, in a given week 80%
remains loyal for the next week (store 2 again), 20% switch to store 1. What will be the
proportion of customers shopping at store 1 & 2 in each of the next two weeks.
How to use Markov chain to forecast the future
(continued)
Sessions learning objective:
 At the end of this discussion students will develop a good skill
in forecasting the future using the Principles of Markov chains.
(Continued)
Discussion issues:
Students are encouraged to participate in the class based on their
previous reading and discussions in the class about Markov chains. (10
minutes)
 Steady state matrix principles
 Long run forecasting
Markov Chain Formula

a) Vij (n) = Vij (n – 1)

1) x P where P = Transition matrix
Vij (n) = Vector for period n
Vij (n – 1) = Vector for period n – 1

V12 (0) = (0.8 0.2) current share

V12 (1) = V12 (1 –1 ) x P
= V12 (0) x P
(0.8 0.2) 0.9 0.1
0.2 0.8
= (0.8 x 0.9) + (0.2 x 0.2) (0.8 x 0.1) + (0.2 x 0.8)
= 0.72 + 0.04 0.08 + 0.16
= 0.76 0.24

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V12 (1) = (0.76 0.24)

V12 (2) = V12 (2 – 1) x P
= V12 (1) x P
(0.76 0.24) 0.9 0.1
0.2 0.8
(0.76x 0.9) + (0.24 x 0.2) 0.76 (0.1) + (0.24 x 0.8)
(0.732 0.268)

b) Long run market share

Assumption
In the log run the share of the systems is assumed to be constant.
Let - the share of store 1 in the long run be V1
- the share of store 2 in the long run be V2

n p n+1
(V1 V2) 0.9 0.1 = (V1 V2)
0.2 0.8
0.9V1 + 0.2V2 = V1
0.1V1 + 0.8V2 = V2
-V1 + 0.9V1 + 0.2V2 = 0
0.1V1 + 0.8V2 – V2 = 0
-0.1V1 + 0.2V2 = 0
0.1V1 + (0.2V2) = 0

0.9V1 + 0.2 (V2 – V1) = V1

0.9V1 + 0.2 – 0.2V1 = V1
0.7V1 + 0.2 = V1
0.2 = 0.3V1
V1 = 2/3

V2 = 1 – V1

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= 1 – 2/3
V2 = 1/3

In the long run 67% of the customers will shop in store 1 & 33% in shop 2.

Prediction:
Long run: only the transition matrix

= At specified time:-
time:- the transition matrix & state vector. Hence unless the transition
matrix is affected, the long run state will not be affected. Moreover, we can’t know the
number of years, weeks to attain the long run state / point but we can know the share

Chapter Three:
Calculus and its application in business
Sessions learning objective:
 At the end of this discussion students will be able to explain
and understand the concept calculus.
Discussion issues:
Students are encouraged to participate in the class based on their
previous reading about calculus. (10 minutes)
 Overview
 Meaning & application

This unit examines the calculus and its application to business, economics and other areas
of problem solving. The major areas of study within the calculus are differential calculus
and integral calculus. Differential calculus focuses on rates of change in analyzing a
situation. Integral calculus involves summation of a special type.
Calculus is a mathematical tool used to solve problems in business, Economics and other
areas.
Types of calculus

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- Differential calculus and

- Integral calculus

1) Differential calculus focuses on rates of change in analyzing a situation. It

broadens the concept of slope.
Application areas:
- Optimization problems i.e. minimizing cost and /or maximizing profit, revenue---

2) Integral calculus involves summation of a special type, total change etc. It is the
inverse of Differential calculus or vice versa like that of log and antilog.
The rules of differentiation:
differentiation:
The rules of differentiation have been developed using the limit approach. The
mathematics involved in providing these rules can be finally complicated. For our
purposes it will suffice the rules without proof. Some of the rules include;
1. Derivative of a constant function.
2. Power functions
3. A constant times a function
4. Sum or differences of functions.
5. Product of functions
6. Derivative of the Quotient of function
Synopsis of Lecture
 The meaning of calculus and its scope is discussed
 The concept and scope of calculus has been discussed
thoroughly

Application of calculus in business decision

Sessions learning objective:
 At the end of this discussion students will be able to use the
concept of calculus in solving some business related
problems.

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Discussion issues:
Students are encouraged to participate in the class based on their
previous reading about application of calculus. (10 minutes)
 Revenue, Cost and Profit application
 Marginal analysis

Revenue, Cost, And Profit Applications

Revenue Applications:
Marginal analysis
Examines Incremental Effects
C(X) = total cost function  (X) = marginal Cost
R(X) = total Revenue function  (X) = Marginal revenue
P(X) = R(X) – (C(X)) = Profit  (X) = marginal Profit
(X) = (X) - (X)

Marginal Cost = is the additional cost incurred as a result of

producing and selling one more unit of a product or service.
Linear cost functions assume that the variable cost per unit is
constant for such functions the marginal cost is the same at any
level of output.
 A non-linear cost function is characterized by variable marginal
costs.
 For the total cost function C(X), the derivative C’(X) represents
i) The instantaneous rate of change in TC given a change in the
number of units produced.
ii) A general expression for the slope of the graph of the TC
function
iii) The marginal cost, MC = (X)

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(X) Can be used to approximate the marginal cost associated

with producing the next unit.
 It is the rate of change in total cost per unit change in
production at an out put level of X unit. It is also an
optimization to the actual cost of making one more unit at any
production level X (non-linear functions).

Example:
Example: Suppose the total cost C(X) in thousands of dollars for
manufacturing X unit is given by the function

C(X) = 575 + 25x ;0<X 50

[0 50]

Required:
1) Find the MC at a production level of X units
2) Find the MC at a production level of 40 unit and interpret the
result
3) Find the actual cost of producing the 41 st unit and compare this
cost with the result found in question number 2

Marginal Revenue = Marginal revenue (MR) is the additional revenue

derived from selling one more unit of a product or service. If each unit
of a product sells at the same price, the MR is always equal to the
price. Eg. R = 10x MR= 10Br.
10Br.
Marginal revenue for non-linear total revenue function is not constant.
For a total revenue function R (X), the derivative (X) represents the
instantaneous rate of change in total revenue given a change in the
number of units sold. For the purpose of marginal analysis, the
derivative is used to represent the
Marginal revenue or MR = (X) P

Max

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Q
It represent / approximately the marginal revenue from selling the next unit
Eg. R(X) = 500x – 0.005x2 X = number of units
(X) = 500 – 0.005X
Marginal Profit= Marginal revenue –Marginal cost
(X) = (X) - (X)
 Marginal revenue (Profit) analysis is concerned with the effect on profit if
one-additional unit of a product is produced and sold. As long as the
additional revenue brought in by the next unit exceeds the cost of
producing and selling that unit, there is a net profit from producing and
selling that unit and total profit increases.
I. If MR > MC,
MC, produce the next unit
II. If MR < MC,
MC, do not produce the next unit.

Profit maximization criterion

If MR = MC, for the last unit produced and sold, total profit will be maximized.
P(X) = R(X) – C(X) = 0
(X) = (X) - (X) = 0
(X) = 0
(X) = (X)

Example:
Example: The market research department of a Company recommends that the Company
to manufacture and market a new transistor radio after suitable test. The
marketing department also presents the following demand equation.
X=10,000-1000P i.e. P=10-X/1000
Furthermore, the financial department provides the following cost equation:
C(X) = 7, 000 + 2x
Conduct a marginal analysis for the company.

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Average cost, Average revenue, Average profit

 Average Cost = (X) =  Cost per unit

Marginal Average cost = (X)  the rate of change of average cost

 Average revenue = (X) =  Revenue/unit

Marginal Average revenue = (X)  R’(X)\X

 Average Profit = (X) =

Marginal Average profit = (X)

Suppose: C(X) = 1, 000 + 25x -

(X) = 25 -

(X) = + 25 -

(X) = - 1/10

(10) =

= Br. –10.10  Shows that a unit increase in production will decrease the average
cost by approximately Br. 10.10 at a production level of 10 units.

If set equal to zero

(X) = + 25 - =0

X = represents the minimum value of f, If (X) > 0 i.e.-Cost

(X) < 0 i.e. –Profit

Synopsis:
Examines Incremental Effects
C(X) = total cost function  (X) = marginal Cost

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R(X) = total Revenue function  (X) = Marginal revenue

P(X) = R(X) – (C(X)) = Profit  (X) = marginal Profit
(X) = (X) - (X)

Marginal Profit= Marginal revenue –Marginal cost

Profit maximization criterion
If MR = MC, for the last unit produced and sold, total profit will be maximized.
P(X) = R(X) – C(X) = 0
(X) = (X) - (X) = 0
(X) = 0
(X) = (X)

Average cost, Average revenue, Average profit

 Average Cost = (X) =  Cost per unit

Marginal Average cost = (X)  the rate of change of average cost

 Average revenue = (X) =  Revenue/unit

Marginal Average revenue = (X)  R’(X)\X

 Average Profit = (X) =

Marginal Average profit = (X)

Higher Order derivatives

Sessions learning objective:
 At the end of this discussion students will be able to
understand about the concept of higher order derivatives.
Discussion issues:
Students are encouraged to participate in the class based on their
previous reading about higher order derivatives. (10 minutes)

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 First derivatives
 Second derivatives
Higher-order Derivatives
If a function F has a derivative for each value of X in some specified interval, then the
derivative function is defined for that interval. If in turn the derivative function itself
has a derivative for points in that interval this new derivative function is called the second
derivative of the original function or the first derivative of .

 The first derivative test

* Locate all critical values X* (X) = 0
* For any critical value X*, determine the value of X and right

Second derivative test

For critical points, where (X) = 0, the most expedient test is the second –derivative
test. Intuitively the 2nd derivative test attempts to determine the concavity of the
function at a critical point.

Eg.
 (X) = -ve
(X) = X3 – 9x
Concave upward
(X) = 0
Concave downward
X3 – 9x = 0
 (X) = +ve
X (X2 – 9) = 0
X (X + 3) (X – 3) = 0
X = 0, X + 3 = 0 or X – 3 = 0
X = 0, X = -3, or X = 3

(0, -3, or 3)  (0,0), (-3, - ), (-3, - )

(X) = 3x2 – 9 max min min

Rule
1  find (X), set it equal to zero, and solve for candidate values, X.
2. Find (X) and evaluate (X)

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a) If (X) is negative, a local maximum occurs at X

b) If (X) is positive, a local minimum occurs at X.
c) If (X) is zero; the test fails to determine what happens at X.

* (X) = 0 is called stationary points. The slope of the line is tangent to a curve.
g. (X) = 3x3 + 5x2 + 2x + 3
(X) = 9x2 + 10x + 2 Where:
(X) = 18x + 10 = The original function
(X) = 18 = Relates information about the
(X) = 0 behavior of
= Relates information about

Given :
If (X) > 0 is increasing
If (X) < 0 is decreasing
If (X) = 0 is constant
If (X) > 0 is increasing
(X) < 0 is increasing
(X) =0 is constant

Chapter Four:
Linear programming technique

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Sessions learning objective:

 At the end of this discussion students will be able to grasp the
basics of Linear Programming Technique.
Discussion issues:
Students are encouraged to participate in the class based on their
previous reading about linear programming technique. (10 minutes)
 Meaning and Definition of Linear programming technique
 Linear programming model (LPM)
 Terminologies

LP models are mathematical representation of LP problems. Some models have a

specialized format where as others have a more generalized format. Despite this, LPMs
have certain characteristics in common knowledge of these characteristics enables us to
recognize problems that are amenable to a solution using LP models and to correctly
formulate an LP model. The characteristics can be grouped into two categories:
Components and assumptions. The components relate to the structure of a model, where
as the assumptions describe the conditions under which the model is valid.

Components of LP Model
a) The Objective function: is the mathematical/ quantitative expression
of the objective of the company/ model. The objective in problem
solving is the criterion by which all decisions are evaluated. In LPMs
a single quantifiable objective must be specified by the decision
maker. For example, the objective might relate to profits, or costs or
market share, best to only one of these. Moreover, because we are
dealing with optimization, the objective will be either maximization
or minimization, but not both at a time

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b) The Decision Variables: represent unknown quantities to be

resolved for. These decision variables may represent such things as
the:
- number of units of different products to be sold
- the # of dollars to invest in various projects
- the # of ads to place with different media
Since the decision maker has freedom of choice among actions, these
decision variables are controllable variables.

c) The constraints: are restrictions which define or limit the

attainability (achievability) feasibility of a proposed course of action.
They limit the degree to which the objective can be pursued.
A typical restriction embodies scarce resources (such as labor supply,
RMs, production capacity, machine time, storage space), legal or
contractual requirements (leg. Product standards, work standards), or
they may reflect other limits based on forecasts, customer orders,
company policies etc.

d) Parameters- are fixed values that specify the impact that one unit of
each decision variable will have on the objective and on any
constraint it pertains to as well as to the numerical value of each
constraint.
The components are the building blocks of an LP model. We can better
understand their meaning by examining a simple LP model as follows.

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Example:
Maximize: 4X1 + 7X2 + 5X3 (profit)… objective function subject to
2X1 + 3X2 + 6X3 300 labor hrs
System
5X1 + 4X3 200 raw mata.
Constraints
3X1 + 5X2 + 2X3 360
X1 = 30 Individual
X1 – qty of product 1 X2 40Constraints
Variables
Decision

X2 qty of product 2 X1, X2, X3 0 Non negativity constructs

X3 qty of product 3

System constraints- involve more than one decision variables

Individual constraint- involve only one decision variable.
None-negativity constrains- specify that no variable will be allowed to
take on a negative value. The non negativity constraints typically apply
in an LP model, whether they are explicitly stated or not.

As a Summary:
Linear programming- is an optimization method, which shows how to allocate scarce
resources in the best possible way subject to more than one limiting condition expressed
in the form of inequalities and /or equations.
LP models are mathematical representation of LP problems. Some models have a
specialized format where as others have a more generalized format. Despite this, LPMs
have certain characteristics in common knowledge of these characteristics enables us to

Linear programming technique (continued)

Sessions learning objective:
 At the end of this discussion students will be able to grasp
more concepts and terminologies about Linear Programming
Technique.
Discussion issues:

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Students are encouraged to participate in the class based on their

previous reading about linear programming technique. (10 minutes)
 Linear programming model (LPM) components
 Terminologies

Assumption of LP models
a) Linearity
The linearity requirement is that each decision variable has a linear
impact on the objective function and in each constraint in which it
appears. Taking the above example, producing one more unit of
products add birr 4 to the total profit. This is true over the entire range
of possible values of x1. The same applies (true) to each of the
constraints.

b) Divisibility: The divisibility requirement pertains to potential

values of decision variables. If is assumed that non-integer values are
acceptable. For example: 3.5 TV sets/ hr would be acceptable 7TV
sets/ 2hr.

c) Certainty: The parameters are known and constant. The certainty

requirement involves two aspects of LP models. The constraint
equations do not change.
(1)With respect to model parameters (i.e. the numerical values) –If is
assumed that these values are known and constant. Eg. In the
above example each unit of product 1 requires 2 labor hours is
known and remain constant, and also the 300 labor available is
deemed to be known and constant.
(2)All the relevant constraints identified and represented in the
model are as they are.

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d) Non-negativity- The non-negativity constraint is that negative

values of variables are unrealistic and, therefore, will not be
considered in any potential solutions, only positive values and zero will
be allowed.

Synopsis of Lecture
 Identify the basic features of Linear programming technique
 Requirements to formulate models
 Various areas to apply linear programming technique

Linear programming model formulation

Sessions learning objective:
 At the end of this discussion students will be able to construct
a valid linear programming model from a given situation.
Discussion issues:
Students are encouraged to participate in the class based on their
previous reading about linear programming model formulation. (10
minutes)
 Linear programming model (LPM) components
 Procedures to be followed

FORMULATING LP MODELS
Once a problem has been defined, the attention of the analyst shifts to
formulating a model. Just as it is important to carefully formulate the
model that will be used to solve the problem. If the LP model is ill
formulated, ill-structured, it can easily lend to poor decisions.

Formulating linear programming models involves the following steps:

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1) Define the problem/ problems definition: to determine the no. of

type 1 and type 2 products to be produced per month so as to
maximize the monetary profit given the restriction.
2) Identity the decision variables or represent unknown quantities.
* Let X1 and X2 be the monthly quantities of type 1 and type 2
products.
3) Determine the objective function: Once the variables have been
identified, the objective function can be specified. It is necessary
to decide if the problem is a maximization or a minimization
problem and the coefficients of each decision variable.

4) Identify the constraints

- system constraints- more than one variable
- individual constraints- one variable
- non-negativity constraints.

As a Summaary:
Formulating Linear Programming Models
Once a problem has been defined, the attention of the analyst shifts to
formulating a model. Just as it is important to carefully formulate the
model that will be used to solve the problem. If the LP model is ill
formulated, ill structured, it can easily lend to poor decisions.

Linear programming model formulation (Continued)

Sessions learning objective:
 At the end of this discussion students will be able to construct
a valid linear programming model for both maximization and
minimization problems.
Discussion issues:

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Students are encouraged to participate in the class based on their

previous reading about linear programming model formulation. (10
minutes)
 Linear programming model (LPM)- Maximization and
Minimization.
 Converting a given problem in to its representative model
 Looking the different types of optimization problems
- Maximization
- Minimization

Linear programming solution approach

Sessions learning objective:
 At the end of this discussion students will be able know the
different approaches to solving linear programming models or
problems.
Discussion issues:
Students are encouraged to participate in the class based on their
previous reading about solution approach to linear programming
problems. (10 minutes)
 Approaches to be used
 Procedures to be followed
 Assumption to consider

There are two approaches to solve linear programming problems.

1. The graphic solution method
2. The algebraic solution/ simplex algorithm
Synopsis of Lecture: (30 minutes)
Solution Approaches To Linear Programming Problems

There are two approaches to solve linear programming problems.

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3. The graphic solution method

4. The algebraic solution/ simplex algorithm

Solving Linear-programming: graphic solution approach

Sessions learning objective:
 At the end of this discussion students will be able to find
solutions to linear programming models or problems using
graphic approach.
Discussion issues:
Students are encouraged to participate in the class based on their
previous reading about the graphic solution approach to solve linear
programming problems. (10 minutes)
 Procedures to be followed
 Assumption to consider

The Graphic solution Method

It’s a relatively straightforward method for determining the optional
solution to certain linear programming problems.
It gives us a clear picture.

This method can be used only to solve problems that involve two
decision variables. However, most linear programming applications
involve situations that have more than two decision variables, so the
graphic approach is not used to solve these.

Example 1. Solve the following problem with graphic approach.

Z max: 60X1 + 50X2
S.t: AX1 + 10X2 100
2X1 + X2 22
3X1 + 3X2 39
X 1 X2 0

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Steps
1. Plot each of the constraints and identify its region.
2. Identify the common region, which is all area that contains all of
the points that satisfy the entire set of constraints.
3. Determine the optional solution-identify the point which lead to
maximum benefit or minimum cost.

4X1 + 10X2 = 100 2X1 + X2 = 22 3X1 + 3X2 = 39

X1 0 25 X1 0 11 X1 0 13
X2 10 0 X2 22 0 X2 13 0

24 Region ABCDE is called feasible

(0 22) region point C = ? 2x 1 + x2 = 22
20 x-3
3x1 + 3x2
= 39
-6x1 + 3x2 = -66
16 3x1 + 3x2 = 39
-3x1 = -27
12
x1 = -27/-3 = 9
2(9) + x2 = 22
8 x2 = 22 – 18 = 4
Point D = 3x1 +
3x2 = 39 x - 4
4 4x1 +
10x2 = 100x3
= -12x1 +
12x2 = -156
12x1 +
0
30x2 = 300
1
8x2 = 144
A 4 8 B 12 16 20 24

x2 = 8
3x1
+ 3(8) = 39
3x1
= 39 – 24
x1 = 15/3 = 5

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To identity the maximum (minimum) value we use the corner point

approach or the extreme point approach. The corner point/ extreme
point approach has one theorem. It states that:

For problems that have optional solutions, a solution will occur at an

extreme, or corner point. Thus if a problem has a single optional
solution, it will occur at a corner point. If it has multiple optional
solutions, at least one will occur at a corner point consequently, in
searching for an optional solution to a problem, we need any consider
the extreme points because one of those must be optional. Further,
determining the value of the objective function at each corner point,
we could identify the optional solution by selecting the corner point
that has the best value (i.e. maximum or minimum, depending on the
optimization case) of the objective function. Extreme points represent
interactions of constraints.

3.1 Determine the values of the decision variables at each

corner point. Some times, this can be done by impaction
(observation) and sometimes by simultaneous equation.
3.2 Substitute the value of the decision variables at each
corner point into the objective function to obtain its value at
each corner point.
3.3 After all corner points have been so evaluated, select the
one with the highest or lowest value depending on the
optimization case.
Value of the obi
Corner Coordinates How function Z
= 60X1 + 50X2
Points X1 X2 determined?
A 0 0 observation 0 br

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B 11 0 observation 660 br
C 9 4 Simultaneous 740 br
equation

D 5 8 Simultaneous 700 br
equation

E 0 10 Observation 500 br

BASIC SOLUTION
X1 = 9 X2 = 4 Z = 740 Br.
After we have got the optimal solution, we have to substitute the value of the decision
variables into the constraints and check whether all the resources available are used or
not. If there is any unused resources we can use it for any other purpose. The amount of
unused resource is known as slack- the amount of a scarce resource that is unused by a
given solution. The slack can range from zero, for a case in which all of a particular
resource is used, to the original amount of the resource that was available (i.e. none of it
is used.)

Computing the amount of slack

Originally unused Amount of slack
Amount used available (Available-used)

Constraint X1 = 9X2 = 4
Assembly 4(9) + 10(4) = 76 100 100 – 76 = 24 hrs
Impective 2(9) 9+ 1(4) = 22 22 22 – 22 = 0 hr
Storage 3(9) + 3(4) = 39 39 39 – 39 = 0 hr
Constraints that have no slack are sometimes referred to as binding constraints since they
limit or bind the solution. In the above cases, inspection time and storage space are
binding constraints, while assembly time has slack.

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Knowledge of unused capacity can be useful for planning. A manager may be able to use
the remaining assembly time for other products, or, perhaps to schedule equipment
maintenance, safety seminars, training sermons or other activities

Interpretation: The company is advised to produce 9 units of type 1 micro computer and 4
units of type 2 micro computers per week to maximize its early profit to Br. 740, and in
doing so the company would be left with unused resource of 24 assembly hrs which can
be used for other purposes.

Exercise: Solve the following problem

C min = 5X1 + 8X2
10X1 + 30X2 140
20X1 + 15X2 145
X1 , X2 0

As A summary
Steps to solve using the graphic approach
Plot each of the constraints and identify its region.
Identify the common region, which is all area that contains all of the
points that satisfy the entire set of constraints.
Determine the optional solution-identify the point that lead to
maximum benefit or minimum cost.

Solving Linear-programming: the simplex algorithm.

Sessions learning objective:
 At the end of this discussion students will be able to find
solutions to linear programming problems using the simplex
procedure.
Discussion issues:

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Students are encouraged to participate in the class based on their

previous reading about the simplex algorithm to solve linear
programming problems. (10 minutes)
 Basic concepts
 Terminologies used
 Procedures to be followed
 Assumption to consider

The Simplex Algorithm/ Algebraic Solution Method

The simplex method is an iterative technique that begins with a feasible solution that is
not optimal, but serves as a starting point. Through algebraic manipulation, the solution is
improved until no further improvement is possible (i.e. until the optional solution has
been identified). Each iteration moves one step closer to the optional solution.

The optimal solution to a linear programming model will occur at an extreme point of the
feasible solution space. This is true even if a model involves more than two variables;
optimal solutions will occur at these points of the feasible solution space; some will be
outside of the feasible solution space. Hence, not every solution will be a feasible
solution. Solutions which represent infasseetwim of constraints are called basic solutions;
those which also satisfy all of the constraints, including the non-negativity constraints,
are called basic feasible solutions. The simplex method is an algebraic procedure for
systematically examining basic feasible solutions. If an optimal solution exists, the
simplex method will identify it. # of basic solution n + mCm  not all basic solutions are
feasible.

The simplex procedure for a maximization problem with all constraints consists of the
following steps.
1. Write the LPM in a Standard form: When all of the constraints are written as
equalities, the LP program is said to be in a standard form. We convert the LPM in to
a standard form by applying the slack variables, s, which carries a subscript that
denotes which constraint it applies to. For example, s 1 refers to the amount of slack in

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the first constraint, S2 to the amount of slack in the second constraint, and so on.
When slack variables are introduced to the constraints, they are no longer inequalities
b/c the slack variable accounts, they become equalities. Further more, every variable
in a model must be represented in the objective function. However, since slack does
not provide any real contribution to the objective, each slack variable is a assigned a
coefficient of zero in the objective function.
Slack = Requirement – Production, scruples – Production – Requirement
Taking the following problem, its standard form is as follows
Z max = 60X1 + 50X2 Z max = 60X1 + 50X2 + 0S1 + 0S2 + 0S3
4X1 + 10X2 100 4X1 + 10X2 + S1 = 100
2X1 + X2 22  2X1 + X2 + S2 = 22
3X1 + 3X2 39 3X1 + 3X2 + S3 = 39
X1, X2 0 All variables 0
(X1, X2, S1, S2, S3 0)
2. Develop the initial tableau
a. List the variables across the top of the table and write the objective function
coefficient of each variables just above it.
b. There should be one row in the body of the table for each constraint. List the slack
variables in the basis column, one per row.
c. In the Cj column, enter the objective function coefficient of zero for each slack
variable.
d. Compute values for row Zj. Cj = Coeff of variable J in the obj function.

e. Computer values for Cj – Zj. bj = RHSV of constraint i.

Aij – coefficient of variable j in constraint i

Pivot column

Solution Cj 60 50 0 0 0 100/4 = 25
leaving
Basis X1 X2 S1 S2 S3 RHSV 22/2 = 11
S1 0 4 10 1 0 0 100 39/3 = 13

S2 0 2 1 0 1 0 22
S3 0 3 3 0 0 1 39
Zj 0 0 0 0 0 0
Cj - Zj 60 50 0 0 0
Initial feasible solution
S1 = 100 Obtained by
S2 = 22 equating tow
S3 =39 Variables
72 to
X1 = 0 Zero
X2 = 0 Decision
Z = 0 Variable
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Entering variable

3. Develop subsequent tables

3.1 Identify the entry variable –variable that has a largest positive value in the Cj – Zj
row.
3.2 Identify the leaving variable –using the constraint coefficient or substitution rates
in the entering variable column divide each one into the corresponding quantity value.
However do not divide by a zero or negative value. The smalls non negative ratio that
results indicate which variable will leave the solution
4. Find unique vectors for the new basic variable using row operations on the pivot
element.
-1/2 R21 –4R2new + R1old, -3R2new + R3old
Solution Cj 60 50 0 0 0
Cj = bi/xj (aij)
Basics X1 X2 S1 S2 S3 RHSV
56/8 = 7
11/1/2 = 22
S1 0 0 8 1 -2 0 56 6/3/2 = 4
X1 60 1 ½ 0 ½ 0 11
S3 0 0 3/2 0 -3/2 1 6
Zs 60 30 0 30 0 660
Cj – Zj 0 20 0 -30 0

Incoming Variable

Solution Cj 60 50 0 0 0 RHSV
basis X1 X2 S1 S2 S3
S1 0 0 0 1 6 -16/3 24
X1 60 1 0 0 1 -1/3 9
X2 50 0 1 0 -1 2/3 4
Zj 60 50 0 10 40/3 740
Opportunity cost
Cj - Zj 0 0 0 -10 -40/3

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5. Compute Cj – Zj row
6. If all Cj – Zj Values are zeros and negatives, you have reached optimality
7. If this is not the case (step 6), repeat 2 to 5 until you get optional solution.
“A simplex solution in a maximization problem in optional if the Cj – Zj row consists
entirely of zeros and negative numbers (i.e. there are no positive values in the bottom
row.)”
Note: The variables in solution all have unit vectors in their respective columns for
the constraint equations. Further, note that a zero appears in row C – Z in every
column whose variable is in solution, in row C – Z in every column whose variable is
in solution, indicating that its maximum contribution to the objective function has
been realized.
Example
A manufacture of lawn and garden equipment makes two basic types
of lawn mowers; a push type and a self propelled model. The push type
require 9 minutes to assemble and 2 minutes to package; the self-
propelled mover requires 12 minute to assemble and 6 minutes to
package. Each type has an engine. The company has 12hrs of
assembly time available, 75 engines, and 5hrs of packing time profits
are Birr 70 for the self propelled model and br 45 for the push type
mower per unit.

Required:
To determine how many units of each type of mower to produce so as to maximize
profit.

As A summary:
The simplex method is an iterative technique that begins with a feasible solution that is
not optimal, but serves as a starting point. Through algebraic manipulation, the solution is
improved until no further improvement is possible (i.e. until the optional solution has
been identified.) Each iteration moves one step closer to the optional solution.

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Solving Linear-programming: the simplex algorithm.

(Continued)
Sessions learning objective:
 At the end of this discussion students will understand on how
to apply simplex procedure to find solutions to linear
programming problems.
Discussion issues:
Students are encouraged to participate in the class based on their
previous class discussion and reading about the simplex algorithm to
solve linear programming problems. (Continued) (10 minutes)
 Procedures to be followed
 Assumption to consider
Synopsis:
Different cases will be taken for illustrative purpose and analysis and
some basic ideas will be discussed.
 Supportive exercises will be given to exercise more.
 Techniques will be illustrated on how to solve using the
approach.

Exercise on the linear programming in general

Sessions learning objective:
 At the end of this session students will upgrade their skills of
solving different types of optimization problems using the
possible techniques.
Discussion issues:
 To show students different techniques on how to
systematically solve linear programming problems

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 Giving exercise on linear programming issues to be solved by

the two approaches

Chapter Five:
Mathematics of finance
Sessions learning objective:
 At the end of this discussion students will be able to grasp the
basic concepts of Mathematics of finance.
Discussion issues:
Students are encouraged to participate in the class based on their
previous reading about mathematics of finance. (10 minutes)
 Mathematics of finance introduction
 Time value of money
 Terminologies

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The basic concept of mathematics of finance is that money has time value which is
described either as present value or future. Present value is the value of money today;
future value is the value of money at some point in the future. The different between
money now and the same money in the future is called interest. Interest have a wide
spread influence over decisions made by businesses and every of us in our personal lives.
Therefore, the basic objective of this unit is to discuss interest rates and their effects on
the value of money. Specifically, it covers simple interest, compound interest, annuity
and mortgage problems.

INTERESTS

Interest is the price paid for the use of a sum of money over a period of time. It is a fee
paid for the use of another’s money, just rent is paid for the use of another’s house. A
savings institution (Banks) pay interest to depositors on the money in the savings account
since the institutions have use of those funds while they are on deposit. On the other
hand, a borrower pays interest to a lending agent (bank or individual) for use of the
agent’s fund over the term of the loan.

Interest is usually computed as percentage of the principal over a given period of time.
This is called interest rate. Interest rate specifies the rate at which interest accumulates
per year through out the term of the loan. The original sum of money that is lent or
invested/ borrowed is called the principal.

Interests are of two types: simple interest and compound interest. In the first part of this
unit we shall explore these two concepts.

Topic: Mathematics of finance-Simple interest

rate
Sessions learning objective:

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 At the end of this discussion students will be able to apply the

concept of simple interest rates in order to measure the value
of money.
Discussion issues:
Students are encouraged to participate in the class based on their
previous reading about simple interest rates. (10 minutes)
 Simple interest rate
 Future value
Simple Interest

If interest is paid on the initial amount of money invested or borrowed only and not on
subsequently accrued interest, it is called simple interest. The sum of the original
amount (principal) and the total interest is the future amount or maturity value or in
short amount. Simple interest generally used only on short-term loans or investments –
offen of duration less than one year. Simple interest is given by the following formula.

I = prt ….. ----------------------------------(1)

Where: I = Simple interest
P = principal amount
r = Annual simple interest rat
t = time in years, for which the interest is paid
If any three of the four variables are given, you can solve for the fourth (unknown
variable) and their relationship is as follows:
Amount (A) = P + I
= P + Prt. factor out the common term P
= P (1 + rt) ………………………………………(2)

P = I/rt or P = ……………(3)

r = I/pt………………………….(4)
t = I/pr …………………………(5)

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Example 1
Ato Messay wanted to buy TV which costs Br. 10, 000. He was short of cash and went to
Commercial Bank of Ethiopia (CBE) and borrowed the required sum of money for 9
months at an annual interest rate of 6%. Find the total simple interest and the maturity
value of the loan.

Example 2
How long will it take if Br. 10, 000 is invested at 5% simple interest to double in value?
Example 3
How much money you have to deposit in an account today at 3%
simple interest rate if you are to receive Br. 5, 000 as an amount in 10
years?

Example 4.
At what interest rate will Br. 5, 000 yield Br. 2, 000 in 8 years time.

Example 5.
Find the Interest on Br. 5, 000 at 10% for 45 days.

At what interest rate you should invest Br. 5000, if you want to receive
an amount of Br. 7,000 in 8 years time.
Answer = 5%

Summary:
If interest is paid on the initial amount of money invested or borrowed only and not on
subsequently accrued interest, it is called simple interest. The sum of the original
amount (principal) and the total interest is the future amount or maturity value or in
short amount. Simple interest generally used only on short-term loans or investments –
often of duration less than one year. Simple interest is given by the following formula.

I = Prt
Where: I = Simple interest
P = principal amount

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r = Annual simple interest rat

t = duration in terms of number of years
If any three of the four variables are given, you can solve for the fourth (unknown
variable) and the future value of the principal is computed as follows:
Amount (A) = P + I

Mathematics of finance-Compound interest rate

Sessions learning objective:
 At the end of this discussion students will be able to apply the
concept of compound interest rates in order to measure the
value of money.
Discussion issues:
Students are encouraged to participate in the class based on their
previous reading about compound interest rates. (10 minutes)
 Compound interest rate
 Future value

Compound Interest

If the interest, which is due, is added to the principal at the end of each interest period
(such as a month, quarter, and year), then this interest as well as the principal will earn
interest during the next period. In such a case, the interest is said to be compounded. The
result of compounding interest is that starting with the second compounding period, the
account earns interest on interest in addition to earning interest on principal during the
next payment period. Interest paid on interest reinvested is called compound interest.

The sum of the original principal and all the interest earned is the compound amount.
The difference between the compound amount and the original principal is the compound
interest.

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The compound interest method is generally used in long-term borrowing unlike that of
the simple interest used only for short-term borrowings. The time interval between
successive conversions of interest into principal is called the interest period, or
conversion period, or Compounding period, and may be any convenient length of time.
The interest rate is usually quoted as an annual rate and must be converted to appropriate
rate per conversion period for computational purposes. Hence, the rate per compound
period (i) is found by dividing the annual nominal rate (r) by the number of compounding
periods per year (m):
i = r/m

Example if r = 12%, i is calculated as follows:

Conversion period (m) Rate per compound period (i)
1. Annually (once a year) -------------------------------- i = r/1 = 0.12/1 = 0.12
2. Semi annually (every 6 months) --------------------- i = r/2 = 0.12/2 = 0.06
3. Quarterly (every 3 months) -------------------------- i = r/4 = 0.12/4 = 0.03
4. Monthly ------------------------------------------------- i = r/12 = 0.12/12 = 0.01

Example 1
Assume that Br. 10, 000 is deposited in an account that pays interest of 12% per year,
compounded quarterly. What are the compound amount and compound interest at the end
of one year?

In general, if p is the principal earning interest compounded m times a year at an annual

rate of r, then (by repeated use of the simple interest formula, using i = r/m, the rate per
period, the amount A at the end of each period is:
(1) A = p (1 + i)………………compound amount at the end of first period.
If we are interested in determining the compound amount after two periods, it
may be computed using the equation:
(2) Compound amount = Compound amount + Interest earned during
after two periods after one period the 2nd period
A = p (1 + i) + [P (1 + i)] (i)

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Factoring P and (1 + i) from both terms of the right side of the equation gives us:
A = P (1 + i) (1 + i)
= P (1 + i)2
(3) Compound amount = Compound amount + Interest earned
after three periods after two period during the 3rd period
A = P(1 + i)2 + [P (1 + i)2] (i)

Factor out p and (1 + i)2 from the terms on the right side of the equation and it
gives you:
A= P (1 + i)2 (1 + i)
= P (1 + i)3
(4) Compound amount
= P (1 + i)n
after nth period

The compound amount formulas developed so far are summarized below:

1. Compound amount after one period = p (1 + i)1
2. Compound amount after two periods = p (1 + i)2
3. Compound amount after three periods = p (1 + i)3
4. Compound amount after nth periods = p (1 + i)n

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………….* Compound amount formula.

A = P (1 + i)n

Where: A = amount (future value) at the end of n periods.

P = Principal (present value)
i = r/m = Rate per compounding period.
n = mt = total number of conversion periods
t = total number of years
m = number of compounding/ conversion periods
per Year
r = annual nominal rate of interest
In general, the compound amount can be found by multiplying the principal by (1 + i) n.
So for the above problem the amount at the end of the year, using the general formula, is
equal to:
A = P (1 + i)n n = mt = 4 x 1 = 4
= 10, 000 (1.03)4 i = r/m = 12%/4 = 3%
= Br. 11, 255.088

Compound Interest = Compound amount – original principal

= 11, 225.088 – 10, 000
= Br. 1, 255.088

We may evaluate “A” in several different ways. Among the possible

alternatives are:
1. Use a hand-held calculator with a Y x function key. This is the procedure most
often used.

2. Using Logarithms
Restate the equation by finding for log A (or In A) and then finding
the antilog, using either a hand-held calculator with logarithmic
functions or a table of logarithms. Let us illustrate this
alternative.

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A = 10, 000 (1.03)4

log A = log 10, 000 + log (1.03)4
= log 10,000 + 4 log 1.03
= log 104 + 4 log 1.03

= 4 + 4(0.01284)
= 4 + 0.05135
log A = 4.05135
A = Antilog 4.05135
= Br. 11255.117

Basic rules of logarithm

1. ax = b Eg. 2x = 5
log ax = log b log 2x = log 5
x log a = lob b x log 2 = log 5
x = log b/ log a x = log 5/ log2
x = 2.322
2. abx + c = d
abx = d – c
bx = d – c/a

log bx = log let: =K

X log b = log K divide both side of the equality by log b.

X=

Eg. 4 (3x) + 10 = 18 find the value of X

4 (3x) = 18 – 10
4 (3x) = 8 (Divide by 4)
3x = 2
log 3x = log 2

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X log 3 = log 2

X=

= 0.63093

3. X3 = a Eg. X3 = 1, 000
logX3 = log a log X3 = log 1, 000
3 log x = log a 3 log X = log 103

log x = ; Let =K log X = 3/3

X = Antilog K log X = 1
X = Antilog 1
X = 10

4. a = b (c + x)d find the value of X

(c + x)d = a/b
log (c + X)d = log a – log b
d log c + X = log a = log b

log c + X = Let: =K

log c + x = K
c + x = Antilog K
X = Antilog K - C

3. The third way of finding the compound amount is using specially

prepared tables which provide values of (1 + i) n for selected
values of i and n.

Therefore, to calculate the value of “A” or other variables in the

compound interest formula, you can use any of these three
approaches which ever convenient to you.

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Example 2. Find the compound amount and compound interest after

10 years if Br. 15, 000 were invested at 8% interest;
a) If compounded annually

b) If compounded semiannually
c) If Compounded quarterly

d) If compound monthly
e) If compounded weekly

f) if Compounded daily, and hourly

g) If compounded continuously (Instantaneously) what happens
to the compound amount if interest is compounded continuously?
To drive a formula for continuous compound interest, we begin by
writing:
(1 + i)n = (1 + r/m) mt

Then, by inserting 1 = r/r in the exponent, we obtain

(1 + r/m)mt (r/r)
= (1 + r/m) (m/r). (rt)

Then, letting m/r = X, we have

[(1 + 1/x)x] rt

As X increases indefinitely, the term (1 + 1/x) x approaches the

value of the familiar mathematical constant e = 2.7182818…….
This means that the factor
(1 + i)n = [(1 + 1/x)x]rt approaches
ert as n increases indefinitely. The resulting formula for the
amount under continuous compounding of interest is given by:

A = P ert
………………..**
Where: A= amount at the end of time t under continuous
compounding
p = principal

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r = annual rate, compounded continuously

t= time, in years
Note: the value of ert may be found using a calculator.

 What can you observe from the above discussion? When a

number of conversion period within a year increases, the interest
earned also increases continuously toward an upper limit. The
limiting case occurs where interest is compounded continuously.

Example 3.
How long it take to accumulate Br. 8, 000 if you invest Br. 6, 000 at
12% compounded monthly?

Synopsis:
If the interest, which is due, is added to the principal at the end of each interest period
(such as a month, quarter, and year), then this interest as well as the principal will earn
interest during the next period. In such a case, the interest is said to be compounded. The
result of compounding interest is that starting with the second compounding period, the
account earns interest on interest in addition to earning interest on principal during the
next payment period. Interest paid on interest reinvested is called compound interest.

The sum of the original principal and all the interest earned is the compound amount.
The difference between the compound amount and the original principal is the compound
interest.

Mathematics of finance-Present Value of money

Sessions learning objective:
 At the end of this discussion students will be able to
understand on how to apply the concept of present value of
money.

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Discussion issues:
Students are encouraged to participate in the class based on their
previous reading about Present value of money. (10 minutes)
 Discounting
 Application of present value
The present value
Frequently it is necessary to determine the principal P which must be
invested now at a given rate of interest per conversion period in order
that the compound amount A be accumulated at the end of n
conversion periods. Under these conditions, p is called the present
value of A. This process is called discounting and the principal is now a
discounted value of future income A. If:
A = P (1 + i)n then dividing both sides by (1 + i)n leads to

P= = A (1 + i)-n

P = A (91 + i) -n ……… ………* Present value of compound

amount.

Example 4. How much should you invest now at 8% compounded

semiannually to have Br. 10, 000 toward your brother’s college
education in 10 years?
Synopsis:
Frequently it is necessary to determine the principal P which must be
invested now at a given rate of interest per conversion period in order
that the compound amount A be accumulated at the end of n
conversion periods. Under these conditions, p is called the present
value of A. This process is called discounting and the principal is now a
discounted value of future income A. If:
A = P (1 + i)n then dividing both sides by (1 + i)n leads to

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P= = A (1 + i)-n

P = A (1 + i) -n ……… ………* Present value of compound

amount.

Effective interest rate

Sessions learning objective:
 At the end of this discussion students will be able to
understand the concept of effective interest rate.
Discussion issues:
Students are encouraged to participate in the class based on their
previous reading about effective interest. (10 minutes)
 Effective interest rate
 Application of effective interest rate

EFFECTIVE RATE

An effective rate is the simple interest rates that would produce the
same return in one year had the same principal been invested at
simple interest without compounding. In other words, the effective rate
r converted m times a year is the simple interest rate that would
produce an equivalent amount of interest in one year. It is denoted by
re.

If principal p is invested at an annual rate r, compounded m times a

year, then in one year,
A = P (1 + r/m)m
What simple interest rate will produce the same amount A in one year?
We call this simple interest rate the effective rate. To find r e we
proceed as follows:

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(Amount at simple interest after 1 year) = (Amount at compound

interest after 1 year)
P (1 + re) = p (1 + r/m)m ……….Divide both sides by p
1 + re = (1 + r/m)m …………..isolate re on the left side and gives
you:

re = (1 + r/m)m - 1
………..* effective interest rate formula.
Where: r = nominal annual rate of
interest
m = no. of conversion periods per
year.

re = e r - 1 …………..** effective interest rate in continuous

compounding.

Example 5. An investor has an opportunity to invest in two

investment alternatives A and B which pays 15% compounded
monthly, and 15.2% compounded semi-annually respectively.
Which investment is better investment, assuming all else
equal?

Example 6. What is the effective rate corresponding to a nominal rate

of 16% compounded quarterly?
Synopsis of Lecture
An effective rate is the simple interest rates that would produce the
same return in one year had the same principal been invested at
simple interest without compounding. In other words, the effective rate
r converted m times a year is the simple interest rate that would
produce an equivalent amount of interest in one year. It is denoted by
re.

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If principal p is invested at an annual rate r, compounded m times a

year, then in one year,
A = P (1 + r/m)m
What simple interest rate will produce the same amount A in one year?
We call this simple interest rate the effective rate. To find r e we
proceed as follows:

re = (1 + r/m)m - 1
………..* effective interest rate formula.
Where: r = nominal annual rate of
interest
m = no. of conversion periods per
year.

An Annuity- Overview
Sessions learning objective:
 At the end of this discussion students will be able to
understand the concept of an annuity.
Discussion issues:
Students are encouraged to participate in the class based on their
previous reading about ordinary annuity. (10 minutes)
 An annuity
 Introduction to an ordinary annuity

ANNUITIES

An annuity is any sequence of equal periodic payments. The payments

may be made weekly, monthly, quarterly, annually, semiannually or for
any fixed period of time. The time between successive payments is
called payment period for the annuity. If payments are made at the

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end of each payment period, the annuity is called an ordinary

annuity. If payment is made at the beginning of the payment period,
it is called annuity due. In this course we will discuss only ordinary
annuities. The amount, or future value, of an annuity is the sum of all
payments plus the interest earned during the term of the annuity.

The term of an annuity refers to the time from the begging of the
first payment period to the end of the last payment period.
1 Ordinary Annuity
An ordinary annuity is a series of equal periodic payments in which
each payment is made at the end of the period. In an ordinary annuity
the first payment is not considered in interest calculation for the first
period because it is paid at the end of the first period for which interest
is calculated. Similarly, the last payment does not qualify for interest at
all since the value of the annuity is computed immediately after the
last payment is received.

An Ordinary Annuity-future value

Sessions learning objective:
 At the end of this discussion students will be able to
understand the concept of an ordinary annuity and future
value.
Discussion issues:
Students are encouraged to participate in the class based on their
previous reading about ordinary annuity. (10 minutes)
 Introduction to an ordinary annuity
 Future value of ordinary annuity

Future value (Amount) of an ordinary annuity

Example1. What is the amount of an annuity if the size of each
payment is Br. 100 payable at the end of each quarter for one year at
an interest rate of 4% compounded quarterly?

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If R represents the amount of the periodic payment, i represents the interest rate per
payment period, and n represents the number of payment periods, then
R R R -------- R R
Periods
0 1 2 3 ------- n-1 n
The first payment of R accumulates interest for n-1 periods, the second payment R for n –
2 periods etc. The last payment accumulate no interest, the next to last payment
accumulates one period for interest. So using the future value for compound interest we
see the future value of the annuity:
A = R (1 + i) n-1 + R (1 + i)n-2 + ………..+ R (1 + i)1 + R….Equation 1
Multiplying each side of the equation by (1 + i), we obtain
A (1 + i) = R (1 + i)n + R (1 + i)n-1 + ……….+ R(1 + i)2 + R (1 + i) …… Eg. 2.
Then subtracting the first equation (eq. 1) from the second equation (eq. 2), gives you:
A (1 + i) = R (1 + i)n + R (1 + i)n-1 + …….+ R (1 + i)2 + R (1 + i)
A = R (1 + i)n-1 + ……..R (1 + i)2 + R(1 + i) + R
A (1 + i) – A = R (1 + i) n – R
A [(1 + i)] = R [(1 + i)n –1]
A (i) = R[(1 + i)n –1] Dividing both sides by i, we have

A=
………………..* Amount of an ordinary annuity

Where: A = Amount (future value) of an

ordinary annuity at the end of
its term
R = Amount of periodic payment
i = interest rate per payment
period
n = (mt) total no. of payment
periods

Solve the above problem (example 1) using the annuity formula:

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A=

Example 2. Mr X. Deposits Br. 100 in a special savings account at the end of each
month. If the account pays 12%, compounded monthly, how much money, will Mr. X
have accumulated just after 15th deposit?

Example 3. A person deposits Br. 200 a month for four years into an account that pays
7% compounded monthly. After the four years, the person leaves the
account untouched for an additional six years. What is the balance after the
10 year period?

synopsis:
Future value (Amount) of an ordinary annuity

A= ………………. Amount of an ordinary annuity

Where: A = Amount (future value) of an ordinary annuity at the end of its term
R = Amount of periodic payment
i = interest rate per payment period n = (mt) total no. of payment periods
Sinking fund
Sessions learning objective:
 At the end of this discussion students will be able to
understand the concept of Sinking fund.
Discussion issues:
Students are encouraged to participate in the class based on their
previous reading about sinking fund. (10 minutes)
 Overview
 Meaning & description

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SINKING FUND
A sinking fund is a fund into which equal periodic payments are made
in order to accumulate a definite amount of money up on a specific
date. Sinking funds are generally established in order to satisfy some
financial obligations or to reach some financial goal.

If the payments are to be made in the form of an ordinary annuity, then the required
periodic payment into the sinking fund can be determined by reference to the formula for
the amount of an ordinary annuity. That is, if:

A=R then,

R=

=A

Example 4. How much will have to be deposited in a fund at the end of each year at 8%
compounded annually, to pay off a debt of Br. 50, 000 in five years?

Example 5. Ato Ayalkebet has a savings goal of Br. 100, 000 which he would like to
reach 15 years from now. During the first 5 years he is financially able to
deposit only Br. 1000 each quarter into the savings account. What must his
quarterly deposit over the last 10 (ten) years be if he is to reach his goal? The
account pays 10% interest, compounded quarterly.

Synopsis:
A sinking fund is a fund into which equal periodic payments are made
in order to accumulate a definite amount of money up on a specific

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date. Sinking funds are generally established in order to satisfy some

financial obligations or to reach some financial goal.

A=R then, R= =A

Present value of an ordinary annuity

Sessions learning objective:
 At the end of this discussion students will be able to explain
and understand the concept of present value of an ordinary
annuity.
Discussion issues:
Students are encouraged to participate in the class based on their
previous reading about present value of an ordinary annuity. (10
minutes)
 Overview
 Meaning & application

Present value of an ordinary annuity

The present value of an ordinary annuity is the sum of the present

values of all the payments, each discounted to the beginning of the
term of the annuity. It represents the amount that must be invested
now to purchase the payments due in the future.

The present value of an annuity can be computed in two ways:

 Discounting all periodic payments to the present (beginning of the term
individually) or
 Discounting the future value (amount) of an annuity to the beginning of the term

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Example 6. What is the present value of an annuity if the size of each payment is Br. 200
payable at the end of each quarter for one year and the interest rate is 8%
compounded quarterly?

Using the first approach (discounting each payment individually), the present value will
be:
0 1 2 3 4 Periods (quarter)
Br. 200 200 200 200

Present value
196.1 = 200(1.02)1
192.23 = 200(1.02)2
188.46 = 200(1.02)3
184.77 = 200(1.02)4
761.56 Br = Present value.

Equivalently we may find the future value of the ordinary annuity using the formula and
then discount it to the present taking it as a single future value.

A=R

= 200

= Br. 824.32
P = A (1 + i)-n
= 824.32 (1.02)-4
Br = 761.56

If we multiply the future value of an ordinary annuity by the compounding discounting

factor, we get the present value of an annuity as follows:

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P=R ((1 + i)-n)

=R

…………………..* Present value of an ordinary annuity.

P = R 7. What is the present value of an annuity that pays Br. 400 a month for the
Example
next five years if money is worth 12% compounded monthly?

Synopsis:
The present value of an ordinary annuity is the sum of the present
values of all the payments, each discounted to the beginning of the
term of the annuity. It represents the amount that must be invested
now to purchase the payments due in the future.

The present value of an annuity can be computed in two ways:

 Discounting all periodic payments to the present (beginning of the term
individually) or
 Discounting the future value (amount) of an annuity to the beginning of the term

Amortization
Sessions learning objective:
 At the end of this discussion students will be able to explain
and understand the concept of amortization.
Discussion issues:
Students are encouraged to participate in the class based on their
previous reading about amortization. (10 minutes)
 Overview
 Meaning & application

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Amortization
Amortization means retiring a debt in a given length of time by equal
periodic payments that include compound interest. After the last
payment, the obligation ceases to exist it is dead and it is side to have
been amortized by the periodic payments. Prominent examples of
amortization are loans taken to buy a car or a home amortized over
periods such as 5, 10, 20 or 30 years.

In amortization the interest is to determine the periodic payment, R, so as to amortize

(retire) a debt at the end of the last payment. Solving the present value of ordinary
annuity formula for R in terms of the other variable, we obtain the following amortization
formula:

R=P
…………………………………** Amortization formula
Where: R = Periodic payment
P = Present value of a loan
i = Rate per period
n = Number of payment periods

Example
1. Ato Elias borrowed Br. 15, 000 from Commercial Band of Ethiopia and agree to
repay the loan in 10 equal installments including all interests due. The banks
interest charges are 6% compounded Quarterly. How much should each annual
payment be in order to retire the debt including the interest in 10 years.

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If you have Br. 100,000 in an account that pays 6% compounded monthly and I you
decide to withdraw equal monthly payments for 10 years at the end of which time the
account will have a zero balance, how much should be withdrawn each month?

2. An employee has contributed with her employer to a retirement plan for 20 years
a certain amount twice a year. The contribution earns an interest rate of 10%
compounded semiannually. At the date of her retirement the total retirement
benefit is Br. 300, 000. The retirement program provides for investment of this
amount at an interest rate of 10% compounded semiannually. Semiannual
payments will be made for 10 years to the employee of her family in the event of
her death.
1. What semi annual payment should she made?
2. What semi annual payment should be made for her or her family?
3. How much interest will be earned on Br. 300, 000 over the 40 years?

Synopsis:
Amortization means retiring a debt in a given length of time by equal
periodic payments that include compound interest.

R=P
Amortization formula
Where: R = Periodic payment
P = Present value of a loan
i = Rate per period
n = Number of payment periods

Mortgage payments
Sessions learning objective:
 At the end of this discussion students will be able to explain
and understand the concept of mortgage payments.

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Discussion issues:
Students are encouraged to participate in the class based on their
previous reading about mortgages. (10 minutes)
 Overview
 Meaning & application

Mortgage Payments
In a typical home purchase transaction, the home buyer pays part of the cost in cash and
borrows the remaining needed, usually from a bank or a savings and loan associations.
The buyer amortizes the indebtedness by periodic payments over a period of time.
Typically payments are monthly and the time period is long such as 30 years, 25 years
and 20 years. Mortgage payment and amortization are similar. The only differences are:
 the time period in which the debt/ loan is amortized /repaid/
 the amount borrowed.

In mortgage payments m is equal to 12 because the loan is repaid from monthly salary or
Income, but in amortization money take other values. Similarly stated mortgage
payments are of amortization in nature involving the repayment of loan monthly over an
extended period of time.

Therefore, in mortgage payments we are interested in the determination of monthly

payments.
Taking:
A = total debt
R = monthly mortgage payments
r = stated nominal rate per annum
n = 12 x number of years (period of the loan)
R can be determined as follows:

R=A or R=A

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A=R

Example: 1
Ato Messay purchased a house for Br. 115, 000. He made a 20% down payment with the
balance amortized by a 30 year mortgage at an annual interest of 12% compounded
monthly so as to amortize/ retire the debt at the end of the 30th year.
Required:
1. Find the periodic payment
2. Find the interest charged.
Find the interest charged.

Example: 2
Ato Messay purchased a house for Br. 50, 000. He made an amount of down payment
and pay monthly Br. 600 to retire the mortgage for 20 years at an annual interest rate of
24% compounded monthly.
Required.
Find the mortgage, down payment, interest charged and percentage of the
down payment to the selling price.

Ato Liku purchases a house for Br. 250, 000. He makes a 20% down payment, with a
balance amortized by a 30 year mortgage at an annual interest rate of 12% compounded
monthly.
a) Determine the amount of the monthly mortgage payment.
b) What is the total amount of interest Ato Liku will pay over the life of the
mortgage?
c) Determine the amount of the mortgage Ato Liku will have paid after 10
years?

Synopsis
In a typical home purchase transaction, the home buyer pays part of the cost in cash and
borrows the remaining needed, usually from a bank or a savings and loan associations.

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The buyer amortizes the indebtedness by periodic payments over a period of time.
Typically payments are monthly and the time period is long such as 20 years, 25 years
and 30 years.
Therefore, in mortgage payments we are interested in the determination of monthly
payments.
Taking:
A = total debt
R = monthly mortgage payments
r = stated nominal rate per annum
n = 12 x number of years (period of the loan)
R can be determined as follows:

R=A or R=A

End of the Semester

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