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Mathematics For Business

Chapter 3: Mathematics of Finance

Mathematics For Business


Calculating Percentages
Percentages are a type of a fraction and represent part (P ) of a
whole (W ). It can be presented as

When we say a number increases by r%, then the increase in the


number (B) is

The increased number is

Similarly, when a number decreases by r,% then the decreased


number is

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Scale Factor

In general, if the percentage rise is r% then the final value consists


of the original (100%) together with the increase (r%), giving a
total of

which is called a scale factor.


Similarly, if the percentage decrease is r% then the final value
consists of the original (100%) together with the increase (r%),
giving the scale factor

To go forwards in time we multiply by this scale factor, whereas


to go backwards we divide.

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Examples
Ali gave correct answers to 23 of the 25 questions on the
driving test. What percent of the questions did he get correct?

2Joe earns $8.67 per hour working for Dracken International. If


Joe earns a merit raise of 12%, how much is his raise? What is
his new hourly wage?

The new hourly wage is: 8.67 + 1.04 =$9.71


3In 2013,
a stock was worth $1.25 a share. In 2014, the same stock
was worth $0.85 a share. What was the percent decrease?

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Exercises
1Calculate
a) %10 of $2.90
b) %75 of $1250
2Find the single percentage increase or decrease equivalent to
a) an increase of 30% followed by an increase of 40%
b) a decrease of 30% followed by a decrease of 40%
c) an increase of 10% followed by a decrease of .50%
d) an increase of 15% followed by a decrease of .50%
3Find the new quantities when
a) 1600$ is increased by %12
b) the population of a town, currently at 7560, rises by 3%
c) a good priced by a firm at $87.90 is subject to a 9% tax
d) a good priced at 2300 Dhs is reduced by 25% in a sale
e) a car, valued at 90000 Dhs, depreciates by 32%

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Exercises
4 A firms annual sales rise from 50,000 to 55,000 from one year to
the next. Express the rise as a percentage of the original.
5 The government imposes a 15% tax on the price of a good. How
much does the consumer pay for a good priced by a firm at $1360?
6 Investments fall during the course of a year by 7%. Find the value
of an investment at the end of the year if it was worth $9500 at
the beginning of the year.
7 Shares originally worth $10.50 fall in a stock market crash to
$2.10. Find the percentage decrease.
8 Walter Electric shipped a large shipment of capacitors but clients
eventually returned 2% of the capacitors. If 130 capacitors were
returned from that months shipment, how many had been shipped ?
9 At Best Buy the price of a DVD player dropped by 20% to $ 1 7 9 .
What was the original price to the nearest dollar?
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Introduction
When money is borrowed (or invested), the borrower must repay
the original amount, within a certain amount of time.
The initial amount is called the principal, capital or the present
value and is denoted by (P)
The borrower usually must also pay a charge for borrowing
the money, called interest (I)
The total amount paid is called the future value or amount
of the loan and is denoted by (S)
The amount of interest depends on the size of the principal (P),
the length of time the loan (n), and the interest rate ( r % )
Nearly all interest is calculated using one of two methods:
1Simple interest: pays interest only on the principal, not on any
interest which has accumulated.
2Compound interest: pays interest on the principal and the accu-
mulated interest, not just the principal.
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Compound Interest
If the interest due at the end of each payment period is added to
the principal, so that the interest computed for the next payment
period is based on this new amount of the old principal plus
interest, then the interest is said to have been compounded
That is, compound interest is interest paid on the initial
principal and previously earned interest.
Amount of Annual Compound Interest
If a principal P is invested for n years earning interest at the rate of
r% per year compounded annually, then the accumulated amount is

Example: Ali deposited $500.00 into an account earning 5%


compounded annually. How much will Ali have after 10 years?

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Compound Interest
In practice, interest is usually compounded more than once a
year where the interval of time between successive interest
calculations is called the conversion period.
In general, for a given interest rate more conversions means
youll earn more on an investment ... and pay more on a loan.
If interest at a rate of r% per year is compounded m times a year
on a principal of P , then:
the simple interest rate per conversion period is , and
the number of conversion periods after n years is mn.
Compound Interest Formula
The amount S after t years due to a principal P invested at an annual
interest rate r% compounded m times per year is

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Compound Interest

The most common intervals are semiannually, quarterly,


monthly, and daily. What do we mean by compounding
semiannually, quarterly, and so on? It means that at the end of a
fixed time period, interest is calculated and added to the
account.
Here is a summary of common compound interest intervals.

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Examples
Example
Ali invested $800 at 12% for 2 years. Find the amount at the end
of 2 years if the interest is compounded.
Solution: P = 800, r = 0.12, and n = 2
Annually: This means that m = 1, so

Semiannually: This means that m = 2, so

Monthly: This means that m = 12, so

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Examples
Example
How much should Omar invest at 8%, compounded quarterly, so
that he will have 50,000 Dhs at the end of 7 years?
Solution: We are given S = 50000, r = 0.08, m = 4, and n = 7. Using
the compound interest formula, we have

Solve the equation for P:

Omar should invest 28,718.7 to have 50,000 Dhs in 7 years. In


other words, the present value of 50,000 due in 7 years is 2,8719
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Examples
Example
3An investor has visions of doubling her money in 6 years. What
interest rate is required for her to do so if the investment draws
interest compounded quarterly?
Solution: We have S = 2P , m = 4, and n = 6. Using the
compound interest formula, we have

We can divide both sides by P and have


Taking the 24th root of both sides of the equation gives

Solve for r to get r = 0.1172, or r = 11.72% annual rate.


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Examples
Example
4IfMaryam has 10,000 Dhs to invest at 3% per annum
compounded monthly, how long will it be before she has 15,000
Dhs? Solution: Given S = 15, 000, P = 10, 000, m = 12, and r
= 0.03. Using the compound interest formula, we have

We can divide both sides by 10000 and have


Taking the logarithm of both sides of the equation gives

Solve for n to get


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Continuous Compounding of Interest
What happens to the accumulated amount over a fixed period
of time if the interest is compounded more and more
frequently? What happens if we compound continuously, for
example every minute, second or microsecond.
The more often interest is compounded, the larger the accumu-
lated amount. But does the accumulated amount approach a limit
when interest is computed more and more frequently?
This is called continuous compounding, the total value is given by
the formula below
Continuous Compounding
The amount S after t years due to a principal P invested at an annual
interest rate r% compounded continuously is

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Examples
Example 1
Amina deposited $650 into an account earning 4% compounded con-
tinuously. How much will Amina have at the end of 11 years?
In this case, we are given P = 650, r = 0.04 ,and n = 11. Using the
continuous compound interest formula, we have

Example 2
A present value of $1000 is invested at 10% compounded continuously.
How many years are required for a future value of $?3000
In this case, we are given P = 1000, r = 0.1, and S = 3000. Using the
continuous compound interest formula, we have

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Exercises
1Suppose $10,000 is invested at an annual rate of 5% for 10 years.
Find the future value if interest is compounded as follows:

a) Annually c) Monthly e) Daily


b) Quarterly d) Weekly f)Continuously

2Alia places $9000 in a savings account that pays 8% per year


compounded continuously. How much will she have in the
account after 5 years?
3Ahmed has recently inherited $92,000. He decides to invest it for
10years before he spends any of it. The two banks in his town
offer the following terms:
Bank A: 5.5% per year compounded annually.
Bank B: 5.25% per year compounded monthly.
Which bank offers Ahmed the greater interest on his inheritance?
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Exercises
4 Ali was offered $25,000 cash now or $29,500 to be paid after
two years for a resort cabin. If money can be invested in todays
market for 4% annual interest compounded quarterly, which offer
should Ali accept?
5 How much should be invested now at 4% per annum so that
after 2 years the amount will be $10,000 when the interest is
compounded:
a) Monthly?
b) Daily?
c) Continuously?
6 Saleh plans to buy a house in four years. He will make a
40,000 Dhs down payment on the property. How much should
he invest today at 6% annual interest compounded monthly to
have the required amount in four years?
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Exercises

7 John received a $1000 gift that he deposited in a savings bank


that compounded interest quarterly. After 5 years of
accumulating interest, the account had grown to $1485.95.
What was the annual interest rate of the bank?
8 On the day of their first grandchilds birth, a new set of grandpar-
ents invested $10,000 in a trust fund earning 4.5% compounded
monthly. How old the grandchild will be when the trust fund is
worth $25,000?
9 How long will it take for an investment to double in value if it
earns 5% compounded annually?
10 How long will it take an investment of $8000 to triple if the
investment earns interest at the rate of 8% compounded
continuously?
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Annual Percentage Rate (APR)
The Annual percentage rate (APR) or the effective rate of interest
is the equivalent annual simple rate of interest that would
yield the same amount as compounding after 1 year.
The effective rate of an annual interest rate r compounded m
times per year is the simple interest rate that produces the same
total value of investment per year as the compound interest.
Annual Percentage Rate (APR)
When the nominal rate is compounded m times per year,

When the nominal rate is compounded continuously,

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Example
Example
Find the annual percentage rate of 8% compounded quarterly.
Solution:
In this case, we have, r = 0.08, and m = 4. Using the APR formula,
we have

In percentage form, AP R = 8.243% is the effective rate of 8% com-


pounded quarterly.

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Exercises

1 Bank A is now lending money at 10% interest compounded an-


nually. The rate at Bank B is 9.6% compounded monthly, and
the rate at Bank C is 9.7% compounded quarterly. If you need to
borrow money, at which bank will you pay the least interest?
2 Find the effective rate of interest corresponding to a nominal
rate of 8% per year compounded

a) Annually c) Quarterly e) Daily


b) Semiannually d) Monthly f) Continuously

3 In the last 5 years, Bendix Mutual Fund grew at the rate of


10.4% per year compounded quarterly. Over the same period,
Acme Mutual Fund grew at the rate of 10.6% per year
compounded semiannually. Which mutual fund has a better rate
of return?
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