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Quantitative Methods
for Business
COMM5005
Lecture 2

Shengyu Li
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Topics
In this lecture we will help you to revise the following
topics and show them in business contexts
• Equation-solving techniques
• Solving inequalities
• Using logarithms to solve equations
• Simple interest
• Compound interest
• Effective rates of interest
• Net present value and Internal rate of return
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Readings
Sections of Haeussler Paul and Wood 14th ed. will help you
to understand this week’s topics more clearly.
Chapter Name Pages
0.7 - 0.8 Equations, in particular linear; 28-42
Quadratic equations
1.1 - 1.4 Applications and More Algebra 48-65
3.4, 3.6 System of Linear Equations 152-162, 164-171
4.4 Logarithmic and Exponential 200-203
Equations
5.1 - 5.3 Mathematics of Finance 209-222
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1. Techniques for solving equations

a. The quadratic formula
We can use the quadratic formula to find any solution for a
general type of equations:
𝑎𝑥 ! + 𝑏𝑥 + 𝑐 = 0
The solutions are given by the formula

−𝑏 ± 𝑏 ! −4𝑎𝑐
𝑥=
2𝑎
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Example 1: Break-even point, Profit and Loss

Custom made chairs are sold for $325 each and the total
cost of sales is represented by
𝐶 = 1350 + 15𝑞 + 𝑞 !
where q is the quantity sold.
a) Find at what level of sales the break-even point occurs.
b) At what level of sales there will be a profit of $20,000?

Profit is defined as
Profit = Total Revenue - Total Cost.
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b. Fractional equations
When there is an unknown in a denominator of an
equation, we can multiply both sides with the least common
denominator to get free of the fractions then solve the
equation and check if the solutions satisfy the original
equation.
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Example 2: Equilibrium

Demand for a product is

1000
𝑝=
𝑞
and supply is given by the equation
𝑞
𝑝= +5
20
a) Graph the demand and the supply curves.
b) What is the equilibrium price and quantity where demand
equals supply?
c) Find the equilibrium price and quantity when a tax of $1 is
imposed on the supplier.
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c. Simultaneous equation techniques

Where two or more equations involve the same variables,
simultaneous equation techniques may be used to solve them.
Operations which are permitted include
• adding or subtracting one equation to/from another,
• multiplying or dividing an equation by a non-zero
constant,
• adding or subtracting a multiple of one equation to/from
another.
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Example 3
In the newspaper market, a large media organisation is trying to
determine the price it should charge for print and online 7-day
subscriptions.
• It estimates that if it charges $5.50 per week for online access
and $9 for print its subscription, revenue will be $4,075,000.
• One scenario suggests that subscribers decide on their access
format due to convenience not price, so the relative numbers
using each format do not respond to small price changes.
Under this assumption it estimates revenue would be
$4,050,000 if it charged $6 for online and $8.50 for print access.
• How many of each type of subscriber is it estimating?
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2. Solving inequalities

Rules for inequalities

• If 𝑎 < 𝑏 then 𝑎 + 𝑐 < 𝑏 + 𝑐 and 𝑎 − 𝑐 < 𝑏 − 𝑐
" $
• If 𝑎 < 𝑏 and 𝑐 is a positive number then 𝑎𝑐 < 𝑏𝑐 and < .
# #
" $
• If 𝑎 < 𝑏 and 𝑐 is a negative number then 𝑎𝑐 > 𝑏𝑐 and > .
# #

• If 0 < 𝑎 < 𝑏 and 𝑛 is a positive number then 𝑎% < 𝑏 % .

• If 0 < 𝑎 < 𝑏 and 𝑛 is a negative number then 𝑎% > 𝑏 % .
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• When solving inequalities we need to be careful of

direction of the inequality sign.
Example:
−6𝑥 + 4 < 36
−6𝑥 < 32
𝑥 > −32/6
𝑥 > −5.33
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Example 4: Leasing vs. Purchasing

Kathryn wants to compare the costs of owning and leasing

a car. She can lease a car for $450 per month. Under this
plan, the cost per mile (gas and oil) is $0.06. If she were
to purchase the car, the fixed annual expense would be
$4800, and other costs would amount to $0.08 per mile.
What is the least number of miles she would have to drive
per year to make leasing no more expensive than
purchasing?
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Inequalities with absolute values

Where inequalities have an absolute value sign there
are two answers to consider. For example
15𝑥 − 3 ≥ 7
is equivalent to
15𝑥 − 3 ≤ −7 𝑜𝑟 15𝑥 − 3 ≥ 7.
In the former case,
&
15𝑥 ≤ −4 → 𝑥 ≤ − = −0.267
'(
In the latter case,
')
15𝑥 ≥ 10 → 𝑥 ≥ = 0.667
'(
Thus, the solutions are 𝑥 ≤ −0.267 and 𝑥 ≥ 0.667.
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3. Using logs to solve equations

When the variable for which we wish to solve is a power then

logarithms can be useful.
Watch this video to see how: https://youtu.be/kUuKqcti5GU
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Example 5: Asset depreciation

After depreciation an asset’s book value, B, on a

company’s balance sheet is $11,694.65. It has been
depreciated monthly using the formula
1 %
B=𝐶 1−
𝑁
Express this equation in terms of n, no. periods, then find
when the asset was purchased if its lifespan N is 36
months and C, its cost, was $15,500.
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• If you had any difficulty solving these equations make

sure you do plenty of practice as they are all
fundamental techniques that are needed often.
• Don’t forgot to look at the course webpage for the
eLearning Tutorial 1 link. The tutorial is on Lines and
Inequalities. Although it is open all semester this would
be an appropriate time to work through it. You can do it
multiple times if you wish.
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Time value of

Do $100 today have the same value as $100 next

year or $100 after 5 years? Why?

Now or Next year

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Present value of $100 in 15 years

100

90

80

70
Dollars

60

50

40

30

20

10

0
0 2 4 6 8 10 12 14

Years in future
At 2% interest At 3% interest At 5% interest At 8% interest
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2. Simple Interest

• By simple interest we mean that an investment earns

interest each period but not interest on the interest.
• For a principal amount P, with interest per period r and
time t, the final sum S equals
𝑆 =𝑃+𝑃∗𝑟∗𝑡

𝑺 = 𝑷 𝟏 + 𝒓𝒕
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Commonwealth bank term deposit rates 19

https://www.commbank.com.au/content/dam/commbank/personal/apply-
online/download-printed-forms/InvInterestRates_ADB1072.pdf
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Example 6

Currently the Commonwealth Bank is offering term

deposits where for an investment of $10,000-$49,999 for a
12-month period you will earn 1.1% p.a. paid at maturity.
Assuming you invest $30,000, withdraw the interest at
maturity and close the account, what is the total amount
you have?
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3. Compound interest
Compound Interest: interest paid on both the principal and the
previous interest.
Year 0 Year 1 Year 2 Year 3 Year 4 Year 5
Simple $5.00 $5.00 $5.00 $5.00 $5.00
Interest (5%)
Value $100.00 $105.00 $110.00 $115.00 $120.00 $125.00
Compound $5.00 $5.25 $5.51 $5.79 $6.08
interest (5%)
Value $100.00 $105.00 $110.25 $115.76 $121.55 $127.63
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Compound interest

Now imagine you have $30,000 and invest it for three

years at an interest rate of 1.15% per annum where
interest is compounded annually.
Let’s look at what happens to the total amount in your
account as interest is added over the next three years.
Assume you earn the same rate of interest on both the
principal and the previous interest.
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After 1 year S = 30,000 + 30,000*0.0115 S= 30,000(1+0.0115)

= 30,000 + 345 = 30,345
= 30,345

After 2 years S = 30,345 + 30,345*0.0115 S= 30,000(1+0.0115)2

= 30,345 + 348.97 = 30,693.97
= 30,693.97

After 3 years S = 30,693.97 + 30,693.97*0.0115 S= 30,000(1+0.015)3

= 30,693.97 + 352.98 = 31,046.95
= 31,046.95
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Future value formula

In general, if an amount P is compounded for n periods at an

interest rate of r per period then its future value S is given by
the formula
𝒏
𝐒=𝐏 𝟏+𝒓 [2]
where P is principal, r is the interest rate per period and n is
the number of periods.
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Can rates be negative?

Usually we assume that interest rates can only be

positive but recent events show that this is not always
the case. See for example
https://www.bloomberg.com/quicktake/negative-interest-
rates
which cites pay negative interest for central banks in
Japan, Sweden, Denmark, Germany and Switzerland
as well as the European Central Bank. They encourage
banks to loan money rather than hoarding it.
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Can rates be negative? 26

Negative interest rates: Savers have to pay while borrowers

get paid. The idea is to encourage lending and boost the
economic growth (after other options are exhausted).
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Converting an annual rate

An annual rate of interest can be converted to the rate per

period, r, by dividing it by the number of times interest is
compounded per year. For example, if the annual rate is
2.4% per annum and interest is compounded monthly then

0.024
r= = 0.002
12
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Example 7
If $30,000 is invested, with interest earned at 1.0% p.a.
and compounded 4 weekly, how much would we have
after 12 months (52 weeks)?
A. $30,330.00
B. $27,345.36
C. $30,301.39
D. another amount
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Example 8

Simon invests $45,000 in an account which pays interest

of 1.8% p.a. compounded monthly. If no other deposits or
withdrawals are made, how much will the account balance
be after
a) ten months
b) 2 years
c) How much is there after ten months if interest is
compounded daily?
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Present value formula

The present value P of an amount in the future S is

𝑺 &𝒏
𝐏= =𝑺 𝟏+𝒓 [3]
𝟏$𝒓 𝒏
• Applying formula [2] is known as compounding.
• Applying formula [3] is known as discounting.
• The discounting formula can be used to convert the
value to an earlier period, not necessarily the present.
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Example 9
A business will receive payments of $50,000 in 20 day’s
time, $45,000 in 35 days from now and $100,000 in 60 days
from now. If the current interest rate is 6% p.a.
compounded daily, what is the total present value of these
payments?
20 days 35 days 60 days
$50,000

$45,000

$100,000
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Continuous compounding
We have seen that the more frequently interest is compounded,
the greater is the amount of interest that will be earned each year.
Is there a limit to how much can be earned when interest is
compounded instantaneously?

Let’s m be the frequency within a year that interest is compounded

!
𝑟 !" 1 # #"
S=P 1+ =P 1+ .
𝑚 𝑚/𝑟
!
$ "
As m approaches ∞, 1 + approaches e = 2.71828...
!/#
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Continuous compounding

Thus, when interest is compounded continuously, the

future value of a principal P is
𝒓𝒕
𝑺 = 𝑷𝒆
where e is the number 2.71828…
r is the annual interest rate and t is time in years
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Example 10
A sum of $32,500 is invested at 3.2% compounded
continuously and is worth $96,800 after t years. Use this
formula to find t.
96,800 = 32,500𝑒 ).)+!,
Is t equal to
A. 19.73
B. 34.11
C. 20.08
D. Something else?
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6. Effective rates of interest

Sometimes we need to convert interest rates where compounding
occurs several times per year to an annual effective rate.
If $P is invested at a nominal rate of ra% p.a. compounded n
times per year it will produce the same final sum as $P invested at
the annual effective rate of re% p.a. after one year. Therefore,
𝑟" % 𝑟" %
P 1+ = 𝑃 1 + 𝑟- → 1 + = 1 + 𝑟-
𝑛 𝑛

𝒓𝒂 𝒏
𝒓𝒆 = 𝟏 + −𝟏
𝒏
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Example 11

Investment A earns 5.3% per annum with monthly

compounding and investment B earns 5.25% per annum
with daily compounding.
Which investment has the greater return, A or B?
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Equations of Value
• An amount, say $1000, in year 3 is not worth the same
as $1000 in year 5 or any other year because some
interest applies. To compare these amounts we must
either discount or compound one of them.
• An equation of value illustrates that when one is
considering two methods of paying a debt (or making
some other transaction), at anytime, the value of all
payments under one method must equal the value of all
payments under the other method.
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Net Present Value (NPV)

Businesses as part of their budgeting process often

need to
§ consider alternative projects,
§ look at the cash flows from one project under different
assumptions about the cost of capital and the returns
expected.
Because returns are coming in at various times it is
difficult to see the true picture.
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Net Present Value (NPV)

The net present value is a way of comparing the current

value of a stream of cash flows with the costs involved in
set up.

𝑹𝟏 𝑹𝟐 𝑹𝒏
𝐍𝐏𝐕 = + 𝟐
+ ⋯+ 𝒏
−𝑪
𝟏+𝒓 𝟏+𝒓 𝟏+𝒓
If NPV > 0, then the investment is profitable;
If NPV < 0, then the investment is not profitable.
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Example 12
A company is investing in a new piece of equipment. It is
expected to result in cash flow of $35,000 after one year,
$50,000 after two years and $60,000 after three years
then be obsolete. The cost of borrowing is 4.8% p.a.
a) What is the present value of the three cash flows?
b) If the equipment costs $85,000 to buy now, would the
company invest in the new equipment?
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NPV 41
IRR

r
5. Internal rate of return

The internal rate of return is the discount rate which will

make the cash flows equal to the cost.
𝑹𝟏 𝑹𝟐 𝑹𝒏
𝐂= + 𝟐
+ ⋯+ 𝒏
𝟏 + 𝑰𝑹𝑹 𝟏 + 𝑰𝑹𝑹 𝟏 + 𝑰𝑹𝑹
Since it is difficult to solve an equation for IRR, an iterative
process is used by financial calculators or computers,
starting with a guess.
We will see how to solve the next problem using Excel.
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Example 13

An investor has a choice of two properties to purchase.

Property A needs a significant amount of renovation work
done but once the work is completed it will bring higher
returns than property B. Assume that whichever property is
chosen it will be sold after 6 years.
Property A will cost $3.2 million now and another $1.1
million in one year’s time (due to the renovations). It will
then return $500,000 a year for 4 years then will be sold
after six years for $5.4 million.
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Property B will cost $4 million and return $400,000 per

year for the first three years then $450,000 for the next
two. It will be sold at the end of year six for $4.5 million.
Which property has the
1. higher NPV if interest is 7.5% p.a.?
2. higher IRR?
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Calculate NPV in Excel

NPV formula only includes

future values, costs are
added separately.
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Calculate IRR in Excel 45

For the IRR formula,

the value range
includes costs.
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Summary
• Today we have examined a number of important
concepts used in financial mathematics.
• Using present versus future value appropriately is one
of the hardest choices for students to get right.
• We will look more at financial topics such as
annuities, annuities due and loan repayments in the
next lecture as well as more examples.