7-Applications of Basic Mathematics VU

LECTURE 7
Applications of Basic Mathematics
OBJECTIVES
The objectives of the lecture are to learn about:
• Scope of Module 2
• Review of lecture 6
• Annuity
• Accumulated value
• Accumulation Factor
• Discount Factor
• Discounted value
• Algebraic operations
• Exponents
• Solving Linear equations

Module 2
Module 2 covers the following lectures:

• Linear Equations (Lectures 7)

• Investments (Lectures 8)
• Matrices (Lecture 9)
• Ratios & Proportions and Index Numbers (Lecture 10)
Annuity

It some point in your life you may have had to make a series of fixed payments over a
period of time - such as rent or car payments - or have received a series of payments
over a period of time, such as bond coupons. These are called annuities.
Annuities are essentially series of fixed payments required from you or paid to you at
a specified frequency over the course of a fixed period of time.
An annuity is a type of investment that can provide a steady stream of income over a
long period of time. For this reason, annuities are typically used to build retirement
income, although they can also be a tool to save for a child’s education, create a trust
fund, or provide for a surviving spouse or heirs.
The most common payment frequencies are yearly (once a year), semi-annually
(twice a year), quarterly (four times a year) and monthly (once a month).

Calculating the Future Value or accumulated value of an Annuity

If you know how much you can invest per period for a certain time period, the future value of an
ordinary annuity formula is useful for finding out how much you would have in the future by
investing at your given interest rate. If you are making payments on a loan, the future value is
useful for determining the total cost of the loan.

Let's now run through Example 1. Consider the following annuity cash flow schedule:

In order to calculate the future value of the annuity, we have to calculate the future value of each

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cash flow. Let's assume that you are receiving $1,000 every year for the next five years, and you
invested each payment at 5%. The following diagram shows how much you would have at the
end of the five-year period:

Since we have to add the future value of each payment, you may have noticed that, if you have
an annuity with many cash flows, it would take a long time to calculate all the future values and
then add them together. Fortunately, mathematics provides a formula that serves as a short cut
for finding the accumulated value of all cash flows received from an annuity:

C=Payment per period or amount of annuity

i = interest rate
n = number of payments

((1 + i)n - 1) / i) is called accumulation factor for n periods.

Accumulated value of n period = payment per period × accumulation factor for n

periods

If we were to use the above formula for Example 1 above, this is the result:

=$1000*[5.53]
=$5525.63

Note that the $0.01 difference between $5,525.64 and $5,525.63 is due to a rounding
error in the first calculation. Each of the values of the first calculation must be
rounded to the nearest penny - the more you have to round numbers in a calculation
the more likely rounding errors will occur. So, the above formula not only provides a
short-cut to finding FV of an ordinary annuity but also gives a more accurate result.

Calculating the Present Value or discounted value of an Annuity

If you would like to determine today's value of a series of future payments, you need to use the
formula that calculates the present value of an ordinary annuity.

For Example 2, we'll use the same annuity cash flow schedule as we did in Example 1. To obtain
the total discounted value, we need to take the present value of each future payment and, as we
did in Example 1, add the cash flows together.

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Again, calculating and adding all these values will take a considerable amount of time, especially
if we expect many future payments. As such, there is a mathematical shortcut we can use for PV
of ordinary annuity.

C = Cash flow per period

i = interest rate
n = number of payments.
(1 – (1 + i)-n ) / i is called discount factor for n periods.
Thus Discounted value of n period = payment per period × discount factor for n
period
The formula provides us with the PV in a few easy steps. Here is the calculation of
the annuity represented in the diagram for Example 2:

= $1000*[4.33]
= $4329.48

NOTATIONS
The following notations are used in calculations of Annuity:
R = Amount of annuity
N = Number of payments
I = Interest rater per conversion period
S = Accumulated value
A = Discounted or present worth of an annuity

ACCUMULATED VALUE
The accumulated value S of an annuity is the total payments made
including the interest. The formula for Accumulated Value S is as follows:
S = r ((1+i)^n – 1)/i
Accumulation factor for n payments = ((1 + i)^n – 1) / i
It may be seen that:
Accumulated value = Payment per period x Accumulation factor for n payments

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The discounted or present worth of an annuity is the value in today’s rupee value.
As an example if we deposit 100 rupees and get 110 rupees

(i.e. 10 % interest on 100 Rs. which is 100*10/100 = 10 Rs. so total amount is

100+10 = 110 or
simply 100( 1+10/100) = 100( 1+ 0.1) = 100(1.1) = 110 )

after one year, the Present Worth or of 110 rupees will be 100. Here 110 will be
future value of 100 at the end of year 1.

The amount 110, if invested again, can be Rs. 121 after year 2.

(i.e. 10 % of 110 is 110*10/100 = 11, so total amount is 110+11 = 121)

The present value of Rs. 121, at the end of year 2, will also be 100.

DISCOUNT FACTOR AND DISCOUNTED VALUE

When future value is converted into present worth, the rate at which
the calculations are made is called Discount factor rate. In the previous example 10%
was used to make the calculations. This rate is called Discount Rate. The present
worth of future payments is called Discounted Value.

EXAMPLE 1. ACCUMULATION FACTOR (AF) FOR n PAYMENTS

Calculate Accumulation Factor and Accumulated value when:
rate of interest i = 4.25 %
Number of periods n = 18
Amount of Annuity R = 10,000 Rs.
Accumulation Factor AF = ((1 + 0.0425)^18-1)/0.0425 = 26.24
Accumulated Value S = 10,000x 26.24 = 260,240 Rs

EXAMPLE 2. DISCOUNTED VALUE (DV)

In the above example calculate the value of all payments at the beginning of term of
annuity i-e present value or discounted value.
Discount rate = 4.25%
Number of periods = 18
Amount of annuity= 10000 Rs
Value of all payments at the beginning of term of Annuity or discounted value
= Payment per period x Discount Factor (DF)
Formula for Discount Factor = (1-1/(1+i)^n)/i
= (1-1/(1+0.0425)^18))/0.0425= 12.4059

Discounted value = 10000 × 12.4059 = 124059 Rs

EXAMPLE 3. DISCOUNTED VALUE (DV)
How much money deposited now will provide payments of Rs. 2000 at the end of each
half-year for 10 years if interest is 11% compounded six-monthly.
Amount of annuity = 2000Rs
Rate of interest = i = 11% / 2 = 0.055
Number of periods = n = 10 × 2 = 20
DISCOUNTED VALUE = 2,000 x ((1-1 / (1+0.055)^20) / 0.055)
= 2,000 x11.95
=23,900.77

ALGEBRAIC OPERATIONS
Algebraic Expression indicates the mathematical operations to be carried out on a
combination of NUMBERS and VARIABLES.

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The components of an algebraic expression are separated by Addition and

Subtraction.
In the expression 2x2 – 3x -1 the components 2x2, 3x and 1 are separated by minus
“-“ sign.

In algebraic expressions there are four types of terms:

• Monomial, i.e. 1 term (Example: 3x2)
• Binomial, i.e. 2 terms (Example: 3x2+xy)
• Trinomial, i.e. 3 terms (Example: 3x2+xy-6y2)
• Polynomial, i.e. more than 1 term (Binomial and trinomial examples are also
polynomial)
Algebraic operations in an expression consist of one or more FACTORs separated by
MULTIPLICATION or DIVISION sign.
Multiplication is assumed when two factors are written beside each other.
Example: xy = x*y
Division is assumed when one factor is written under an other.
Example: 36x2y / 60xy2

Factors can be further subdivided into NUMERICAL and LITERAL coefficients.

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There are two steps for Division by a monomial.

1. Identify factors in the numerator and denominator
2. Cancel factors in the numerator and denominator

Example:
36x2y / 60xy2
36 can be factored as 3 x 12.
60 can be factored as 5 x 12
x2y can be factored as (x)(x)(y)
xy2 can be factored as (x)(y)(y)
Thus the expression is converted to: 3 x 12(x)(x)(y)/ 5 x 12(x)(y)(y)
12x(x)(y) in both numerator and denominator cancel each other. The result is:
3(x)/5(y)

Another example of division by a monomial is (48a2 – 32ab)/8a.

Here the steps are:
1. Divide each term in the numerator by the denominator
2. Cancel factors in the numerator and denominator
48a2 / 8a = 8x6(a)(a) / 8a = 6(a)
32(a)(b) / 8(a) = 4x8(a)(b) / 8(a) = 4(b)
The answer is 6(a) – 4(b).

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How to multiply polynomials? Look at the example –x(2x2 – 3x -1). Here each term in
the trinomial 2x2 – 3x -1 is multiplied by –x.
= (-x)(2x2) + (-x)(-3x) + (-x)(-1)
= -2x3+ 3x2 +x

Please note that product of two negatives is positive.

(3x6y3 / x2z3)2
Exponent of a term means calculating some power of that term. In the example we
are required to work out exponent of 3x6y3 / x2z3 to the power of 2. The steps in this
calculation are:
1. Simplify inside the brackets first.
2. Square each factor
3. Simplify
In the first step, the expression 3x6y3 / x2z3 is first simplified to (3x4)(y3)/z3.
In the next step we take squares. The resulting expression is:
(32)(x4*2)(y3*2)/z3*2 = 9x8 y6 /z6

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LINEAR EQUATION
If there is an expression A + 9 = 137, how do we calculate the value of A?
A = 137 – 9 = 128
As you see the term 9 was shifted to the right of the equality.

To solve linear equations:

1. Collect like terms
2. Divide both sides by numerical coefficient.

Step 1: x = 341.25 + 0.025x

x – 0.025x = 341.25
x(1-0.025) = 341.25
0.975x = 341.25
Step 2. x = 341.25/0.975 = 350

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