Business 2022

Mathematics
 

CHAPTER 1:
Linear Equations and their interpretive
application
INTRODUCTION
 
Mathematics Vs Business Mathematics

Mathematics: is an area of knowledge, which includes the study of such topics as

numbers (arithmetic and number theory), formulas and related structures (algebra),
shapes and spaces in which they are contained (geometry), and quantities and their
changes (calculus and analysis).

Business Mathematics: consists of Mathematical concepts related to business.

 
Importance of Business
Mathematics
To analyze and solve
different problems we encounter in
business.

To forecast, estimate and evaluate the

financial performance of the
business. 

It helps us in taking and improving

decision-making about different
aspects of the business.
Algebraic Expression - a mathematical statement indicating that numerical
quantities are linked by mathematical operations. E.g. x+2, 2x + y

Equation -an equation can be defined as a mathematical statement consisting of

an equal symbol between two algebraic expressions that have the same value.

A mathematical statement that says two algebraic expressions are equal. 

E.g. y = 2x + 3 

In an algebraic equation, the left-hand side is equal to the right-hand side.

2x + 17y – 3 ?
Linear Functions
A function is simply a mapping or relationship between an input or set of
inputs, and an output.

We usually write that y, the output, is a function f of x, the input: y = f (x).

y could be a linear function of x, where the relationship can be expressed as a
straight line on a graph eg. P=f(Q)

or y could be a non-linear function of x, in which case the relationship

between the two variables would be represented graphically as a curve.
Eg Pr=f(Li)

If the relationship is linear, we could write the equation for this straight line
as y=a+bx 
 y=a+bx 
y and x are called variables is the independent variable, and y is the
dependent variable, the degree of X  one

 a and b are parameters;

a is termed the intercept and
b is the slope or gradient of the line.

The intercept is the point at which the line crosses the y-axis, while the slope
measures the steepness of the line.
e.g 2x - 3y = 7
2x + 3xy = 7 ?
Application of Linear Equations 

Depreciation
Over time, fixed assets, with the exception of land, lose their ability to provide
services.

This periodic recording of the cost of fixed assets as an expense is called

depreciation.

Net Book Value=Initial Cost- Initial Cost(Dep Rate)

Dep=Initial Cost(Dep Rate)

Capital Asset Pricing Model (CAPM)

The Capital Asset Pricing Model (CAPM) describes the relationship between systematic
risk and expected return for assets

The CAPM was introduced by Jack Treynor (1961, 1962), William F. Sharpe (1964),
John Lintner (1965a,b) and Jan Mossin (1966) independently, building on the earlier
work of Harry Markowitz on diversification and modern portfolio theory.

Sharpe, Markowitz and Merton Miller jointly received the 1990 Nobel Memorial Prize in
Economics for this contribution to the field of financial economics.
The beta of a potential investment is a measure of how much risk the
investment will add to a portfolio that looks like the market.

If a stock is riskier than the market, it will have a beta greater than one.

If a stock has a beta of less than one, the formula assumes it will reduce the
risk of a portfolio.
Slope:
The slope or gradient of a line is a number that describes both
the direction and the steepness of the line.

 Slope is often denoted by the letter m. X1 # X2

Slope is calculated by finding the ratio of the "vertical change" to the

"horizontal change" between (any) two distinct points on a line.

Sometimes the ratio is expressed as a quotient ("rise over run"), giving

the same number for every two distinct points on the same line.
The direction of a line is either increasing, decreasing, horizontal or
vertical.
1)A line is increasing if it goes up from left to right. The slope
is positive, i.e.  m>0
2)A line is decreasing if it goes down from left to right. The slope
is negative, i.e. m<0
3)If a line is horizontal the slope is zero. This is a constant function.
4)If a line is vertical the slope is undefined 
The general notation of a linear equation is Y = mx + b,
Where, m = slope
b = y-intercept.

A line’s slope number tells us how much the line falls (or rises) for a stated change in x.

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.

Linear equations are equations whose slope is constant throughout the line.
E.g Y=3x-7
Intercepts - Those points at which the graph of a line, L, crosses the axes are
called intercepts.

The X-intercept is the point at which the line crosses the X-axis and it is found at
(X, 0)

and the Y-intercept is the point at which the y-axis is crossed. Its coordinate is at
(0, y).
 
E.g Y=3x-7

X-intercept (7/3,0) and Y-intercept (0,-7)

DEVELOPING THE EQUATION OF A STRAIGHT LINE
There are at least three ways of developing the equation of a line, these are:
1) The slope - intercept form
2) The slope - point form
3) Two-points form.

1) The slope - intercept form

Slope-intercept is a specific form of linear equations. It has the following general
structure.
y=mx+b,

E.g Slope=10
Y-intercept=20
 
A line that has a slope of 10 and a y-intercept of 20 has the following equation:
Y=10x +20
E.g
Suppose the fixed cost (set up cost) for producing product x be Birr 2,000. After
setup it costs Birr 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 and interpret this number.
3. State the y-intercept of the line and interpret this number.

E.g .
A Salesman has a fixed base salary of Br 200 a week. In addition, he receives a sales
commission that is 20 percent of his total Birr values of sales. State the relationship
between the salesman’s total weekly salary and his sales for the week.
2) The slope - point form

The equation is useful when we know:

one point on the line: (x1,y1)
and the slope of the line: m,
and want to find other points on the line.

E.g m=3 (x1, y1) = (3,2)

Y=3x-7
E.g
A salesman earns a weekly base salary plus a sales commission of 20% of his total
weekly sales.
When his total weekly sales total Birr 1000, his total salary for the week is Birr 400.
Derive the formula describing the relationship between total salary and sales.

E.g
If the relationship between total cost and the number of units made is linear, and if cost
increases by Birr 7 for each additional unit made, and if the total cost of 10 units is Br
180, find the equation of the relationship between total cost (Y) and number of units
made (x)
3) Two-points form.

Two points are given.

There are 2 steps to find the Equation of the Straight Line :
1. Find the slope of the line
2. Put the slope and one point into the "Point-Slope Formula"

E.g
A sales man has a base salary and, in addition, receives a commission, which is a fixed
percentage of his sales volume. When his weekly sales are Birr 1000, his total salary is Birr
400. When his weekly sales are Birr 500, his total salary is Birr 300. Determine his base salary
and his commission percentage and express the relationship between sales and salary in
equation form
A printer quotes the price of Birr 1,400 for printing 100 copies of a report and Birr 3000 for
printing 500 copies. Assuming a linear relationship what would be the price for printing
300 copies?

Horizontal and vertical Lines

Horizontal lines are lines whose slope is zero.

These lines are parallel to the X-axis.

Vertical lines are lines whose slope is undefined.

These lines are parallel to the Y-axis.

Given the points (3, 6) & (8, 6) - the line through them is horizontal because both y-coordinates
are the same (6). The equation of the line becomes y=6.

Given the points (5, 2) and (5, 12), the line that passes through them is vertical, and its equation is
x = 5.
 Parallel and Perpendicular Lines

Two distinct lines that do not intersect are parallel. Non-vertical parallel lines have the
same slope.
Any two vertical lines, however, are also parallel. It is important to note that vertical lines
have undefined slope. E.g Y= 2x-10 and Y=2x+14 are parallel.

 
Perpendicular lines form an angle of 90∘
two lines are perpendicular to each other if the product of their slopes is - 1 or
the slope of one is the negative reciprocal of the slope of the other.

However, for vertical and horizontal lines, (they are perpendicular to each other),
this rule of m1 . m2 = -1 doesn’t hold true.
Lines through the Origin
Any equation in the variables x and y that has no constant term other than zero will have
a graph that passes through the origin. Or, a line that passes through the origin has an x-
intercept and a y-intercept of (0,0). These lines are expressed in the form Y = mx.
 LINEAR cost-out put relationships

Variable costs are costs that vary in proportion to changes in the activity base.
Variable costs are the costs that change in total each time an additional unit is produced or sold.

Variable costs have the following characteristics:

1) Cost per unit remains the same regardless of changes in the activity base.
2) Total cost changes in proportion to changes in the activity base.
`
E.g. Direct labor, Direct Materials, Commissions, Taxes ,Operational expenses
Fixed Costs
Fixed costs are costs that remain the same in total dollar amount as the activity base changes.
Fixed costs are those that stay the same in total regardless of the number of units produced or sold

fixed costs have the following characteristics:

1. Cost per unit decreases as the activity level increases, and increases as the activity level decreases.
2. Total cost remains the same regardless of changes in the activity base.
E.G Rent, Employee Salaries, Loan Payments
Why is the total variable cost (TVC) curve slopes up at an accelerating rate?
Because of the law of diminishing marginal returns which states that employing an additional
factor of production will eventually cause a relatively smaller increase in output. 
Total costs
The total cost (TC) curve is found by adding total fixed and total variable costs. Its
position reflects the amount of fixed costs, and its gradient reflects variable costs.
Average fixed costs(AFC)
Average fixed costs are found by dividing total fixed costs by output. As fixed cost is divided
by an increasing output, average fixed costs will continue to fall.
The  AFC curve will slope down continuously, from left to right.
Average variable costs(AVC)
Average variable costs are found by dividing total variable costs by output.
The  AVC curve will at first slope down from left to right, then reach a minimum point, and
rise again.
AVC is ‘U’ shaped because of the principle of variable Proportions, which explains the three
phases of the curve:
• Increasing returns to the variable factors, which cause average costs to fall, followed by:
• Constant returns, followed by
• Diminishing returns, which cause costs to rise.
Average total cost
Average total cost (ATC) is also called average cost or unit cost
Average total cost (ATC) can be found by adding average fixed costs (AFC) and average
variable costs (AVC). The ATC curve is also ‘U’ shaped because it takes its shape from the
AVC curve, with the upturn reflecting the onset of diminishing returns to the variable factor.
Marginal costs
Marginal cost is the cost of producing one extra unit of output.  It can be found by calculating the
change in total cost when output is increased by one unit. Marginal costs are derived exclusively
from variable costs, and are unaffected by changes in fixed costs. Marginal cost is the derivative
of the cost function
•Revenue is the total amount of money a company brings in from selling its goods and services
at a specific price.
•Total revenue (TR)is the full amount of total sales of goods and services.
•It is calculated by multiplying the total amount of goods and services sold by their prices.
TR=Q×P where: TR=total revenue Q=quantity P=price​

•Average revenue(AR) is the revenue per unit of the commodity sold. It is obtained by dividing
the total revenue by the number of units sold. Mathematically AR = TR/Q

•Marginal revenue (MR) - the increase in total revenue as the result of one additional sale.
Interpretation of the graph:
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. 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 = VC) only in linear equations.
 
Fixed costs do not affect the marginal cost of production since they do not typically vary with additional
units. Variable costs, however, tend to increase with expanded capacity, adding to marginal cost due to
the law of diminishing marginal returns.

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.

 
Breakeven Analysis
The break-even point is the level of operations at which a company’s revenues and expenses are
equal. Break-even point is the point at which there is no loss or profit to the company.
At break-even, a company reports neither an income nor a loss from operations.
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
Total cost = Variable cost + Fixed cost
TC= VQ+FC
Total Revenue = Price x Quantity
TR = PQ.
Where Q = units product & units sold in revenue
TC = Total Cost
FC = Fixed Cost
VC = Unit variable Cost
 Assumptions of Breakeven Analysis
1. Selling price is constant throughout the entire relevant range [relevant
range – is the limit of cost-driver activity within a specified relationship
between costs and the cost driver is valid].
2. Costs are linear over the relevant range.
3. In multi-product companies, the sales mix is constant.
4. In manufacturing firms, inventories do not change (Units produced = Units
sold).
5. Expenses may be classified in to variable and fixed categories. Total
variable expenses vary directly with activity level. Total fixed expenses do
not change with activity level.
6. Efficiency and productivity will be unchanged.
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,
 

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 break-even point is affected by changes in the fixed costs, unit variable costs, and
the unit selling price.
CASE 1 - FIXED COST
Effect of Changes in Fixed Costs :Fixed costs do not change in total with changes in the
level of activity. However, fixed costs may change because of other factors such as
advertising campaigns, changes in property tax rates, or changes in factory supervisors’
salaries.
Assume for the above problem FC is decreased by Br. 5000, Citrus Paribus (other things
being constant)

Changes in fixed costs affect the break-even point as follows:

1. Increases in fixed costs increase the break-even point.
2. Decreases in fixed costs decrease the break-even point.
CASE 2-UNIT VARIABLE COST
Effect of Changes in Unit Variable Costs :Unit variable costs do not change with
changes in the level of activity.
However, unit variable costs may be affected by other factors such as changes in the
cost per unit of direct materials, changes in the wage rate for direct labor, or changes in
the sales commission paid to salespeople.

Assume for the above problem unit variable cost decreased by Birr 1, citrus paribus

Changes in unit variable costs affect the break-even point as follows:

1. Increases in unit variable costs increase the break-even point.
2. 2. Decreases in unit variable costs decrease the break-even point.
CASE 3- SELLING PRICE
Effect of Changes in Unit Selling Price: Changes in the unit selling price affect the unit contribution
margin(Unit Contribution Margin = Sales Price per Unit – Variable Cost per Unit ) and, thus, the
break-even point.
Assume for the above problem selling price is decreased by br. 1, Citrus Paribus
Specifically, changes in the unit selling price affect the break-even point as follows:

1. Increases in the unit selling price decrease the break-even point.

2. Decreases in the unit selling price increase the break-even point.
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

Apple vs Sony

For example, Apple has no manufacturing facilities of its own, and rival Sony has 57
electronics factories. Apple relies exclusively on contract manufac-turers for
production of all of its products, whereas Sony owns its own plants. Less fixed assets
has enabled Apple to remain financially lean with virtually no long-term debt. Sony,
in contrast, has built up massive debt on its balance sheet.
Target Profit :FINDING THE QUANTITY LEVEL WHICH INVOLVES PROFIT
At the break-even point, sales and costs are exactly equal. However, the goal of most companies
is to make a profit.
By modifying the break-even equation, the sales required to earn a target or desired amount of
profit may be computed. For this purpose, target profit is added to the break-even equation, as
shown below.
Example For the above manufacturing co. if it wants to make a profit of 25000 br. What should
be the quantity level?

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

CASE 2 MERCHANDISING /RETAIL BUSINESS

retail business state their cost equation in terms of revenue (because they purchase and sell)
Breakeven Revenue = BEQ X P
Markup = Selling price – Variable cost
i. as a function of cost, 
ii. as a function of retail price
Example: Assume a bus. Firm with product A has the following cost & revenue items.
Variable cost of A = 100 br.
Selling price = 150 br.
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.
 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.