Term Paper on "Personal Finance Define Which Stage"

Term Paper 10 pages (4021 words) Sources: 1+

[EXCERPT] . . . .

Personal Finance

Define which stage of the live-cycle are Jay and Rebecca in today. What important financial planning issues characterize this stage?

According to Modigliani and Brumberg (1954) there are six potential stages that an individual or couple may experience: Individual supported by parents, young single, young couple- no children, couple or individual with children, empty nesters, and retired (Personal Finance. N.D.P.1). Based on the data presented Jay and Rebecca fall into the couple or individual with children category which is characterized by: income approximately equal to expenditures, potential upgrade of house, purchase children's toys, clothing, and supplies, purchase life insurance, college tuition expenses, and debt management (Personal Finance. N.D.P.1). Financial planning should consist of saving for retirement, investing, securing adequate insurance coverage, saving for child's tuition, and estate planning.

Construct the Balance Sheet and Income Statement for the Bennett's (information is presented both as background and as listed Assets, Debt and Expenses in the table). Do Jay and Rebecca have a positive or negative net worth?

Assets: Cash-Checking $6,700

Savings in Securities $26,500

Life Insurance Cash Value $1,700

Vehicles #1, #2 $20,300

Personal Property $17,000

Total Assets $72,200

Liabilities: Car Loan #1 $7,500

Student Loan $10,500

Furniture Loan $4,600

Credit Card $2,000

Total Liabilities $24,600

Net Worth $47,600

Income Statement

Revenues Salaries $107,000 Annual- $8,916.67 Monthly

Expenses- Annual $74,610 -- Monthly $4,250.83

Debt Expense- $1,145

Rent $1,500

Life Insurance $54.17

3. Using information from the Balance Sheet and Income Statement calculate:

Current ratio- Current (liquid) Assets / Current Liabilities

33,200 (cash, savings, and investments) / 24,600 (current debts paid on= 1.35

Monthly living expense covered ratio- Current Assets / Monthly Living

Expenses: $33,200/$6,950 (all monthly expenses from data provided)=4.78

Debt Ratio- Total Liabilities / Total Assets

$24,600 / $72,200= .34

Long-term debt coverage ratio- Monthly Living Expenses / Monthly Debt Payments

$6,950 / $1,145= 6.07

Savings ratio- Total Savings / Net Income

33,200/$83,400= 40%

4. Use the information provided by the ratios and recommended ratio limits from the textbook to assess the Bennett's financial health.

The current ratio of 1.35 is below the recommended value of 2. "It is also important to track the trend of this ratio; an upward trend is recommended" (Pocket Financial Planner. N.D.P.1.). The value is above 1 however, which is satisfactory.

The monthly living expense covered ratio referred to "as the emergency fund ratio should ideally be between 3 and 6 depending on the volatility of your job" (Pocket Financial Planner. N.D.P.1.). Jay and Rebecca have a 4.78 ration which again is satisfactory.

A debt ratio "above 1 means a negative net worth; the closer the ratio is to zero, the better. When the ratio hits zero, you are debt free" (Pocket Financial Planner. N.D.P.1.). The .34 ratio suggests that the debt load is manageable and not overwhelming.

"The long-term debt coverage ratio tells you how many times over you could pay debt obligations-based your monthly living expenses. A higher ratio indicates that you could cover debt payments for a longer period of time if you had a loss of income" (Pocket Financial Planner. N.D.P.1.). The 6.07 ratio for Jay and Rebecca is quite solid and indicates financial health.

For the savings ratio "good rule of thumb is to keep these ratios above 10%

and preferably above 15%. The higher the ratio the better" (Pocket

Financial Planner. N.D.P.1.).. Jay and Rebecca

at 40% have a healthy ratio.

5. Do they have an emergency fund? How much would you recommend that they have in it?

Currently, Jay and Rebecca have no emergency fund however; they could easily allocate $1,000 for that purpose. A recommended emergency fun consists of a "cash reserve which is as liquid as possible (a high-yield online savings account is just about perfect) and should contain at least $1,000 (at first) and eventually six to twelve months of your household's take-home salary (eventually)" (the Simple Dollar. January 3, 2007. P.1.)

6. Recall that the Bennett's already have a house savings fund for a future down payment (FMV of $23,000). How much will this house-savings fund be worth in 3, 5, and 10 years assuming an annual growth rate of 5%. How much will the fund be worth if they could achieve a 10% nominal rate of return for the same 3, 5 and 10 years?

At 5%

At 10%

3

$26,642.80

3

$30,613

5

$29,354.90

5

$37,041.50

10

$37,464.70

10

$59,655.10

7. How much will Jay and Rebecca have to save at the beginning of each year to accumulate $50,000 for Emily to attend university if they can earn 9% per annum, assuming she enrolls at the age of 19? If the Bennett's had to accumulate $100,000 to fund Emily's educational expenses, how much would they need to save at the beginning of each year, assuming the same rate of return? If they could earn 12% per year on their investments, how much would they need to save at the end of each year to meet the $100,000 target?

Assuming Emily just turned 3 the Bennett's would have 16 years to save $50,000. According to the future value of an annuity due formula; $1,390.05 per year. To save $100,000 earning 9% the couple would need to save $2,780.09. To save $100,000 at 12% with investment at the end of each period the future value of an ordinary annuity provides a value of $2,339.18 each year.

8. Assuming an 8% return for the current year from Jay's ETF, and a 33% marginal tax rate, how much will the Bennett's pay in taxes on their investment, either from their savings or current income this year? By how much, after taxes will their account grow this year?

$3,500* 1.08=$3,780. Gain = $2,780*.33= $917.40 taxes. $2,780- $917.40= $1,862.60 in after tax gain.

9. Calculate the amount of CPP and EI taxes withheld from Jay's and Rebecca's pay based on their current income? Total taxes annually $23,600 equals $1,966.67 monthly withheld

PART II: Cash Management

10. Jay has been on the Internet researching various investment alternatives. He has learned about T-bills and is wondering if they are an appropriate vehicle to put Bennett's savings for a house? Treasury or T-bills are short-term investments issued by national governments. "Government of Canada Treasury Bills offer attractive interest rates and are fully guaranteed by the federal government. They are available for terms of one month to one year and are essentially risk-free if held to maturity" (Canada Trust. T-Bills. N.D.P.1.). The safety of this investment would be ideal for Jay and Rebecca's house fund, although the rate of 1.32% on a one year bill does not offer a stellar return.

11. He also read about Canada Saving Bonds. How appropriate are these bonds as a saving vehicle for the same purposes? From a safety perspective these bonds offer a similar advantage to T-bills however, the rate of .65 does not offer a quality return (Government of Canda. N.D.P.1).

12. What recommendation would you give to the Bennett's with respect to their down-payment savings: hold as is or change? What investment vehicle would you recommend? For house savings I would recommend the t-bill approach or perhaps a money market account which pays a higher rate and would offer a safe and guaranteed return on investment. The key point is that this money cannot be placed at risk of loss of principal.

13. Bennett's have heard about "pay yourself first" concept. Rebecca is not sure how to do this. Give her advice about the ways to automate her savings. The "pay yourself first" concept simply means allocating income to savings prior to paying out other expenses. The simplest method to do this is a transfer of 1- 20% of paycheck income to a designated savings account. Jay and Rebecca have disposable income of $6,950 monthly and from this amount $695.00 should be automatically transferred to a separate account. The account can be a traditional savings account or perhaps an investment account. An alternative to this approach would be to save through a Canadian "registered Retirement Savings Plan (RSP) an investment account designed primarily for saving toward your retirement years" (Canada Trust. RSP. N.D.P.1).

14. The family's total monthly real disposable income (after taxes) is approximately $6,950/mth. Calculate Bennett's current monthly debt payments. Calculate and interpret their debt limit ratio.

Monthly bills:

Car Pmt $485

Student Loan $150

Furniture Loan $260

Credit Card $250

$1,145 monthly debt

Debt to Income Ratio = $1,145/$6,950= 16%

15. If they would like to replace their Vehicle#2 and take on another car loan of $600/month, what would their revised debt limit ratio be? What advice would you give to Jay and Rebecca (to buy or not to buy)? The revised debt to income ratio with the new car payment would be 25%: $1,745/$6,950. One of the largest credit card companies MasterCard recommends "non-mortgage debt payments above 20% of your income indicate that steps may be needed to pay down debt. Non-mortgage debt payments over 20% exceed your net income borrowing limit" (MasterCard. N.D.P.1.). Based on this figure… READ MORE

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