Solution:
A= 0 which is the annual savings
i = 6%, annual interest
n = period of 40 years
Find: F = future worth of the money
F = A [(1+i)n -1]/i
F = 250 [(1 + 0.06)40 – 1]/ 0.06
F = ,690.49, I will have this amount if I save 0 yearly in 40 years.
Solution:
Given are the future cost, F, which is ,000; and the annual interest, i, which is 5%. We are asked to determine the series of equal savings, A, at the each year in a period, n, of 6 years.
F= A [(1+i)n -1]/i
A = 40,000/ [(1+ 0.05)6 -1]/ 0.05
A= ,880.70
I should save ,880.70 every end of the year in six years to be able to have ,000 to buy a new boat.
Discussion Board
The Helms are planning to invest money for their future and in the event of layoff. However, they only have 00 liquid balance in which only 00 of it is earning interest. It is advisable for them to add more to their savings while both of them are in the height of their careers. Also, they should invest all their savings where their money can earn interest and grow for future use. The 0 checking account with Mid-City Bank seems to be stagnant and is not a wise decision to keep this account when the money on it is not growing.
The Helms are thinking about investing on a certificate of deposit, CD, which is also known as time deposit. CD is a savings account held for a fixed-term with the understanding or agreement that the depositor can only withdraw by giving written notice. It entitles the depositor to receive interest. A CD bears a maturity date generally ranging from a month to five years; a specified fixed interest rate and can be issued in any denomination (Investopedia, 2006). Its advantages include (2006): a guaranteed, locked-in interest rate for a specific period; a depositor can choose from the range of period depending on how long he want to invest his money; the longer the period of time, the higher the interest rate; one can often start with a 0 minimum investment; and CDs are insured by a private insurance company or safer if federally insured. However, CDs have some disadvantages including: penalty if the money is withdrawn earlier before its maturity date; local, state and federal taxes on income; and the investor might be lock in at low interest rate for a long period of time since the agreed upon interest is fixed even if the interest rates become higher.
There is also an option of investing some of their money in the stock market. Stock market is term to refer to a place where stocks and bonds are ‘traded’. Stocks are units of ownership in a company. When the Helms will invest in a stock the money that will be received from them is called as equity capital because the company who issue stock to them uses the money as capital to finance expansion or pay for equipment. Stocks in a less complicated meaning are a collection of shares in a company. A stock is certificate declaring one owns a small fraction of the company. Investors like the Helms will not go directly to the company because there are stock brokers to facilitate individual buyers and to explain to the investors the terms and conditions of becoming a stock holder.
When one invested his money to the stock market, the potential return is higher compared to the return when the money is invested in a CD. The average long tern return from investing in stocks is 10 to 12 (2006) percent compared to CD which return, looking at the Annual Percentage Yield, APY, ranges from 4 to 6 percent (2006) and depends on how long the money is invested. However, since the benefit or return is higher in stock market investment, the potential risk is also higher and not the guaranteed even by the company who issued the stock. If the company experience financial problems, an investor may not receive the dividends expected. But if the company performs well one can get the higher return. It is recommended then for the Helms to split their money: part of it will be invested in CD and the other half in the stock market so that not all their money will be at higher potential risk. Also, if they really want to prepare for their future they should invest on long term period where the money can earn higher return. They should choose a reliable bank or financial institution when investing in CD where the money can be guaranteed. Likewise, they should study carefully the financial situation of the company in which they will buy a stock.
References:
Individual Project 2
Below is the prepared monthly income and expense plan for the year 2003 of couple . This monthly plan is based on their total projected income and expenses for 2003. The expenses vary per month depending on the scheduled payments of some of their expenses and on the total income generated by during the month. They have a joint savings account which amounted to 00 but they prefer not to withdraw this amount below 0 at any time during the year.
The couple decided to project their monthly income and expense plan to see whether they can invest on a Certificate of Deposit within the year and how much they can invest for a CD in preparation of their future or for buying their own house. The expected expenses for 2003:
Expenses
Amount (Annually)
Monthly Average
Housing (rent)
,600
0
Transportation
5100
425
Food (includes dining out)
8100
675
Utilities
3000
250
Payroll taxes:
Donna
12,000
1000
Sherman
1500
125
Insurance:
Life – payable in May
720
Auto – payable in January
1,500
Leisure and entertainment:
Vacation in May
1,200
All others
1,800
150
Clothing
1,500
125
Others
,900
325
Total Expenses
,920
The total projected income of the couple for 2003 is as follows:
Donna’s annual salary
,996 (33/month)
Sherman’s total salary (June, July& August)
,000 (,000/ month)
Sherman’s allowance from his scholarship
,600 (,400 for February & 00 for October)
Total annual income
,596
Based on their annual income and expenses we can obtain their monthly income and monthly expenses. The expenses can be divided into two categories: variable and fixed. Among the variable expenses are the expenses for transportation, utilities, food, entertainment and leisure. Among the fixed expenses are the taxes, insurance payments, and the house rental. Although variable expenses, transportation, food and utilities expenses in this plan are assumed to be fixed for budgeting purposes since these are necessities while the entertainment and leisure expenses may or may not be included in certain months because they are not necessities.
The agreed that whatever will be left with their money (net) after all the expenses have been computed in a month will be added to their savings for the next month.
In January, their money would not be enough to be able to pay for Auto Insurance, so it is advisable for them to talk to the insurance agent and promise to pay the insurance in February. Due to late payment, a 10% penalty is assumed, making the Auto insurance amounted to ,650 in the month of February.
Monthly Budget Plan for 2003
January
February
March
Assets
Assets
Assets
Savings
,000
Savings
,133
Savings
,991
Income:
Income:
Income:
Donna’s Salary
3333
Donna’s Salary
3333
Donna’s Salary
3333
Sherman’s Scholarship
2400
Total Asset
,333
Total Asset
,866
Total Asset
,324
Expenses
Expenses
Expenses
Housing
550
Housing
550
Housing
550
Transportation
425
Transportation
425
Transportation
425
Food
675
Food
675
Food
675
Utilities
250
Utilities
250
Utilities
250
Payroll Tax:
Payroll Tax:
Payroll Tax:
Donna
1000
Donna
1000
Donna
1000
Others
300
Auto Insurance
1650
Clothing
125
Others
325
All others
350
Total Expenses
,200
Total Expenses
,875
Total Expenses
,375
Net
,133
Net
,991
Net
,949
April
May
June
Assets
Assets
Assets
Savings
,949
Savings
,382
Savings
5
Income:
Income:
Income:
Donna’s Salary
3333
Donna’s Salary
3333
Donna’s Salary
3333
Sherman’s Salary
3000
Total Asset
,282
Total Asset
,715
Total Asset
,228
Expenses
Expenses
Expenses
Housing
550
Housing
550
Housing
550
Transportation
425
Transportation
425
Transportation
425
Food
675
Food
675
Food
675
Utilities
250
Utilities
250
Utilities
250
Payroll Tax:
Payroll Tax:
Tax: Donna
1000
Donna
1000
Donna
1000
Sherman
125
Life Insurance
720
Others
300
Vacation
1200
Clothing
150
Total Expenses
,900
Total Expenses
,820
Total Expenses
,475
Net
,382
Net
5
Net
,753
July
August
September
Assets
Assets
Assets
Savings
,753
Savings
,261
Savings
,769
Income:
Income:
Income:
Donna’s Salary
3333
Donna’s Salary
3,333
Donna’s Salary
3,333
Sherman’s Salary
3000
Sherman’s Salary
,000
Sherman’s Salary
Total Asset
,086
Total Asset
,594
Total Asset
,102
Expenses
Expenses
Expenses
Housing
550
Housing
550
Housing
550
Transportation
425
Transportation
425
Transportation
425
Food
675
Food
675
Food
675
Utilities
250
Utilities
250
Utilities
250
Payroll Tax:
Payroll Tax:
Payroll Tax:
Donna
1000
Donna
1000
Donna
1000
Sherman
125
Sherman
125
Clothing
150
Clothing
150
Clothing
150
Leisure
325
Leisure
325
All others
350
Others
325
Others
325
Entertainment/leisure
350
Total Expenses
,825
Total Expenses
,825
Total Expenses
,750
Net
,261
Net
,769
Net
,352
October
November
December
Assets
Assets
Assets
Savings
,352
Savings
,060
Savings
,993
Income:
Income:
Income:
Donna’s Salary
3333
Donna’s Salary
3,333
Donna’s Salary
3,333
Sherman’s Scholarship
1,200
Total Asset
,885
Total Asset
,393
Total Asset
,326
Expenses
Expenses
Expenses
Housing
550
Housing
550
Housing
550
Transportation
425
Transportation
425
Transportation
425
Food
675
Food
675
Food
675
Utilities
250
Utilities
250
Utilities
250
Payroll Tax:
Payroll Tax:
Payroll Tax:
Donna
1000
Donna
1000
Donna
1000
Sherman
125
Holiday Vacation
1500
Christmas Shopping
1000
Clothing
150
Clothing
150
Clothing
300
Leisure
325
Leisure
325
All others
350
Others
325
Others
225
Entertainment/leisure
350
Total Expenses
,825
Total Expenses
,400
Total Expenses
,400
Net
,060
Net
,993
Net
,926
In April they must not spend so much in leisure and other expenses so that they can have enough money for their planned vacation in May. However, during the quarter break in April, Sherman’s employer had a remodeling project and gave Sherman a job which earned him ,500. Even after the payroll tax was deducted from this amount, this amount still added up to their total income and can be added to their savings or the can spend it for leisure activities. They can even add it to their budget for vacation on May. This unexpected event has little effect on the plan since it is classified as income. In December, the can afford a holiday vacation and Christmas shopping with their income and part of their savings.
As required by the their liquid asset in the plan did not go below 0. In fact, the money increases so by the end of the year, they have saved ,926 which is enough to invest in a Certificate of Deposit where their money can earn interest. It is recommended that they withdraw at least ,500 of their savings and invest them in CD. Based on the list of their expected expenses, their short term goal in 2003 is to have a vacation in May. They did not identify their long term goals which are also necessary in planning a budget. The could have thought about their future. Their long term goals may include buying a house since they spend much on house rental every month; planning for retirement; or saving for child’s education in case they decided to have children in the coming years.
Unit 2 Assignment
Individual Project
Couple are considering putting money on investments. They are currently renting an apartment but are also considering purchasing a condominium for 0,000 with a down payment of ,000. and will each make about ,000 next year and will have accumulated about ,000 to invest. They are considering investments in condominium, municipal bonds, high-yield corporate stocks, savings account in a commercial bank or a high-growth common stocks.
To compare which investment is the best, we will compute for the after-tax yields of each investment, assuming that the couple has a 28% marginal tax rate. After-tax investment return or yield of a taxable investment can be calculated using the formula: After-tax yield = Pre-tax yield (1-MTR) where MTR is the marginal tax rate.
Computing for the after-tax yield of each investment:
a) The condominium has an annual increase of 5% in market value
b) Municipal bonds: municipal bonds are free of federal tax so the after-tax yield of municipal bonds is not affected by the marginal tax and is still 5%
c) High-yield corporate stocks: after-tax yield = 0.08 (1- 0.28) x 100= 5.76%
d) Savings account in a commercial bank:
After-tax yield= 0.03 (1-0.28) x 100= 2.16%
e) High-growth common stock: there is no expected dividend yield but the market value increases by 10% annually.
Investing in a condominium will not provide a yearly return to the investor. However, the couple will no longer to pay monthly rental for the apartment when they purchase a condominium and at the same time the market value of the condominium increases by 5% annually. Supposed that the couple decided to sell the condo unit after 10 years, the market value or the future worth of the 0,000-condominium may amount to 2,889.46 after 10 years. This means that they may earn ,889.46 or almost 62% of the price they have bought the condominium. Likewise, the high-growth common stock, if all ,000 was invested with it, may have a value of 3,749.70 after 10 years or almost 38.55% of its actual value.
Municipal bond’s major characteristic is having no federal tax for investor to pay for, as well as local and state taxes but has low annual yield. This is because municipal bonds are issued by states or cities to raise money for municipal project such as hospitals, schools or airports (2006). On the other hand, high yield corporate stocks are subject to taxes but have higher return. But the higher return is accompanied by higher potential risk and not the guaranteed even by the company who issued the stock. If the company experience financial problems, an investor may not receive the dividends expected. But if the company performs well one can get the higher return. Savings account in a commercial bank is the most common type of investment, the money invested is highly secured although the return has the lowest rate compared to other forms of investment.
It will be recommended for the to invest the ,000 of the ,000 in a condominium unit with a down payment of ,000 dollars and the balance to be paid in installments via the couple’s monthly income depending on the scheme of the developer of the condominium. Instead of paying for house rental, it will be better for them to have their own house and at the same time an investment for the future. Some of the money should be invested in a high-growth corporate stock that although they will not receive annual dividend, at the end of the investment period, the investor can sold the stock at a higher price. Some should also be invested in savings account such as a Certificate of Deposits which is comparable to a stock although lesser rate of return or an ordinary savings account so that in case of emergency they can immediately used the money.
Reference:
Individual Project 2
reviewed her November’s statement with MasterCard and notices the beginning balance was 0 and she made a 0 payment on November 10 while had purchases of on November 5, 0 on November 15 and on November 30. With an APR of 16% we can compute the interest she paid using the average daily balance method, the previous balance method and the adjusted balance method.
The average daily balance method involves getting the weighted sum of the balance subtracting payments as they occur.
Average Daily Balance Method:
Statement for November
Period
Days (a)
Balance (b)
a x b
1 to 4
4
(Previous Bal.) 0
,400
5 to 9
5
(Purchase)80
400
10 to 14
5
(Payment 0) new Bal. 400
2,000
15 to 29
15
(Purchase) 100
1,500
30
1
(Purchase) 50
50
Weighted Sum
,350
Average daily balance = weighted sum/ 30 days (billing period)
= ,350/30 = 1.67
Interest charge = Monthly rate x Average daily balance
Where: monthly Interest rate = APR/12
= 16%/12
= 1.33%
Interest Charge = 0.0133 x 1.67 = .81
Using the Previous balance method where interest is computed based on the previous balance:
Previous Balance = 0
Monthly Interest Rate = 1.33%
Interest Charge = monthly interest rate x previous Balance
= 0.0133 x 0
= .98
Using the Adjusted Balance Method where interest equals to the previous balance less any payments or returns made during the current billing cycle:
Previous Balance 0
Less current Payment 200
$ 400
Interest Charge = 0 x 1.33 % (Monthly Rate) = .32
Among the four methods of computing the interest, the average balance method is the most advisable method and the one which is an advantage to the card user because, based on the computations above, it has the less interest charge. Sometimes, other credit cards offer lesser APR but use the adjusted balance or the previous balance method which when computed will still give higher interest than those who uses the average balance method.
Basically, credit cards are used in making purchases and on shopping wherein the borrower must make a minimum payment each month based on the outstanding method. Aside from credit cards, there are other sources of credit that can choose from depending on her needs. When would like to buy a house she can choose a mortgage loan. A mortgage loan, known as ‘secure, closed-end’ credit is based on collateral and a specific number of payments are scheduled for a specified peri0od of time. A car loan is also this type of credit.
There is also the ‘unsecured, closed-end’ credit called signature loan where credit is available when the creditor is wiling to make the loan based on the borrower’s creditworthiness. Signature loan can be used for home improvements. Finally, if wants to get a loan using her house as collateral, there is the ‘open-end equity’ or ‘secured, open-end’ loan where loans are made against a borrower’s property and the amount of the loan is based on the equity in the home (2002).
Whatever credit source chooses, she should consider and look after not only on the APR but also on the method of computing the interest. There are credit companies who offer lower APR but have higher interest charged when computed.
References:
Discussion Board
If one of my friends had a serious financial misfortunes and is unable to pay for his debts, my first advice would be to read law about having debts and law on bankruptcy to determine the best move he can do about his debts. Bankruptcy is one of the many options in dealing with debts. It is a legal process through which people and businesses can eliminate all or portion of their debts or stretch out the monthly payments under the protection and supervision of a court (2006). There are two types of bankruptcy, the chapter 13 and the chapter 7 bankruptcies.
The chapter 13 bankruptcy, also known as the wage earner plan is the type in which one can have his debt paid at a reduced amount and at reduced or at no interest at all in a period of 3 to 5 years ( 2006). It is payment plan whose goal is to protect the debtor from foreclosure, garnishment, levy or similar consequences ( 2005). To be eligible for chapter 13 bankruptcy, the debtor must have an income exceeds his reasonable living expenses to sufficiently provide repayment to creditors of past debts. The debtor must also meet with a credit counselor and attend money management classes before a final order will be issued by the bankruptcy court. On the other hand the chapter 7 or straight bankruptcy is the type where one completely wipes out his debts except the secured debts if he wishes to keep the security ( 2006). Secured debts can be houses with mortgages or cars that are financed and to keep the house or car, payment to creditor must continue (2006). The debts are cancelled but the bankrupt person may have to surrender items of property. Under straight bankruptcy, the income of the debtor is examined and compared to State Median Income. If his income is above the state median income, and can repay 25% of his unsecured debt ( 2005), the debtor will be disqualified for chapter 7 and may apply for chapter 13 bankruptcy.
After having awareness of the basics about bankruptcy he should then analyze his financial status and his options. Better yet he should consult a money management consultant or a public lawyer who understand more about debts because debts are serious legal matter.
References:
Unit 3. Insurance Planning
Discussion Board
An insurance policy gives the details on the circumstances under which the insurance company is responsible for claims and its financial limits of responsibility. Most insurance for automobiles has certain agreements that both parties will benefit. Generally, a personal auto policy includes a first page that states the agreement including the policy limits and the premiums paid by the holder; a part for the bodily injury liability coverage; part for the medical payments coverage or personal injury protection, PIP; part for the property damage liability; part for the coverages for damage to your auto, collision and comprehensive; part for the duties after an accident; and the general provisions.
Bob’s passenger, Ruth, is covered by the insurance under the personal injury protection, PIP. Whether Ruth is a Bob’s family member or not she was covered by Bob’s insurance policy. PIP pays up to a maximum of 0,000 per person depending on the kind of accident and the kind of treatment that she should undergo as stated in a certification. The front and rear damage to Bob’s car is under the collision coverage regardless of who is at fault. Collision coverage has standard deductible of 0 but deductibles generally range from 0 to 00. The damage to the car in front of him seems to be Bob’s fault. If proven that it is his fault, his insurance, under the Property Damage Liability, PDL, coverage will pay to repair damages to the car in front of him. The amount that the insurance will pay depends on the cost of the repair. On the other hand, the damage of the car behind him seems to be not his fault. But if proven that it is also Bob’s fault, the PDL is also applicable. The car behind him is liable for the rear damage of his car, thus the insurance company can reimburse from the owner or from the other driver’s insurance company the amount they paid for the repair of the rear damage of Bob’s car.
The total amount of liability protection for bodily harm and the property damage will be shouldered by the insurance company provided that the insurance company is notified promptly after the accident and accurate information such as how, when and where the accident happened is given. The total amount that will be paid by the insurance company also depends on the premiums paid by Bob and on the terms and conditions on the insurance company.
References:
Individual Project
and each take home ,000 per year. They have two children, 11 and 13 years of age. They have estimated that the remaining family members if one of them dies would need about 75% of the present combined take-home salary to retain their current standard of living aside from an extra /month in child care expenses that would be required in a single-parent household. The estimated survivors’ benefits would total about ,000 per month.
The ‘needs approach’ is a method of calculating how much life insurance is required by an individual or a family to cover their needs and expenses ( 2006) and is a function of two variables: how much will be needed at death to meet obligations; and how much future income is needed to sustain the household. Using the needs approach, we can compute how much the Wright family needs in the maintenance fund if Sue Wright dies today. First, computation of the expenses is needed: Combined take-home salary= ,000 x 2 = ,000
Expenses to retain the standard of living = ,000 x 75% = ,000
Monthly expenses if Sue died = ,000/12 = ,000
Monthly child-care expenses =
Total Monthly expenses = ,050
Computing for the monthly income if Sue died:
Tom’s Salary = ,000/12 = ,333.33/month
Survivors’ Benefits = ,000/month
Total Monthly Income = ,333.33
Subtracting the total monthly income from the total monthly expenses:
,050- ,333.33 = 6.67
The family would need 6.67 every month from the family’s maintenance fund.
Supposed that both Tom and Sue has a life insurance protection gap, which is the difference between the resources needed and the resources that would be available to maintain a family’s current living standard after the death of one of the primary earner (CET, 2004), the family should take some steps earlier to close that gap.
After having computed the gap, the Wrights should look at their funding sources such as financial investments and life insurances and as long as both and are still living, they should, if possible, increase the premiums that they pay on their insurances and to make some more good investments that will provide them additional funding sources that will close the protection gap.
References:
Unit 4. Investing
Individual Project
is single lawyer and financially well-off. His income has exceeded ,000 a year and has sufficient liquid and tangible assets and a condominium. He has investments in stocks and bonds worth about ,000 which some worked well but other did not. current approach to his investments has some disadvantages. First, he selected investments based only on articles about investments that he read. He should have consulted financial analysts and made comparisons on different kinds of investments that are more suitable for him and where his money can effectively earn and grow. A fund manager can help him manage his money and pool them into the best securities and diversify his investment. Also, although he already found out that some of his investments did not work out well, he still did not find time to review and evaluate his current portfolio. His other investments might also not doing good and he can still do something to save his investments. Aside from that he is not sure if his current investments are aligned with his long-term goal which is for his retirement.
Mutual funds for people who have moderate-risk tolerance level like should have a mixed asset for his portfolio on a time frame of 10 years or more. For it is recommended to invest 60% of his money for growth and 40% for income. 60% will go to stock funds which are riskier compared to other investments but it is where money will grow and provide higher return over a long period which he can use for his retirement. Others will go to bond funds which produce income and help in the diversification of his portfolio. He may invest his money in corporate bond funds, government bond funds and municipal bond funds. Some of his money may be invested in money market funds.
Recommended Portfolio for Cliff:
Sample Portfolio
Client Profile
Age
33
Time Horizon
10 years plus
Risk Tolerance
Moderate
Growth Funds
35%
Value Funds
10%
Large-Cap Funds
5%
Corporate Bond Funds
15%
Government Bond Funds
10%
Municipal Bond Funds
10%
Money Market Funds
15%
It is recommended that to balance his portfolio, he should set goals other than his retirement and marriage plan, in order to decide why he is putting his money away, how long he expect to need it and his attitude to risk. He should also set target allocation. There are investments such as stocks that are very risky and there are some that are tolerable. He should be aware of what he can get with his investments. One way to balance his money is to diversify such as with mutual funds; when one investment is down another might be up thus reduces the overall risk. The mutual fund will have a fund manager who is responsible for investing the pooled money into specific bonds or stocks (Woodard, 2006). His portfolio should be rebalanced on a regular basis such as when he is five percentage points away from his target allocation (Anonymous, 2006). It can be rebalance by selling some of the stocks and but bonds or divide the equities depending on his needs.
References:
Discussion Board
When one has invested in a stock market, he is entitled for a dividend depending on the terms of the corporation where he bought a stock. Dividend represents a distribution of assets to stockholders, and a corresponding reduction in stockholder’s equity. There are different types of dividend. One of these is the regular cash dividend. Regular cash dividends are a distribution of cash to stockholders wherein both cash and retained earnings are reduced. They are usually paid and declared quarterly and expressed as some dollar amount per share or as some percentage of par value. Another way to distribute earnings to shareholders is through share repurchases. Unlike regular cash dividends which imply a commitment to continue payments in the future, a share repurchase is a onetime return of cash. It is basically a buyback of ones own share. One advantage of share repurchase over dividend is that dividend pays for tax as regular income does while share repurchase pays tax as capital. The money a shareholder can receive are almost the same but dividend is more appealing because a shareholder can receive regular earnings on a specified time interval.
Stock dividend is typically a ratio. For example a 10% stock dividend means that you get 10 shares for every 100 you own. Instead of receiving cash periodically, in stock dividend one can increase his share. Its main advantage over cash dividend is that a cash dividend reduces total stockholder’s equity by the amount of dividend while a stock dividend does not change total stockholders’ equity ( 2006) so it is more preferable than cash dividend but it is not a distribution of assets, shareholder simply maintains his proportionate interesting the firm. Moreover, a stock split is categorized as a type of dividend which is an increase in the number of outstanding shares by reducing the par value of the stock. It is desirable because it used to move the stock into a more popular trading range and increase share demand. For example, before a 2-for-1 stock split, one has 400,000 shares at par, after a 2-for-1 stock split he will have 800,000 shares at .50 par but his total equity remains the same.
Reference:
Unit 5. Long Term Planning
Group Project
The ability of to afford a new house depends on their gross income and the factors from a lender’s perspective. From a lender’s perspective, factors such as the front-end ratio; the back-end ratio; and the down payment determine the ability to purchase a house.
The back-end ratio calculates the percentage of the gross income required to cover the debts. Most lenders recommend that the debt-to-income ratio does not exceed 36% of the gross income. With , their debt-to-income ratio can be calculated as follows:
Total Gross income = Kim’s Gross Income/year + Dan’s Gross Income/year
= ,000 + ,000
= ,000
Maximum debt expenses = (,000 x 0.36)/12
= ,790
The couple’s only debt is a car loan that requires a monthly payment of 0. Therefore, looking at the back-end ratio, they can afford a home mortgage.
The 20% down payment plus ,000 closing cost can be easily paid by the using their savings that earn ,840 last year. Computing for the monthly payments for a 0,000 home to determine if the can afford the home:
Cost of the home = 0,000
20% Down payment = 0,000 x 0.20 = ,000
Principal = Cost of the Home – down payment
= 0,000 – ,000
= 4,000
Interest = 8% (Variable)
Period of payment in months = 30 years x 12 = 360
Using the formula for computing the monthly amortization or the monthly payments, M:
M = (P x i)/ {1- [1/(1+ i)N]} where: M = monthly payment
P = Principal
i = monthly interest which is 8%/12
N = period which is 30 x 12 = 360
M = (224,000 x 0.0067)/ {1- [1/(1+0.0067)360 ]}
= ,649.88
,649.88 will be the amount that must be paid by the in a 30-year variable rate loan with 20% down payment at 8% initial interest.
Front-end ratio is the percentage of their yearly gross income dedicated toward paying the mortgage monthly (2005). The mortgage payment consists of the principal, interest, taxes and insurance, PITI. These four components or the PITI should not exceed 28% to 30% of the gross income to be able to afford a home mortgage. These may also include the maintenance and utilities although not included in their monthly mortgage. Calculating the front-end ratio:
Total Gross income = Kim’s Gross Income/year + Dan’s Gross Income/year
= ,000 + ,000
= ,000
30% of their yearly gross income = ,000 x 0.30 = ,900
Their monthly payment based on the above computation is ,649.88 plus tax amounting to 0/month and insurance of /month, yearly PITI can be computed as:
Principal + Interest = ,649.88 x 12 = ,798.56
Tax = 0 x 12 = 4,560
Insurance = x 12 = 600
PITI : , 958.56
Their PITI does not exceed 30% of their yearly gross income which means that they can afford the 0,000- home mortgage. Other factors to be considered in buying a new home may include the maintenance and utilities which include heat, light, water, sewage and cable TV and telephone services. These factors are expenses necessities that are not included in the back and front-end ratio and are unavoidable when buying a new home (2005).
Since they are offered a variable rate loan, this means that in the process the initial interest rate of 8% may increase and may change their monthly payments. These changes can give problems to the especially when their gross income has not yet increased when that time comes. They may have difficulties paying their monthly amortization.
The may also consider renting that would cost ,400/month plus utilities estimates at 0 and renter’s insurance of /month. Supposed that they will rent over the next five years and the annual rate of housing and rents, and other prices including utilities and others will all rise at 3% over the next five years, we can compute for the total amount that would cost the
Monthly rental: 00 x 12 = ,800/year
Utilities: 0/month x 12 = 2,640/year
Insurance: /month x 12 = 600/year
Total: ,040/year
At an increase of 3% a year:
Year
Amount
1
,040
2
20641.2
3
21,260.44
4
21,898.25
5
22,555.20
Total
6,395
.
After 5 years, the total expenses for rental would be 6,395 which is higher compared to the assumed amount of ,574 when they purchase a home. In other words it is not financially attractive for them to rent a home over the next five years because of the annual increase in rental and other prices unlike when they purchase the home, even if they pay for it they will own the home they are paying for. But if they have to relocate after one year then it would be better to rent a home only within a year and just but a new home in the place where they will be relocated. Even if the price of a home will increase after a year, they can still afford it because they expect to earn about 5% on their money market fund which they will use for the down payment for a new home.
References:
Discussion Board
An employee must save and prepare for his future in case the time has come that he could no longer work. This time is also known as retirement. To be able to prepare for that time, an appropriate retirement plan should be considered depending on one’s personal situation and on his plans on what to do with the money he saved. There are types of retirement plan and each one requires certain qualifications that must be met. The two most popular retirement plan today are the IRA and the 401k. IRA or Individual Retirement Account is a plan that allows a person to make contributions each year if they meet the contribution requirements such as earning income for the year at least equal to the amount of the contribution and having age under 70 ½ (2006). IRA has many types such as Roth IRA; spousal IRA, Rollover, and the traditional IRA. Generally, all accumulated interest, dividends and capital gains on a traditional IRA are tax-deferred until the money is withdrawn while in Roth IRA, all these are tax –free if one has met certain requirements.
Another popular retirement plan is the 401k, a trust in which employees are allowed to contribute money before taxes are assessed. Those whose employers offer a retirement plan that qualifies under 401k laws and who are full-time employees are eligible for 401k retirement plan. When joining this plan, employee should select specific investment option. Payments of up to 15% of one’s salary or ,000 each year are auto-deducted directly from the employee’s paycheck to his retirement account and invested in the specified investment option. The money in here like IRA is not taxed until withdrawn so when the employee retired, he will be likely to belong in the lower tax bracket thus lower tax deducted from his money.
The difference of 401k from IRA is that 401k is a pension plan that is offered though the work place that involves one’s contributions from his salary and contributions from his employer while IRA is a private investment funded by one’s own money. So if I am self-employed or an entrepreneur with my own business, I will be interested in IRA but for those who are employed in a company, they should take advantage of the 401k in which an employee can make matching contributions, that some companies contribute 33.3 cents to 50 cents for every the employee contribution (1999). However, you can not withdraw your investment until you retire or there will be a 10% penalty and liabilities in deferred income taxes (2006).
References:
Credit:ivythesis.typepad.com
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