# Chapter 4 Using Tax Concepts for Planning

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Suwen Li
10/12/2007
10 Points Project ---- Financial Planning Problems
Chapter 2 Planning with Personal Financial Statement (10 point)

1. Angela earns \$2,170 per month before taxes in her full-time job and \$900 before taxes
in her part-time job. About \$650 per month is needed to pay taxes. What is Angela’s
disposable income?
(\$2,170 + \$900) - \$650 = \$2,420
Angela’s disposable income is \$2,420.

3. Angela (from problem 1 & 2) inspects her checkbook and her credit card bills and
determines that her net cash flow is \$300. She makes a budget based in her personal cash
flow statement. In two months, she must pay \$375 for tags and taxes on her car. How will
this payment affect her net cash flow for that month? Suggest ways that Angela might
handle this situation.
Angela’s net cash flow for that month will be -\$75. She could use her saving to
cover this amount of cash shortage for that month.

4. From the information in problems 1 thought 3, how much can Angela expect to save in
the next 12 months?
\$300 * 12 - \$375 * 6 = \$1,350
Angela can expect to save \$1,350 in the next 12 months.

5. Angela analyzes her personal budget and decides that she can reduce her recreational
spending by \$50 per month. How much will that increase her annual savings? What will
her annual savings be now?
Angela’s annual savings will be increased by \$50 * 12 = \$600.
Angela’s annual savings will be \$ 1,950 now.

6. If Angela is saving \$350 per month, what is her saving rate (i.e., savings as a
percentage of disposable income)?
Savings Rate = \$350 / \$2,420 = 14.5%
Angela’s savings rate is 14.5%.

Chapter 4 Using Tax Concepts for Planning (10 points)

1. Janet makes \$450 per week. How much will be withheld from her weekly check for
social Security tax? Medicare tax? Total FICA taxes?
Social Security Tax:        6.2% * \$450 = \$27.90
Medicare tax:             1.45% * \$450 = \$6.53
Janet's total FICA taxes are \$34.43 (computed as \$27.90+ \$ 6.53).

3. Nolan is self-employed as a carpenter. He made \$42,000 last year. How much did he
contribute to FICA taxes last year?
Social Security Tax: 6.2% * \$42,000 * 2 = \$5,208
Medicare Tax:        1.45% * \$42,000 * 2 = \$1,218
BUS 147;1179
Suwen Li
10/12/2007
Nolan's total FICA taxes are \$ \$6,426 (computed as \$5,208 + \$1,218)

6. Jim sold a stock that he held for 11 months at a capital gain of \$10,000. he is in the 25
percent marginal tax bracket. What taxes will he pay on the gain?
\$10,000 * 25% = \$2,500
Jim's taxes on this gain will be \$2,500.

12. Martin has a marginal tax rate of 25 percent. He suddenly realizes that he neglected to
include a \$1,000 tax deduction. How will this oversight affect his tax?
This deduction \$1,000 can reduce Martin's taxable income by \$1,000.

13. If Martin (from problem 12) had forgotten a \$1,000 tax credit (instead of a \$1,000 tax
deduction), how would his taxes be affected?
This tax credit \$1,000 will reduce Martin's taxes by \$1,000.

BUS147: Complete the worksheets to any or all of the six (6) Brad Brooks:
A Continuing Case parts that are at the end of Chapters 4, 8, 10, 13, 19, and
21. ( 20 points)

Chapter 4 Brad Brooks--- A Continuing Case

1a. Prepare personal financial statements for Brad, including a personal cash flow
statement and personal balance sheet

Personal cash flow statement
Cash Inflow                                                    This Month
Disposable (after-tax) income                                       \$2,500
Interest on deposits                                                     0
Dividends Payments                                                       0
Total Cash Inflows                                                   \$2,500

Cash Outflows
Rent                                                                  \$600
Cable TV                                                                60
Telephone                                                                50
Groceries                                                              300
Electric and Water                                                       60
Health Care Insurance and Expenses                                      130
Car Expenses                                                            200
Recreation                                                              600
Total Cash Outflows                                                   \$2,100
Total cash Flows                                                      + \$400
BUS 147;1179
Suwen Li
10/12/2007
Personal Balance Sheet
Assets

Liquid Assets
Cash                                                 \$ 500
Checking account                                      3,500
Savings account                                           0
Total liquid assets                                   \$4,000

Household Assets
Home                                                       0
Car                                                   \$1,000
Furniture                                              1,000
Other household assets                                     0
Total household assets                                \$2,000

Investment Assets
Stocks                                               \$ 3,000
Bonds                                                      0
Mutual funds                                               0
Other investments                                          0
Total investment assets                              \$ 3,000
Total Assets                                         \$9,000

Liabilities and Net Worth

Current liabilities
Loans                                                      0
Credit card balance                                   \$2,000
Other current liabilities                                   0
Total current liabilities                             \$2,000

Long-Term Liabilities
Mortgage                                                   0
Car loan                                                   0
Other long-term liabilities                                0
Total long-term liabilities                                0
Total Liabilities                                     \$2,000
Net worth                                             \$7,000
BUS 147;1179
Suwen Li
10/12/2007
b. Based on these statements, make specific recommendations to Brad about what he
needs to do to achieve his goals of paying off his credit card balance and saving for
retirement.
Brad can use his checking account to pay off his credit balance. Brad needs to
increase his net cash flows by reducing his recreation expenses, let’s say \$200. Then he
can increase his saving up to \$ 7,200 (\$600*12) per year. He needs to invest retirement
account to save for retirement right now. By doing this, Brad also can save his tax
payment.

c. What additional goals could you recommend to Brad for the short and long term?
Long-term goal for Brad: Buy a house in 5-10 years. Saving for retirement in 20
years.

2. Consider brad’s goal to retire in 20 years by saving \$4,000 per year starting five year
from now.
\$4,000 per year a realistic goal? If not, what other goal would you advise?
I think the saving goal \$4,000 per year for Brad is not realistic. Brad can save up to
\$7,200 per year if he can cut off his recreation expenses by \$200 per month. The goal that
I would advise is \$7,200 per year.

b. In order for Brad to know what his \$4,000 per year will accumulate to in 20 years,
what additional assumption ( or piece of information) must he make ( or have).
Brad needs to have the information about the interest rate to determine the
accumulation in 20 years.

c. Assuming that Brad invest the \$4,000 per year for 20 years, starting five years from
now and achieves a return of 12% per year, how much will he accumulate in 25 years?

Future Value of an annuity
Payment per Period                                        \$4,000
Number of Period                                               20
Interest Rate per Period                                      12%
Future Value                                              \$288,208

d. Compare the alternative of investing \$4,000 every year for 25 years beginning today
with Brad’s plan to invest \$4,000 every year for 20 years beginning five years from now.
How much additional funds will Brad have to save each year to accumulate the same
amount that he would have in 25 years if he started saving now instead of five years from
now?
Future Value                                            \$288,208
Number of Period                                              15
Interest Rate                                                12%
Payment per Period                                         \$7,730
BUS 147;1179
Suwen Li
10/12/2007
Additional fund that Brad have to save per year = \$7,730 - \$4,000 = \$3,730

3. Develop three or four suggestions that could help Brad reduce his income tax
exposure.
The four suggestions are:
 Sell the stock losers this year to apply the capital loss against the taxable income.
 Reduce taxable income by having a mortgage.
 Investing a retirement account to reduce taxable income.
 Invest long-term stock to subject a lower tax rate in capital gain.

4. Would any of your recommendations in question 1 though 3 change if Brad were 45?
If he were 60? Why or why not?
If Brad is 45, the recommendations would not change.
If Brad is 60, I would change the recommendation about the retirement investing
goal. It is too later to invest retirement account.

5. After you informed Brad of his negative monthly net cash flow, Brad indicated that he
may delay paying his credit card bills for a couple of months to reduce his cash outflows.
What is your response to his idea?
I don’t think Brad’s idea is a good idea. You should pay off your credit card balance on
time to avoid a higher interest rate and obtain good credit card history. By doing those,
you can have a good credit record and get lower interest rate when you need a loan.

20 points Project:
Interview 2 people one that bought a used car and one that has bought a
new car. Compare their experiences with the choice in cars, why they chose
to get in new vs. used, benefits of getting it, down falls. What would they
recommend to a college kid who is ready to buy his first car. What did you
learn from the interview.

Michael (bought a used car): The main reason for me to choose to buy a used car
is because the used car is lot cheaper than a new car. I am a college student, and I don't
have enough money to buy a new car. I bought a 5 year old Toyota used car. The price is
affordable, and the condition of the car is good. The repair expenses are lower than what I
expected. This type of car gets good gas mileage. I borrowed fund from my parents for
paying the car. I am very happy with my car. The recommendation to a college kid who
BUS 147;1179
Suwen Li
10/12/2007
is ready to buy his first car: shopping around via internet. With a limited budget, used car
with good condition is a good choice. Borrow fund from family members is also a good
choice too.

Emily (bought a new car): The main reason for me to buy a new Honda Odyssey
is because I need a bigger car for my family. I have two kids, and I need a minivan to fit
my children and their sports equipment. This minivan does serve my family very well. It
has more space for whole family. It gets good gas mileage too. The price is affordable.
This type of car normally has a good resale value even though I think that I will keep it
for a long time. I like this car very much. I paid it in full. My recommendation to a
college kid who is ready to buy a car: Buy a used car maybe is better choice due to your
financial position.

There are some points that both of the interviewers mentioned: First, when you
make a decision to buy a new car or used car, you should always consider your financial
position. Second, borrow money from your family members is a good idea. Third, for
student in college, buy a used car seems to be a good choice.

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