Final Exam - Review _1 by mudoc123

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```									  Personal Finance:
Another Perspective

Preparing for the
Final Exam –
Review #1
Preparing for the
Final Exam
   How to do well on my exams (by order of what I think
is most important):
• 1. Review the previous quizzes
• 2. Review the PowerPoints and case studies from
each class
• These are the things I consider important
• Especially look for application problems
• 3. Review your 7 – 3”x5” note cards (you can
write on both sides) or write up a good one-sided
reference sheet (8.5” x 11”)
• 4. Review the syllabus (4 objectives)
• Think through the purpose for each case study
Review Problems

1.   Financial Statements
2.   Consumer Loans
3.   Housing Loans
4.   Income Taxes
1. Financial Statements

Data:
 Mickey and Minnie, both recent BYU graduates of 5
years, together get paid \$4,500 every month. Monthly
expenses include \$750 on taxes, \$550 on charitable
contributions, \$1,000 on housing and utilities, \$600 on
transportation, \$400 on food, and an average of \$750
on clothing and other expenses. Assume the remainder
goes into savings.
Calculations:
 Prepare an income statement using the “better method”
and then calculate and interpret their net and gross
savings ratio.
Application: How are they doing?
Both get \$4,500 every month. Monthly expenses include \$750 on taxes, \$550 on
charity,\$1,000 on housing and utilities, \$600 on transportation, \$400 on food, and an
average of \$750 on clothing and other expenses. Calculate and interpret their net and
gross savings ratio. How are they doing?
Both get \$4,500 every month. Monthly expenses include \$750 on taxes, \$550 on
charity,\$1,000 on housing and utilities, \$600 on transportation, \$400 on food, and an
average of \$750 on clothing and other expenses. Calculate and interpret their net and
gross savings ratio. How are they doing?
Income Statement                              Net Savings Ratio (2)
Income before Tax       \$4,500       Income for Savings 450 = 12%
Taxes                      750       Income for Living 3,750
Pay the Lord – Charity      550
Pay themselves - savings 450
Expenses                                They save 12% of their net living
Utilities/Housing        1,000         expenses and 10% of their gross. While
Transportation              600        this is likely low, given they are only 5
Food                        400        years beyond college, it is the minimum
Clothing/other              750        for most people. I would hope it is
Remainder                     \$0        closer to 20% for those in this class!
Note: what they have left over they
pay themselves as savings

Gross savings ratio: Income for savings / Total Income: 450 / 4,500 = 10%
2. Consumer Loans

Data:
 Jonathan needs approximately \$2,500 to buy a new
computer. A 2-year unsecured loan is available with in-
store financing for 10%. The current rate on his
revolving home equity line of credit is 5.75%, although
he is reluctant to use it. Jon is in the 28% federal tax
bracket and the 5.75% state tax bracket.
Calculations and Application
each loan? b. Regardless of the loan chosen, Rich
wants to pay off the loan in 24 months. Calculate the
monthly payments for him, assuming both loans use
the simple interest calculation method. c. Which
loan should he choose?
Jonathan needs \$2,500. A 2-year in-store unsecured loan is 10 percent. The revolving
home equity line of credit is 5.75%. Jon is in the 28% federal and the 5.75% state tax
bracket. a. What are the advantages and disadvantages of each loan? b. Rich wants to pay
off the loan in 24 months. Calculate the monthly payments.
Jonathan needs \$2,500. A 2-year in-store unsecured loan is 10%. The revolving home
equity line of credit is 5.75%. Jon is in the 28% federal and the 5.75% state tax bracket. a.
What are the advantages and disadvantages of each loan? b. Rich wants to pay off the loan
in 24 months. Calculate the monthly payments. c. Which loan should he take?

• Unsecured line of credit
• + No collateral needed
• + Cheaper than a credit card
• + Does not put the house at risk
• - Expensive
• Home equity loan
• + interest may be tax deductible
• + secured loan so lower rate
• - Fail to repay loan--may lose the house
Jonathan needs \$2,500. A 2-year in-store unsecured loan is 10%. The revolving home
equity line of credit is 5.75%. Jon is in the 28% federal and the 5.75% state tax bracket. a.
What are the advantages and disadvantages of each loan? b. Rich wants to pay off the loan
in 24 months. Calculate the monthly payments. c. Which loan should he take?

   B. The unsecured loan monthly payment would be:
• PV = -2,500, I = 10/12, N = 24, PMT = ?
• \$115.36
    The home equity loan monthly payment would be:
• PV = -2,500, I = 5.75/12, N = 24, PMT = ?
• \$110.52
   The home equity loan would save \$116.16. In addition,
the loan would save \$51.46 in taxes based on the
deductibility of the interest: Total Cost =(\$110.52*24)
less amount received -\$2500 * tax rate of 33.75% (28%
Federal + 5.75% state).
• What Jonathan has to decide is whether or not the
\$167.62 in total savings is worth the risk of losing
the house if he cannot repay the loan. I would be
very careful with this decision!
Jonathan needs \$2,500. A 2-year in-store unsecured loan is 10%. The revolving home
equity line of credit is 5.75%. Jon is in the 28% federal and the 5.75% state tax bracket. a.
What are the advantages and disadvantages of each loan? b. Rich wants to pay off the loan
in 24 months. Calculate the monthly payments. c. Which loan should he take?

   C. Either answer is ok, depending on the why. The
home equity loan is cheaper, with tax savings. The
unsecured debt does not risk losing the house. It
would be helpful to know whether he is living on a
budget and if he has the discipline to pay back the loan
quickly.
• The after-tax cost of the 5.75% home equity loan
would be 3.81% using the following calculation
that considers the tax savings on both federal and
state taxes
• 3.81% = 5.75% [ 1 -(.28 + .0575)]
3. Housing Loans

Data:
 You have made the decision to purchase a house, and you found the house
you want for \$200,000 (assume no down-payment for the sake of this
problem). You and your wife have agreed to a 30-year loan, but expect to
pay it off in 7 years as your work looks extremely promising (assume annual
payments). Your wife looked on the web, and found a \$200,000 loan with no
points and no fees at 6.5%, which she is sure, she can lock in. You talked
with your friend who is a mortgage broker, and he knows he can get you a
6.0% loan for the \$200,000, but it has 2 points and a loan origination fee of
\$1,500. Assume you can get either of these loans.
Calculations and Application
 Calculate the (a) total costs for each loan assuming you pay them both off in
7 years (assume you make the final balloon payment at the end of year 7).
(b) What is the effective interest rate of each loan? (c) Which is the cheaper
alternative? (d) Your broker comes back and says she can offer you 5.75%
but with 3 points and the same \$1,500 fees. What is effective cost to you (i.e.
the impact on your effective interest rate) of that third point (i.e. calculate it
with the three points and fees, then compare that to your calculation with 2
points and fees, and subtract the difference)?
Quick Review of EIR Process
3. Calculate the balloon
1. Calculate the
payment due at the end of
payments on
the prepayment period
the total
amount of the
loan

4. Set PMT to
payment, -PV to
2. Calculate
the amount
balloon payment, N to
years before
subtracting all
prepayment, and solve
Loan A: \$200,000, 30-year, no points and no fees, 6.5%, Loan B \$200,000,
6%, 2 points, 1,500 fees, all pay it off in 7. Calculate total costs for each loan,
effective rate, cost of 2nd point.
Loan A: \$200,000, 30-year, no points and no fees, 6.5%, Loan B \$200,000,
6%, 2 points, 1,500 fees, all pay it off in 7. Calculate total costs each loan,
effective rate, and Loan C of 5.75%, 3 points, 1,500 fees, all pay it off in 7.

 Loan A: since no points and fees, the EIR = APR
 Loan B
 1. Calculate the Payment
• I = 6.0% N = 30 PV = -200,000, PMT = 14,529.78
 2. Calculate the amount received
• Points = 2 for \$4,000 plus 1,500 fees = 200,000 - 5,500
• Loan receipt less points of = 194, 500
 3. Calculate balloon at the end of year 7
• N=23 (30 - 7 years), I= 6%, PMT = 14,529.78, PV = ?
• PV Remaining = \$178,765.42
 4. Calculate the effective interest rate
• PMT = \$14,529.78, FV = \$178,765.42, PV = \$-194, 500,
N = 7 I=?
• EIR = 6.52%
Loan A: \$200,000, 30-year, no points and no fees, 6.5%, Loan B \$200,000,
6%, 2 points, 1,500 fees, all pay it off in 7. Calculate total costs each loan,
effective rate, and Loan C of 5.75%, 3 points, 1,500 fees, all pay it off in 7.

Total Costs:
 Loan A: 7 x 15,315.49 + 180,265.39 = \$287,474
• EIR = 6.5%
 Loan B: 7 x 14,529.78+178,765.42 + 5,500 = 285,974
• EIR = 6.52
Cost of the Loan C and third point
 Loan C: 7 x 14,143.25 + 177,981 + 7,500 = 284,484
 PMT = 14,143.25, FV = 177,981, PV = -192, 500, N =
7, I = ?
 EIR = 6.46%
Cost of the third point = 6.52 – 6.46 = .06%
 Loan C is the cheapest loan both in rate terms and in
dollar terms
4. Income Taxes
Data:
 Using the married filing jointly status and their income and expense statement
below, calculate the 2009 tax liability for Mork and Mindy Williams (they have five
children, ages 4, 8, 12, 16, and 18). Mindy is the Young Women’s President of her
ward and has calculated that she drove her car 300 miles last year to girls’ camp,
which was not reimbursed. Exemptions are \$3,650 per person, the standard
deduction for married filing jointly is \$11,400, medical expenses over 7.5% of AGI
and job-related expenditures over 2% of AGI are deductible, charitable deductions
for mileage are .14 per mile, and the child-tax credit is \$1,000 per child under 17. a.
Calculate their tax liability first using the standard deduction and then using
itemized deductions. b. Write a paragraph explaining to the Williams which method
they should use and why? In that paragraph, comment on their marginal and average
tax rates on taxable income.
Income                                      Expenses
Earned Income               \$74,000 Home Mortgage interest              6,200
Interest Income                2,100 Un-reimbursed Medical Bills        4,900
Retirement Plan Contributions         DI and other donations            250
Mork’s IRA                     3,000 Job-related expenditures           1,800
Mindy’s Roth IRA               2,000 Tithing and other offerings        7,000
Tax Table for Married Filing Jointly for 2009:
Amount                           Tax
•   0 to \$16,700                   10%
•   \$16,700 to \$67,900             \$1,670 plus 15% of the amount over \$16,700
•   \$67,900 to \$137,050            \$9,350 plus 25% of the amount over \$67,900
Quick Review of Tax Process

income from all      Standard       = Total Tax Owed
sources less     Deduction or
Itemized
exclusions =
deductions
Total Income

4. Minus
exemptions
= Taxable
2. Subtract          Income         7. Minus taxes
Total Income =                       Balance Due or
Adjusted Gross    5. Look up tax       Amount of
Income (AGI)       on tax table =        Refund
Tentative Tax
Tax Liability (standard deduction)

1.+2. AGI =74000+2100-3000 (IRA) =           \$73,100
Only the IRA is subtracted to get your AGI
3. Less standard deduction                  11,400
4. Less personal exemptions (7 * 3,650) 25,550
Taxable income                       \$36,150
Tax liability
\$16,700*10%=                                1,670
(36,150 -16,700)*15%= 19,450*.15            2,918
5. Total tax liability                      \$4,588
6. Child tax credit                          -4,000
7. Total                                      \$588
Average tax rate = Total taxes due / Taxable income
Average tax rate = \$588 / 36,150 = 1.6%
Marginal tax rate = 15% for both
Tax Liability (Itemized deductions)

   1. + 2. AGI                                                       73,100
3. Less itemized deductions:
Home mortgage Interest 6,200 Un-reimbursed Medical                    0
Job related expenditures    338 Tithes & other offerings           7,000
DI & other donations        250 Mileage                              42
• Total itemized                                               (13,830)
   4. Less personal exemptions (same as before)                    (25,550)
        Taxable Income                                             \$33,720
   Tax liability
• 16,700*10%=                                                    1,700
• (33,720 - 16,700) = 17,020 * 15% =                             2,553
• 5. Total tax liability                                        \$4,223
• 6. Child tax credit less                                      -4,000
• 7. Tax                                                            223
• Average tax rate = \$223 / 33,720 = .7%
   Paragraph should include the savings (\$365), recommendation, and
average and marginal tax rates on taxable income, not gross income.

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