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UNIT
NAME OF STUDENT (PRINT CLEARLY)
CODE:
ECF5220
TITLE:
PRINCIPLES OF FINANCE
LE THANH
NGUYEN THI THU
FAMILY NAME
STUDENT ID. NO.
NGAN
10208786
HIEN
10208674
FIRST NAME
NAME OF LECTURER (PRINT CLEARLY)
DUE DATE
MR. SELVANADAN A/L MUNIAPPAN
05/11/2010
Topic of assignment
CASE IN FINANCE – WAKE UP AND SMELL THE COFFEE
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Campus
MBA INTERNATIONAL
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th
05 November, 2010
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th
05 November, 2010
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UNIT
NAME OF STUDENT
NAME OF LECTURER
Topic of assignment
STUDENT ID. NO.
RECEIVED BY
DATE RECEIVED
TABLE OF CONTENT
Page
QUESTION 1
3
QUESTION 2
4
QUESTION 3
5
QUESTION 4
5
QUESTION 5
6
QUESTION 6
6
QUESTION 7
8
BIBLIOGRAPHY
11
1
CASE STUDY: WAKE UP AND SMELL THE COFFEE
Provided information:
Marty's Salary
$50,000
Laura's Salary
$25,000
Marty's age
30
Laura's age
30
Credit Card Balance owned
$10,000 @ 15.99% per annum
College Loans owned
@12,000 @ 5.25% per annum
(24 months remaining)
Minimum monthly payment
3% of balance owned
required on credit card debt
Car Loans owned
$5,000 @ 5.99% per annum
(24 payments remaining)
Monthly rent
Income Tax Rate
@1,200
28%
2
QUESTION 1
Based on the information provided in the Table, if the Halls continue making minimum
payments on their outstanding debts, how much money will they have left over for all other
expenses?
ANSWER
1  (1  i )  n 
Using the formular PV  PMT 

i


or
PMT 
PV .i
we can compute monthly
1  (1  i ) n
expenses of the Halls as following:
12,000 x(0.0525  12)
 $527.80
1  (1  0.0525  12) 24
(1)
PMTCollege 
(2)
PMTCar 
(3)
PMTCredit card = 3% of balance owned = 0.03 x 10,000 = -$300.00
(4)
PMTRent = -$1,200
5,000 x( 0.0599  12)
 $221.58
(1  (1  0.0599  12) 24
Total monthly expenses of the Halls = (1) + (2) + (3) + (4) =
= $527.80 + $221.58 + $300.00 + $1,200.00 =
= -$2,249.38
The net income of the Halls is shown in the below table:
Marty's Salary
$50,000.00
Laura's Salary
$25,000.00
Total gross income
$75,000.00
Tax amount = 28% x $75,000.00
Net income per annum = 75,000.00 – 21,000.00
Net income per month = $54,000.00 ÷ 12
-$21,000.00
$54,000.00
$4,500.00
Total left over = Total net income – Total expenses = $4,500.00 - $2,249.38 = $2,250.62
3
QUESTION 2
How much money will Laura and Marty have to deposit each month (beginning one month
after the child is born and ending on his or her 18th birthday) in order to have enough saved
up for their child's college education. Assume that the yield on investments is 8% per year,
college expenses increase at the rate of 4% per year, and that their child will enter college
when he or she turns 18 and will complete the degree in 4 years.
ANSWER
With PV = $20,000 and Annual inflation rate = 4%, the College expense in year 1 – 4 will be
as below:
= $20,000
= $20,000
= $20,000
= $20,000
As their deposit ends at their child’s 18th birthday, we have to discount these FV to year 18:
Year
0 ………………
17
1st year
18
2nd year
19
3rd year
20
4th year
21
$40,516.33 $42,136.98 $43,822.46 $45,575.36
Using formula PV 
FV
we have:
(1  i) n
The total savings that the Halls should have when their child is 18 years old is:
The number of period Laura and Marty have to deposit until their child reaches 18 is
18 years × 12 months = 216 periods. The amount that the Halls have to save every month can
 (1  i) n  1 
be computed using formula FV  PMT 
 or
i


PMTEducation 
FVxi
$153,281.95 x(0.08  12)

 $319.28
n
(1  i )  1
(1  0.08  12) 216  1
4
QUESTION 3
How much money will the Halls have to set aside each month so as to have enough saved up
for a down payment on the $140,000 house within 12 months? Assume that the closing costs
amount to 2% of the loan and that the down payment is 10% of the price.
ANSWER
(1)
The down payment of 10% = $140,000 × 10% = $14,000
(2)
The loan = $140,000 – $14,000 = $126,000
(3)
Closing cost of the loan = $126,000 × 2% = $2,520
The total needed for down payment and closing cost = $14,000 + $2,520 = $16,520
In order to calculate the amount that the Halls have to set aside each month, we use formula
 (1  i) n  1
$16,520 x(0.08  12)
FVxi
FV  PMT 

 $1,326.92
 or PMTDown. payment 
n
i
(1  i )  1 (1  0.08  12)12  1


QUESTION 4:
If the interest rate on a 30-year mortgage is at 5% per year when the Halls purchase their
$140,000 house, how much will their mortgage payment be? Ignore insurance and taxes.
ANSWER
After the down payment, the mortgage = $140,000 - $14,000 = $126,000
The mortgate rate = 5%
The number of periods = 30 years x 12 months = 360 periods
In
order
to
calculate
monthly
payment
for
mortgage,
we
use
the
formula
1  (1  i )  n 
PVxi
$126,000 x(0.05  12)
PV  PMT 
 or PMTMortgage  1  (1  i )  n  1  (1  0.05 12) 360  $  676.40
i


5
QUESTION 5:
Construct an amortization schedule for 5%, 30-year mortgage.
ANSWER
Total of mortgage payment = $126,000
Mortgage rate = 5%
Number of periods = 30 years x 12 months = 360
The amortization schedule will be as below:
Month
Beginning
Principal Balance
Monthly payment
(result in Q4)
Interest rate
(per month)
Interest payment
Deduction
of principal
Outstanding
balance
1
126,000.00
-676.40
0.004167
525.00
-151.40
125,848.60
2
125,848.60
-676.40
0.004167
524.37
-152.03
125,696.58
3
125,696.58
-676.40
0.004167
523.74
-152.66
125,543.92
……..
……..
……..
……..
……..
……..
358
2,012.39
-676.40
0.004167
8.38
-668.01
1,344.38
359
1,344.38
-676.40
0.004167
5.60
-670.79
673.59
360
673.59
-676.40
0.004167
2.81
-673.59
0.00
…….
QUESTION 6
If the Halls want to have as much of an after tax income when they retire as they currently
have, and assuming they live until they are 80 years old, how much money should they set
aside each month so as to have enough money accumulated in their retirement nest egg?
Assume that annual inflation rate is 4% per year for the whole term, the investment return is
8% per year before and after retirement, and that their tax rate is 28% throughout their life.
ANSWER
As counted in Question 1, the total income after tax of the Hall’s is $54,000
Their current age is 30 and they will retire at 65, meaning that they have 35 years until they
retire. Their desired annual income at age of 65, when they start retirement, will be
= $213,088.806
Supposed that they will live until 80, the amount that the Halls have to save for their 15 years
retirement will be counted as below:
6
Ages
Year
(n)
Annual Income
FV= PV(1+i)n
65
0
213,088.81
66
1
221,612.36
0.9259
205,196.6277
67
2
230,476.85
0.8573
197,596.7526
68
3
239,695.93
0.7938
190,278.3544
69
4
249,283.76
0.7350
183,231.0079
70
5
259,255.11
0.6806
176,444.6743
71
6
269,625.32
0.6302
169,909.6863
72
7
280,410.33
0.5835
163,616.7350
73
8
291,626.74
0.5403
157,556.8559
74
9
303,291.81
0.5002
151,721.4168
75
10
315,423.49
0.4632
146,102.1051
76
11
328,040.43
0.4289
140,690.9160
77
12
341,162.04
0.3971
135,480.1413
78
13
354,808.53
0.3677
130,462.3583
79
14
369,000.87
0.3405
125,630.4191
80
15
383,760.90
0.3152
120,977.4406
PVIFi,n 
with i=0.04
1
(1  i) n
PV at year 65
(FV*PVIF)
(with i=0.08)
TOTAL ACCUMULATED
2,394,895.4900
Thus, the accumulated present value for their Retirement Nest egg is $2,394,895.49
In order to know how much the Halls have to set aside every month to save for their
Retirement
Nest
Egg,
which
is
up
to
$2,394,895.49,
we
use
the
formula
 (1  i) n  1 
FVxi
FV  PMT 
 or PMT 
i
(1  i ) n  1


PMTRe tirement 
FVxi
$2,394,895.49 x(0.08  12)

 $1,044.04
n
(1  i)  1
(1  0.08  12) 35 x12  1
7
QUESTION 7:
If the Halls continue paying the minimum 3% on their credit card debt each month, how long
will it take them to pay it off and how much total interest will they have paid? If you were
Dan, what would you advise them to do?
ANSWER
Credit Card balance Owed (FV)
$10,000
Interest rate (i)
15.99% pa
Minimum payment 3% (PMT)
$300
We have the number of periods to clear the debt is:
months
And the total interest = $300 x 44.36705 months - $10,000 = $3,310.1153
With the net income of $4,500.00 every month, if I were Dan, in the two coming years
(divided into 4 phases), I will advise the Halls as following:
Phase 1
As per the calculation in Question 1, the left over after paying Car loan, College loan, Credit
card ($300) and Rent, the balance left for their living is $2,550.62.
I would sugget the Halls to live cheap in this phase and pay maximum on credit card debt. If
they target to clear the debt within 6 months, then the monthy credit card payment should be:
PMT 
FVxi
10,000 x( 0.1599  12)

 $1,612.00
n
(1  i )  1 (1  0.1599  12) 6  1
Thus, the Halls have to pay the following expenses:
Car loan
-$221.58
College loan
-$527.80
Monthly rent
-$1,200.00
Credit card
-$1,612.00
Total expenses
-$3,561.38
Left over for cheap livings
$938.62
Phase 2
In the Phase 2, when the Halls already cleared their Credit card debt, they should stop renting,
buying their own house and starting their retirement saving. The payments during this phase
include the following:
8
Car loan
-$221.58
College loan
-$527.80
Down payment and closing cost
-$1,326.92
Retirement
-$1,044.04
Total expenses
-$3,120.34
Left over
$1,379.66
The balace of $1,379.66 should be enough to cover their living costs and also, they should
save some money for their baby.
Phase 3
This is the time when they are 31 years old and when their first baby is born, they should
continue expenses/payments as in Phase 2 and start saving for education plan
Car loan
-$221.58
College loan
-$527.80
Down payment and closing cost
-$1,326.92
Credit card
-$1,612.00
Education
Total expenses
Left over for cheap livings
-$319.28
-$3,439.62
$1,060.38
Phase 4
This is the time when the House Down payment and closing cost finish. The Halls should
start the mortgage plan.
Car loan
-$221.58
College loan
-$527.80
Mortgage
-$676.40
Retirement
Education
Total expenses
Left over for livings
-$1,044.04
-$319.28
-$2,798.10
$1,710.90
Thus, within 24 months, the Halls will pay off their Car loan, College loan and Credit card debt.
Their total expenses now will be much reduced to $2,039.72 and the left over for their living will
be $2,460.28. Starting from their age of 32, they could work towards paying off their mortgage as
quick as possible.
9
The Table below will present Expenses, Net Income and Balance every month that the Halls should have
within 24 months when they are at the ages of 30 and 31
Ages
30
31
Down
payment
& closing
cost
Total
monthly expenses
Monthly
Net Income
Monthly
Balance
1,612.00
3,561.38
4,500.00
938.62
1,200.00
1,612.00
3,561.38
4,500.00
938.62
1,200.00
1,612.00
3,561.38
4,500.00
938.62
527.80
1,200.00
1,612.00
3,561.38
4,500.00
938.62
221.58
527.80
1,200.00
1,612.00
3,561.38
4,500.00
938.62
221.58
527.80
1,200.00
1,612.00
3,561.38
4,500.00
938.62
7
221.58
527.80
1326.92
1044.04
3,120.34
4,500.00
1,379.66
8
221.58
527.80
1326.92
1044.04
3,120.34
4,500.00
1,379.66
9
221.58
527.80
1326.92
1044.04
3,120.34
4,500.00
1,379.66
10
221.58
527.80
1326.92
1044.04
3,120.34
4,500.00
1,379.66
11
221.58
527.80
1326.92
1044.04
3,120.34
4,500.00
1,379.66
12
221.58
527.80
1326.92
1044.04
3,120.34
4,500.00
1,379.66
13
221.58
527.80
1326.92
319.28
1044.04
3,439.62
4,500.00
1,060.38
14
221.58
527.80
1326.92
319.28
1044.04
3,439.62
4,500.00
1,060.38
15
221.58
527.80
1326.92
319.28
1044.04
3,439.62
4,500.00
1,060.38
16
221.58
527.80
1326.92
319.28
1044.04
3,439.62
4,500.00
1,060.38
17
221.58
527.80
1326.92
319.28
1044.04
3,439.62
4,500.00
1,060.38
18
221.58
527.80
1326.92
319.28
1044.04
3,439.62
4,500.00
1,060.38
19
221.58
527.80
676.4
319.28
1044.04
2,789.10
4,500.00
1,710.90
20
221.58
527.80
676.4
319.28
1044.04
2,789.10
4,500.00
1,710.90
21
221.58
527.80
676.4
319.28
1044.04
2,789.10
4,500.00
1,710.90
22
221.58
527.80
676.4
319.28
1044.04
2,789.10
4,500.00
1,710.90
23
221.58
527.80
676.4
319.28
1044.04
2,789.10
4,500.00
1,710.90
24
221.58
527.80
676.4
319.28
1044.04
2,789.10
4,500.00
1,710.90
676.4
319.28
1044.04
2,039.72
4,500.00
2,460.28
Month
Car loan
College
Rent
1
221.58
527.80
1,200.00
2
221.58
527.80
3
221.58
527.80
4
221.58
5
6
25
Credit card
Mortgage
Education
Retirement
……..
10
BIBLIOGRAPHY
Gitman/Juchau/Flanagan, 2008. Principles of Managerial Finance, 5th edition. Pearson Education
Australia.
11