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Applied Math 40S May 16, 2008

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All about Net Worth and debt/equity ratios.

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Applied Math 40S May 16, 2008

1. 1. How much are you worth? (Net Worth) this time for real Money Suit by ﬂickr user zoomar
2. 2. T. Bekka needs a \$105 000 mortgage which he will repay with monthly payments in 25 years. The ﬁrst bank he visits offers a mortgage at 8.5%, and the second bank at 7.9%. HOMEWORK 1. How much does he save each month if he takes the second offer? 2. How much does he save over the life of the mortgage if he takes the second offer?
3. 3. The Meaning of Net Worth Net Worth is the difference between your assets and your liabilities. The term assets refers to the value of everything you own, including any cash or bank deposits, material goods, and investments. A liability is any debt you need to pay. Net worth = Assets - Liabilities Equity is the same as net worth. Note that equity and 'total assets' are not the same.
4. 4. Assets When completing a Net Worth Statement (which will be shown later), it is useful to subdivide the assets into three categories:
5. 5. Assets When completing a Net Worth Statement (which will be shown later), it is useful to subdivide the assets into three categories: 1. Liquid Assets: These include cash accounts (i.e., your chequing and savings accounts), T-bills, money market funds -- any money you can get at quickly and without penalty. This is money available in case of emergency, and also in case of investment opportunities.
6. 6. http://youtube.com/watch?v=MJJN9qwhkkE Assets When completing a Net Worth Statement (which will be shown later), it is useful to subdivide the assets into three categories: 1. Liquid Assets: These include cash accounts (i.e., your chequing and savings accounts), T-bills, money market funds -- any money you can get at quickly and without penalty. This is money available in case of emergency, and also in case of investment opportunities. 2. Semi-Liquid Assets: These include longer-term investments such as stocks, bonds, mutual funds, RRSPs, or real estate. These investments are intended to provide for major future needs such as purchasing a house or retirement.
7. 7. Assets When completing a Net Worth Statement (which will be shown later), it is useful to subdivide the assets into three categories: 1. Liquid Assets: These include cash accounts (i.e., your chequing and savings accounts), T-bills, money market funds -- any money you can get at quickly and without penalty. This is money available in case of emergency, and also in case of investment opportunities. 2. Semi-Liquid Assets: These include longer-term investments such as stocks, bonds, mutual funds, RRSPs, or real estate. These investments are intended to provide for major future needs such as purchasing a house or retirement. 3. Non-Liquid Assets: These include material goods such as your house, car, computer, and other personal property. These items are intended for your long-term personal use, and are not easily converted to cash.
8. 8. Liabilities Liabilities are divided into two types:
9. 9. Liabilities Liabilities are divided into two types: 1. Short-Term Debts: These are debts that must be paid within the next 12 months. These include credit card debts, consumer loans, and smaller personal debts.
10. 10. Liabilities Liabilities are divided into two types: 1. Short-Term Debts: These are debts that must be paid within the next 12 months. These include credit card debts, consumer loans, and smaller personal debts. 2. Long-Term Debts: These are used for two purposes: • to pay for investments such as real estate, including your home • to pay for major purchases such as a summer cottage, motor home, or car
11. 11. The Meaning of Net Worth Net Worth is the difference between your assets and your liabilities. The term assets refers to the value of everything you own, including any cash or bank deposits, material goods, and investments. A liability is any debt you need to pay. Net worth = Assets - Liabilities Equity is the same as net worth. Note that equity and 'total assets' are not the same.
12. 12. The Debt/Equity Ratio The debt/equity ratio shows how your debts compare with your net worth. A debt/equity ratio of 0.40 would indicate that the value of all the debts is 40% of one's net worth. A person's or family's debt/equity ratio should not exceed 50%. The debt mentioned above includes all short-term and long-term debts except the mortgage on your home. Therefore, the formula for the debt/equity ratio is: Total Liabilities - Mortgage Debt/Equity Ratio = Net Worth
13. 13. http://tinyurl.com/4x8exe Includes Mortgage Does Not Include Mortgage Total Liabilities - Mortgage Debt/Equity Ratio = Net Worth
14. 14. Net Worth Problem Mona would like to do some extensive house renovations, but she decided to calculate her net worth and debt/equity ratio before applying for a loan. The following information was used in her calculations. • Her house is valued at \$93,000, and she still has a \$62,000 mortgage against the house. • She has \$4600 in a bank savings account, and she has invested \$21 500 in mutual funds. • Her car is valued at \$16,000, and she still has a two-year loan for \$9600 against it. • She has a life insurance policy with a cash surrender value (near cash) of \$5300. • She has RRSPs worth \$9450, and owns Canada Savings Bonds valued at \$1800. • Her credit card debt is \$2554, and she has a \$3015 consumer loan (for furniture) payable in the next six months.
15. 15. Mona's ﬁnancial situation looks good, because her debt/equity ratio is 0.20, or 20%. How would this change if she made a bank loan for \$15,000? Should she apply for the loan?
16. 16. Note that the loan would raise Mona's debt/equity ratio to 0.51, or 51%. Maybe she should postpone the renovations and save some money ﬁrst, or reduce the cost of the renovations. It is also interesting to note that if Mona were to take the money from her mutual funds instead of making a loan, her debt/equity ratio would rise to about 0.26, or 26%. (This calculation has not been shown.)
17. 17. How to Increase Net Worth The following three strategies to raise one's net worth are often recommended by ﬁnancial planners.
18. 18. How to Increase Net Worth The following three strategies to raise one's net worth are often recommended by ﬁnancial planners. 1. Get a higher rate of return on your investments. You need to exercise caution here, because investments with higher rates of return are often more risky, and there may be a greater chance of losing money.
19. 19. How to Increase Net Worth The following three strategies to raise one's net worth are often recommended by ﬁnancial planners. 1. Get a higher rate of return on your investments. You need to exercise caution here, because investments with higher rates of return are often more risky, and there may be a greater chance of losing money. 2. Reduce your debt. Most consumers can reduce their debts -- especially consumer debts -- by planning and following a budget.
20. 20. How to Increase Net Worth The following three strategies to raise one's net worth are often recommended by ﬁnancial planners. 1. Get a higher rate of return on your investments. You need to exercise caution here, because investments with higher rates of return are often more risky, and there may be a greater chance of losing money. 2. Reduce your debt. Most consumers can reduce their debts -- especially consumer debts -- by planning and following a budget. 3. Save more on a regular basis. Most ﬁnancial advisors believe that this is the primary key to building wealth. The advice in Senior 3 Applied Mathematics was to save 10% of your income to 'pay yourself ﬁrst.' This means save before you spend, not save if you have anything left after spending.
21. 21. Dave, age 30 and single, is concerned about his ﬁnances. He visits a ﬁnancial advisor to help him determine whether his ﬁnances are in good order. The advisor requires the following information to prepare a Net Worth Statement. HOMEWORK He lives in a \$100,000.00 home on which there is an outstanding mortgage of \$60,000.00. There is a car loan of \$15,000.00 on a car that is valued at \$20,000.00. The loan is for three years. Dave has \$3000.00 in the bank and a \$4000.00 cash surrender value (near cash) on his life insurance policy. He has \$10,000.00 in mutual funds and \$3000.00 in Canada Savings Bonds. He also has RRSPs totaling \$15,000.00. At the present time, Dave has a credit card balance of \$4000.00 and a small loan of \$2000.00 that must be paid this year. Prepare a Net Worth Statement for Dave. What is his debt/equity ratio?
22. 22. Bill is married and has a young family. He wants to borrow money to buy a travel trailer. The loan ofﬁcer at the bank uses the following information to prepare a net worth statement. HOMEWORK Bill and his family live in an \$80,000.00 home on which there is an outstanding mortgage of \$52,000.00. He owns a car valued at \$20,000.00 and owes \$12,000.00 on a loan he took to buy the car. He has \$30 000.00 in an RPP (Registered Pension Plan). He also has RRSPs valued at \$7000.00. Bill owes a credit card company \$6000.00, and he has a personal loan for \$2500.00 that must be paid in the next few months. The family has \$1500.00 in a chequing account and another \$3000.00 in a savings account at the local bank. He owns a boat worth \$5000.00.
23. 23. 1. What is the family's present net worth? HOMEWORK 2. What is their debt/equity ratio? 3. The loan required to buy the travel trailer is \$25,000.00. Will the loan increase their debt/equity ratio beyond 0.5? 4. Should Bill buy the travel trailer? Explain. 5. Suggest some ways the family could increase their net worth and/or decrease their debt/equity ratio.