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# Applied Math 40S Slides May 7, 2007

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Net Worth statements and how to find the largest mortgage a buyer can afford.

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### Applied Math 40S Slides May 7, 2007

1. 1. Net Worth Terminology Assets: the value of everything you own, including any cash or bank deposits, material goods, and investments. Categories of Assets (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.
2. 2. Liabilitites: any debt you need to pay. Types of Liabilities (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
3. 3. Net Worth: the difference between your assets and your liabilities. Net Worth = Assets - Liabilities Equity is the same as net worth. Note that equity and 'total assets' are not the same.
4. 4. 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:
5. 5. How to Increase Net Worth The following three strategies to raise one's net worth are often recommended by financial planners. (1) Save more on a regular basis. (2) Reduce your debt. (3) Get a higher rate of return on your investments.
6. 6. 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.
7. 7. • 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. (a) Create a Net Worth Statement for Mona. (b) What is Mona’s net Worth? (c) What is Mona’s Debt/Equity Ratio? (d) How would these change if Mona made a bank loan for the renovations of \$15,000? (e) Should Mona apply for the loan? If not, can you suggest another way she can finance her planned home renovations?
8. 8. "How Much Can I Afford to Pay for a Home?"
9. 9. Calculating the maximum mortgage you can afford ...