Review problems.

1. Finance Cat by flickr
user o205billege

2. 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.
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?

3. Answer
(1) Dave's net worth is $74,000, and his debt/equity ratio is
0.28, or 28%.

4. * 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.
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.
(a) What is the family's present net worth?
(b) What is their debt/equity ratio?
(c) The loan required to buy the travel trailer is $25,000.00. Will the loan
increase their debt/equity ratio beyond 0.5?
(d) Should Bill buy the travel trailer? Explain.
(e) Suggest some ways the family could increase their net worth and/or
decrease their debt/equity ratio.

5. Answers
(2)(a) Net worth is $74,000. (b) Debt/equity ratio is 0.28, or 27.7%.
(c) Their assets increase by $25,000, and the liabilities also increase
by $25,000. The debt/equity ratio increases to 0.62, or 62%.
(d) Bill should probably postpone buying the travel trailer until he has
at least half of the money saved up for it. By doing this, he would keep
the debt/equity ratio below 50%. He should not cash in his RRSPs and
RPPs to pay for the trailer, because these funds are intended for
retirement.
(e) The family could increase their net worth by:
• limiting their consumer spending (which would likely decrease the
credit card and short-term loans debts)
• increasing their savings (they have a reasonable amount in RRSPs
and RPPs, but very little in bank savings or other semi-liquid assets)
• investing their money in accounts that pay more interest or returns
than a bank savings account

6. Who wants to be a millionaire?
HOMEWORK
You want to retire at age 55 with $1 000 000 in savings. You can
invest regularly in an account that pays 8% interest compounded
quarterly. If you are 17 years old now, what should you be paying
as a monthly payment to attain your goal?
How would this change if How would this change if
you started at age 25? 35? you could get a 12% interest
rate?

7. Alice invests $10 000.00 with the help of a financial advisor. Her
expected rate of return is 6% compounded annually. Her advisor
requires a management fee of $100.00 each year. HOMEWORK
a) Determine the value of Alice’s investment at the end of 5
years. Show your work.
b) Alice would like to accumulate a total of $20 000.00 after 10 years.
What minimum interest rate would allow Alice to achieve her goal if
the management fees were eliminated?

8. Rick is entering the University of Winnipeg and needs a computer. He
wonders whether he should purchase or lease it.
HOMEWORK
OPTION 1: Purchase OPTION 2: Lease
• $1299 plus taxes to be financed • Payment of $39.90 plus taxes a
at 16.5% over 36 months month for 36 months.
compounded monthly (monthly • The computer may be purchased at
payments). the end of the lease for $850 plus
taxes.
a) Compare the costs of Option 1 and Option 2.
b) State one advantage for each option. Justify your answer.