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Solution Manual for Personal Financial Planning
15th Edition by Randy Billingsley, Lawrence J.
Gitman, Michael D. Joehnk
SOLUTION MANUAL FOR
Personal Financial Planning 15th Edition by Randy
Billingsley, Lawrence J. Gitman, Michael D. Joehnk
Understanding the
Financial Planning Process
Chapter 1
How Will This Affect Me?
The heart of financial planning is making sure your values line up with how you spend and save.
That means knowing where you are financially and planning on how to get where you want to be
in the future no matter what life throws at you. For example, how should your plan handle the
projection that Social Security costs may exceed revenues by 2035? And what if the government
decides to raise tax rates to help cover the federal deficit? An informed financial plan should
reflect such uncertainties and more.
This chapter overviews the financial planning process and explains its context. Topics include
how financial plans change to accommodate your current stage in life and the role that financial
planners can play in helping you achieve your objectives. After reading this chapter you will
have a good perspective on how to organize your overall personal financial plan.
LEARNING GOALS
LG1 Identify the benefits of using personal financial planning techniques to manage your
finances.
Key concept in this section is the planning model as displayed in Exhibit 1.1. Your standard of
living is greatly impacted by your spending habits and your commitment to saving. Your
spending is measured by your propensity to consume. Wealth is the total value of all property
you own less the amount that you owe to others.
ACTIVITY: Ask the students to assume that they have just inherited $100,000. What will you
do with the money? Write down three ways you will spend or use the money.
Ask the students to share one item with the class and record what they say so that the entire class
can reflect on the answers. Hopefully, at least a few will mention investing even if only $10,000
of the amount. Use their answers to discuss taking care of current needs versus future needs.
Focus on their propensity to consume and its impact on accumulating wealth. Point out the
Financial Planning Tip, ―Be SMART in Planning Your Financial Goals.‖
Use Exhibit 1.2 to show how the average person earns and spends their money and Exhibit 1.6 to
help the student identify where they are now.
LG2 Describe the personal financial planning process and define your goals.
Dwight Eisenhower, army general and president, is quoted as saying ―Plans are useless; Planning
is priceless‖. The process of planning allows you to focus on the issues that are most important
and to be ready when things change.
Exhibit 1.3 lists the Six Step Financial Planning Process. The first and most important is
defining your financial goals. Exhibit 1.6 lists goals by age to demonstrate how goals change
over time. Use the examples in Exhibit 1.5 to ask students if the assumptions are realistic. Yes,
the answer is in the exhibit, but many will not have read chapter at this point. For your use, the
assumptions are:
Assumption 1: Saving a few thousand dollars a year should provide enough to fund my child‘s
college Education.
Assumption 2: An emergency fund lasting 3 months should be adequate.
Assumption 3: I will be able to retire at 65 and should have plenty to live on in retirement.
Assumption 4: I‘m relying on the rule of thumb that I will need only 70 percent of my pre-
retirement income to manage nicely in retirement.
There are several worksheets in the book. Worksheet 1.1 gives the student a format to write
down their Personal Financial Goals. There is power in writing down goals [and most any other
plan]. Recording the goal and then reviewing three months later will help you to keep focus on
the goal.
LG3 Explain the life cycle of financial plans, their role in achieving your financial goals,
how to deal with special planning concerns, and the use of professional financial planners.
Exhibit 1.7 can help focus the attention on how goals differ between the various stages of life.
Section 1-3b lists various decisions that you will have to make over your life. The section 1-3c
addresses Special Planning Concerns. Worksheet 1.2 focuses on the financial benefit to the
family of the second income. If the second income is from a minimum wage job, it may not be a
good financial decision. Of course having a job, even a minimum wage job, may give the person
psychic income that will override the financial impact.
While perhaps off topic, I recall a high school science teacher who was a smoker. He walked
through the amount of money he spent on purchasing tobacco products. That computation had a
lot to do with my decision to not smoke. How this relates to the course is that this is an
illustration of how the financial impact of a decision can drive the decision.
LG4 Examine the economic environment’s influence on personal financial planning.
For older folks, the financial crisis of 2008-2009 is fresh in our memory. To the student of 2021,
that crisis is more of history than life. If you can share a war story on how you were personally
impacted, it will help bring the impact of the world economy on financial plans to life. The book
speaks how to manage this type of crisis, but you had to go through it to really understand the
impact it had.
The value of professional advice is greatly understated. If by talking to a professional you can
prevent making a mistake -- that can be of a great value. Section 1-3e speaks to the use of
professional financial planners. Exhibit 1.9 lists out the various certifications that planners have.
Economic or business cycles are real. Perhaps the most useful thing about the cycles is the
knowledge that if things are bad, you know they will get better. Of course, when life is good,
you know that the bad cycle will come around again. Thus, financial planning requires saving in
the good times for the bad times. See the ―Test Yourself‖ question 1-17 for a short discussion of
business cycles.
The power of compounding is rarely understood. Exhibit 1.8 shows how the amount $10,000
will grow over time. The longer the investment stays invested, the greater the amount – the
power of compound interest.
LG5 Evaluate the impact of age, education, and geographic location on personal income.
Exhibit 1.12 says it all.
LG6 Understand the importance of career choices and their relationship to personal
financial planning.
Exhibit 1.13 shows that the choice of a college major has a financial impact. Of course money
cannot buy happiness, but having a bit helps. If you really want to be an elementary school
teacher, you must recognize that you will not have as much wealth as a lawyer or financial
analyst.
The summary of the learning goals at the end of the chapter should aid the student in reviewing
the chapter when exam time comes. It will be useful to point out to the student how to use this
material.
Link to Solutions to Financial Planning Exercises
Pre-tests
I have mentioned Pre-test in other places. Simply stated, they work. Students who experience a
pre-test, that is a quiz before you have covered the material, perform better on the exam over the
material and they will learn more from the course. At least they will have a higher grade. For a
discussion of pre-testing, see Craig Shoulders and Sam Hicks, ―ADEPT Learning System‖,
Issues in Accounting Education, May 2008 Volume 23, Number 2, pp 161-182.
Financial Facts or Fantasies?
These may be used as ―teasers‖ to get the students on the right page with you. Also, they may be
used as quizzes after you covered the material or as ―pre-test questions‖ to get their attention.
An improved standard of living is one of the payoffs of sound personal financial
Fact: The heart of sound financial planning and effective money management is the greater
enjoyment of the money one makes by improving one‘s standard of living.
A savings account is an example of a tangible asset because it represents something on deposit at
a bank or other financial institution.
Fantasy: A savings account, like stocks, bonds, and mutual funds, is an example of a financial
asset – an intangible, a ―paper‖ asset. Real assets, in contrast, refer to tangibles –physical items
like houses, cars, and appliances.
Personal financial planning involves translating personal financial goals into specific plans and
arrangements that put these plans into action.
Fact: Personal financial plans are based on the specific financial goals that you set for yourself
and your family. Once in place, the plans are put into action using the various financial strategies
explained in this book.
Over the long run, gaining only an extra percent or two on an investment makes little difference
in the amount of earnings generated.
Fantasy: Gaining an extra percent or two on an investment‘s return can make a tremendous
difference – often thousands of dollars – that increases the longer the investment is held.
Inflation generally has little effect on personal financial planning.
Fantasy: Inflation is a vital concern in financial planning. This is because inflation affects not
only the prices we pay for the goods and services we consume but also the amount of money we
make. If ignored, inflation can wreak havoc on our budgets and financial plans.
Your income level depends on your age, education, and career choice.
Fact: All three of these variables are important determinants of your income level, particularly
when accompanied by adequate ambition and disciplined work habits.
Financial Facts or Fantasies?
These may be used as a quiz or as a pre-test to get the students interested.
1. True False An improved standard of living is one of the payoffs of sound personal
financial planning.
2. True False A savings account is an example of a tangible asset because it represents
something on deposit at a bank or other financial institution.
3. True False Personal financial planning involves translating personal financial goals
into specific plans and arrangements that put these plans into action.
4. True False Over the long run, gaining only an extra percent or two on an investment
makes little difference in the amount of earnings generated
5. True False Inflation generally has little effect on personal financial planning.
6. True False Your income level depends on your age, education, and career choice
Answers:
1. True 2. False 3. True 4. False 5. False 6. True
YOU CAN DO IT NOW
The ―You Can Do It Now‖ cases are primary for the student. They may be used in class to start
a discussion of the topic. They will help make the topic more real or relevant to the students. In
most cases, it will only take about five minutes of class time.
Start a List of Your Financial Goals
Yogi Berra summed it up: ―If you don't know where you're going, you might not get there.‖ And
so, it is with your financial goals. Pick up some paper now and start a list of your financial goals.
Maybe it‘s as simple as saving $25 by the end of the month or as lofty as saving $200,000 for
retirement by the time you‘re 50. You‘ll never achieve your goals if you don‘t know what they
are, much less know whether they‘re realistic. Go ahead and dream. List your goals (short-term,
intermediate, and long-term) and start laying out how you‘ll get there. You can do it now.
Start Building an Emergency Fund
What would happen if you lost your job, got hurt, or had an unexpected big expense? Even if
you‘re not making much money now, you could start building an emergency fund by putting
aside even $10 a month. As this chapter points out, your goal is to eventually set aside enough to
last at least 6-month. Considering the risk of not doing so, you can do it now.
Recognize that YOU are Your Most Important Asset
Your greatest asset is YOU. So, it‘s important to build the value of your best asset by investing
in your education and career. The amount you can consume, save, and invest is directly related to
your earning ability. Consider that over an entire career, the average bachelor‘s degree holder
will earn $2.1 million, which is about twice what the typical high school grad earns. (For
additional motivating information, see the source of these statistics: The Hamilton Project at the
Brookings Institution, http://hamiltonproject.org/earnings_by_major/). It‘s so important to realize
you‘re your greatest asset and act on it – you can do it now.
Financial Impact of Personal Choices
Read and think about the choices being made. Do you agree or not? Ask the students to discuss
the choices being made.
Andrew Cuts Back on Lunch Out and Lattes
Andrew buys lunch out most days and buys a latte every morning. He believes he could cut back
a bit and save $5 a day, which is $35 a week and $140 a month. So, what's the impact of this
seemingly modest cut-back?
If Andrew invests his $35 savings a week every month at 5 percent, he will have the following in
the future:
20 years: $57,545
30 years: $116,516
40 years: $213,643
So, the seemingly small act of investing only $5 a day would have a dramatic long-term effect on
Andrew's future accumulated wealth.
Applying Personal Finance
While similar to the ―You can do it now‖ activities, the Applying Personal Finance projects are
longer and more involved activities the student can do to better understand personal finance.
Generally, the project asked the student to disclose their personal information and data. As a
homework assignment, the student will benefit from doing the assignment, but there are no right
or wrong answers. Also, there will be a tendency to make up answers that sound good to the
student.
If you choose to assign these projects, grading will be either check the student did something or
not. Or, you could give an A, C, F for a good attempt, an attempt, or no attempt.
Taken seriously, the student will benefit from the project. As a graded project, it will be difficult
to grade.
The Chapter 1 project takes the student to the Exhibit 1.4 and asks the student to examine their
financial behavior. Weaknesses may be identified, and the student could change their behavior
to be one that is more conducive to building a solid financial plan.
Watch Your Attitude!
Many people‘s attitude toward money has as much or more to do with their ability to accumulate
wealth as it does with the amount of money they earn. As observed in Exhibit 1.4, your attitude
toward money influences the entire financial planning process and often determines whether
financial goals become reality or end up being pipe dreams. This project will help you examine
your attitude toward money and wealth so that you can formulate realistic goals and plans.
Use the following questions to stimulate your thought process.
a. Am I a saver, or do I spend almost all the money I receive?
b. Does it make me feel good just to spend money, regardless of what it‘s for?
c. Is it important for me to have new clothes or a new car just for the sake of having them?
d. Do I have clothes hanging in my closet with the price tags still on them?
e. Do I buy things because they are a bargain or because I need them?
f. Do I save for my vacations, or do I charge everything and take months paying off mycredit
card at high interest?
g. If I have a balance on my credit card, can I recall what the charges were for without looking
at my statement?
h. Where do I want to be professionally and financially in 5 years? In 10 years?
i. Will my attitude toward money help get me there? If not, what do I need to do?
j. If I dropped out of school today or lost my job, what would I do?
Does your attitude toward money help or hinder you? How can you adjust your attitude so that
you are more likely to accomplish your financial goals?
Solutions to Financial Planning Exercises
1. Benefits of Personal Financial Planning. How can using personal financial planning
tools help you improve your financial situation? Describe changes you can make in
at least three areas.
Student answers will vary. In general, personal financial planning tools help individuals
to organize their finances, evaluate their current financial condition, and track changes in
their financial condition throughout their life to see if they are making progress toward
their financial goals. Use of budgets and financial statements will provide the
information you need to maintain a financial plan.
2. Personal Financial Goals and the Life Cycle. Use Worksheet 1.1. Describe your
current status based on the personal financial planning life cycle shown in Exhibit
1.7. Fill out Worksheet 1.1, ―Summary of Personal Financial Goals,‖ with goals
reflecting your current situation and your expected life situation in 5 and 10 years.
Discuss the reasons for the changes in your goals and how you’ll need to adapt your
financial plans as a result. Which types of financial plans do you need for your
current situation, and why?
Student answers will vary depending on their personal situation. The purpose of this
exercise is to encourage students to focus on how their personal goals and plans will
change over their financial planning life cycle and to help them be specific in setting their
goals by designating dollar amounts and dates. Worksheet 1.1 in the chapter lists
examples of financial goals.
3. Personal Financial Goals. Recommend three financial goals and related activities
for someone in each of the following circumstances:
a. A junior in college
b. A 30-year-old computer programmer who plans to earn an MBA degree
c. A couple in their 30s with two children, ages 3 and 6
d. A divorced 52-year-old man with a 16-year-old child and a 78-year-old father
who is ill
Student answers will vary. Suggestions may include the following:
a. Junior in college—pay off all credit card debt by graduation; pay off all student loans
within 10 years of graduation; save $2,000 for a down payment on another vehicle
during the next 3 years.
b. 30-year old computer programmer who plans to earn an MBA—pay off auto loan
before beginning degree; find a cheaper place to live; set aside $5,000 for emergency
use during school.
c. Couple in their 30s with two children, ages 3 and 6—begin college fund for each
child; fund Roth IRAs for both parents; max out [that is, put as much as you can in
plan] employer-sponsored retirement plan, such as 401k, each year.
d. Divorced 52-year old man with a 16-year old child and a 78-year old father who is
ill—engage the help of friends or family in carpooling teenager to school and
activities; explore community or church programs which might provide assistance for
the father, such as Meals on Wheels or a visitation program; help father with estate
planning needs, hiring an attorney if needed.
4. Life Cycle of Financial Plans. Hudson Ross and Camila Cox are planning to get
married in six months. Both are 30 years old and have been out of college for several
years. Hudson uses three credit cards and has a bank account balance of $7,500
while Camila only uses one credit card and has $9,500 in her bank account. What
financial planning advice would you give the couple?
Two issues are presented here: Number of credit cards and number of checking accounts.
Having too many credit cards can lower you FICO score and your credit rating because
you have the potential of maxing out on each of the cards and getting into financial
difficulty. Hudson should reduce his cards to one. Camila should keep her card.
Two bank accounts can work okay if the various expenses are allocated between the two
spouses. If one spouse has the job of paying all the bills, that spouse needs to have access
to all accounts, which defeats the purpose of multiple accounts. Most couples have only
one checking account. Here the combined balances are more than they need in their
checking account. They should move about half of their $17,000 to an investment
account.
5. Impact of Economic Environment on Financial Planning. Summarize current and
projected trends in the economy with regard to GDP growth, unemployment, and
inflation. How should you use this information to make personal financial and
career planning decisions?
Answers on economic trends will depend on current economic conditions. If the GDP is
growing, the economy is expanding, and general economic conditions are considered
favorable. Unemployment is probably low, and jobs are available. If the GDP is slowing,
the economy may not be doing well, and jobs may be scarce. Changes in the CPI indicate
the level of inflation. If inflation is rising, purchasing power is declining, and you will
need more money to achieve your financial goals. In periods of high inflation, interest
rates rise making it more difficult to afford big-ticket items. Knowledge of current
economic conditions can help you plan the level of savings v spending. In period of
inflation, physical assets [such as real estate] are better than financial assets such as
saving accounts.
6. Financial Impact of Career Decisions. Brooklyn Hughes and Madison Powell, both
freshmen and friends at a major university, are interested in going into a computer
sciences career. While they're not just interested in the money they can make, they
do want to have a sense of the compensation in that career. What do the data in
Exhibit 1.13 tell Brooklyn and Madison?
The income level of ―computer science and engineering‖ has a median early career pay of
about $72,000 and a median mid-career pay of about $120,000. These salaries are
sufficient to provide for a comfortable standard of living in most places.
Of course, any of these careers can lead to management positions in large technology
companies that can result is a very comfortable standard of living.
In summary, computer science careers look favorable for a high [that is a very, very
comfortable] standard of living.
7. Career Choices and Financial Planning. Assume that you graduated from college
with a major in marketing and took a job with a large consumer products company.
After three years, you are laid off when the company downsizes. Describe the steps
you’d take to ―repackage‖ yourself for another field.
Possible steps to ―repackage‖ yourself might include:
 Analyzing skills and experience to identify transferable skills
 Looking for companies in related fields and industries
 Considering your own interests to see if other career paths make sense
 Networking extensively
 Researching fields that use your skills
 Developing functional resume focusing on skills rather than job titles
 Obtaining additional education or training, perhaps obtaining certifications
Critical Thinking Cases
1.1 Aaron’s Need to Know: Personal Finance or Golf?
During the Christmas break of his final year at the University of Florida (U of F), Aaron Barnes
plans to put together his résumé in order to seek full-time employment as a software engineer
during the spring semester. To help Aaron prepare for the job interview process, his older brother
has arranged for him to meet with a friend, Carolyn Jenkins, who has worked as a software
engineer since her graduation from U of F two years earlier. Carolyn gives him numerous
pointers on résumé preparation, the interview process, and possible job opportunities.
After answering Aaron‘s many questions, Carolyn asks Aaron to update her on what he‘s up to at
U of F. As they discuss courses, Carolyn shares that of all the electives she took, the personal
financial planning course was most useful. Aaron says that, although he had considered personal
financial planning for his last elective, he‘s currently leaning toward a beginning golf course. He
feels that the course will be fun because some of his friends are taking it. He points out that he
doesn‘t expect to get rich and already knows how to balance his checkbook. Carolyn tells him
that personal financial planning involves much more than balancing a checkbook, and that the
course is highly relevant regardless of income level. She strongly believes that the personal
financial planning course will benefit Aaron more than beginning golf—a course that she also
took while at U of F.
Critical Thinking Questions
1. Describe to Aaron the goals and rewards of the personal financial planning process.
2. Explain to Aaron what is meant bythe term financial planning and why it is important
regardless of income.
3. Describe the financial planning environment to Aaron. Explain the role of the consumer and
the impact of economic conditions on financial planning.
4. What arguments would you present to convince Aaron that the personal financial planning
course would benefit him more than beginning golf?
Aaron’s Need to Know: Personal Finance or Golf?
1. Personal financial planning is a process through which financial plans are developed and
implemented to achieve personal financial goals. An individual can develop these goals
in a fashion consistent with his or her emotional needs and preferences. As a process,
personal financial planning is dynamic and prospective as well as immediate and
retrospective. Furthermore, it can be adjusted to changes in goals, emotional orientation,
available resources, and the economic environment.
2. Personal financial planning covers the key elements of one‘s financial affairs and
provides a plan to achieve financial goals. Income level is one input in the process but
does not dictate its importance. An efficient, well-developed personal financial plan can
help to maximize an individual‘s wealth and quality of life given his or her income and
goals. If desired goals cannot be met with a given level of income, financial planning will
help evaluate what is really important, and establish realistic and attainable goals. Thus,
financial planning is important regardless of one‘s income.
3. The personal financial planning environment is made up of three key groups, all of which
Aaron will contact directly or indirectly. Government establishes an intangible structure
in which an economy or society must function. It levies taxes to fund its operations and
institutes regulations which direct and control the actions of the participants in the
economic environment. Businesses produce goods and services, employ labor, and use
land and capital. They receive money as payment for their goods and services and pay
wages, rents, interest, and profit. Businesses are a key part of the circular flow of income
supporting our economy. Businesses establish the price and availability of goods and
services in our economy through competitive interaction with each other and interfacing
with government and consumers. Finally, the consumer is the focal point of the financial
planning environment. Consumer choices determine the types of products and services
businesses provide. Because consumers are net providers of funds to government and
businesses, their decisions to spend or save have a major effect on the planning
environment. However, government and businesses place a number of constraints on the
environment, and consumers must therefore function within those limits.
The economy is a dynamic mechanism that reacts to numerous inputs. Economic
fluctuations can cause significant changes in one‘s wealth, thereby affecting financial
plans. Changes in price levels result from increases in inflation, which can directly affect
an individual‘s present and future consumption patterns, level of wealth, standard of
living, and quality of life. Changes in economic conditions also affect nearly all aspects
of one‘s financial life, from career choices to retirement. Thus, the state of the economy
and its fluctuations are important factors defining the financial planning environment and
affecting how one implements a financial plan.
4. Although beginning golf would probably provide a great deal of personal satisfaction,
personal finance would, in the long run, provide more benefits. The personal finance
course will help Aaron better understand the financial environment, thereby allowing him
to establish a realistic quality of life and personal financial goals. He could then develop a
plan to achieve his goals and a methodology for monitoring the ongoing effectiveness of
that plan. With an understanding of the personal finance environment, the financial
planning process, and goal setting techniques, Aaron can optimize the use of his assets,
provide for a secure financial future, and acquire the resources to realize his quality of
life goals. Finally, the rewards achieved from using these financial planning techniques
could, in the future, allow Aaron to take not only beginning golf but also intermediate
golf and possibly join a golf club in the future.
1.2 Cameron’s Dilemma: Finding a New Job
Cameron Foster, a 55-year-old retail store manager earning $85,000 a year, has worked for
the same company during his entire 30-year career. Cameron was recently laid off and is
still unemployed 10 months later, and his severance pay and 6 months’ unemployment
compensation have run out. Because he has consistently observed careful financial
planning practices, he now has sufficient savings and investments to carry him through
several more months of unemployment.
Cameron is actively seeking work but finds that he is overqualified for available lower-
paying jobs and underqualified for higher-paying, more desirable positions. There are no
openings for positions equivalent to the manager’s job he lost. He lost his wife several
years earlier and is close to his two grown children, who live in the same city.
Cameron has these options:
• Wait out the recession until another retail store manager position opens up.
• Move to another area of the country where store manager positions are more plentiful.
• Accept a lower-paying job for two or three years and then go back to school evenings to
finish his college degree and qualify for a better position.
• Consider other types of jobs that could benefit from his managerial skills.
Critical Thinking Questions
1. What important career factors should Cameron consider when evaluating his options?
2. What important personal factors should Cameron consider when deciding among his
career options?
3. What recommendations would you give Cameron in light of both the career and
personal dimensions of his options noted in Questions 1 and 2?
4. What career strategies should today’s workers employ in order to avoid Cameron’s
dilemma?
This case asks students to consider the long-range implications of career and financial planning.
In today‘s business world, changes in the economy and in corporate strategies often result in
workforce downsizing. Many students may be faced with the loss of a job during their working
years. They may find themselves in Cameron‘s position, overqualified for some jobs and
underqualified for others. Knowing what steps to take to avoid this situation is an important
aspect of career and financial planning.
There are many correct answers to these questions; some possibilities are given below.
1. Important career factors for Cameron to consider when looking for a new job include
salary, opportunity for advancement, his transferable skills that could apply to a field
other than retailing, availability of benefits, available training programs, types of
industries and companies (size, work environment, etc.) that interest him, and tuition
reimbursement policies so he can finish his degree.
2. Personal factors that Cameron should take into account as he investigates job
opportunities include location/need to relocate (his children live in the area), personal
lifestyle needs (is he willing to travel, work overtime, commute further?), type of work
situation most suitable for him (managing others, part of a team, level of public contact,
etc.), and any personal interests that could open doors to a new career. (There is some
overlap between career and personal factors.)
3. Cameron should consider a lower-paying job on a short-term basis and at the same time
look for a managerial job in another field. He cannot afford to wait out the recession; his
funds will run out in a few months. This two-pronged approach is therefore preferable to
one or the other. A job at a lower salary, particularly one with good benefits and a tuition
reimbursement policy, would allow him to finish his degree or obtain other job training to
qualify for a better position. Because he has no dependents, he should be able to cover his
living expenses, although he may have to cut back on some discretionary expenses. He
should look in several fields and not limit himself to retailing, particularly if he does not
wish to relocate to another area of the country away from his grown children. If he is
committed to staying in retailing, he probably will have to move. He needs to determine
his personal priorities to make these decisions. We do not have enough information to
know what they would be. He may want to participate in some career workshops or get
some career counseling to work out some of these issues.
4. There are many strategies today‘s workers can employ to avoid being placed in
Cameron‘s position. Staying with one employer and one basic type of work for 25 years,
as Cameron did, will be the exception rather than the rule. Job changes, whether
voluntary or involuntary, should be made with certain objectives in mind, such as
broadening your base of experience and learning new skills—for example, computer
skills and management responsibility. Keeping up with industry trends and overall
economic conditions is very important. This can alert you to the skills needed for future
success and provide advance warning of possible downsizings. Don‘t allow yourself to be
―pigeonholed‖ into one very specific type of job for too long; look for opportunities to
transfer within your company or to another firm to get more diverse experience. Think of
your capabilities in terms of general skills that can be applied to other jobs, companies,
and industries. Develop and maintain a network of professional contacts in firms and
industries that appeal to you and be willing to share your knowledge with others who
need your help.
Test Yourself Questions
1-1 What is a standard of living? What factors affect the quality of life?
Standard of living, which varies from person to person, represents the necessities,
comforts, and luxuries enjoyed by a person. It is reflected in the material items a person
owns, as well as the costs and types of expenditures normally made for goods and
services.
Although many factors such as geographic location, public facilities, local costs of living,
pollution, traffic, and population density affect one‘s quality of life, the main determinant
of quality of life is believed to be wealth.
1-2 Are consumption patterns related to quality of life? Explain.
Generally, consumption patterns are related to quality of life, which depends on a
person‘s socioeconomic strata. This implies that wealthy persons, who are likely to
consume non-necessity items, quite often live higher quality lives than persons whose
wealth permits only consumption of necessities.
1-3 What is average propensity to consume? Is it possible for two people with very
different incomes to have the same average propensity to consume? Why?
The average propensity to consume is the percentage of each dollar of a person‘s income
that is spent (rather than saved), on average, for current needs rather than savings. Yes, it
is quite possible to find two persons with significantly different incomes with the same
average propensity to consume. Many people will increase their level of consumption as
their incomes rise, i.e., buy a nicer home or a newer car. Thus, even though they may
have more money, they may still consume the same percentage (or more) of their
incomes as before.
1-4 Discuss the various forms in which wealth can be accumulated.
An individual‘s wealth is the accumulated value of all items he or she owns. People
accumulate wealth as either financial assets or tangible assets. Financial assets are
intangible assets such as savings accounts or securities, such as stocks, bonds and mutual
funds. Financial assets are expected to provide the investor with interest, dividends, or
appreciated value. Tangible assets are physical items, such as real estate, automobiles,
artwork, and jewelry. Such items can be held for either consumption or investment
purposes or both.
1-5 What is the role of money in setting financial goals? What is the relationship of
money to utility?
Money is the exchange medium used as the measure of value in our economy. Money
provides the standard unit of exchange (in the case of the U.S., the dollar) by which
specific personal financial plans—and progress with respect to these plans—can be
measured. Money is therefore the key consideration in establishing financial plans. Utility
refers to the amount of satisfaction derived from purchasing certain types or quantities of
goods and services. Since money is used to purchase these goods and services, it is
generally believed that greater wealth (money) permits the purchase of more and better
goods and services that in turn result in greater utility (satisfaction).
1-6 Explain why financial plans must be psychologically as well as economically sound.
What is the best way to resolve money disputes in a relationship?
Money is not only an economic concept; it is also a psychological one that is linked
through emotion and personality. Each person has a unique personality and emotional
makeup that determines the importance and role of money in his or her life, as well as
one‘s particular money management style. Personal values also affect one‘s attitudes to
money. Money is a primary motivator of personal behavior and has a strong impact on
self-image. To some, money is of primary importance, and accumulation of wealth is a
dominant goal. For others, money may be less important than lifestyle considerations.
Therefore, every financial plan must be developed with a view towards the wants, needs,
and financial resources of the individual and must also realistically consider his or her
personality, values, and money emotions.
Money is frequently a source of conflict in relationships, often because the persons
involved aren‘t comfortable discussing this emotion-laden topic. Each person may have
different financial goals and personal values, leading to different opinions on how to
spend/save/invest the family‘s money. To avoid arguments and resolve conflicts, it is
essential to first become aware of each person‘s attitude toward money and his or her
money management style, keep the lines of communication open, and be willing to listen
and to compromise. It is possible to accommodate various money management styles
within a relationship or family by establishing personal financial plans that take
individual needs into account. Some families are able to avoid conflict by establishing
separate accounts, such as yours, mine and household, with a set amount allocated to
each account each pay period. This way, no one feels deprived, and enough has been set
aside to paythe bills and to meet common financial goals.
1-7 Explain why it is important to set realistically attainable financial goals. Select one
of your personal financial goals and develop a brief financial plan for achieving it.
Realistic goals are set with a specific focus and a reasonable time frame to achieve
results. It is important to set realistically attainable financial goals because they form the
basis upon which our financial plans are established. If goals are little more than ―pipe
dreams,‖ then the integrity of the financial plans would be suspect as well
Students‘ descriptions of the steps to achieve a specific goal will, of course, vary. They
should follow the general guidelines in the chapter: define financial goals, develop
financial plans and strategies to achieve goals, implement financial plans and strategies,
periodically develop and implement budgets to monitor and control progress toward
goals, use financial statements to evaluate results of plans and budgets, and redefine goals
and revise plans as personal circumstances change.
1-8 Distinguish between long-term, intermediate, and short-term financial goals. Give
examples of each.
Individual time horizons can vary, but in general individuals would expect to achieve
their short-term financial goals in a year or less, intermediate-term goals in the next 2-5
years, and long-term financial goals in more than 5 years. Refer to Worksheet 1.1 for
examples of financial goals.
In making personal financial goals, individuals must first carefully consider their current
financial situation and then give themselves a pathway to reach their future goals. People
in the early stages of their financial planning life cycle may need more time to
accomplish long-term goals than those who are already established in their careers and
may also need to give themselves more flexibility with their goal dates.
1-9 What types of financial planning concerns does a complete set of financial plans
cover?
Financial plans provide the roadmap for achieving your financial goals. The six-step
financial planning process (introduced in Exhibit 1.3) results in separate yet interrelated
components covering all the important financial elements in your life. Some elements
deal with the more immediate aspects of money management, such as preparing a budget
to help manage spending. Others focus on acquiring major assets, controlling borrowing,
reducing financial risk, providing for emergency funds and future wealth accumulation,
taking advantage of and managing employer-sponsored benefits, deferring and
minimizing taxes, providing for financial security when you stop working, and ensuring
an orderly and cost effective transfer of assets to your heirs.
1-10 Discuss the relationship of life-cycle considerations to personal financial planning.
What are some factors to consider when revising financial plans to reflect changes
in the life cycle?
Personal needs and goals change as you move through different stages of your life. So,
too, do financial goals and plans, because they are directly influenced by personal needs.
When your personal circumstances change, your goals must reflect the new situation.
Factors such as job changes, a car accident, marriage, divorce, birth of children or the
need to care for elderly relatives must be considered in revising financial plans.
1-11 Cooper Bryant’s investments over the past several years have not lived up to his full
return expectations. He is not particularly concerned, however, because his return is
only about 2 percentage points below his expectations. Do you have any advice for
Cooper?
The loss of two percentage points on investment returns is anything but inconsequential,
particularly if the loss occurs annually over a period of several years. For example, if
Cooper had invested $1,000 at an 8 percent return and subsequently had invested all
earnings from the initial investment at 8 percent, in 40 years he would have accumulated
$21,725 from the initial $1,000 investment. If, on the other hand, he had earned a 10
percent return on the same investment, he would have accumulated $45,259 in 40
years—more than double his return at 8 percent! Clearly, two percentage points over time
can make a significant difference! Calculate various rates of return on a $1,000
investment to see that for every 2 percent increase in return, your investment results will
more than double over a 40-year period.
By carefully considering his investment and banking choices, it is likely that Cooper
would be able to get a 2 percent greater rate of return without taking on additional risk.
This can be done both by choosing investments and bank accounts that hold down
expenses, as well as by finding investments of the same type that have performed better.
1-12 Describe employee benefit and tax planning. How do they fit into the financial
planning framework?
Employee benefits, such as insurance (life, health, and disability) and pension and other
types of retirement plans, will affect your personal financial planning. You must evaluate
these benefits so that you have the necessary insurance protection and retirement funds. If
your employer‘s benefits fall short of your needs, you must supplement them. Therefore,
employee benefits must be coordinated with and integrated into other insurance and
retirement plans.
Tax planning involves looking at an individual‘s current and projected earnings and
developing strategies that will defer and/or minimize taxes. For income tax purposes,
income may be classified as active income, passive income, or portfolio income. While
most income is currently subject to income taxes, some may be tax free or tax deferred.
Tax planning considers all these dimensions and more. Tax planning is an important
element of financial planning because it guides the selection of investment vehicles and
the form in which returns are to be received. This means that it is closely tied to
investment plans and often dictates certain investment strategies.
1-13 ―There’s no sense in worrying about retirement until you reach middle age.‖
Discuss this point of view.
This statement reflects a very limited and too often expressed point of view. Due to the
inconsistencies and vagaries of our economic system—and of life itself!—the goals of
and plans for retirement should be established early in life. If retirement goals are
incorporated into an individual‘s financial planning objectives, short- and long-term
financial plans can be coordinated. Thus, financial plans can guide present actions not
only to maximize current wealth and/or utility, but also to provide for the successful
fulfillment of retirement goals. Furthermore, if retirement is desired earlier than
anticipated, the plans may still permit the fulfillment of retirement goals.
1-14 Discuss briefly how the following situations affect personal financial planning:
a. Being part of a dual-income couple
Couples should discuss their money attitudes and financial goals and decide how to
manage joint financial affairs before they get married. Take an inventory of your
financial assets and liabilities, including savings and checking accounts; credit card
accounts and outstanding bills; auto, health, and life insurance policies; and
investment portfolios. You may want to eliminate some credit cards. Too many cards
can hurt your credit rating, and most people need only one or two. Each partner
should have a card in his or her name to establish a credit record. Compare employee
benefit plans to figure out the lowest-cost source of health insurance coverage, and
coordinate other benefits. Change the beneficiary on your life insurance policies as
desired. Adjust withholding amounts as necessary based on your new filing category.
b. Major life changes, such as marriage or divorce
Major life changes such as marriage and divorce:
Marriage. Finances must be merged and there may be a need for life insurance.
Divorce. Financial plans based on two incomes are no longer applicable. Revised
plans must reflect any property settlements, alimony, and/or child support.
c. Death of a spouse
The surviving spouse is typically faced with decisions on how to receive and invest life
insurance proceeds and manage other assets. In families where the deceased made most
of the financial decisions with little or no involvement of the surviving spouse, the
survivor may be overwhelmed by the need to take on financial responsibilities. Advance
planning can minimize many of these problems.
1-15 What is a professional financial planner? Does it make any difference whether the
financial planner earns money from commissions made on products sold as opposed
to the fees he or she charges?
Unlike accounting and law, the field professional financial planning field is largely
unregulated, and almost anyone can call themselves a professional financial planner.
Most financial planners are honest and reputable, but there have been cases of fraudulent
practice. So, it‘s critical to thoroughly check out a potential financial advisor–preferably
interview two or three.
Most financial planners fall into one of two categories based on how they are paid:
commissions or fees. Commission-based planners earn commissions on the financial
products they sell, whereas fee-only planners charge fees based on the complexity of the
plan they prepare. Many financial planners take a hybrid approach and charge fees and
collect commissions on products they sell, offering lower fees if you make product
transactions through them.
The way a planner is paid—commissions, fees, or both—should be one of your major
concerns. Obviously, you need to be aware of potential conflicts of interest when using a
planner with ties to a brokerage firm, insurance company, or bank. Many planners now
provide clients with disclosure forms outlining fees and commissions or various
transaction costs.
1-16 Discuss the following statement: ―The interactions among government, business,
and consumers determine the environment in which personal financial plans must
be made.‖
Government, businesses, and consumers are the three major participants in the economic
system. Government provides the structure within which businesses and consumers
function. In addition, it provides a number of essential services that generally improve the
quality of the society in which we live. To create this structure, various regulations are set
forth, and to support its activities and provision of essential services, taxes are levied.
These activities tend to constrain businesses and consumers.
Businesses provide goods and services for consumers and receive money payments in
return. They also employ certain inputs in producing and selling goods and services. In
exchange they pay wages, rents, interest, and profit. Businesses are a key component in
the circular flow of income that sustains our economy. They create the competitive
environment in which consumers select from many different types of goods and services.
By understanding the role and actions of businesses on the cost and availability of goods
and services, consumers can better function in the economic environment and, in turn,
implement more efficient personal wealth maximizing financial plans.
Consumers are the focal point of the personal finance environment. Their choices
ultimately determine the kinds of goods and services that businesses will provide. Also,
consumer spending and saving decisions directly affect the present and future circular
flows of income. Consumers must; however, operate in the financial environment created
by the actions of government and business. Consumers may affect change in this
environment through their elected officials, purchasing decisions and/or advocacy
groups. Yet, basically, change occurs slowly and tediously, often with less than favorable
results. Thus, consumers should attempt to optimize their financial plans within the
existing financial environment.
1-17 What are the stages of an economic cycle? Explain their significance for your
personal finances.
The stages of the economic cycles are expansion, peak, contraction, and trough. Each of
these stages relates to real gross domestic product (GDP), which is an important indicator
of economic activity. The stronger the economy, the higher the levels of real GDP and
employment. During an expansion, employment is high, the economy is active and
growing, and prices tend to rise. During an expansion, real GDP increases until it hits a
peak, which usually signals the end of the expansion and the beginning of a contraction.
During a contraction, real GDP falls into a trough, which is the end of a contraction and
the beginning of an expansion. An understanding of these four basic stages, coupled with
knowledge of the stage in which the economy is presently operating, should permit
individuals to adjust and implement financial actions in order to efficiently and
successfully achieve their personal financial goals.
1-18 What is inflation, and why should it be a concern in financial planning?
Inflation is a state of the economy in which the general price level is rising. It is
important in financial planning because it affects what we pay for goods and services; it
impacts how much we earn on our jobs; it directly affects interest rates and, therefore, it
affects such things as mortgage and car loan payments. The most common measure of
inflation is the consumer price index, which is based on the changes in the cost of a
typical ―market basket‖ of consumer goods and services. This can be used to compare
changes in the cost of living over time for the typical family. Inflation is measured by the
percentage change in the consumer price index from one time period to another, so that as
the CPI rises, the cost of living also increases.
1-19. ―All people who have equivalent formal education earn similar incomes.‖ Do you
agree or disagree with this statement? Explain your position.
Disagree. Although higher levels of education may result in higher levels of income, this
does not mean that everyone with a given level of education will achieve a specified level
of income. Factors such as age, marital status, geographical location, and career choice
also impact a person‘s level of income. A number of other factors, such as the degree of
personal motivation and the methods by which one utilizes his or her formal education,
can also affect one‘s income level.
1-20 Discuss the need for career planning throughout the life cycle and its relationship to
financial planning. What are some of your own personal career goals?
Career planning is a critical part of the life cycle of the personal financial planning
process. The choice of a career affects the amount you earn. By setting both short- and
long-term career goals, you can incorporate them into your financial plans. For example,
if you need additional education and/or other training for a particular job, you may
include a savings plan to obtain the needed funds. You should reevaluate your career
decision periodically to see if it still meets your personal and financial goals. Other
important considerations with regard to a specific job (and company) include the earnings
potential, advancement opportunities, and benefits, plus how well the job fits your
lifestyle and values. In today‘s rapidly changing job environment, you should expect to
change careers several times. It is important to keep up with developments in your
industry, acquire a broad base of experience, and continue to learn new skills, both
general and technical.
Each student will, of course, have a different list of personal career goals based upon his
or her career orientation and goals. However, responses should include discussion of
personal financial planning and associated career planning goals and how a career choice
would best fulfill quality of life, standard of living, and wealth maximization objectives.
Goals might include getting a bachelor‘s, master‘s or other degree, working in a specific
industry, owning one‘s own business, finding a job in a different area of the country or
overseas, achieving a desired salary and/or responsibility level by a certain age, or
finding a job that meets lifestyle needs.
Key Terms
average propensity to
consume The percentage of each dollar of income, on average, that a person spends
for current needs rather than savings.
consumer price
index (CPI) A measure of inflation based on changes in the cost of consumer goods
and services.
contraction The phase of the economic cycle when real GDP falls.
expansion The phase of the economic cycle when levels of employment and
production are high and the economy is growing, generally accompanied
by rising prices for goods and services.
financial assets Intangible assets, such as savings accounts and securities, that are acquired
for some promised future return.
financial goals Results that an individual wants to attain, such as buying a home, building
a college fund, or achieving financial independence.
flexible-benefit
(cafeteria) plan A type of employee benefit plan wherein the employer allocates a certain
amount of money and then the employee ―spends‖ that money for benefits
selected from a menu covering everything from childcare to health and life
insurance to retirement benefits.
goal dates Target dates in the future when certain financial objectives are expected to
be completed.
gross domestic
product (GDP) The total of all goods and services produced in a country; used to monitor
economic growth.
inflation A state of the economy in which the general price level is increasing.
money The medium of exchange used as a measure of value in financial
transactions.
peak The phase of the economic cycle when an expansion ends, and a
contraction begins.
personal financial planning A systematic process that considers important elements of an
individual‘s financial affairs in order to fulfill financial goals.
professional
financial planner An individual or firm that helps clients establish financial goals and
develop and implement financial plans to achieve those goals.
standard of living The necessities, comforts, and luxuries enjoyed or desired by an individual
or family.
tangible assets Physical assets, such as real estate and automobiles, that can be held for
either consumption or investment purposes.
trough The phase of the economic cycle when a contraction ends and an
expansion begins.
utility The amount of satisfaction received from purchasing certain types or
quantities of goods and services.
wealth The total value of all items owned by an individual such as savings
accounts, stocks, bonds, home, and automobiles.
Chapter Outline
Learning Goals
I. The Rewards of Sound Financial Planning
A. Improving Your Standard of Living
B. Spending Money Wisely
1. Current Needs
2. Future Needs
C. Accumulating Wealth
*Test Yourself*
II. The Personal Financial Planning Process
A. Steps in the Financial Planning Process
B. Defining Your Financial Goals
1. The Role of Money
2. The Psychology of Money
C. Money and Relationships
D. Types of Financial Goals
E. Putting Target Dates on Financial Goals
1. Long-term Goals
2. Short-term Goals and Intermediate Goals
*Test Yourself*
III. From Goals to Plans: A Lifetime of Planning
A. The Life Cycle of Financial Plans
B. Plans to Achieve Your Financial Goals
1. Asset Acquisition Planning
2. Liability and Insurance Planning
3. Savings and Investment Planning
4. Employee Benefit Planning
5. Tax Planning
6. Retirement and Estate Planning
C. Special Planning Concerns
1. Managing Two Incomes
2. Managing Employee Benefits
3. Managing Your Finances in Tough Economic Times
4. Adapting to Other Major Life Changes
D. Technology in Financial Planning
E. Using Professional Financial Planners
F. Types of Planners
G. Choosing a Financial Planner
*Test Yourself*
VI. The Planning Environment
A. The Players
1. Government
a. Taxation
b. Regulation
2. Business
3. Consumers
B. The Economy
1. Economic Cycles
2. Inflation, Prices, and Planning
*Test Yourself*
V. What Determines Your Personal Income?
A. Demographics and Your Income
B. Your Education
C. Where You Live
D. Your Career
E. Planning Your Career
*Test Yourself*
Summary
Key Terms
Financial Planning Exercises
Applying Personal Finance
Watch Your Attitude!
Critical Thinking Cases
1.1 Aaron’s Need to Know: Personal Finance or Golf?
1.2 Cameron’s Dilemma: Finding a New Job
Using Financial
Statements and Budgets
Chapter 2
How Will This Affect Me?
A recent survey shows that more than half of adult Americans could not cover 6 months of living
expenses or the cost of medical emergencies. And younger millennials between the ages of 18
and 24 are the least prepared*. These are scary findings … and this chapter shows what you can
do to avoid being part
of these alarming statistics.
Everyone knows it‘s hard to get where you need to go if you don‘t know where you are.
Financial goals describe your destination, and financial statements and budgets are the tools that
help you determine exactly where you are in the journey. This chapter helps you define your
financial goals and explains how to gauge your progress carefully over time.
Hopefully most of your students have had a semester of financial accounting. If so, while this
chapter will be a review for them, they may need help understanding the differences between
cash and accrual accounting. The chapter deals with cash accounting; the previous accounting
course dealt with accrual accounting. If they have not had an accounting course, the students
may have a hard time. If this material is new to them, it will be helpful if you go over
worksheets (2.1 and 2.2) and then discuss the Financial Planning Exercises 3 (preparing a
balance sheet) and 4 (preparing an income statement).
LEARNING GOALS
LG1 Understand the relationship between financial plans and statements.
The statement above ―it‘s hard to get where you need to go if you don‘t know where you are‖ is
very true. There are three basic financial statements: Balance Sheet, Income Statement, and
Budget. The balance sheet tells you where you are as of a stated date. The income statement
reports the income and expenses of the most recent period, be it a year, quarter or month. The
budget is a forward-looking document that reports your plan for the next period [five years, one
year, quarter or month]. If your balance sheet is not consistent with your financial goal, you
know you need to make some changes.
Note the ―Financial Road Sign‖ that discusses the 50/30/20 rule.
• 50 percent of income goes to living expenses and necessities (needs), which include rent,
utilities, groceries, insurance, and transportation.
• 30 percent of income goes to flexible spending (wants), which includes everything you want
but don‘t need to buy. Examples are spending money on eating out, movies, and travel.
• 20 percent of income goes to meeting financial goals, which are achieved through saving,
investments, building up and maintaining an emergency fund, and payments to reduce debts.
To get a feel for where your students are in their ability to account for their financial
transactions, ask the students if they have a checking account. Then ask them if they know the
balance of that account. Exhibit 2.1 presents the impact of the financial statements on the
financial plan. The statements give feedback to the plan.
LG2 Prepare a personal balance sheet.
The Balance Sheet computes the net worth [assets less liabilities] as of a given date. By
comparing the current balance sheet with the previous one from a year ago, you can see if you
are moving toward your goal, or not. While liquid assets and investments may look the same,
their purpose is very different. The liquid assets are available to spend or pay off debt, while the
investments are for the long term. Recall that here we are discussing personal balance sheet.
Therefore, the concept of depreciation is not the same as with generally accepted accounting
principles (GAAP). With GAAP, depreciation is the allocation of a past cost over its useful life.
With a personal balance sheet, depreciation is a decline in value – the assets are stated at their
market value. Accordingly, it is common for personal property to decline in value and real
property to increase in value – though it is not guaranteed.
Liabilities are amounts owed to others. The classification as current [due within one year] and
long-term is important. The current liabilities have to be paid in the short run, while long-term
liabilities may be paid in the future or be paid with a monthly payment – which is a current
liability. Worksheet 2.1 gives a format for a personal balance sheet—a fill-in-the-blanks
approach that is useful for financial planning. In the chapter, the worksheet includes example
data for Dylan and Julia Butler. Note that the worksheet computes the net worth as the assets
less liabilities. While it may be computed as the original net worth plus or minus cumulative net
income since the individual or family started keeping records, the extra work is not useful.
Simply compute as assets less liabilities.
Exhibit 2.2 gives the student hope that in the future theywill have a net worth.
LG3 Generate a personal income and expense statement.
While the balance sheet reports financial position as of a given day, the income statement covers
a stated period, typically a month or year. The Financial Planning Exercises Number 4 should
lead the students to consider what income is. The exercise asks the question is income gross pay
or net pay. If you take the position that it is net pay, you are saying that you have no control over
the payroll deductions. But you can control at least some of them and your actions should be
consistent with your financial plan. You decide how many exemptions to claim for withholding
income taxes. You may have some choice as to what health insurance you select, what life
insurance to select, or perhaps other benefits such as childcare or additional health benefits. The
expenses you can control are typically referred to as variable expenses and those you have no
control over are fixed expenses. You can control whether or not to incur a fixed expense [to
have cable TV or not], but once you decide to incur the item it is fixed for future periods.
Worksheet 2.2 lists the typical income and expenses items. The example for Dylan and Julia
Butler gives the students an example of an income statement. Exhibit 2.3 reports how we spend
our after-tax income, at least the average amount we spend for various items.
LG4 Develop a good record-keeping system and use ratios to evaluate personal financial
statements.
Without records, you are flying blind. It‘s like the person who says they can spend money as
long as they have a check in their checkbook. Records give you a way to prepare financial
reports which allow you to evaluate where you are on your financial plan. There is inexpensive
software that will help you keep records, but you still have to record the transactions in order to
have data for your financial statements.
With financial statements you may use ratio analysis to better understand how you are doing.
Exhibit 2.5 gives a list of useful ratios. It will be useful to do some sensitivity analysis, that is,
ask the students is it good or bad to move from a solvency ratio of 35% to 50%; liquidity ratio
from 13% to 8%; and so on. This will help student understand the information in the ratio.
LG5 Construct a cash budget and use it to monitor and control spending.
The income statement reports the cash surplus or deficit for the period. But is the surplus of
$2,000 good or not. You need something to compare it to. Frequently you compare to the
previous period. While that is better than no comparison, comparing to your planned surplus is
better. Your planned surplus is the bottom line of your budget. The budget is a statement in
dollars of your planned income and expenses for the period, typically month or year. By
comparing the current expenses with budgeted expenses, you create a budget variance. That
variance tells you if you need to hold the course or change your direction. The actual income or
expense compared to the budgeted amount gives you the ability to monitor and control your
expenses.
Worksheet 2.3 gives a common format for a cash budget, your planned expenditures for the year.
The cash budget for Dylan and Julia Butler is an example. Worksheet 2.4 gives an example of
comparing actual to budget and the resulting variance.
LG6 Apply time value of money concepts to put a monetary value on financial goals.
Financial plans are concerned with what future amounts you will need to be able to provide for
your desired lifestyle at that time. Since the time is in the future, typically you need to apply the
concept called the time value of money, the idea that a dollar today is worth more than a dollar
received or spent in the future. Hopefully your students have been exposed to this concept in
previous courses. If not, use short time periods [3 or 5 years] to demonstrate the concept.
Perhaps use financing of a car as an example: You can pay $20,000 today or $400 per month for
5 years. With a 6% annual rate, the present value of an annuity of $400 per month, for 60
months, at .06/12 monthly rate, is $20,690. If you are OK with a 6% rate, pay cash.
The book discusses spreadsheets financial functions such as PV, FV, and PMT. Also, the use of
a financial calculator and timelines are discussed. It depends upon the culture of your program
whether you use calculators or spreadsheets. The Rule of 72 is very useful for quick
comparisons. Discuss it.
LG7 Understand the relationship between inflation and nominal interest rates and
calculate the real interest rate.
The interest rate used in time value of money computations matters. The appropriate rate is the
inflation adjusted rate. In the example in the text, the nominal rate of 8% becomes an inflation
rate of 4.85% if you expect 3% inflation. The Fisher equation which computes the inflation
adjusted rate is discussed. The best way to handle inflation in long-term financial planning
decisions is first to consider prevailing forecasts of future inflation. The next step is to
incorporate the effect of those inflationary expectations on future cash flows. Then the rates you
use to plan are considered inflation adjusted rates.
Link to Solutions to Financial Planning Exercises
Financial Facts or Fantasies?
These may be used as ―teasers‖ to get the students on the right page with you. Also, they may be
used as quizzes after you covered the material or as ―pre-test questions‖ to get their attention.
• Whereas the balance sheet summarizes your financial condition at a given point in time, the
income and expense statement report on your financial performance over time.
Fact: A balance sheet is like a photograph of your financial condition (covering just one day out
of the year), while an income and expense statement is like a motion picture (covering the full
year or some other time period).
• Because financial statements are used to record actual results, they‘re really not that important
in personal financial planning.
Fantasy: Personal financial statements let you know where you stand financially. As such, they
not only help you set up realistic financial plans and strategies but also provide a system for
monitoring the amount of progress you‘re making toward the financial goals you've set.
• A leased car should be listed as an asset on your personal balance sheet.
Fantasy: You are only ―using‖ the leased car and do not own it. Consequently, it should not be
included as an asset on the balance sheet.
• Only the principal portion of a loan should be recorded on the liability side of a balance sheet.
Fact: The principal portion of a loan represents the unpaid balance and is the amount of money
you owe. In contrast, interest is a charge that will be levied over time for the use of the money.
• Generating a cash surplus is desirable, because it adds to your net worth.
Fact: You can only increase your net worth by generating a cash surplus, someone giving you
additional assets, or through increases in market values. The only one of the three you control is
generating cash surplus.
• When evaluating your income and expenses statement, primary attention should be given to the
top line: income received.
Fantasy: If you focus on only income and ignore expenses, you will quickly find yourself with
a cash deficit and your net worth will decrease. Expenses are equally important and must be
controlled.
Financial Facts or Fantasies?
These may be used as a quiz or as a pre-test to get the students interested.
1. True False Whereas the balance sheet summarizes your financial condition at a given point in
time, the income and expense statement report on your financial performance over
time.
2. True False Because financial statements are used to record actual results, they‘re really not
that important in personal financial planning.
3. True False A leased car should be listed as an asset on your personal balance sheet.
4. True False Only the principal portion of a loan should be recorded on the liability side of a
balance sheet.
5. True False Generating a cash surplus is desirable, because it adds to your net worth.
6. True False When evaluating your income and expenses statement, primary attention should
be given to the top line: income received.
Answers: 1. True 2. False 3. False 4. True 5. True 6. False
YOU CAN DO IT NOW
The ―Do It Now‖ cases may be assigned to the students as short cases or problems. They will
help make the topic more real or relevant to the students. In most cases, it will only take about
ten minutes to do, that is, until the student starts looking around at the web site. But they will
learn by doing so.
Track Your Expenses
It's easy for spending to become so automatic that we're not aware we're doing it. So where does
your money go? The only way to find out is to keep track of it. Writing down what you spend in
a paper journal or using an app like Expensify (www.expensify.com) is simple and will make
you more aware of where your money goes. Knowing where you are will probably make you
feel better too - so do it now.
Save Automatically
We all know we should save regularly. One way to create a savings "habit" is to literally make it
automatic.
Open a savings account apart from your checking account. This will separate your savings from
what you have available to spend. And then set up an automatic deposit to your savings account
each month. This sets your "habit." You can do it now.
Financial Impact of Personal Choices
Read and think about the choices being made. Do you agree or not? Ask the students to discuss
the choices being made.
No Budget, No Plan: Mason Bought a Boat!
Mason is 28 and has a good job as a sales rep. He's always found budgeting boring and has been
intending to start a financial plan for years.
Recently, Mason went out with some friends on a rented boat to fish. He had a great time and
saw a boat sale on his way home. Before he knew it, the salesman convinced Sean that the deal
was just too good to pass up. So Mason bought a $10,000 boat and financed 80 percent of the
cost for the next 5 years. Sean now finds himself relying more on his credit card to get by each
month.
What if Mason had kept track of his money, used a budget, and had a set of financial goals?
Knowing where his money went and having a financial plan would have increased the chance
that Mason would make more deliberate, informed financial decisions.
Applying Personal Finance
What’s Your Condition?
Financial statements reflect your financial condition. They help you measure where you are now.
Then,
as time passes and you prepare your financial statements periodically, you can use them to track
your
progress toward financial goals. Good financial statements are also a must when you apply for a
loan.
This project will help you to evaluate your current financial condition.
Look back at the discussion in this chapter on balance sheets and income and expense
statements,
and prepare your own. If you‘re doing this for the first time, it may not be as easy as it sounds!
Use the following questions to help you along.
1. Have you included all your assets at fair market value (not historical cost) on your balance
sheet?
2. Have you included all your debt balances as liabilities on your balance sheet? (Don‘t take your
monthly payment amounts multiplied by the number of payments you have left—this total
includes
future interest.)
3. Have you included all items of income on your income and expense statement? (Remember,
your
paycheck is income and not an asset on your balance sheet.)
4. Have you included all debt payments as expenses on your income and expense statement?
(Your
phone bill is an expense for this month if you‘ve already paid it. If the bill is still sitting on your
desk
staring you in the face, it‘s a liability on your balance sheet.)
5. Are there occasional expenses that you‘ve forgotten about, or hidden expenses such as
entertainment
that you have overlooked? Look back through your checkbook, spending diary, or any other
financial records to find these occasional or infrequent expenses.
6. Remember that items go on either the balance sheet or the income and expense statement,
but not on both. For example, the $350 car payment you made this month is an expense on your
income and expense statement. The remaining $15,000 balance on your car loan is a liability on
your balance sheet, while the fair market value of your car at $17,500 is an asset.
After completing your statements, calculate your solvency, liquidity, savings, and debt service
ratios. Now, use your statements and ratios to assess your current financial condition. Do you
like
where you are? If not, how can you get where you want to be? Use your financial statements and
ratios
to help you formulate plans for the future.
Solutions to Financial Planning Exercises
1. Preparing Financial Statements: Axel Gibson is preparing his balance sheet and
income and expense statement for the year ending June 30, 2020. He is having
difficulty classifying six items and asks for your help. Which, if any, of the following
transactions are assets, liabilities, income, or expense items?
a. Axel rents a house for $1,350 a month.
The monthly rent is a monthly expense. The payment will reduce an asset, Cash.
b. On June 21, 2020, Axel bought diamond earrings for his wife and charged them
using his MasterCard. The earrings cost $900, but he hasn’t yet received the bill.
The purchase will result in a new asset, personal property for $900. Since he purchased
using a credit card, his current liabilities also increase by $900. Credit card debt is
typically due within one month, so it is a current liability.
c. Axel borrowed $3,500 from his parents last fall, but so far, he has made no
payments to them.
Since no loan payments were made during the period, a corresponding expense would not
appear. Whether or not the ―loan‖ is a real loan or a gift from the parents is a question of
fact to be determined. If real loan, the balance sheet will list a liability of $3,500. If a
gift, net worth will increase by the amount of cash received, a direct contribution to his
net worth.
d. Axel makes monthly payments of $225 on an installment loan; about half of it is
interest, and the balance is repayment of principal. He has 20 payments left, totaling
$4,500.
The income and expense statement will show an expense: payment of loan $225 per
month times 12 months, a total for the year of $2,700. When a balance sheet is prepared,
the loan balance will be reduced by half of the $225 per month [$112.50] which represent
payment of principal. Since it is useful to know the amount of interest being paid, the
loan payment may be split into $112.50 interest and $112.50 loan repayment.
e. Axel paid $3,800 in taxes during the year and is due a tax refund of $650, which he
hasn’t yet received.
The payment of taxes is an expense recorded as paid, typically monthly or when
paycheck is received. The refund is not recorded on the income and expense statement
until it is received. The receivable is not recorded on a cash basis balance sheet. When
the refund is received it may be treated as a reduction of tax expense rather than an
income item. Doing so will reflect the correct amount of tax paid for the year.
f. Axel invested $2,300 in some common stock.
The cash asset goes down and the investment asset goes up. The investment will appear
on the balance sheet.
2. Projecting Financial Statements: Put yourself 10 years into the future. Construct a
fairly detailed and realistic balance sheet and income and expense statement
reflecting what you would like to achieve by that time.
While everyone's financial statements will differ based on their own expectation of the
future, each should have similar elements such as: assets such as a home, automobiles
and investments; liabilities such as a mortgage, an auto loan, and consumer debt; and a
positive net worth. The statement of income and expense should reflect income from a
job or business, investment income, and expenses for items such as home maintenance,
food, debt payments, savings, taxes, and insurance.
3. Preparing Personal Balance Sheet: Use Worksheet 2.1. Sadie Richardson’s banker has
asked her to submit a personal balance sheet as of June 30, 2020, in support of an
application for a $6,000 home improvement loan. She comes to you for help in preparing it.
So far, she has made the following list of her assets and liabilities as of June 30, 2020:
Cash on hand $ 70
Balance in checking account 180
Balance in money market deposit account with
Southwest Savings 650
Bills outstanding:
Telephone $ 20
Electricity 70
Charge account balance 190
Visa 180
MasterCard 220
Taxes 400
Insurance 220 1,300
Condo and property 68,000
Condo mortgage loan 52,000
Automobile: 2015 Honda Civic 12,000
Installment loan balances:
Auto loans 3,000
Furniture loan 500 3,500
Personal property:
Furniture 1,050
Clothing 900 1,950
Investments:
U.S. government savings bonds 500
Stock of Commodities Corp. 3,000 3,500
From the data given, prepare Sadie Richardson’s balance sheet, dated June 30, 2020
(follow the balance sheet form shown in Worksheet 2.1). Then evaluate her balance sheet
relative to the following factors: (a) solvency, (b) liquidity, and (c) equity in her dominant
asset.
See following page for Worksheet 2.1 for Sadie Richardson.
3-a. Solvency Ratio: This term refers to having a positive net worth. The calculation for her
solvency ratio is as follows:
Solvency Ratio = Total Net Worth = $29,550 = 34.22%
Total Assets $86,350
This indicates that Sadie could withstand about a 34% decline in the market value of her assets
before she would be insolvent. Although this is not too low a value, some thought might be given
to increasing her net worth.
3-b. Liquidity Ratio: A simple analysis of Sadie‘s balance sheet reveals that she's not very
liquid. In comparing current liquid assets ($900) with current bills outstanding ($1,300),
it is obvious that she cannot cover her bills and is, in fact, $400 short (i.e., $1,300 current
debt – $900 current assets). Her liquidity ratio is:
Liquidity ratio = Liquid Assets = $ 900 =
69.21%
Total Current Debts $1,300
This means she can cover only about 69% of her current debt with her liquid assets.
If we assume that her installment loan payments for the year are about $2,000 (half the
auto loan balance and all of the furniture loan balance) and add them to the bills
outstanding, the liquidity ratio at this level of liquid assets is:
Liquidity ratio = Liquid assets = $ 900 = 27%
Total Current Debts $3,300
This indicates that if she lost income, she could cover only about 27% of her existing
one-year debt obligations with her liquid assets—and this does not include her mortgage
payment! This is clearly not a favorable liquidity position.
3-c. Equity in Her Dominant Asset: Sadie‘s dominant asset is her condo and property, which is
currently valued at $68,000. Since the loan outstanding on this asset is $52,000, the equity is
$16,000 (i.e., $68,000 – $52,000). This amount indicates about a 24% equity interest (i.e.,
$16,000/$68,000) in the market value of her real estate. This appears to be a favorable equity
position. However, if Sadie was forced to sale the condo to pay other debt, the selling costs
could be 15% of sales price and the distressed sale price could wipe out the balance of her equity
Additional Issue: The data is to be used as is. However, used clothes and household
furnishings have very little value it they are to be sold. So, the value of her personal
property may be overstated. Similarly, the value of the 2015 Honda Civic seems high.
Worksheet 2.1, Exercise 3, chapter 2
BALANCE SHEET
Name(s)Sadie Richardson Date June 30, 2020
ASSETS LIABILITIES
Liquid Assets Current Liabilities
Cash on hand $ 70.00 Utilities $ 90.00
In checking 180.00 Rent
Savings accounts Insurance premiums
Money market
funds and deposits
650.00 Taxes
Medical/dental bills
Certificates of deposit
(<1 yr. to maturity)
Repair bills
Total Liquid Assets $ 900.00 Bank credit card balances 400.00
Investments
Dept. store credit card
balances 190.00
Stocks $ 3,000.00 Travel and entertainment
card balances
Bonds 500.00 Gas and other credit card
balances
Certificates of deposit
(>1 yr. to maturity)
Bank line of credit
balances
Mutual funds Other current liabilities 400.00
220.00
Real estate Total Current Liabilities $ 1,300.00
Retirement funds, IRA Long-Term Liabilities
Other Primary residence
mortgage
$ 52,000.00
Total Investments $ 3,500.00
Real Property Second home mortgage
Primary residence $ 68,000.00 Real estate investment
mortgage
Second home
Other Auto loans 3,000.00
Total Real Property $ 68,000.00 Appliance/furniture loans 500.00
Personal Property Home improvement loans
Auto(s): 2015 Honda Civi c$ 12,000.00 Single-payment loans
Auto(s): Education loans
Recreational vehicles
Margin loans
Household furnishing 1,050.00
Jewelry and artwork Other long-term loans
Other 900.00 Total Long-Term Liabilities $ 55,500.00
Other (II) Total Liabilities $ 56,800.00
Net Worth [(I) - (II)] $ 29,550.00
Total Liabilities and Net Worth$ 86,350.00
Total Personal Property $ 13,950.00
(I)Total Assets $ 86,350.00
4. Preparing Income and Expense Statement: Use Worksheet 2.2. Ariana and Nicholas
Peterson are about to construct their income and expense statement for the year ending
December 31, 2020. They have put together the following income and expense information
for 2020:
Ariana’s salary $47,000
Reimbursement for travel expenses 1,950
Interest on:
Savings account 110
Bonds of Delta Corporation 70
Groceries 4,150
Rent
Utilities
9,600
960
Gas and auto expenses 650
Nicholas’ tuition, books, and supplies 3,300
Books, magazines, and periodicals 280
Clothing and other miscellaneous expenses
Cost of photographic equipment
purchased with charge card
2,700
2,200
Amount paid to date on photographic equipment 1,600
Ariana’s travel expenses 1,950
Purchase of a used car (cost) 9,750
Outstanding loan balance on car 7,300
Purchase of bonds in Delta Corporation 4,900
Using the information provided, prepare an income and expense statement for the
Peterson’s for the year ending December 31, 2020 (follow the form shown in Worksheet
2.2).
See worksheet on following page.
Worksheet 2.2 Exercise 4, Chapter 2
hole
or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a
password-protected website or school-approved learning management system for classroom use.
INCOME AND EXPENSE STATEMENT
Name(s)
For the [month or year]
Ariana and Nicholas Peterson
Year Ended December 31, 2020
Income
Wages and salaries Name: Ariana Peterson $ 47,000.00
Name:
Name:
Self-employment income
Bonuses and commissions
Investment income Interest received 180.00
Dividends received
Rents received
Sale of securities
Other: Reimbursement of travel expenses 1,950.00
Pensions and annuities
Other income
(I) Total Income $ 49,130.00
Expenses
Housing Rent/mortgage payment
(include insurance and taxes, if applicable)
$
9,600.00
Repairs, maintenance, improvements
Utilities Gas, electric, water 960.00
Phone
Cable TV and other
Food Groceries 4,150.00
Dining out
Transportation Auto loan payments cost less loan, 9750-7300 2,450.00
License plates, fees, etc.
Gas, oil, repairs, tires, maintenance 650.00
Medical Health, major medical, disability insurance
(payroll deductions or not provided by employer)
Doctor, dentist, hospital, medicines
Clothing Clothes, shoes, and accessories 2,700.00
Insurance Homeowner’s (if not covered by mortgage payment)
Life (not provided by employer) &/or Long-term Care
Auto
Taxes Income and social security
Property (if not included in mortgage)
Appliances, furniture, and other
major purchases
Loan payments
Purchases and repairs
Personal care Laundry, cosmetics, hair care
Recreation and entertainment Vacations
Other recreation and entertainment 280.00
Other items Books, tuition, and supplies 3,300.00
Photographic equipment -- amount paid 1,600.00
Travel expenses 1,950.00
Purchase of Delta Corporation Bonds 4,900.00
(II) Total Expenses $ 32,540.00
© 2021 Cengage Learning®. May not be scanned, cop
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5. Preparing Cash Budget: Landon and Naomi Gray are preparing their cash budget.
Help the Grays reconcile the following differences, giving reasons to support your answers.
a. Their only source of income is Landon’s salary, which amounts to $5,000 a month
before taxes. Landon wants to show the $5,000 as their monthly income, whereas
Naomi argues that his take-home pay of $3,917 is the correct value to show.
Like many questions it depends. If the taxes and other payroll deductions are considered
out of their control, then only the take home pay would be listed. But, since they have
some options in the computation of payroll deductions, the gross pay should be listed.
Among the options is the number of exemptions for income tax withholding, the option
to purchase health insurance for the non-working spouse through the employer or
elsewhere, and perhaps other fringe benefits such as childcare and flexible benefits.
b. Naomi wants to make a provision for fun money, an idea that Landon cannot
understand.
He asks, ―Why do we need fun money when everything is provided for in the
budget?‖
By having an allowance for "fun money," the Grays have specifically set aside a certain
portion of their income for a little self-indulgence. This will serve three basic purposes:
(1) it will give a little financial independence to each member of the family; (2) to a
certain extent it allows for a little impulse buying which might further the enjoyment of
life under a budget control thus diminishing the possibility of it occurring by taking from
another account; and (3) it generally promotes a higher quality of life. The inclusion of
"fun money" is probably justified.
6. Identifying Missing Budget Items: Here is a portion of Joshua Sanders’s budget record
for a recent month. Fill in the blanks in columns 5 and 6.
Note, here the answers are included in bold. They may be deleted if you wish to use in
classroom.
Item
(1)
Amount
Budgeted
(2)
Amount
Spent
(3)
Beginning
Balance
(4)
Monthly
Surplus
(Deficit)
(5)
Cumulative
Surplus
(Deficit)
(6)
Rent $550 $575 $50 -$25 $25
Utilities 150 145 15 5 20
Food 510 475 -45 35 -10
Auto 75 95 -25 -20 -45
© 2021 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole
or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a
password-protected website or school-approved learning management system for classroom use.
Recreation
and
Entertainment
100 110 -50 -10 -60
7. Personal Cash Budget Use Worksheet 2.3. Prepare a record of your income and expenses
for the last 30 days; then prepare a personal cash budget for the next three months. (Use
the format in Worksheet 2.3 but fill out only three months and the Total column.) Use the
cash budget to control and regulate your expenses during the next month. Discuss the
impact of the budget on your spending behavior, as well as any differences between your
expected and actual spending patterns.
This question requires a personal response that will differ for each student. Therefore, a
specific example has not been provided. However, the Critical Thinking Cases in this
chapter provide several examples of possible answers to this question; it is recommended
that the cases be examined in conjunction with this question.
The question provides an effective means to involve the student in the budgeting process.
Most students are somewhat amazed when they find out how they have actually been
spending their money. Before assigning this question, it is interesting to ask the students
to estimate how they actually spend their money. A comparison of their estimates with
the actual spending records typically reflects the unconscious manner in which they may
be spending. Most students will find that the use of a budget to control and regulate
expenses allows them to make more meaningful and satisfying purchases.
PLEASE NOTE: Exercises 8 through 10 deal with time value of money, and solutions using
Excel, the tables, and the financial calculator will be presented. The factors are taken from the
tables as follows: future value–Appendix A; future value annuity–Appendix B; present value–
Appendix C; present value annuity–Appendix D. If using the financial calculator, set on End
Mode and 1 Payment/Year. The +/- indicates the key to change the sign of the entry, in these
instances from positive to negative. This keystroke is required on some financial calculators in
order to make the programmed equation work. Other calculators require that a "Compute" key be
pressed to attain the answer.
© 2021 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole
or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a
password-protected website or school-approved learning management system for classroom use.
8. Calculating present and future values: Use future or present value techniques to solve
the following problems.
a. Starting with $15,000, how much will you have in 10 years if you can earn 6 percent
on your money? If you can earn only 4 percent?
EXCEL TABLE CALCULATOR
Use FV function: rate is 6% Table of Future Values, App A 15000 +/- PV
FV(rate, term, annual payment,
Present value, 0 for end of period)
PV * FV factor 6%, 10 yrs. 6 I
FV(.06,10,0,15000,0) = $15,000 * 1.791 10 N
$26,862.72 $26,865.00 FV $26,862.72
Use FV function: rate is 4% 15000 +/- PV
FV(rate, term, annual payment,
Present value, 0 for end of period)
PV x FV factor 4%, 10 yrs. 4 I
FV(.04,10,0,15000,0) = $15,000 * 1.480 10 N
$22,203.66 $22,200.00 FV $22,203.66
b. If you inherited $45,000 today and invested all of it in a security that paid a 7
percent rate of return, how much would you have in 25 years?
EXCEL TABLE CALCULATOR
Use FV function: rate is 7% Table of Future Values, App A 45000 +/- PV
FV(rate, term, annual payment,
Present value, 0 for end of period)
PV * FV factor 7%, 25yrs. 7 I
FV(.07,25,0,45000,0) = $45,000 * 5.427 25 N
$244,234.47 $244,215.00 FV $244,234.47
c. If the average new home costs $275,000 today, how much will it cost in 10 years if
the price increases by 5 percent each year?
EXCEL TABLE CALCULATOR
Use FV function: rate is 5% Table of Future Values, App A 275000 +/- PV
FV(rate, term, annual payment,
present value, 0 for end of period)
PV * FV factor 5%, 10yrs. 5 I
FV(.05,10,0,275000,0) = $275,000 * 1.629 10 N
$447,946.02 $447,975.00 FV $447,946.02
© 2021 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole
or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a
password-protected website or school-approved learning management system for classroom use.
d. You think that in 15 years, it will cost $212,000 to provide your child with a 4-year
college education. Will you have enough if you take $70,000 today and invest it for
the next 15 years at 5 percent? If you start from scratch, how much will you have to
save each year to have $212,000 if you can earn 4 percent rate of return on your
investments?
No, you will have $126.066, which is less than your $212,000 goal.
EXCEL TABLE CALCULATOR
Use FV function: rate is 4% Table of Future Values, App A 70000 +/- PV
FV(rate, term, annual payment,
present value, 0 for end of period)
PV * FV factor 4%, 15yrs. 4 I
FV(.04,15,0,70000,0) = $70,000 * 1.801 15 N
$126,066.05 $126,070.00 FV $126,066.05
You will need to deposit $10,587.51 at the end of each year for 15 years in order to
reach the $212,000 goal. I am assuming a 4% rate of return on investments.
EXCEL TABLE CALCULATOR
Use PMT function to determine
annual payment
Table of Future Values Annuity,
App B
212000 +/- FV
PMT(rate, term, present value,
future value, 0 for end of period)
PV / FVA factor 4%, 15yrs. 4 I
PMT(.04,15,0,212000,0) = $212,000 / 20.024 15 N
$10,587.51 $10,587.30 PMT $10,587.51
e. If you can earn 4 percent, how much will you have to save each year if you want to
retire in 35 years with $1 million?
You will need to invest $13,577.32 at the end of each year at a rate of 4% for the next 35
years in order to retire with $1 million.
EXCEL TABLE CALCULATOR
Use PMT function to determine
annual saving amount with rate of
4%, to accumulate $1 million
Table of Future Values Annuity,
App B
1000000 +/- FV
PMT(rate, term, present value,
future value, 0 for end of period)
PV / FVA factor 4%, 35yrs. 4 I
PMT(.04,35,0,1000000,0) = $1,000,000 / 73.652 35 N
$13,577.32 $13,577.36 PMT $13,577.32
© 2021 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole
or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a
password-protected website or school-approved learning management system for classroom use.
f. You plan to have $750,000 in savings and investments when you retire at age 60.
Assuming that you earn an average of 8 percent on this portfolio, what is the
maximum annual withdrawal you can make over a 25-year period of retirement?
You will be able to withdraw $70,259.08 at the end of each year for 25 years if you retire with
$750,000 invested at 8%. If you live beyond 85, you have a problem.
EXCEL TABLE CALCULATOR
Use PMT function to determine
annual withdrawal
Table of Present Values Annuity,
App D
750000 +/- PV
PMT(rate, term, present value,
0 for end of period)
PV / PVA factor 8%, 25yrs. 8 I
PMT(.08,25,750000) = $750,000 / 10.675 25 N
$70,259.08 $70,257.61 PMT $70,529.08
9. Evaluating a Saving Goal: Over the past several years, Natalie Howard has been able to
save regularly. As a result, she has $54,188 in savings and investments today. She wants to
establish her own business in 5 years and feels she will need $100,000 to do so.
a. If she can earn 4 percent on her money, how much will her $54,188 in
savings/investments
be worth in five years? Will Natalie have the $100,000 she needs? If not, how much
more money will she need?
If Natalie can earn 4% on her money, $54,188 will be worth about $65,928 in 5 years:
EXCEL TABLE CALCULATOR
Use FV function: rate is 4% Table of Future Values, App A 54188 +/- PV
FV(rate, term, annual payment,
Present value, 0 for end of period)
PV * FV factor 4%, 5yrs. 4 I
FV(.04,5,0,54188,0) = $54,188 * 1.217 5 N
$65,927.99 $65,946.80 FV $65,927.99
No, she will fall short by about $34,072.
© 2021 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole
or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a
password-protected website or school-approved learning management system for classroom use.
Solution Manual for Personal Financial Planning 15th Edition by Randy Billingsley, Lawrence J. Gitman  Complete Verified Chapter's.docx
Solution Manual for Personal Financial Planning 15th Edition by Randy Billingsley, Lawrence J. Gitman  Complete Verified Chapter's.docx
Solution Manual for Personal Financial Planning 15th Edition by Randy Billingsley, Lawrence J. Gitman  Complete Verified Chapter's.docx

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  • 1. Solution Manual for Personal Financial Planning 15th Edition by Randy Billingsley, Lawrence J. Gitman, Michael D. Joehnk
  • 2. SOLUTION MANUAL FOR Personal Financial Planning 15th Edition by Randy Billingsley, Lawrence J. Gitman, Michael D. Joehnk Understanding the Financial Planning Process Chapter 1 How Will This Affect Me? The heart of financial planning is making sure your values line up with how you spend and save. That means knowing where you are financially and planning on how to get where you want to be in the future no matter what life throws at you. For example, how should your plan handle the projection that Social Security costs may exceed revenues by 2035? And what if the government decides to raise tax rates to help cover the federal deficit? An informed financial plan should reflect such uncertainties and more. This chapter overviews the financial planning process and explains its context. Topics include how financial plans change to accommodate your current stage in life and the role that financial planners can play in helping you achieve your objectives. After reading this chapter you will have a good perspective on how to organize your overall personal financial plan. LEARNING GOALS LG1 Identify the benefits of using personal financial planning techniques to manage your finances. Key concept in this section is the planning model as displayed in Exhibit 1.1. Your standard of living is greatly impacted by your spending habits and your commitment to saving. Your spending is measured by your propensity to consume. Wealth is the total value of all property you own less the amount that you owe to others. ACTIVITY: Ask the students to assume that they have just inherited $100,000. What will you do with the money? Write down three ways you will spend or use the money.
  • 3. Ask the students to share one item with the class and record what they say so that the entire class can reflect on the answers. Hopefully, at least a few will mention investing even if only $10,000 of the amount. Use their answers to discuss taking care of current needs versus future needs. Focus on their propensity to consume and its impact on accumulating wealth. Point out the Financial Planning Tip, ―Be SMART in Planning Your Financial Goals.‖ Use Exhibit 1.2 to show how the average person earns and spends their money and Exhibit 1.6 to help the student identify where they are now. LG2 Describe the personal financial planning process and define your goals. Dwight Eisenhower, army general and president, is quoted as saying ―Plans are useless; Planning is priceless‖. The process of planning allows you to focus on the issues that are most important and to be ready when things change. Exhibit 1.3 lists the Six Step Financial Planning Process. The first and most important is defining your financial goals. Exhibit 1.6 lists goals by age to demonstrate how goals change over time. Use the examples in Exhibit 1.5 to ask students if the assumptions are realistic. Yes, the answer is in the exhibit, but many will not have read chapter at this point. For your use, the assumptions are: Assumption 1: Saving a few thousand dollars a year should provide enough to fund my child‘s college Education. Assumption 2: An emergency fund lasting 3 months should be adequate. Assumption 3: I will be able to retire at 65 and should have plenty to live on in retirement. Assumption 4: I‘m relying on the rule of thumb that I will need only 70 percent of my pre- retirement income to manage nicely in retirement. There are several worksheets in the book. Worksheet 1.1 gives the student a format to write down their Personal Financial Goals. There is power in writing down goals [and most any other plan]. Recording the goal and then reviewing three months later will help you to keep focus on the goal. LG3 Explain the life cycle of financial plans, their role in achieving your financial goals, how to deal with special planning concerns, and the use of professional financial planners. Exhibit 1.7 can help focus the attention on how goals differ between the various stages of life. Section 1-3b lists various decisions that you will have to make over your life. The section 1-3c addresses Special Planning Concerns. Worksheet 1.2 focuses on the financial benefit to the family of the second income. If the second income is from a minimum wage job, it may not be a good financial decision. Of course having a job, even a minimum wage job, may give the person psychic income that will override the financial impact. While perhaps off topic, I recall a high school science teacher who was a smoker. He walked through the amount of money he spent on purchasing tobacco products. That computation had a
  • 4. lot to do with my decision to not smoke. How this relates to the course is that this is an illustration of how the financial impact of a decision can drive the decision. LG4 Examine the economic environment’s influence on personal financial planning. For older folks, the financial crisis of 2008-2009 is fresh in our memory. To the student of 2021, that crisis is more of history than life. If you can share a war story on how you were personally impacted, it will help bring the impact of the world economy on financial plans to life. The book speaks how to manage this type of crisis, but you had to go through it to really understand the impact it had. The value of professional advice is greatly understated. If by talking to a professional you can prevent making a mistake -- that can be of a great value. Section 1-3e speaks to the use of professional financial planners. Exhibit 1.9 lists out the various certifications that planners have. Economic or business cycles are real. Perhaps the most useful thing about the cycles is the knowledge that if things are bad, you know they will get better. Of course, when life is good, you know that the bad cycle will come around again. Thus, financial planning requires saving in the good times for the bad times. See the ―Test Yourself‖ question 1-17 for a short discussion of business cycles. The power of compounding is rarely understood. Exhibit 1.8 shows how the amount $10,000 will grow over time. The longer the investment stays invested, the greater the amount – the power of compound interest. LG5 Evaluate the impact of age, education, and geographic location on personal income. Exhibit 1.12 says it all. LG6 Understand the importance of career choices and their relationship to personal financial planning. Exhibit 1.13 shows that the choice of a college major has a financial impact. Of course money cannot buy happiness, but having a bit helps. If you really want to be an elementary school teacher, you must recognize that you will not have as much wealth as a lawyer or financial analyst. The summary of the learning goals at the end of the chapter should aid the student in reviewing the chapter when exam time comes. It will be useful to point out to the student how to use this material. Link to Solutions to Financial Planning Exercises Pre-tests
  • 5. I have mentioned Pre-test in other places. Simply stated, they work. Students who experience a pre-test, that is a quiz before you have covered the material, perform better on the exam over the material and they will learn more from the course. At least they will have a higher grade. For a discussion of pre-testing, see Craig Shoulders and Sam Hicks, ―ADEPT Learning System‖, Issues in Accounting Education, May 2008 Volume 23, Number 2, pp 161-182. Financial Facts or Fantasies? These may be used as ―teasers‖ to get the students on the right page with you. Also, they may be used as quizzes after you covered the material or as ―pre-test questions‖ to get their attention. An improved standard of living is one of the payoffs of sound personal financial Fact: The heart of sound financial planning and effective money management is the greater enjoyment of the money one makes by improving one‘s standard of living. A savings account is an example of a tangible asset because it represents something on deposit at a bank or other financial institution. Fantasy: A savings account, like stocks, bonds, and mutual funds, is an example of a financial asset – an intangible, a ―paper‖ asset. Real assets, in contrast, refer to tangibles –physical items like houses, cars, and appliances. Personal financial planning involves translating personal financial goals into specific plans and arrangements that put these plans into action. Fact: Personal financial plans are based on the specific financial goals that you set for yourself and your family. Once in place, the plans are put into action using the various financial strategies explained in this book. Over the long run, gaining only an extra percent or two on an investment makes little difference in the amount of earnings generated. Fantasy: Gaining an extra percent or two on an investment‘s return can make a tremendous difference – often thousands of dollars – that increases the longer the investment is held. Inflation generally has little effect on personal financial planning. Fantasy: Inflation is a vital concern in financial planning. This is because inflation affects not only the prices we pay for the goods and services we consume but also the amount of money we make. If ignored, inflation can wreak havoc on our budgets and financial plans. Your income level depends on your age, education, and career choice. Fact: All three of these variables are important determinants of your income level, particularly when accompanied by adequate ambition and disciplined work habits. Financial Facts or Fantasies? These may be used as a quiz or as a pre-test to get the students interested.
  • 6. 1. True False An improved standard of living is one of the payoffs of sound personal financial planning. 2. True False A savings account is an example of a tangible asset because it represents something on deposit at a bank or other financial institution. 3. True False Personal financial planning involves translating personal financial goals into specific plans and arrangements that put these plans into action. 4. True False Over the long run, gaining only an extra percent or two on an investment makes little difference in the amount of earnings generated 5. True False Inflation generally has little effect on personal financial planning. 6. True False Your income level depends on your age, education, and career choice Answers: 1. True 2. False 3. True 4. False 5. False 6. True YOU CAN DO IT NOW The ―You Can Do It Now‖ cases are primary for the student. They may be used in class to start a discussion of the topic. They will help make the topic more real or relevant to the students. In most cases, it will only take about five minutes of class time. Start a List of Your Financial Goals Yogi Berra summed it up: ―If you don't know where you're going, you might not get there.‖ And so, it is with your financial goals. Pick up some paper now and start a list of your financial goals. Maybe it‘s as simple as saving $25 by the end of the month or as lofty as saving $200,000 for retirement by the time you‘re 50. You‘ll never achieve your goals if you don‘t know what they are, much less know whether they‘re realistic. Go ahead and dream. List your goals (short-term, intermediate, and long-term) and start laying out how you‘ll get there. You can do it now. Start Building an Emergency Fund What would happen if you lost your job, got hurt, or had an unexpected big expense? Even if you‘re not making much money now, you could start building an emergency fund by putting aside even $10 a month. As this chapter points out, your goal is to eventually set aside enough to last at least 6-month. Considering the risk of not doing so, you can do it now. Recognize that YOU are Your Most Important Asset Your greatest asset is YOU. So, it‘s important to build the value of your best asset by investing in your education and career. The amount you can consume, save, and invest is directly related to
  • 7. your earning ability. Consider that over an entire career, the average bachelor‘s degree holder will earn $2.1 million, which is about twice what the typical high school grad earns. (For additional motivating information, see the source of these statistics: The Hamilton Project at the Brookings Institution, http://hamiltonproject.org/earnings_by_major/). It‘s so important to realize you‘re your greatest asset and act on it – you can do it now. Financial Impact of Personal Choices Read and think about the choices being made. Do you agree or not? Ask the students to discuss the choices being made. Andrew Cuts Back on Lunch Out and Lattes Andrew buys lunch out most days and buys a latte every morning. He believes he could cut back a bit and save $5 a day, which is $35 a week and $140 a month. So, what's the impact of this seemingly modest cut-back? If Andrew invests his $35 savings a week every month at 5 percent, he will have the following in the future: 20 years: $57,545 30 years: $116,516 40 years: $213,643 So, the seemingly small act of investing only $5 a day would have a dramatic long-term effect on Andrew's future accumulated wealth. Applying Personal Finance While similar to the ―You can do it now‖ activities, the Applying Personal Finance projects are longer and more involved activities the student can do to better understand personal finance. Generally, the project asked the student to disclose their personal information and data. As a homework assignment, the student will benefit from doing the assignment, but there are no right or wrong answers. Also, there will be a tendency to make up answers that sound good to the student. If you choose to assign these projects, grading will be either check the student did something or not. Or, you could give an A, C, F for a good attempt, an attempt, or no attempt. Taken seriously, the student will benefit from the project. As a graded project, it will be difficult to grade. The Chapter 1 project takes the student to the Exhibit 1.4 and asks the student to examine their financial behavior. Weaknesses may be identified, and the student could change their behavior to be one that is more conducive to building a solid financial plan.
  • 8. Watch Your Attitude! Many people‘s attitude toward money has as much or more to do with their ability to accumulate wealth as it does with the amount of money they earn. As observed in Exhibit 1.4, your attitude toward money influences the entire financial planning process and often determines whether financial goals become reality or end up being pipe dreams. This project will help you examine your attitude toward money and wealth so that you can formulate realistic goals and plans. Use the following questions to stimulate your thought process. a. Am I a saver, or do I spend almost all the money I receive? b. Does it make me feel good just to spend money, regardless of what it‘s for? c. Is it important for me to have new clothes or a new car just for the sake of having them? d. Do I have clothes hanging in my closet with the price tags still on them? e. Do I buy things because they are a bargain or because I need them? f. Do I save for my vacations, or do I charge everything and take months paying off mycredit card at high interest? g. If I have a balance on my credit card, can I recall what the charges were for without looking at my statement? h. Where do I want to be professionally and financially in 5 years? In 10 years? i. Will my attitude toward money help get me there? If not, what do I need to do? j. If I dropped out of school today or lost my job, what would I do? Does your attitude toward money help or hinder you? How can you adjust your attitude so that you are more likely to accomplish your financial goals?
  • 9. Solutions to Financial Planning Exercises 1. Benefits of Personal Financial Planning. How can using personal financial planning tools help you improve your financial situation? Describe changes you can make in at least three areas. Student answers will vary. In general, personal financial planning tools help individuals to organize their finances, evaluate their current financial condition, and track changes in their financial condition throughout their life to see if they are making progress toward their financial goals. Use of budgets and financial statements will provide the information you need to maintain a financial plan. 2. Personal Financial Goals and the Life Cycle. Use Worksheet 1.1. Describe your current status based on the personal financial planning life cycle shown in Exhibit 1.7. Fill out Worksheet 1.1, ―Summary of Personal Financial Goals,‖ with goals reflecting your current situation and your expected life situation in 5 and 10 years. Discuss the reasons for the changes in your goals and how you’ll need to adapt your financial plans as a result. Which types of financial plans do you need for your current situation, and why? Student answers will vary depending on their personal situation. The purpose of this exercise is to encourage students to focus on how their personal goals and plans will change over their financial planning life cycle and to help them be specific in setting their goals by designating dollar amounts and dates. Worksheet 1.1 in the chapter lists examples of financial goals. 3. Personal Financial Goals. Recommend three financial goals and related activities for someone in each of the following circumstances: a. A junior in college b. A 30-year-old computer programmer who plans to earn an MBA degree c. A couple in their 30s with two children, ages 3 and 6 d. A divorced 52-year-old man with a 16-year-old child and a 78-year-old father who is ill Student answers will vary. Suggestions may include the following: a. Junior in college—pay off all credit card debt by graduation; pay off all student loans within 10 years of graduation; save $2,000 for a down payment on another vehicle during the next 3 years. b. 30-year old computer programmer who plans to earn an MBA—pay off auto loan before beginning degree; find a cheaper place to live; set aside $5,000 for emergency use during school.
  • 10. c. Couple in their 30s with two children, ages 3 and 6—begin college fund for each child; fund Roth IRAs for both parents; max out [that is, put as much as you can in plan] employer-sponsored retirement plan, such as 401k, each year. d. Divorced 52-year old man with a 16-year old child and a 78-year old father who is ill—engage the help of friends or family in carpooling teenager to school and activities; explore community or church programs which might provide assistance for the father, such as Meals on Wheels or a visitation program; help father with estate planning needs, hiring an attorney if needed. 4. Life Cycle of Financial Plans. Hudson Ross and Camila Cox are planning to get married in six months. Both are 30 years old and have been out of college for several years. Hudson uses three credit cards and has a bank account balance of $7,500 while Camila only uses one credit card and has $9,500 in her bank account. What financial planning advice would you give the couple? Two issues are presented here: Number of credit cards and number of checking accounts. Having too many credit cards can lower you FICO score and your credit rating because you have the potential of maxing out on each of the cards and getting into financial difficulty. Hudson should reduce his cards to one. Camila should keep her card. Two bank accounts can work okay if the various expenses are allocated between the two spouses. If one spouse has the job of paying all the bills, that spouse needs to have access to all accounts, which defeats the purpose of multiple accounts. Most couples have only one checking account. Here the combined balances are more than they need in their checking account. They should move about half of their $17,000 to an investment account. 5. Impact of Economic Environment on Financial Planning. Summarize current and projected trends in the economy with regard to GDP growth, unemployment, and inflation. How should you use this information to make personal financial and career planning decisions? Answers on economic trends will depend on current economic conditions. If the GDP is growing, the economy is expanding, and general economic conditions are considered favorable. Unemployment is probably low, and jobs are available. If the GDP is slowing, the economy may not be doing well, and jobs may be scarce. Changes in the CPI indicate the level of inflation. If inflation is rising, purchasing power is declining, and you will need more money to achieve your financial goals. In periods of high inflation, interest rates rise making it more difficult to afford big-ticket items. Knowledge of current economic conditions can help you plan the level of savings v spending. In period of inflation, physical assets [such as real estate] are better than financial assets such as saving accounts.
  • 11. 6. Financial Impact of Career Decisions. Brooklyn Hughes and Madison Powell, both freshmen and friends at a major university, are interested in going into a computer sciences career. While they're not just interested in the money they can make, they do want to have a sense of the compensation in that career. What do the data in Exhibit 1.13 tell Brooklyn and Madison? The income level of ―computer science and engineering‖ has a median early career pay of about $72,000 and a median mid-career pay of about $120,000. These salaries are sufficient to provide for a comfortable standard of living in most places. Of course, any of these careers can lead to management positions in large technology companies that can result is a very comfortable standard of living. In summary, computer science careers look favorable for a high [that is a very, very comfortable] standard of living. 7. Career Choices and Financial Planning. Assume that you graduated from college with a major in marketing and took a job with a large consumer products company. After three years, you are laid off when the company downsizes. Describe the steps you’d take to ―repackage‖ yourself for another field. Possible steps to ―repackage‖ yourself might include:  Analyzing skills and experience to identify transferable skills  Looking for companies in related fields and industries  Considering your own interests to see if other career paths make sense  Networking extensively  Researching fields that use your skills  Developing functional resume focusing on skills rather than job titles  Obtaining additional education or training, perhaps obtaining certifications
  • 12. Critical Thinking Cases 1.1 Aaron’s Need to Know: Personal Finance or Golf? During the Christmas break of his final year at the University of Florida (U of F), Aaron Barnes plans to put together his résumé in order to seek full-time employment as a software engineer during the spring semester. To help Aaron prepare for the job interview process, his older brother has arranged for him to meet with a friend, Carolyn Jenkins, who has worked as a software engineer since her graduation from U of F two years earlier. Carolyn gives him numerous pointers on résumé preparation, the interview process, and possible job opportunities. After answering Aaron‘s many questions, Carolyn asks Aaron to update her on what he‘s up to at U of F. As they discuss courses, Carolyn shares that of all the electives she took, the personal financial planning course was most useful. Aaron says that, although he had considered personal financial planning for his last elective, he‘s currently leaning toward a beginning golf course. He feels that the course will be fun because some of his friends are taking it. He points out that he doesn‘t expect to get rich and already knows how to balance his checkbook. Carolyn tells him that personal financial planning involves much more than balancing a checkbook, and that the course is highly relevant regardless of income level. She strongly believes that the personal financial planning course will benefit Aaron more than beginning golf—a course that she also took while at U of F. Critical Thinking Questions 1. Describe to Aaron the goals and rewards of the personal financial planning process. 2. Explain to Aaron what is meant bythe term financial planning and why it is important regardless of income. 3. Describe the financial planning environment to Aaron. Explain the role of the consumer and the impact of economic conditions on financial planning. 4. What arguments would you present to convince Aaron that the personal financial planning course would benefit him more than beginning golf? Aaron’s Need to Know: Personal Finance or Golf? 1. Personal financial planning is a process through which financial plans are developed and implemented to achieve personal financial goals. An individual can develop these goals in a fashion consistent with his or her emotional needs and preferences. As a process, personal financial planning is dynamic and prospective as well as immediate and retrospective. Furthermore, it can be adjusted to changes in goals, emotional orientation, available resources, and the economic environment. 2. Personal financial planning covers the key elements of one‘s financial affairs and provides a plan to achieve financial goals. Income level is one input in the process but does not dictate its importance. An efficient, well-developed personal financial plan can help to maximize an individual‘s wealth and quality of life given his or her income and goals. If desired goals cannot be met with a given level of income, financial planning will
  • 13. help evaluate what is really important, and establish realistic and attainable goals. Thus, financial planning is important regardless of one‘s income. 3. The personal financial planning environment is made up of three key groups, all of which Aaron will contact directly or indirectly. Government establishes an intangible structure in which an economy or society must function. It levies taxes to fund its operations and institutes regulations which direct and control the actions of the participants in the economic environment. Businesses produce goods and services, employ labor, and use land and capital. They receive money as payment for their goods and services and pay wages, rents, interest, and profit. Businesses are a key part of the circular flow of income supporting our economy. Businesses establish the price and availability of goods and services in our economy through competitive interaction with each other and interfacing with government and consumers. Finally, the consumer is the focal point of the financial planning environment. Consumer choices determine the types of products and services businesses provide. Because consumers are net providers of funds to government and businesses, their decisions to spend or save have a major effect on the planning environment. However, government and businesses place a number of constraints on the environment, and consumers must therefore function within those limits. The economy is a dynamic mechanism that reacts to numerous inputs. Economic fluctuations can cause significant changes in one‘s wealth, thereby affecting financial plans. Changes in price levels result from increases in inflation, which can directly affect an individual‘s present and future consumption patterns, level of wealth, standard of living, and quality of life. Changes in economic conditions also affect nearly all aspects of one‘s financial life, from career choices to retirement. Thus, the state of the economy and its fluctuations are important factors defining the financial planning environment and affecting how one implements a financial plan. 4. Although beginning golf would probably provide a great deal of personal satisfaction, personal finance would, in the long run, provide more benefits. The personal finance course will help Aaron better understand the financial environment, thereby allowing him to establish a realistic quality of life and personal financial goals. He could then develop a plan to achieve his goals and a methodology for monitoring the ongoing effectiveness of that plan. With an understanding of the personal finance environment, the financial planning process, and goal setting techniques, Aaron can optimize the use of his assets, provide for a secure financial future, and acquire the resources to realize his quality of life goals. Finally, the rewards achieved from using these financial planning techniques could, in the future, allow Aaron to take not only beginning golf but also intermediate golf and possibly join a golf club in the future.
  • 14. 1.2 Cameron’s Dilemma: Finding a New Job Cameron Foster, a 55-year-old retail store manager earning $85,000 a year, has worked for the same company during his entire 30-year career. Cameron was recently laid off and is still unemployed 10 months later, and his severance pay and 6 months’ unemployment compensation have run out. Because he has consistently observed careful financial planning practices, he now has sufficient savings and investments to carry him through several more months of unemployment. Cameron is actively seeking work but finds that he is overqualified for available lower- paying jobs and underqualified for higher-paying, more desirable positions. There are no openings for positions equivalent to the manager’s job he lost. He lost his wife several years earlier and is close to his two grown children, who live in the same city. Cameron has these options: • Wait out the recession until another retail store manager position opens up. • Move to another area of the country where store manager positions are more plentiful. • Accept a lower-paying job for two or three years and then go back to school evenings to finish his college degree and qualify for a better position. • Consider other types of jobs that could benefit from his managerial skills. Critical Thinking Questions 1. What important career factors should Cameron consider when evaluating his options? 2. What important personal factors should Cameron consider when deciding among his career options? 3. What recommendations would you give Cameron in light of both the career and personal dimensions of his options noted in Questions 1 and 2? 4. What career strategies should today’s workers employ in order to avoid Cameron’s dilemma? This case asks students to consider the long-range implications of career and financial planning. In today‘s business world, changes in the economy and in corporate strategies often result in workforce downsizing. Many students may be faced with the loss of a job during their working years. They may find themselves in Cameron‘s position, overqualified for some jobs and underqualified for others. Knowing what steps to take to avoid this situation is an important aspect of career and financial planning. There are many correct answers to these questions; some possibilities are given below. 1. Important career factors for Cameron to consider when looking for a new job include salary, opportunity for advancement, his transferable skills that could apply to a field other than retailing, availability of benefits, available training programs, types of
  • 15. industries and companies (size, work environment, etc.) that interest him, and tuition reimbursement policies so he can finish his degree. 2. Personal factors that Cameron should take into account as he investigates job opportunities include location/need to relocate (his children live in the area), personal lifestyle needs (is he willing to travel, work overtime, commute further?), type of work situation most suitable for him (managing others, part of a team, level of public contact, etc.), and any personal interests that could open doors to a new career. (There is some overlap between career and personal factors.) 3. Cameron should consider a lower-paying job on a short-term basis and at the same time look for a managerial job in another field. He cannot afford to wait out the recession; his funds will run out in a few months. This two-pronged approach is therefore preferable to one or the other. A job at a lower salary, particularly one with good benefits and a tuition reimbursement policy, would allow him to finish his degree or obtain other job training to qualify for a better position. Because he has no dependents, he should be able to cover his living expenses, although he may have to cut back on some discretionary expenses. He should look in several fields and not limit himself to retailing, particularly if he does not wish to relocate to another area of the country away from his grown children. If he is committed to staying in retailing, he probably will have to move. He needs to determine his personal priorities to make these decisions. We do not have enough information to know what they would be. He may want to participate in some career workshops or get some career counseling to work out some of these issues. 4. There are many strategies today‘s workers can employ to avoid being placed in Cameron‘s position. Staying with one employer and one basic type of work for 25 years, as Cameron did, will be the exception rather than the rule. Job changes, whether voluntary or involuntary, should be made with certain objectives in mind, such as broadening your base of experience and learning new skills—for example, computer skills and management responsibility. Keeping up with industry trends and overall economic conditions is very important. This can alert you to the skills needed for future success and provide advance warning of possible downsizings. Don‘t allow yourself to be ―pigeonholed‖ into one very specific type of job for too long; look for opportunities to transfer within your company or to another firm to get more diverse experience. Think of your capabilities in terms of general skills that can be applied to other jobs, companies, and industries. Develop and maintain a network of professional contacts in firms and industries that appeal to you and be willing to share your knowledge with others who need your help.
  • 16. Test Yourself Questions 1-1 What is a standard of living? What factors affect the quality of life? Standard of living, which varies from person to person, represents the necessities, comforts, and luxuries enjoyed by a person. It is reflected in the material items a person owns, as well as the costs and types of expenditures normally made for goods and services. Although many factors such as geographic location, public facilities, local costs of living, pollution, traffic, and population density affect one‘s quality of life, the main determinant of quality of life is believed to be wealth. 1-2 Are consumption patterns related to quality of life? Explain. Generally, consumption patterns are related to quality of life, which depends on a person‘s socioeconomic strata. This implies that wealthy persons, who are likely to consume non-necessity items, quite often live higher quality lives than persons whose wealth permits only consumption of necessities. 1-3 What is average propensity to consume? Is it possible for two people with very different incomes to have the same average propensity to consume? Why? The average propensity to consume is the percentage of each dollar of a person‘s income that is spent (rather than saved), on average, for current needs rather than savings. Yes, it is quite possible to find two persons with significantly different incomes with the same average propensity to consume. Many people will increase their level of consumption as their incomes rise, i.e., buy a nicer home or a newer car. Thus, even though they may have more money, they may still consume the same percentage (or more) of their incomes as before. 1-4 Discuss the various forms in which wealth can be accumulated. An individual‘s wealth is the accumulated value of all items he or she owns. People accumulate wealth as either financial assets or tangible assets. Financial assets are intangible assets such as savings accounts or securities, such as stocks, bonds and mutual funds. Financial assets are expected to provide the investor with interest, dividends, or appreciated value. Tangible assets are physical items, such as real estate, automobiles, artwork, and jewelry. Such items can be held for either consumption or investment purposes or both.
  • 17. 1-5 What is the role of money in setting financial goals? What is the relationship of money to utility? Money is the exchange medium used as the measure of value in our economy. Money provides the standard unit of exchange (in the case of the U.S., the dollar) by which specific personal financial plans—and progress with respect to these plans—can be measured. Money is therefore the key consideration in establishing financial plans. Utility refers to the amount of satisfaction derived from purchasing certain types or quantities of goods and services. Since money is used to purchase these goods and services, it is generally believed that greater wealth (money) permits the purchase of more and better goods and services that in turn result in greater utility (satisfaction). 1-6 Explain why financial plans must be psychologically as well as economically sound. What is the best way to resolve money disputes in a relationship? Money is not only an economic concept; it is also a psychological one that is linked through emotion and personality. Each person has a unique personality and emotional makeup that determines the importance and role of money in his or her life, as well as one‘s particular money management style. Personal values also affect one‘s attitudes to money. Money is a primary motivator of personal behavior and has a strong impact on self-image. To some, money is of primary importance, and accumulation of wealth is a dominant goal. For others, money may be less important than lifestyle considerations. Therefore, every financial plan must be developed with a view towards the wants, needs, and financial resources of the individual and must also realistically consider his or her personality, values, and money emotions. Money is frequently a source of conflict in relationships, often because the persons involved aren‘t comfortable discussing this emotion-laden topic. Each person may have different financial goals and personal values, leading to different opinions on how to spend/save/invest the family‘s money. To avoid arguments and resolve conflicts, it is essential to first become aware of each person‘s attitude toward money and his or her money management style, keep the lines of communication open, and be willing to listen and to compromise. It is possible to accommodate various money management styles within a relationship or family by establishing personal financial plans that take individual needs into account. Some families are able to avoid conflict by establishing separate accounts, such as yours, mine and household, with a set amount allocated to each account each pay period. This way, no one feels deprived, and enough has been set aside to paythe bills and to meet common financial goals. 1-7 Explain why it is important to set realistically attainable financial goals. Select one of your personal financial goals and develop a brief financial plan for achieving it.
  • 18. Realistic goals are set with a specific focus and a reasonable time frame to achieve results. It is important to set realistically attainable financial goals because they form the basis upon which our financial plans are established. If goals are little more than ―pipe dreams,‖ then the integrity of the financial plans would be suspect as well Students‘ descriptions of the steps to achieve a specific goal will, of course, vary. They should follow the general guidelines in the chapter: define financial goals, develop financial plans and strategies to achieve goals, implement financial plans and strategies, periodically develop and implement budgets to monitor and control progress toward goals, use financial statements to evaluate results of plans and budgets, and redefine goals and revise plans as personal circumstances change. 1-8 Distinguish between long-term, intermediate, and short-term financial goals. Give examples of each. Individual time horizons can vary, but in general individuals would expect to achieve their short-term financial goals in a year or less, intermediate-term goals in the next 2-5 years, and long-term financial goals in more than 5 years. Refer to Worksheet 1.1 for examples of financial goals. In making personal financial goals, individuals must first carefully consider their current financial situation and then give themselves a pathway to reach their future goals. People in the early stages of their financial planning life cycle may need more time to accomplish long-term goals than those who are already established in their careers and may also need to give themselves more flexibility with their goal dates. 1-9 What types of financial planning concerns does a complete set of financial plans cover? Financial plans provide the roadmap for achieving your financial goals. The six-step financial planning process (introduced in Exhibit 1.3) results in separate yet interrelated components covering all the important financial elements in your life. Some elements deal with the more immediate aspects of money management, such as preparing a budget to help manage spending. Others focus on acquiring major assets, controlling borrowing, reducing financial risk, providing for emergency funds and future wealth accumulation, taking advantage of and managing employer-sponsored benefits, deferring and minimizing taxes, providing for financial security when you stop working, and ensuring an orderly and cost effective transfer of assets to your heirs. 1-10 Discuss the relationship of life-cycle considerations to personal financial planning. What are some factors to consider when revising financial plans to reflect changes in the life cycle?
  • 19. Personal needs and goals change as you move through different stages of your life. So, too, do financial goals and plans, because they are directly influenced by personal needs. When your personal circumstances change, your goals must reflect the new situation. Factors such as job changes, a car accident, marriage, divorce, birth of children or the need to care for elderly relatives must be considered in revising financial plans. 1-11 Cooper Bryant’s investments over the past several years have not lived up to his full return expectations. He is not particularly concerned, however, because his return is only about 2 percentage points below his expectations. Do you have any advice for Cooper? The loss of two percentage points on investment returns is anything but inconsequential, particularly if the loss occurs annually over a period of several years. For example, if Cooper had invested $1,000 at an 8 percent return and subsequently had invested all earnings from the initial investment at 8 percent, in 40 years he would have accumulated $21,725 from the initial $1,000 investment. If, on the other hand, he had earned a 10 percent return on the same investment, he would have accumulated $45,259 in 40 years—more than double his return at 8 percent! Clearly, two percentage points over time can make a significant difference! Calculate various rates of return on a $1,000 investment to see that for every 2 percent increase in return, your investment results will more than double over a 40-year period. By carefully considering his investment and banking choices, it is likely that Cooper would be able to get a 2 percent greater rate of return without taking on additional risk. This can be done both by choosing investments and bank accounts that hold down expenses, as well as by finding investments of the same type that have performed better. 1-12 Describe employee benefit and tax planning. How do they fit into the financial planning framework? Employee benefits, such as insurance (life, health, and disability) and pension and other types of retirement plans, will affect your personal financial planning. You must evaluate these benefits so that you have the necessary insurance protection and retirement funds. If your employer‘s benefits fall short of your needs, you must supplement them. Therefore, employee benefits must be coordinated with and integrated into other insurance and retirement plans. Tax planning involves looking at an individual‘s current and projected earnings and developing strategies that will defer and/or minimize taxes. For income tax purposes, income may be classified as active income, passive income, or portfolio income. While most income is currently subject to income taxes, some may be tax free or tax deferred. Tax planning considers all these dimensions and more. Tax planning is an important
  • 20. element of financial planning because it guides the selection of investment vehicles and the form in which returns are to be received. This means that it is closely tied to investment plans and often dictates certain investment strategies. 1-13 ―There’s no sense in worrying about retirement until you reach middle age.‖ Discuss this point of view. This statement reflects a very limited and too often expressed point of view. Due to the inconsistencies and vagaries of our economic system—and of life itself!—the goals of and plans for retirement should be established early in life. If retirement goals are incorporated into an individual‘s financial planning objectives, short- and long-term financial plans can be coordinated. Thus, financial plans can guide present actions not only to maximize current wealth and/or utility, but also to provide for the successful fulfillment of retirement goals. Furthermore, if retirement is desired earlier than anticipated, the plans may still permit the fulfillment of retirement goals. 1-14 Discuss briefly how the following situations affect personal financial planning: a. Being part of a dual-income couple Couples should discuss their money attitudes and financial goals and decide how to manage joint financial affairs before they get married. Take an inventory of your financial assets and liabilities, including savings and checking accounts; credit card accounts and outstanding bills; auto, health, and life insurance policies; and investment portfolios. You may want to eliminate some credit cards. Too many cards can hurt your credit rating, and most people need only one or two. Each partner should have a card in his or her name to establish a credit record. Compare employee benefit plans to figure out the lowest-cost source of health insurance coverage, and coordinate other benefits. Change the beneficiary on your life insurance policies as desired. Adjust withholding amounts as necessary based on your new filing category. b. Major life changes, such as marriage or divorce Major life changes such as marriage and divorce: Marriage. Finances must be merged and there may be a need for life insurance. Divorce. Financial plans based on two incomes are no longer applicable. Revised plans must reflect any property settlements, alimony, and/or child support.
  • 21. c. Death of a spouse The surviving spouse is typically faced with decisions on how to receive and invest life insurance proceeds and manage other assets. In families where the deceased made most of the financial decisions with little or no involvement of the surviving spouse, the survivor may be overwhelmed by the need to take on financial responsibilities. Advance planning can minimize many of these problems. 1-15 What is a professional financial planner? Does it make any difference whether the financial planner earns money from commissions made on products sold as opposed to the fees he or she charges? Unlike accounting and law, the field professional financial planning field is largely unregulated, and almost anyone can call themselves a professional financial planner. Most financial planners are honest and reputable, but there have been cases of fraudulent practice. So, it‘s critical to thoroughly check out a potential financial advisor–preferably interview two or three. Most financial planners fall into one of two categories based on how they are paid: commissions or fees. Commission-based planners earn commissions on the financial products they sell, whereas fee-only planners charge fees based on the complexity of the plan they prepare. Many financial planners take a hybrid approach and charge fees and collect commissions on products they sell, offering lower fees if you make product transactions through them. The way a planner is paid—commissions, fees, or both—should be one of your major concerns. Obviously, you need to be aware of potential conflicts of interest when using a planner with ties to a brokerage firm, insurance company, or bank. Many planners now provide clients with disclosure forms outlining fees and commissions or various transaction costs. 1-16 Discuss the following statement: ―The interactions among government, business, and consumers determine the environment in which personal financial plans must be made.‖ Government, businesses, and consumers are the three major participants in the economic system. Government provides the structure within which businesses and consumers function. In addition, it provides a number of essential services that generally improve the quality of the society in which we live. To create this structure, various regulations are set forth, and to support its activities and provision of essential services, taxes are levied. These activities tend to constrain businesses and consumers.
  • 22. Businesses provide goods and services for consumers and receive money payments in return. They also employ certain inputs in producing and selling goods and services. In exchange they pay wages, rents, interest, and profit. Businesses are a key component in the circular flow of income that sustains our economy. They create the competitive environment in which consumers select from many different types of goods and services. By understanding the role and actions of businesses on the cost and availability of goods and services, consumers can better function in the economic environment and, in turn, implement more efficient personal wealth maximizing financial plans. Consumers are the focal point of the personal finance environment. Their choices ultimately determine the kinds of goods and services that businesses will provide. Also, consumer spending and saving decisions directly affect the present and future circular flows of income. Consumers must; however, operate in the financial environment created by the actions of government and business. Consumers may affect change in this environment through their elected officials, purchasing decisions and/or advocacy groups. Yet, basically, change occurs slowly and tediously, often with less than favorable results. Thus, consumers should attempt to optimize their financial plans within the existing financial environment. 1-17 What are the stages of an economic cycle? Explain their significance for your personal finances. The stages of the economic cycles are expansion, peak, contraction, and trough. Each of these stages relates to real gross domestic product (GDP), which is an important indicator of economic activity. The stronger the economy, the higher the levels of real GDP and employment. During an expansion, employment is high, the economy is active and growing, and prices tend to rise. During an expansion, real GDP increases until it hits a peak, which usually signals the end of the expansion and the beginning of a contraction. During a contraction, real GDP falls into a trough, which is the end of a contraction and the beginning of an expansion. An understanding of these four basic stages, coupled with knowledge of the stage in which the economy is presently operating, should permit individuals to adjust and implement financial actions in order to efficiently and successfully achieve their personal financial goals. 1-18 What is inflation, and why should it be a concern in financial planning? Inflation is a state of the economy in which the general price level is rising. It is important in financial planning because it affects what we pay for goods and services; it impacts how much we earn on our jobs; it directly affects interest rates and, therefore, it affects such things as mortgage and car loan payments. The most common measure of inflation is the consumer price index, which is based on the changes in the cost of a typical ―market basket‖ of consumer goods and services. This can be used to compare changes in the cost of living over time for the typical family. Inflation is measured by the
  • 23. percentage change in the consumer price index from one time period to another, so that as the CPI rises, the cost of living also increases. 1-19. ―All people who have equivalent formal education earn similar incomes.‖ Do you agree or disagree with this statement? Explain your position. Disagree. Although higher levels of education may result in higher levels of income, this does not mean that everyone with a given level of education will achieve a specified level of income. Factors such as age, marital status, geographical location, and career choice also impact a person‘s level of income. A number of other factors, such as the degree of personal motivation and the methods by which one utilizes his or her formal education, can also affect one‘s income level. 1-20 Discuss the need for career planning throughout the life cycle and its relationship to financial planning. What are some of your own personal career goals? Career planning is a critical part of the life cycle of the personal financial planning process. The choice of a career affects the amount you earn. By setting both short- and long-term career goals, you can incorporate them into your financial plans. For example, if you need additional education and/or other training for a particular job, you may include a savings plan to obtain the needed funds. You should reevaluate your career decision periodically to see if it still meets your personal and financial goals. Other important considerations with regard to a specific job (and company) include the earnings potential, advancement opportunities, and benefits, plus how well the job fits your lifestyle and values. In today‘s rapidly changing job environment, you should expect to change careers several times. It is important to keep up with developments in your industry, acquire a broad base of experience, and continue to learn new skills, both general and technical. Each student will, of course, have a different list of personal career goals based upon his or her career orientation and goals. However, responses should include discussion of personal financial planning and associated career planning goals and how a career choice would best fulfill quality of life, standard of living, and wealth maximization objectives. Goals might include getting a bachelor‘s, master‘s or other degree, working in a specific industry, owning one‘s own business, finding a job in a different area of the country or overseas, achieving a desired salary and/or responsibility level by a certain age, or finding a job that meets lifestyle needs.
  • 24. Key Terms average propensity to consume The percentage of each dollar of income, on average, that a person spends for current needs rather than savings. consumer price index (CPI) A measure of inflation based on changes in the cost of consumer goods and services. contraction The phase of the economic cycle when real GDP falls. expansion The phase of the economic cycle when levels of employment and production are high and the economy is growing, generally accompanied by rising prices for goods and services. financial assets Intangible assets, such as savings accounts and securities, that are acquired for some promised future return. financial goals Results that an individual wants to attain, such as buying a home, building a college fund, or achieving financial independence. flexible-benefit (cafeteria) plan A type of employee benefit plan wherein the employer allocates a certain amount of money and then the employee ―spends‖ that money for benefits selected from a menu covering everything from childcare to health and life insurance to retirement benefits. goal dates Target dates in the future when certain financial objectives are expected to be completed. gross domestic product (GDP) The total of all goods and services produced in a country; used to monitor economic growth. inflation A state of the economy in which the general price level is increasing. money The medium of exchange used as a measure of value in financial transactions. peak The phase of the economic cycle when an expansion ends, and a contraction begins. personal financial planning A systematic process that considers important elements of an individual‘s financial affairs in order to fulfill financial goals.
  • 25. professional financial planner An individual or firm that helps clients establish financial goals and develop and implement financial plans to achieve those goals. standard of living The necessities, comforts, and luxuries enjoyed or desired by an individual or family. tangible assets Physical assets, such as real estate and automobiles, that can be held for either consumption or investment purposes. trough The phase of the economic cycle when a contraction ends and an expansion begins. utility The amount of satisfaction received from purchasing certain types or quantities of goods and services. wealth The total value of all items owned by an individual such as savings accounts, stocks, bonds, home, and automobiles.
  • 26. Chapter Outline Learning Goals I. The Rewards of Sound Financial Planning A. Improving Your Standard of Living B. Spending Money Wisely 1. Current Needs 2. Future Needs C. Accumulating Wealth *Test Yourself* II. The Personal Financial Planning Process A. Steps in the Financial Planning Process B. Defining Your Financial Goals 1. The Role of Money 2. The Psychology of Money C. Money and Relationships D. Types of Financial Goals E. Putting Target Dates on Financial Goals 1. Long-term Goals 2. Short-term Goals and Intermediate Goals *Test Yourself* III. From Goals to Plans: A Lifetime of Planning A. The Life Cycle of Financial Plans B. Plans to Achieve Your Financial Goals 1. Asset Acquisition Planning 2. Liability and Insurance Planning 3. Savings and Investment Planning 4. Employee Benefit Planning 5. Tax Planning 6. Retirement and Estate Planning C. Special Planning Concerns 1. Managing Two Incomes 2. Managing Employee Benefits 3. Managing Your Finances in Tough Economic Times 4. Adapting to Other Major Life Changes D. Technology in Financial Planning E. Using Professional Financial Planners F. Types of Planners G. Choosing a Financial Planner *Test Yourself*
  • 27. VI. The Planning Environment A. The Players 1. Government a. Taxation b. Regulation 2. Business 3. Consumers B. The Economy 1. Economic Cycles 2. Inflation, Prices, and Planning *Test Yourself* V. What Determines Your Personal Income? A. Demographics and Your Income B. Your Education C. Where You Live D. Your Career E. Planning Your Career *Test Yourself* Summary Key Terms Financial Planning Exercises Applying Personal Finance Watch Your Attitude! Critical Thinking Cases 1.1 Aaron’s Need to Know: Personal Finance or Golf? 1.2 Cameron’s Dilemma: Finding a New Job Using Financial Statements and Budgets Chapter 2 How Will This Affect Me?
  • 28. A recent survey shows that more than half of adult Americans could not cover 6 months of living expenses or the cost of medical emergencies. And younger millennials between the ages of 18 and 24 are the least prepared*. These are scary findings … and this chapter shows what you can do to avoid being part of these alarming statistics. Everyone knows it‘s hard to get where you need to go if you don‘t know where you are. Financial goals describe your destination, and financial statements and budgets are the tools that help you determine exactly where you are in the journey. This chapter helps you define your financial goals and explains how to gauge your progress carefully over time. Hopefully most of your students have had a semester of financial accounting. If so, while this chapter will be a review for them, they may need help understanding the differences between cash and accrual accounting. The chapter deals with cash accounting; the previous accounting course dealt with accrual accounting. If they have not had an accounting course, the students may have a hard time. If this material is new to them, it will be helpful if you go over worksheets (2.1 and 2.2) and then discuss the Financial Planning Exercises 3 (preparing a balance sheet) and 4 (preparing an income statement). LEARNING GOALS LG1 Understand the relationship between financial plans and statements. The statement above ―it‘s hard to get where you need to go if you don‘t know where you are‖ is very true. There are three basic financial statements: Balance Sheet, Income Statement, and Budget. The balance sheet tells you where you are as of a stated date. The income statement reports the income and expenses of the most recent period, be it a year, quarter or month. The budget is a forward-looking document that reports your plan for the next period [five years, one year, quarter or month]. If your balance sheet is not consistent with your financial goal, you know you need to make some changes. Note the ―Financial Road Sign‖ that discusses the 50/30/20 rule. • 50 percent of income goes to living expenses and necessities (needs), which include rent, utilities, groceries, insurance, and transportation. • 30 percent of income goes to flexible spending (wants), which includes everything you want but don‘t need to buy. Examples are spending money on eating out, movies, and travel. • 20 percent of income goes to meeting financial goals, which are achieved through saving, investments, building up and maintaining an emergency fund, and payments to reduce debts. To get a feel for where your students are in their ability to account for their financial transactions, ask the students if they have a checking account. Then ask them if they know the balance of that account. Exhibit 2.1 presents the impact of the financial statements on the financial plan. The statements give feedback to the plan.
  • 29. LG2 Prepare a personal balance sheet. The Balance Sheet computes the net worth [assets less liabilities] as of a given date. By comparing the current balance sheet with the previous one from a year ago, you can see if you are moving toward your goal, or not. While liquid assets and investments may look the same, their purpose is very different. The liquid assets are available to spend or pay off debt, while the investments are for the long term. Recall that here we are discussing personal balance sheet. Therefore, the concept of depreciation is not the same as with generally accepted accounting principles (GAAP). With GAAP, depreciation is the allocation of a past cost over its useful life. With a personal balance sheet, depreciation is a decline in value – the assets are stated at their market value. Accordingly, it is common for personal property to decline in value and real property to increase in value – though it is not guaranteed. Liabilities are amounts owed to others. The classification as current [due within one year] and long-term is important. The current liabilities have to be paid in the short run, while long-term liabilities may be paid in the future or be paid with a monthly payment – which is a current liability. Worksheet 2.1 gives a format for a personal balance sheet—a fill-in-the-blanks approach that is useful for financial planning. In the chapter, the worksheet includes example data for Dylan and Julia Butler. Note that the worksheet computes the net worth as the assets less liabilities. While it may be computed as the original net worth plus or minus cumulative net income since the individual or family started keeping records, the extra work is not useful. Simply compute as assets less liabilities. Exhibit 2.2 gives the student hope that in the future theywill have a net worth. LG3 Generate a personal income and expense statement. While the balance sheet reports financial position as of a given day, the income statement covers a stated period, typically a month or year. The Financial Planning Exercises Number 4 should lead the students to consider what income is. The exercise asks the question is income gross pay or net pay. If you take the position that it is net pay, you are saying that you have no control over the payroll deductions. But you can control at least some of them and your actions should be consistent with your financial plan. You decide how many exemptions to claim for withholding income taxes. You may have some choice as to what health insurance you select, what life insurance to select, or perhaps other benefits such as childcare or additional health benefits. The expenses you can control are typically referred to as variable expenses and those you have no control over are fixed expenses. You can control whether or not to incur a fixed expense [to have cable TV or not], but once you decide to incur the item it is fixed for future periods. Worksheet 2.2 lists the typical income and expenses items. The example for Dylan and Julia Butler gives the students an example of an income statement. Exhibit 2.3 reports how we spend our after-tax income, at least the average amount we spend for various items.
  • 30. LG4 Develop a good record-keeping system and use ratios to evaluate personal financial statements. Without records, you are flying blind. It‘s like the person who says they can spend money as long as they have a check in their checkbook. Records give you a way to prepare financial reports which allow you to evaluate where you are on your financial plan. There is inexpensive software that will help you keep records, but you still have to record the transactions in order to have data for your financial statements. With financial statements you may use ratio analysis to better understand how you are doing. Exhibit 2.5 gives a list of useful ratios. It will be useful to do some sensitivity analysis, that is, ask the students is it good or bad to move from a solvency ratio of 35% to 50%; liquidity ratio from 13% to 8%; and so on. This will help student understand the information in the ratio. LG5 Construct a cash budget and use it to monitor and control spending. The income statement reports the cash surplus or deficit for the period. But is the surplus of $2,000 good or not. You need something to compare it to. Frequently you compare to the previous period. While that is better than no comparison, comparing to your planned surplus is better. Your planned surplus is the bottom line of your budget. The budget is a statement in dollars of your planned income and expenses for the period, typically month or year. By comparing the current expenses with budgeted expenses, you create a budget variance. That variance tells you if you need to hold the course or change your direction. The actual income or expense compared to the budgeted amount gives you the ability to monitor and control your expenses. Worksheet 2.3 gives a common format for a cash budget, your planned expenditures for the year. The cash budget for Dylan and Julia Butler is an example. Worksheet 2.4 gives an example of comparing actual to budget and the resulting variance. LG6 Apply time value of money concepts to put a monetary value on financial goals. Financial plans are concerned with what future amounts you will need to be able to provide for your desired lifestyle at that time. Since the time is in the future, typically you need to apply the concept called the time value of money, the idea that a dollar today is worth more than a dollar received or spent in the future. Hopefully your students have been exposed to this concept in previous courses. If not, use short time periods [3 or 5 years] to demonstrate the concept. Perhaps use financing of a car as an example: You can pay $20,000 today or $400 per month for 5 years. With a 6% annual rate, the present value of an annuity of $400 per month, for 60 months, at .06/12 monthly rate, is $20,690. If you are OK with a 6% rate, pay cash. The book discusses spreadsheets financial functions such as PV, FV, and PMT. Also, the use of a financial calculator and timelines are discussed. It depends upon the culture of your program whether you use calculators or spreadsheets. The Rule of 72 is very useful for quick comparisons. Discuss it.
  • 31. LG7 Understand the relationship between inflation and nominal interest rates and calculate the real interest rate. The interest rate used in time value of money computations matters. The appropriate rate is the inflation adjusted rate. In the example in the text, the nominal rate of 8% becomes an inflation rate of 4.85% if you expect 3% inflation. The Fisher equation which computes the inflation adjusted rate is discussed. The best way to handle inflation in long-term financial planning decisions is first to consider prevailing forecasts of future inflation. The next step is to incorporate the effect of those inflationary expectations on future cash flows. Then the rates you use to plan are considered inflation adjusted rates. Link to Solutions to Financial Planning Exercises Financial Facts or Fantasies? These may be used as ―teasers‖ to get the students on the right page with you. Also, they may be used as quizzes after you covered the material or as ―pre-test questions‖ to get their attention. • Whereas the balance sheet summarizes your financial condition at a given point in time, the income and expense statement report on your financial performance over time. Fact: A balance sheet is like a photograph of your financial condition (covering just one day out of the year), while an income and expense statement is like a motion picture (covering the full year or some other time period). • Because financial statements are used to record actual results, they‘re really not that important in personal financial planning. Fantasy: Personal financial statements let you know where you stand financially. As such, they not only help you set up realistic financial plans and strategies but also provide a system for monitoring the amount of progress you‘re making toward the financial goals you've set. • A leased car should be listed as an asset on your personal balance sheet. Fantasy: You are only ―using‖ the leased car and do not own it. Consequently, it should not be included as an asset on the balance sheet. • Only the principal portion of a loan should be recorded on the liability side of a balance sheet. Fact: The principal portion of a loan represents the unpaid balance and is the amount of money you owe. In contrast, interest is a charge that will be levied over time for the use of the money. • Generating a cash surplus is desirable, because it adds to your net worth.
  • 32. Fact: You can only increase your net worth by generating a cash surplus, someone giving you additional assets, or through increases in market values. The only one of the three you control is generating cash surplus. • When evaluating your income and expenses statement, primary attention should be given to the top line: income received. Fantasy: If you focus on only income and ignore expenses, you will quickly find yourself with a cash deficit and your net worth will decrease. Expenses are equally important and must be controlled.
  • 33. Financial Facts or Fantasies? These may be used as a quiz or as a pre-test to get the students interested. 1. True False Whereas the balance sheet summarizes your financial condition at a given point in time, the income and expense statement report on your financial performance over time. 2. True False Because financial statements are used to record actual results, they‘re really not that important in personal financial planning. 3. True False A leased car should be listed as an asset on your personal balance sheet. 4. True False Only the principal portion of a loan should be recorded on the liability side of a balance sheet. 5. True False Generating a cash surplus is desirable, because it adds to your net worth. 6. True False When evaluating your income and expenses statement, primary attention should be given to the top line: income received. Answers: 1. True 2. False 3. False 4. True 5. True 6. False YOU CAN DO IT NOW The ―Do It Now‖ cases may be assigned to the students as short cases or problems. They will help make the topic more real or relevant to the students. In most cases, it will only take about ten minutes to do, that is, until the student starts looking around at the web site. But they will learn by doing so. Track Your Expenses It's easy for spending to become so automatic that we're not aware we're doing it. So where does your money go? The only way to find out is to keep track of it. Writing down what you spend in a paper journal or using an app like Expensify (www.expensify.com) is simple and will make you more aware of where your money goes. Knowing where you are will probably make you feel better too - so do it now. Save Automatically We all know we should save regularly. One way to create a savings "habit" is to literally make it automatic.
  • 34. Open a savings account apart from your checking account. This will separate your savings from what you have available to spend. And then set up an automatic deposit to your savings account each month. This sets your "habit." You can do it now. Financial Impact of Personal Choices Read and think about the choices being made. Do you agree or not? Ask the students to discuss the choices being made. No Budget, No Plan: Mason Bought a Boat! Mason is 28 and has a good job as a sales rep. He's always found budgeting boring and has been intending to start a financial plan for years. Recently, Mason went out with some friends on a rented boat to fish. He had a great time and saw a boat sale on his way home. Before he knew it, the salesman convinced Sean that the deal was just too good to pass up. So Mason bought a $10,000 boat and financed 80 percent of the cost for the next 5 years. Sean now finds himself relying more on his credit card to get by each month. What if Mason had kept track of his money, used a budget, and had a set of financial goals? Knowing where his money went and having a financial plan would have increased the chance that Mason would make more deliberate, informed financial decisions. Applying Personal Finance What’s Your Condition? Financial statements reflect your financial condition. They help you measure where you are now. Then, as time passes and you prepare your financial statements periodically, you can use them to track your progress toward financial goals. Good financial statements are also a must when you apply for a loan. This project will help you to evaluate your current financial condition. Look back at the discussion in this chapter on balance sheets and income and expense statements, and prepare your own. If you‘re doing this for the first time, it may not be as easy as it sounds! Use the following questions to help you along.
  • 35. 1. Have you included all your assets at fair market value (not historical cost) on your balance sheet? 2. Have you included all your debt balances as liabilities on your balance sheet? (Don‘t take your monthly payment amounts multiplied by the number of payments you have left—this total includes future interest.) 3. Have you included all items of income on your income and expense statement? (Remember, your paycheck is income and not an asset on your balance sheet.) 4. Have you included all debt payments as expenses on your income and expense statement? (Your phone bill is an expense for this month if you‘ve already paid it. If the bill is still sitting on your desk staring you in the face, it‘s a liability on your balance sheet.) 5. Are there occasional expenses that you‘ve forgotten about, or hidden expenses such as entertainment that you have overlooked? Look back through your checkbook, spending diary, or any other financial records to find these occasional or infrequent expenses. 6. Remember that items go on either the balance sheet or the income and expense statement, but not on both. For example, the $350 car payment you made this month is an expense on your income and expense statement. The remaining $15,000 balance on your car loan is a liability on your balance sheet, while the fair market value of your car at $17,500 is an asset. After completing your statements, calculate your solvency, liquidity, savings, and debt service ratios. Now, use your statements and ratios to assess your current financial condition. Do you like where you are? If not, how can you get where you want to be? Use your financial statements and ratios to help you formulate plans for the future. Solutions to Financial Planning Exercises 1. Preparing Financial Statements: Axel Gibson is preparing his balance sheet and income and expense statement for the year ending June 30, 2020. He is having difficulty classifying six items and asks for your help. Which, if any, of the following transactions are assets, liabilities, income, or expense items? a. Axel rents a house for $1,350 a month. The monthly rent is a monthly expense. The payment will reduce an asset, Cash. b. On June 21, 2020, Axel bought diamond earrings for his wife and charged them using his MasterCard. The earrings cost $900, but he hasn’t yet received the bill.
  • 36. The purchase will result in a new asset, personal property for $900. Since he purchased using a credit card, his current liabilities also increase by $900. Credit card debt is typically due within one month, so it is a current liability. c. Axel borrowed $3,500 from his parents last fall, but so far, he has made no payments to them. Since no loan payments were made during the period, a corresponding expense would not appear. Whether or not the ―loan‖ is a real loan or a gift from the parents is a question of fact to be determined. If real loan, the balance sheet will list a liability of $3,500. If a gift, net worth will increase by the amount of cash received, a direct contribution to his net worth. d. Axel makes monthly payments of $225 on an installment loan; about half of it is interest, and the balance is repayment of principal. He has 20 payments left, totaling $4,500. The income and expense statement will show an expense: payment of loan $225 per month times 12 months, a total for the year of $2,700. When a balance sheet is prepared, the loan balance will be reduced by half of the $225 per month [$112.50] which represent payment of principal. Since it is useful to know the amount of interest being paid, the loan payment may be split into $112.50 interest and $112.50 loan repayment. e. Axel paid $3,800 in taxes during the year and is due a tax refund of $650, which he hasn’t yet received. The payment of taxes is an expense recorded as paid, typically monthly or when paycheck is received. The refund is not recorded on the income and expense statement until it is received. The receivable is not recorded on a cash basis balance sheet. When the refund is received it may be treated as a reduction of tax expense rather than an income item. Doing so will reflect the correct amount of tax paid for the year. f. Axel invested $2,300 in some common stock. The cash asset goes down and the investment asset goes up. The investment will appear on the balance sheet. 2. Projecting Financial Statements: Put yourself 10 years into the future. Construct a fairly detailed and realistic balance sheet and income and expense statement reflecting what you would like to achieve by that time. While everyone's financial statements will differ based on their own expectation of the future, each should have similar elements such as: assets such as a home, automobiles and investments; liabilities such as a mortgage, an auto loan, and consumer debt; and a positive net worth. The statement of income and expense should reflect income from a
  • 37. job or business, investment income, and expenses for items such as home maintenance, food, debt payments, savings, taxes, and insurance. 3. Preparing Personal Balance Sheet: Use Worksheet 2.1. Sadie Richardson’s banker has asked her to submit a personal balance sheet as of June 30, 2020, in support of an application for a $6,000 home improvement loan. She comes to you for help in preparing it. So far, she has made the following list of her assets and liabilities as of June 30, 2020: Cash on hand $ 70 Balance in checking account 180 Balance in money market deposit account with Southwest Savings 650 Bills outstanding: Telephone $ 20 Electricity 70 Charge account balance 190 Visa 180 MasterCard 220 Taxes 400 Insurance 220 1,300 Condo and property 68,000 Condo mortgage loan 52,000 Automobile: 2015 Honda Civic 12,000 Installment loan balances: Auto loans 3,000 Furniture loan 500 3,500 Personal property: Furniture 1,050 Clothing 900 1,950 Investments: U.S. government savings bonds 500 Stock of Commodities Corp. 3,000 3,500 From the data given, prepare Sadie Richardson’s balance sheet, dated June 30, 2020 (follow the balance sheet form shown in Worksheet 2.1). Then evaluate her balance sheet relative to the following factors: (a) solvency, (b) liquidity, and (c) equity in her dominant asset. See following page for Worksheet 2.1 for Sadie Richardson.
  • 38. 3-a. Solvency Ratio: This term refers to having a positive net worth. The calculation for her solvency ratio is as follows: Solvency Ratio = Total Net Worth = $29,550 = 34.22% Total Assets $86,350 This indicates that Sadie could withstand about a 34% decline in the market value of her assets before she would be insolvent. Although this is not too low a value, some thought might be given to increasing her net worth. 3-b. Liquidity Ratio: A simple analysis of Sadie‘s balance sheet reveals that she's not very liquid. In comparing current liquid assets ($900) with current bills outstanding ($1,300), it is obvious that she cannot cover her bills and is, in fact, $400 short (i.e., $1,300 current debt – $900 current assets). Her liquidity ratio is: Liquidity ratio = Liquid Assets = $ 900 = 69.21% Total Current Debts $1,300 This means she can cover only about 69% of her current debt with her liquid assets. If we assume that her installment loan payments for the year are about $2,000 (half the auto loan balance and all of the furniture loan balance) and add them to the bills outstanding, the liquidity ratio at this level of liquid assets is: Liquidity ratio = Liquid assets = $ 900 = 27% Total Current Debts $3,300 This indicates that if she lost income, she could cover only about 27% of her existing one-year debt obligations with her liquid assets—and this does not include her mortgage payment! This is clearly not a favorable liquidity position. 3-c. Equity in Her Dominant Asset: Sadie‘s dominant asset is her condo and property, which is currently valued at $68,000. Since the loan outstanding on this asset is $52,000, the equity is $16,000 (i.e., $68,000 – $52,000). This amount indicates about a 24% equity interest (i.e., $16,000/$68,000) in the market value of her real estate. This appears to be a favorable equity position. However, if Sadie was forced to sale the condo to pay other debt, the selling costs could be 15% of sales price and the distressed sale price could wipe out the balance of her equity Additional Issue: The data is to be used as is. However, used clothes and household furnishings have very little value it they are to be sold. So, the value of her personal property may be overstated. Similarly, the value of the 2015 Honda Civic seems high.
  • 39. Worksheet 2.1, Exercise 3, chapter 2 BALANCE SHEET Name(s)Sadie Richardson Date June 30, 2020 ASSETS LIABILITIES Liquid Assets Current Liabilities Cash on hand $ 70.00 Utilities $ 90.00 In checking 180.00 Rent Savings accounts Insurance premiums Money market funds and deposits 650.00 Taxes Medical/dental bills Certificates of deposit (<1 yr. to maturity) Repair bills Total Liquid Assets $ 900.00 Bank credit card balances 400.00 Investments Dept. store credit card balances 190.00 Stocks $ 3,000.00 Travel and entertainment card balances Bonds 500.00 Gas and other credit card balances Certificates of deposit (>1 yr. to maturity) Bank line of credit balances Mutual funds Other current liabilities 400.00 220.00 Real estate Total Current Liabilities $ 1,300.00 Retirement funds, IRA Long-Term Liabilities Other Primary residence mortgage $ 52,000.00 Total Investments $ 3,500.00 Real Property Second home mortgage Primary residence $ 68,000.00 Real estate investment mortgage Second home Other Auto loans 3,000.00 Total Real Property $ 68,000.00 Appliance/furniture loans 500.00 Personal Property Home improvement loans Auto(s): 2015 Honda Civi c$ 12,000.00 Single-payment loans Auto(s): Education loans Recreational vehicles Margin loans Household furnishing 1,050.00 Jewelry and artwork Other long-term loans Other 900.00 Total Long-Term Liabilities $ 55,500.00 Other (II) Total Liabilities $ 56,800.00 Net Worth [(I) - (II)] $ 29,550.00 Total Liabilities and Net Worth$ 86,350.00 Total Personal Property $ 13,950.00 (I)Total Assets $ 86,350.00
  • 40.
  • 41. 4. Preparing Income and Expense Statement: Use Worksheet 2.2. Ariana and Nicholas Peterson are about to construct their income and expense statement for the year ending December 31, 2020. They have put together the following income and expense information for 2020: Ariana’s salary $47,000 Reimbursement for travel expenses 1,950 Interest on: Savings account 110 Bonds of Delta Corporation 70 Groceries 4,150 Rent Utilities 9,600 960 Gas and auto expenses 650 Nicholas’ tuition, books, and supplies 3,300 Books, magazines, and periodicals 280 Clothing and other miscellaneous expenses Cost of photographic equipment purchased with charge card 2,700 2,200 Amount paid to date on photographic equipment 1,600 Ariana’s travel expenses 1,950 Purchase of a used car (cost) 9,750 Outstanding loan balance on car 7,300 Purchase of bonds in Delta Corporation 4,900 Using the information provided, prepare an income and expense statement for the Peterson’s for the year ending December 31, 2020 (follow the form shown in Worksheet 2.2). See worksheet on following page.
  • 42. Worksheet 2.2 Exercise 4, Chapter 2 hole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use. INCOME AND EXPENSE STATEMENT Name(s) For the [month or year] Ariana and Nicholas Peterson Year Ended December 31, 2020 Income Wages and salaries Name: Ariana Peterson $ 47,000.00 Name: Name: Self-employment income Bonuses and commissions Investment income Interest received 180.00 Dividends received Rents received Sale of securities Other: Reimbursement of travel expenses 1,950.00 Pensions and annuities Other income (I) Total Income $ 49,130.00 Expenses Housing Rent/mortgage payment (include insurance and taxes, if applicable) $ 9,600.00 Repairs, maintenance, improvements Utilities Gas, electric, water 960.00 Phone Cable TV and other Food Groceries 4,150.00 Dining out Transportation Auto loan payments cost less loan, 9750-7300 2,450.00 License plates, fees, etc. Gas, oil, repairs, tires, maintenance 650.00 Medical Health, major medical, disability insurance (payroll deductions or not provided by employer) Doctor, dentist, hospital, medicines Clothing Clothes, shoes, and accessories 2,700.00 Insurance Homeowner’s (if not covered by mortgage payment) Life (not provided by employer) &/or Long-term Care Auto Taxes Income and social security Property (if not included in mortgage) Appliances, furniture, and other major purchases Loan payments Purchases and repairs Personal care Laundry, cosmetics, hair care Recreation and entertainment Vacations Other recreation and entertainment 280.00 Other items Books, tuition, and supplies 3,300.00 Photographic equipment -- amount paid 1,600.00 Travel expenses 1,950.00 Purchase of Delta Corporation Bonds 4,900.00 (II) Total Expenses $ 32,540.00 © 2021 Cengage Learning®. May not be scanned, cop C ie Ad SH orN d e u tp Il n ic ca otm ed e, ( o O rR pD os EtF e Id CItT o) a [(p I)u -( b II li )c ]ly$ accessible w 1 e 6 b ,5 si9 te 0, .0 in 0 w
  • 43. 5. Preparing Cash Budget: Landon and Naomi Gray are preparing their cash budget. Help the Grays reconcile the following differences, giving reasons to support your answers. a. Their only source of income is Landon’s salary, which amounts to $5,000 a month before taxes. Landon wants to show the $5,000 as their monthly income, whereas Naomi argues that his take-home pay of $3,917 is the correct value to show. Like many questions it depends. If the taxes and other payroll deductions are considered out of their control, then only the take home pay would be listed. But, since they have some options in the computation of payroll deductions, the gross pay should be listed. Among the options is the number of exemptions for income tax withholding, the option to purchase health insurance for the non-working spouse through the employer or elsewhere, and perhaps other fringe benefits such as childcare and flexible benefits. b. Naomi wants to make a provision for fun money, an idea that Landon cannot understand. He asks, ―Why do we need fun money when everything is provided for in the budget?‖ By having an allowance for "fun money," the Grays have specifically set aside a certain portion of their income for a little self-indulgence. This will serve three basic purposes: (1) it will give a little financial independence to each member of the family; (2) to a certain extent it allows for a little impulse buying which might further the enjoyment of life under a budget control thus diminishing the possibility of it occurring by taking from another account; and (3) it generally promotes a higher quality of life. The inclusion of "fun money" is probably justified. 6. Identifying Missing Budget Items: Here is a portion of Joshua Sanders’s budget record for a recent month. Fill in the blanks in columns 5 and 6. Note, here the answers are included in bold. They may be deleted if you wish to use in classroom. Item (1) Amount Budgeted (2) Amount Spent (3) Beginning Balance (4) Monthly Surplus (Deficit) (5) Cumulative Surplus (Deficit) (6) Rent $550 $575 $50 -$25 $25 Utilities 150 145 15 5 20 Food 510 475 -45 35 -10 Auto 75 95 -25 -20 -45 © 2021 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
  • 44. Recreation and Entertainment 100 110 -50 -10 -60 7. Personal Cash Budget Use Worksheet 2.3. Prepare a record of your income and expenses for the last 30 days; then prepare a personal cash budget for the next three months. (Use the format in Worksheet 2.3 but fill out only three months and the Total column.) Use the cash budget to control and regulate your expenses during the next month. Discuss the impact of the budget on your spending behavior, as well as any differences between your expected and actual spending patterns. This question requires a personal response that will differ for each student. Therefore, a specific example has not been provided. However, the Critical Thinking Cases in this chapter provide several examples of possible answers to this question; it is recommended that the cases be examined in conjunction with this question. The question provides an effective means to involve the student in the budgeting process. Most students are somewhat amazed when they find out how they have actually been spending their money. Before assigning this question, it is interesting to ask the students to estimate how they actually spend their money. A comparison of their estimates with the actual spending records typically reflects the unconscious manner in which they may be spending. Most students will find that the use of a budget to control and regulate expenses allows them to make more meaningful and satisfying purchases. PLEASE NOTE: Exercises 8 through 10 deal with time value of money, and solutions using Excel, the tables, and the financial calculator will be presented. The factors are taken from the tables as follows: future value–Appendix A; future value annuity–Appendix B; present value– Appendix C; present value annuity–Appendix D. If using the financial calculator, set on End Mode and 1 Payment/Year. The +/- indicates the key to change the sign of the entry, in these instances from positive to negative. This keystroke is required on some financial calculators in order to make the programmed equation work. Other calculators require that a "Compute" key be pressed to attain the answer. © 2021 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
  • 45. 8. Calculating present and future values: Use future or present value techniques to solve the following problems. a. Starting with $15,000, how much will you have in 10 years if you can earn 6 percent on your money? If you can earn only 4 percent? EXCEL TABLE CALCULATOR Use FV function: rate is 6% Table of Future Values, App A 15000 +/- PV FV(rate, term, annual payment, Present value, 0 for end of period) PV * FV factor 6%, 10 yrs. 6 I FV(.06,10,0,15000,0) = $15,000 * 1.791 10 N $26,862.72 $26,865.00 FV $26,862.72 Use FV function: rate is 4% 15000 +/- PV FV(rate, term, annual payment, Present value, 0 for end of period) PV x FV factor 4%, 10 yrs. 4 I FV(.04,10,0,15000,0) = $15,000 * 1.480 10 N $22,203.66 $22,200.00 FV $22,203.66 b. If you inherited $45,000 today and invested all of it in a security that paid a 7 percent rate of return, how much would you have in 25 years? EXCEL TABLE CALCULATOR Use FV function: rate is 7% Table of Future Values, App A 45000 +/- PV FV(rate, term, annual payment, Present value, 0 for end of period) PV * FV factor 7%, 25yrs. 7 I FV(.07,25,0,45000,0) = $45,000 * 5.427 25 N $244,234.47 $244,215.00 FV $244,234.47 c. If the average new home costs $275,000 today, how much will it cost in 10 years if the price increases by 5 percent each year? EXCEL TABLE CALCULATOR Use FV function: rate is 5% Table of Future Values, App A 275000 +/- PV FV(rate, term, annual payment, present value, 0 for end of period) PV * FV factor 5%, 10yrs. 5 I FV(.05,10,0,275000,0) = $275,000 * 1.629 10 N $447,946.02 $447,975.00 FV $447,946.02 © 2021 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
  • 46. d. You think that in 15 years, it will cost $212,000 to provide your child with a 4-year college education. Will you have enough if you take $70,000 today and invest it for the next 15 years at 5 percent? If you start from scratch, how much will you have to save each year to have $212,000 if you can earn 4 percent rate of return on your investments? No, you will have $126.066, which is less than your $212,000 goal. EXCEL TABLE CALCULATOR Use FV function: rate is 4% Table of Future Values, App A 70000 +/- PV FV(rate, term, annual payment, present value, 0 for end of period) PV * FV factor 4%, 15yrs. 4 I FV(.04,15,0,70000,0) = $70,000 * 1.801 15 N $126,066.05 $126,070.00 FV $126,066.05 You will need to deposit $10,587.51 at the end of each year for 15 years in order to reach the $212,000 goal. I am assuming a 4% rate of return on investments. EXCEL TABLE CALCULATOR Use PMT function to determine annual payment Table of Future Values Annuity, App B 212000 +/- FV PMT(rate, term, present value, future value, 0 for end of period) PV / FVA factor 4%, 15yrs. 4 I PMT(.04,15,0,212000,0) = $212,000 / 20.024 15 N $10,587.51 $10,587.30 PMT $10,587.51 e. If you can earn 4 percent, how much will you have to save each year if you want to retire in 35 years with $1 million? You will need to invest $13,577.32 at the end of each year at a rate of 4% for the next 35 years in order to retire with $1 million. EXCEL TABLE CALCULATOR Use PMT function to determine annual saving amount with rate of 4%, to accumulate $1 million Table of Future Values Annuity, App B 1000000 +/- FV PMT(rate, term, present value, future value, 0 for end of period) PV / FVA factor 4%, 35yrs. 4 I PMT(.04,35,0,1000000,0) = $1,000,000 / 73.652 35 N $13,577.32 $13,577.36 PMT $13,577.32 © 2021 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
  • 47. f. You plan to have $750,000 in savings and investments when you retire at age 60. Assuming that you earn an average of 8 percent on this portfolio, what is the maximum annual withdrawal you can make over a 25-year period of retirement? You will be able to withdraw $70,259.08 at the end of each year for 25 years if you retire with $750,000 invested at 8%. If you live beyond 85, you have a problem. EXCEL TABLE CALCULATOR Use PMT function to determine annual withdrawal Table of Present Values Annuity, App D 750000 +/- PV PMT(rate, term, present value, 0 for end of period) PV / PVA factor 8%, 25yrs. 8 I PMT(.08,25,750000) = $750,000 / 10.675 25 N $70,259.08 $70,257.61 PMT $70,529.08 9. Evaluating a Saving Goal: Over the past several years, Natalie Howard has been able to save regularly. As a result, she has $54,188 in savings and investments today. She wants to establish her own business in 5 years and feels she will need $100,000 to do so. a. If she can earn 4 percent on her money, how much will her $54,188 in savings/investments be worth in five years? Will Natalie have the $100,000 she needs? If not, how much more money will she need? If Natalie can earn 4% on her money, $54,188 will be worth about $65,928 in 5 years: EXCEL TABLE CALCULATOR Use FV function: rate is 4% Table of Future Values, App A 54188 +/- PV FV(rate, term, annual payment, Present value, 0 for end of period) PV * FV factor 4%, 5yrs. 4 I FV(.04,5,0,54188,0) = $54,188 * 1.217 5 N $65,927.99 $65,946.80 FV $65,927.99 No, she will fall short by about $34,072. © 2021 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.