Question

Balance Sheet- Richard called and said that he had compiled a list of assets and would send it. It came a few days later. His assets included a home worth $300,000, approximately $350,000 in securities, two cars worth $40,000 with loans of $15,000 against them, and other assets including jewelry (worth $5,000), art ($5,000), and furniture ($7,000). Richard and his wife had money market funds of $2,000, a bonus due of $5,000 net of taxes, and credit card payments due of $12,000. Their house had a $130,000 mortgage.  He said to assume that his salary will rise 6 percent a year, and his investment income is 11 percent a year (the investment loss came a year ago). His expenses should rise 3 percent a year except for medical, which will grow at a rate of 6 percent yearly, and taxes, which will grow at about 7 percent a year.

Cash Flow- Richard said he was not worried about the losses taken. He would make them up, but Monica insisted that they save additional monies. He wanted to know what I recommended to help him save. He said he knew Monica was secretly putting away part of her household money into an account in her own name. Richard came in with his cash flow statistics below.

Inflows ($)		Outflows ($)
Salary	100,000	Mortgage & Home Maintenance	20,000
Investment Income	8,000	Food	5,000
		Clothing	8,000
		Health Care	6,000
		Transportation	2,000
		Personal	3,000
		Recreation	4,000
		Cars, Entertainment	9,000
		Hobby	1,000
		Gifts & Charity	2,000
		Insurance	6,000
		Taxes	26,000

Debt- Richard and Monica have diametrically opposite points of view on debt. Richard views debt as an opportunity to generate cash to make up for past investment losses. He has asked you whether he should remortgage his house and place the proceeds in the stock market. He says the present time may be appropriate to refinance because market rates for mortgage loans of 6.5 percent are well below his mortgage rate of 8 percent. He wants to use an adjustable rate that provides an even lower 4 percent rate for the first year with rates thereafter 2 percent above the five-year Treasury rate.

Richard wants a 30-year mortgage because he said he doesn’t expect “to go anywhere” and the annual repayments would be low. He said he was thinking about buying a new car. While the existing one worked well, he was tired of it. If cash flows get tight, he isn’t at all averse to using credit card debt. He says that whereas credit card rates are high, the overall impact is not great and “people manage to pay money back.” Monica has listened quietly to Richard with a pained expression on her face, occasionally shaking her head. She says she is afraid of taking on more debt and wants a budget to limit spending of all types.

Case Application Questions:

1. Construct the balance sheet.

2. Would you tell Richard and Monica that it was strong? Why?

3. Complete the balance sheet section of the plan.

4. What recommendations would you have to help them save more?

5. Construct their cash flow statement for this year and the next two years.

6. What do the future cash flow figures indicate?

7. Complete the cash flow section of the plan.

8. What do you think of Richard’s idea of borrowing to place money in the stock market?

9. Do you think the couple should refinance their mortgage?

10. Complete the debt and future budgeting part of the plan.

Answer 1

(i) Current status through balance sheet

Liabilities	amount	assets	amount
Mortgage (against house)	130000	house	300000
Loan Against cars	15000	2 cars	40000
credit card payment dues	12000	securities	350000
Proprietory fund	557000	jewelery	5000
		art	5000
		Furniture	7000
		Money mkt fund	2000
		bonus due to receive	5000
Total	714000	Total	714000

ii) yes, this is a strong balance sheet as we have less amount of mortgage in comparison of assets.

iv) we can refinance our loan as we all know option 1. there is less interest will be charged i.e 6.5% in comparison to what we are paying i.e 8%, through this we can save approx 1.5% of loan principal amount and we have 2nd option that to use adjustable rate i.e floating rate it can be bit risky beacuse it is going to be change every time as that is lower as 4% in first year and thereafter 2% above of 5 year treasury rate. as treasury rate is not given we will assumed it 3%. so, the best option among fixed and floatation rate is floatation rate because it will allow less cash outflow.

(v)

Inflow	current year	1st year	next year
Salary	100000	106000	112360
Investment income	8000	8880	9857
Total inflow	108000	114880	122217
Outflow
Mortgage and home maintenance	20000	20600	21218
food	5000	5150	5305
clothing	8000	8240	8487
healthcare	6000	6360	6742
Transportation	2000	2060	2122
Personal	3000	3090	3183
recreation	4000	4120	4243
car, entertainemnt	9000	9270	9548
hobby	1000	1030	1061
gift and charity	2000	2060	2121
insurance	6000	6180	6365
taxed	26000	27820	28654
total	92000	95980	99050

(vi) There is increasing trend in cash flow as we can see salary is increasing by 6% p.a and investment income is 11% which is higher than the expense rate increasing trend i.e most of expenses are increasing annualy 3% except medical which is 6% and taxes which is 7%. so therefore because of this there is positive trends.

(vii) if he remortgage loan and invest that money is stock market. And the remortgage is for 30 years. - we can do so also as we are seeing that investment income having increasing trend in income of 11% but as stock market is volatile in nature we can not assure that this trend is going for long period and it is also mentioned that the emi is going to be low as the loan period is for 30 year. therefore richard idea of borrowing to place in stock market is viable, but he has to keep himself update for the changes going in market so that in any adverse market situation he will be able to minimize his losses as much as possible.

(ix) refinancing option is also viable as above mentioned