Question

Richard and Monica had a disagreement between the two concerning educational planning. Richard believed that education was a cost that could be financed from current savings when the kids entered college. Monica said they should begin right now even though no children were planned for at least three years.

Stacy, Monica and Richard’s daughter, was already separated from her husband. She had decided to seek a divorce. Her husband Frank was a corporate executive with a salary of $200,000 a year. They had about $1 million in assets, including a home. All assets were in Frank’s name.

Monica had a brother, Jim, a corporate manager who had $3.2 million in his company’s stock. His job was a little precarious now and the stock formed 90 percent of his marketable assets and 80 percent of his total assets.

Monica’s mother, a widow, had Alzheimer’s and was increasingly unable to remember and operate on her own. She had about $200,000 in her name, which might have to be used to place her in a nursing home. Her doctor said she had no more than three years to live.

Case Application Questions:

What information would you need to answer the couple’s dispute?

Provide an estimated yearly college savings needed assuming that the two wanted to fund for a four-year private school education. Assume a 3 percent college inflation and a 5 percent investment return with annual savings beginning currently and their child being born in three years with college starting at age 18. Make other assumptions as needed. Four-year private institutions: $35,260 a year

What divorce planning recommendations do you have for Stacy? Justify them.

What advice do you have for Jim in both financial planning and investing?

What advice would you give Monica for her mother?

Answer 1

The information needed to answer the couple's dispute is that what is the current yield Richard is getting on his current savings and what is the expected rate of return on the monthly investments Monica plans to have in the case she wants to plan for her kids education from right now. The option where the future value of investments shall be higher when the kid joins college should be adopted for better profitability.

Let us assume yearly college savings is 'X'. Assuming a 3 percent college inflation year-on-year and first year's annual college charge being USD 35,260 a year, the total amount that needs to be paid for child's education is USD 147,515, as shown below. I have assumed this amount needs to be paid upfront.

Particulars (USD)	Year 1	Year 2	Year 3	Year 4	Total
Annual charge of education in private institution	35,260	36,318	37,407	38,530	147,515

Assuming a 5 percent investment return with annual savings beginning currently and their child being born in three years with college starting at age 18, the total investment horizon is for (18+3)= 21 years assuming yearly college savings as 'X'. The total future value at the end of 21 years must be equal to USD 147, 515.

Calculating for X, from the formula X*((1+0.05)^{^21}-1)/0.05 = USD147,515

X = USD4130 approximately.

Stacy should get 50% of the assets Frank owns i.e. USD 1 million and 50% of Frank's annual salary of USD 200,000 as alimony for being his rightful wife. This money she receives now can be reinvested at an annual rate of return of 5% to generate enough money for her living separately.

Jim's overall investment assets portfolio is concentrated in one stock which needs to be diversified to get a better rate of return. Ideally, Jim should sell off his stock in his company which comprises 90 percent of his marketable assets and 80 percent of his total assets as the company is currently not performing well. He can either use the cashflow received from selling this stock and reinvest in high perfroming stocks or invest it in liquid instruments like mutual funds which might generate a higher rate of return than the return teh current stockholdings are generating.

I would request Monica to help her mother in getting the money of USD200,000 in her name invested in a liquid instrument for generating higher return for the next 3 years.