Question

CASE 2

Victor and Maria Advise Their Niece

Victor and Maria have always enjoyed a close relationship with Maria's niece Teresa, who graduated from college with a pharmacy degree. Teresa recently asked Maria for some assistance with her finances now that her education debts are coming due. She owes $19,000 in student loans and earns $44,000 per year in disposable income. Teresa would like to take on additional debt to furnish her apartment and buy a better car.

(a) What advice might Maria give Teresa about managing her student loan debt?

(b) If next year Teresa were to consolidate her loans into one loan at 6 percent interest, what advice might Maria give regarding Teresa's overall debt limit using both the debt payments-to-disposable income method and the continuous-debt method? (Hint: Use Table 6-3 on page 183 or visit the Garman/Forgue companion website to calculate monthly payments for various time periods.)

Answer 1

	(a)	Teresa should clear her student loan before taking
		any further loan.
		Since her disposable income is $44,000 per year
		which is higher than the loan outstandingof $19,000,
		she can clear her student loan within a year
	(b)	Debt payments-to-disposable income method
		Limit of Debt Payment to disposable income	15%
		Maximum annualdebt payment=0.15*44000	$          6,600
		Maximum monthly debt payment=6600/12	$              550
		Assuming a 60 month loan, repayment period	60	months
		Monthly interest=6/12=0.5%	0.005
		Uniform series Present Worth Factor(PWF):
		(((1+i)^N)-1)/(i*((1+i)^N))
		i=monthly interest rate=0.005
		N=Number of month=60
		PWF=(((1+0.005)^60)-1)/(0.005*((1+0.005)^60))
		PWF=((1.005^60)-1)/(0.005*(1.005^60))	51.7255608
		Overall Debt Limit=550*51.725561	$        28,449
		This can also be calculted by using excelPV function
		with Rate=0.005,Nper=60, Pmt=-550
		Overall Debt Limit=	$28,449	(Using excel PV function with Rate=0.005,Nper=60, Pmt=-550)
		Continuous-debt method:
		Under this method you should be debt free in 48months
		Repayment period in months	48
		PWF=((1.005^48)-1)/(0.005*(1.005^48))	42.5803178
		Overall Debt Limit=550*42.5803178	$        23,419
		Overall Debt Limit=	$23,419	(Using excel PV function with Rate=0.005,Nper=48, Pmt=-550)