Question

In: Accounting

Case Application: Financial Statement, Cash, and Debt Analysis Balance Sheet - Richard called and said that...

Case Application: Financial Statement, Cash, and Debt Analysis

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:

Construct the balance sheet.

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

Complete the balance sheet section of the plan.

What recommendations would you have to help them save more?

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

What do the future cash flow figures indicate?

Complete the cash flow section of the plan.

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

Do you think the couple should refinance their mortgage?

Complete the debt and future budgeting part of the plan.

Solutions

Expert Solution

  

Ans A . Balance Sheet

Ans B Balance Sheet of Monica and Richard is strong because they are having a net worth of 5,80,000$. However the investment in MMf is low but the cash balance is ggod at 16000$. Also investment will give sufficient income to repay the debt.

Ans D. Home maintainence and cars entertainment cost around 20% of the expenses, so taking focus on same wil help in savings.

Ans E Cash Flow in the image

.

Ans F and G : CAsh flow show a good cash flow in the coming future and strong cash position as per cash flow.

Ans H : Yes Richard's idea of borrowing from market to invest in stock market beacuse it will give returns @ 11% which is more than the borrowing rate. and yes the couple should refinance their mortgage on the basis of above discussion


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