Question

In: Accounting

Gary and Ace are happily married, and have adopted a daughter, Gidget, who is 2 years...

Gary and Ace are happily married, and have adopted a daughter, Gidget, who is 2 years old. They met while attending Lindenwood, and still feel strong loyalty to their alma mater. Gary played on the Lions football team and majored in exercise science. He works as a construction worker, and earns $60,000/year. Ace majored in communications and works for a local radio station selling advertising. He earns $35,000/year. They expect to earn this amount of money annually for the next 30 years. 20% of their income is used to pay taxes and other payroll deductions. They think they can earn an annual rate of return, after inflation, of 6%.

Their home is worth $300,000, and has a $250,000 mortgage. They have two cars, each worth $25,000, and each with a loan of $15,000. If one of them dies, they won't need both cars, so the survivor would sell one of them. They have credit card debt of $10,000. Gary has $50,000 in his 401k, while Ace has $40,000 in his They have other investments totaling $75,000.

Gary wants to have a big party when he die. He wants his ashes spread to the end zone of Harlan Hunter Stadium. He says the Lions as a team are near dead anyway, so why not The cost for this is expected to be $20,000. Ace wants a New Orleans style funeral, with a parade. He wants to be buried in a mausoleum, because he is afraid of worms and doesn't want to be buried in the ground. The cost for his funeral is expected to be $40,000. They want to ensure that if one of them dies, the other will have enough money to pay off the car, home, and credit card bills, and fund the cost of their funerals and burial. They also want to make su that Gidget is provided for, which means they want $2,000/month for her care until she is age 23. They are uncertain whether social security will provide any benefits, as they are convinced that right-wing, zealots will take benefits away from those raised in alternative family situations, so don't plan on any social security income.

Using each of the three methods (Human Life Replacement, Needs Approach, and Capital Re how much life insurance will Ace and Gary EACH need?

Solutions

Expert Solution

Under Human Life Replacement method all the future income which a person is expect to earn for the family is considered net off personal expenses and personal taxes and deductions. The present value of the net future cash income is the amount of life insurance required. Computation:

Human Life Replacement
Gary Ace
Salary per annum      60,000.00      35,000.00
Less: 20% Deductions    -12,000.00       -7,000.00
Net Salary p.a.      48,000.00      28,000.00
Present value factor @6% for 30 years 13.7648 13.7648
Present value of Income        6,60,710        3,85,414

Under Needs approach the expenses incurred on a daily basis for the dependents in family is considered alongwith loans, forseeable expenses and any other special needs are taken into account to arrive at the amount of insurance required. Computation is as follows:

Needs Approach Gary Ace
Gidget annual expenses 24000 24000
Gidget annual expeses for 21 years (2 years to 23 years at 6%)        5,04,000        5,04,000
Home loan mortgage        2,50,000        2,50,000
Car Loan            30,000            30,000
Credit Card Debt            10,000            10,000
401K balance          -50,000          -40,000
Other Investments          -75,000          -75,000
Funeral expenses            20,000            40,000
Present value of 1 car (sold off on death)          -25,000          -25,000
       6,64,000        6,94,000

Under Capital Re Approach only the capital requirements are considered.

Capital Re approach Gary Ace
Home loan mortgage        2,50,000        2,50,000
Car Loan            30,000            30,000
Credit Card Debt            10,000            10,000
Funeral expenses            20,000            40,000
Present value of 1 car (sold off on death)          -25,000          -25,000
       2,85,000        3,05,000

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