Personal Finance, Fourth Canadian Edition Solution Manual

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NAMEDATEPart 1: Brad MacDonald—A Continuing CaseCASE QUESTIONS1.What is Brad’s financial planning life stage? With respect to his current financial position, what are someof the things that Brad should be considering?Brad is in the Early Career life stage. With respect to his current financial position, Brad shouldconsider following the pay-yourself-first principle. In addition, he should try to manage his debt a littlebetter instead of having his debt manage him. Brad should also consider investing in mutual funds.2.What are Brad’s major goals? Evaluate his goals with respect to how specific, measurable, and realisticthey are. Are these short-term or long-term goals? What additional goals could you recommend toBrad for the short and long term?Brad’s major goals are to: (1) gain control of his personal finances, (2) reduce his credit card balance,and (3) start to save $4000 per year toward retirement. With respect to his first goal, Brad needs tobe more specific with what it means to him to gain control of his finances. Does he just want to meethis monthly expenses, or would he like to have a certain dollar amount left over at the end of eachmonth toward his other goals? Furthermore, this will allow him to measure his progress toward achievinghis first goal. Brad should specify how much he would like to put down on his credit card each monthand at what point he would like to have his credit card paid off completely. Based on his cash flow, hewill be then able to determine how realistic his second goal is. Finally, although Brad has specified howmuch he would like to save for retirement he has not indicated at what age he would like to retire, howlong he will be retired, and what type of lifestyle expenses he will have in retirement. By specifyingthese amounts, he will be able to measure whether or not saving $4000 per year toward retirement isenough. For that matter, a budget plan will help him determine if saving $4000 per year is realistic.3.Prepare personal financial statements for Brad, including a personal cash flow statement and personalbalance sheet. Based on these statements, make specific recommendations to Brad about what he needsto do to achieve his goals of paying off his credit card balance and saving for retirement.Brad MacDonald Worksheet: Part 11

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NAMEDATEPersonal Cash Flow StatementIncomeThis MonthGross monthly pay$4500Total income$4500ExpensesTaxes, CPP, and EI ($4000 - $3380)$1120Rent1600Tenant’s insurance ($240/12)20Car payment400Utilities100Credit card payment250Smartphone210Groceries200Clothes100Car expenses250Entertainment350Total Expenses$4600Net Cash Flows($100)Personal Balance SheetAssetsLiquid AssetsCash$0Chequing account4000Savings account200Other liquid assets0Total liquid assets$4200Brad MacDonald Worksheet: Part 12

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NAMEDATEHousehold AssetsHome$0Car11 000Furniture1500Other household assets0Total household assets$12 500Investment AssetsStocks$1300Bonds0Mutual funds0Other investments0Total investment assets$1300Total Assets$18 000Liabilities and Net WorthCurrent LiabilitiesLoans$0Credit card balance8000Other current liabilities0Total current liabilities$8000Long-term LiabilitiesMortgage$0Car loan10 000Other long-term liabilities0Total long-term liabilities10 000Total Liabilities$18 000Net Worth$0Brad MacDonald Worksheet: Part 13

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NAMEDATEIt is obvious that Brad needs to reduce his expenditures to bring them in line with his income; hismonthly net cash flow is negative. Although other recommendations are plausible, the most obviousareas where Brad can do this are:(1)Move out of the condo (depending on his lease agreement) and return to an apartment similarto the one that he previously occupied. This would result in savings of approximately $400 permonth, which would balance his budget.(2)Reduce the use of his cell phone, which, we’ll assume, will result in an additional $100 per monthin savings.(3)Reduce monthly entertainment expenses by one-half, which will result in an additional $175 permonth in savings.Implementing these three recommendations will result in a reduction of monthly expenses of$675 and will generate an excess of income over expenses of $575 per month ($675 – $100).I would also recommend to Brad that he develop a monthly cash budget and closely monitor allexpenses each month against this budget.These actions would enable Brad to save $575312 months5$6900 per year. In turn, this wouldenable him to save $4000 per year and to pay off his credit card balance in less than three years:$575312 months5$6900 per year2$4000 savings5$2900 to credit cards per year. If Braddoes not start saving $4000 per year for another five years, he can pay off his $8000 credit cardbalance in just over one year.As mentioned above, I would recommend that Brad establish a monthly budget and set a goal ofkeeping his expenditures within budgetary limits. I would also recommend that Brad begin saving forretirement as soon as he has paid his credit card balance. Brad is probably paying a high interest rateon his credit card debt. Consequently, it would make more sense for Brad to pay his credit card debtbefore investing for retirement. Brad should not wait five years to begin saving for retirement, as thiswould result in a loss of compounded interest.Brad MacDonald Worksheet: Part 14

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NAMEDATE4.Calculate Brad’s current ratio, liquidity ratio, debt-to-assets ratio, and savings ratio. What do these ratiostell you about how Brad is managing his financial resources?Current ratio5liquid assets/current liabilities5$4200/$80005$0.525. Brad has insufficientliquid assets to cover his upcoming payments. For every dollar of liabilities, Hasan has approximately$0.53 in liquid assets.Liquidity ratio5liquid assets/monthly living expenses5$4200/($4600 – $1120)51.207. Withhis present level of liquid assets, Brad is able to cover a little more than one month’s worth of livingexpenses. Although Brad has sufficient liquidity for his upcoming payments, he has inadequateliquidity if he were to face an emergency, such as an injury or illness.Debt-to-assets ratio5total liabilities/total assets5$18 000/$18 00051 or 100%. Althoughit appears that Brad carries a significant amount of debt, this is not unusual for the Early Career lifestage. Over time, his debt-to-assets ratio should decrease from its current level.Savings ratio5savings during the period/disposable income during the period52100/338052(.0296) or22.96%. Based on his current spending patterns, Brad is not in a position to save aportion of his disposable income. Brad must reevaluate his spending habits if he is to achieve his goalsof paying off his credit card and saving for retirement.5.Consider Brad’s goal to retire in 20 years by saving $4000 per year starting five years from now.a.Based on your analysis of Brad’s cash flow and your recommendations, is saving $4000 per year arealistic goal? If not, what other goal would you advise?As explained in Question 3, with certain reductions in current expenditures, Brad can realisticallyachieve his goal of saving $4000 per year in less than a year (assuming he pays his credit cardbalance first).b.In order for Brad to know what his $4000 per year will accumulate to in 20 years, what additionalassumption (or piece of information) must he make (or have)?In order for Brad to determine his total accumulated savings, he will need to make certain assumptionsabout the rate of return that he can earn annually on his $4000 per year in savings.Brad MacDonald Worksheet: Part 15

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NAMEDATEc.Assuming that Brad invests the $4000 per year for 20 years, starting five years from now, and achievesan annual return of 9 percent, compounded monthly, how much will he accumulate in 25 years?P/Y51, C/Y512, N520, I/Y59, PV50, PMT5$4000,FV5$213 594.17d.Compare the alternative of investing $4000 every year for 25 years beginning today, with Brad’s planto invest $4000 every year for 20 years beginning five years from now. How much will Brad have to saveeach year to accumulate the same amount that he would have had in 25 years if he started saving nowinstead of five years from now? (Again, assume a 9 percent annual return, compounded monthly.)If Brad starts saving now, he will have to save $2382.92 each year to accumulate the same amount in25 years, calculated as:P/Y51, C/Y512, N525, I/Y59, PV50,PMT5$2382.92, FV5$213 594.176.Develop three or four suggestions that could help Brad reduce his income tax exposure.Suggestions to Reduce TaxesProsConsIn order to reduce his income tax exposure,(a)Brad should review his financial situation to determine if he can take advantage of any deductionsthat he may not be aware of, such as carrying charges and/or professional dues.(b)If Brad is able to cut back on his expenditures as outlined above, he may be able to make RRSPcontributions that would provide him with a dollar-for-dollar deduction against his current income.However, any RRSP contributions made would reduce his ability to quickly pay off his credit cardbalance and/or his car loan. In order to offset this trade-off, Brad could apply the tax refundgenerated by the RRSP contribution against one or both of his debt obligations.(c)As a salesperson, Brad may be eligible to deduct employment expenses that he may not be aware.For example, an employee may be able to deduct expenses if they maintain a work space at home.There are strict conditions for this type of employee deduction. Brad should review CRA guideT4044 - Employment Expenses to determine if he would be eligible employee expense deductions.Brad MacDonald Worksheet: Part 16

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NAMEDATE(d)Brad should review how effectively he is using his tax credits. In particular, charitable contributionsare effective at reducing tax for individuals because the tax credit earned is calculated based onthe highest federal marginal income tax bracket of 29 percent. Since Brad’s income falls below thismarginal tax threshold, every dollar that he contributes to a qualifying charity will reduce his taxpayable by more than what he had paid in tax on that dollar.Brad MacDonald Worksheet: Part 17

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How to achieve the goalAssess alternative plans available and choose the most appropriate plangiven the financial situation.How to implement the planSharon decided saving $500 a month is the best plan; deposit the moneyin a liquid investment, such as a savings account.How to evaluate the planSharon should monitor the progress to ensure that saving $500 each monthis not too ambitious and is realistic.NAMEDATEChapter 1: The Sampsons—A Continuing CaseCASE QUESTIONHelp the Sampsons summarize their current financial position, their goals, and their plans for achieving theirgoals by filling out the following worksheets.Current Financial PositionMajor AssetsAmountSavings (high, medium, or low)LowMoney owed$150 000 mortgage, $2000 credit card balanceSalaryThe Sampson’s income was $54 000, but will now be about$66 000 since Sharon just started a part-time jobFinancial GoalsGoal 1. Purchase a New Car for Sharon This YearGoal 2. Pay for the Children’s Post-Secondary Education in 12–17 Years from NowHow to achieve the goalAssess alternative plans available and choose the most appropriate plangiven the financial situation and the savings necessary for Sharon’s new car.How to implement the planThe Sampsons decided saving $300 a month is the best plan. Long-terminvestments, such as a tax-deferred education account (RESP), should beconsidered as investments.How to evaluate the planThe Sampsons should monitor the progress to ensure they are saving $300each month, especially given the additional savings for Sharon’s new car.The Sampsons Worksheet: Chapter 11

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NAMEDATEGoal 3. Set Aside Money for RetirementHow to achieve the goalSet aside a manageable and realistic amount each month towardretirement. This amount is currently contingent on meeting their other,shorter-term plans of buying a new car and saving for their children’spost- secondary education.How to implement the planSeek the advice of a financial adviser to assess different investmentoptions, such as stocks or bonds. The Sampsons should be aware thatadvisers may exaggerate the potential of investments and may recommendinvestments that give the adviser high commissions.How to evaluate the planThe Sampsons should monitor their progress to ensure they are saving atleast some money for retirement. Since this is a very long-term goal, anannual assessment of their retirement savings is appropriate.The Sampsons Worksheet: Chapter 12

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NAMEDATEPart 2: Brad MacDonald—A Continuing CaseCASE QUESTIONS1.What factors should Brad consider in selecting a financial institution?Brad should consider the convenience of making deposits and withdrawals, including ABM locationsand the availability of Web-based access. He should also consider interest rates paid to depositors andminimum balance requirements. Finally, Brad should consider fees such as service charges, per chequecharges, and ABM-use charges.2.If Brad’s shares double in value over the next five years, what annual return, compounded monthly, would herealize? Based on his projected annualized return, would it be advisable to sell the shares to pay off his creditcard? Should Brad consider shopping for a new credit card? If so, how should he go about doing this?If Brad is projecting that his stocks will double in the next five years, then the annual return,compounded monthly, that he will realize is 13.94%, computed as follows:P/Y512, C/Y512, N560,I/Y513.94, PV5 21300, PMT50, FV52600Since there is no PMT being made, you may, assume any P/Y and adjust N to find the same:P/Y51, C/Y512, N560,I/Y513.94, PV5 21300, PMT50, FV52600Comparing this to the 21 percent interest rate, compounded daily, that he is paying on his credit card,the best decision is, therefore, to liquidate the stock and use the proceeds to pay down his credit cardbalances. This is true even if the stock Brad owns do double in value over the next five years.Brad should also be advised to shop for a new credit card, considering the number of “fee-less” creditcards on the market today whose interest rates may be as low as 9 or 10 percent. A few internet searcheswill allow Brad to compare at least two or three credit cards with no fee and low interest rates.3.Address Brad’s reluctance to pay off his credit card balance. Show him what he could earn in five years if hepaid off the credit card balance and invested the required minimum monthly payment saved at 6 percent,compounded monthly. NOTE: The required minimum monthly payment is 3 percent of the outstandingbalance of $8000.To convince Brad to pay off his credit card balance, point out to him that it is unlikely that he wouldrealize a 21 percent annual return on his stocks over five years. If Brad were to sell his stocks and usethe proceeds to pay off his credit card balance, he would not pay the monthly minimum payments of$245 (3%3$8000). Instead, he could invest the $240 minimum payment per month at an annualrate of 6 percent, compounded monthly, accumulating over $16 744.81 in five years, calculated as:P/Y512, C/Y512, N560, I/Y56, PV50, PMT5 2240,FV516 744.81Brad MacDonald Worksheet: Part 21

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NAMEDATE4.Assume that Brad has managed to pay off his credit card and no longer has a required minimum monthlypayment of $250. All other expenses remain the same. Refer to Brad’s personal cash flow statement thatyou developed in Part 1 and recompute his personal cash flow statement:Given no credit card payment, with all other expenses staying the same, Brad’s Personal Cash FlowStatement shows a Positive Net Cash Flow of $150:Personal Cash Flow StatementIncomeThis MonthGross monthly pay$4500Total Income$4500ExpensesTaxes, CPP, and EI ($40002$3380)$1120Rent1600Tenant’s insurance ($240/12)20Car payment400Utilities100Credit Card Payment250Smartphone210Groceries200Clothes100Car expenses250Entertainment350Total Expenses$4600$150Net Cash FlowsSince Brad made the decision to closely monitor his expenses and reduce his smartphone andentertainment expenses, Brad’s revised cash flow statement is shown below. Note that he now hasa positive net cash flow of $350 because he has managed to cut his monthly expenses by a total of$450. In this scenario, he saved $250 monthly due to having no credit card payment, $50 onsmartphone expenses, and $150 on entertainment expenses. This results in an overall PositiveNet Cash Flow of $350.Brad MacDonald Worksheet: Part 22

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NAMEDATEPersonal Cash Flow StatementIncomeThis MonthGross monthly pay$4500Total Income$4500ExpensesTaxes, CPP, and EI ($40002$3380)$1120Rent1600Tenant’s insurance ($240/12)20Car payment400Utilities100Smartphone160Groceries200Clothes100Car expenses250Entertainment200Total Expenses$4150Net Cash Flows$350Determine if Brad can afford to:a.Purchase the new car.If Brad purchases the car that he discussed and finances it at 8 percent for four years, a financialcalculator or website shows that his monthly car payments will amount to $488:P/Y512, C/Y512, N548, I/Y58, PV520 000,PMT52488.26,FV50Monthly car payment calculators can be found by searching for “calculators for car payments.”This exceeds his current car payment of $400 by more than $88. You should also mention to Bradthat not only will his car payment increase with the purchase of his new vehicle, but very likely hiscar insurance will increase as well. (SUVs are one of the highest insurance cost categories for carinsurance.) Purchasing the new car would result in Brad’s current monthly cash surplus being reduced.You need to mention to Brad that this will greatly restrict his ability to save for other goals such as hisdesired retirement.Brad MacDonald Worksheet: Part 23

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NAMEDATEb.Lease the new car.Brad’s idea to lease a car will result in lease payments of approximately $400 per month.Considering that Brad’s current three-year-old car has 87 000 kilometres on it (an average of29 000 kilometres per year), he should also expect to incur additional kilometre charges over andabove the $400 per month lease payment. At a rate of $0.35 per kilometre, Brad will incur anextra monthly charge of $145.83, calculated as ((29 0002240 000) * 0.35)412. You shouldalso remind Brad that in three years he will have no vehicle to show for his $400 per month leasepayment. At the end of the three-year lease term, the cumulative value of his $400 per monthlease payment and extra kilometres charges will exceed the cumulative value of his current $400payment. Although there is no immediate reduction of his monthly cash surplus, Brad will have topay an extra $5250 ($145.83/month * 36 months) at the end of the lease for the extra kilometreshe will have driven based on his past driving history. This will impact his future ability to save for hisother financial goals. Furthermore, Brad must pay a security deposit of $800 when signing the lease,which can be paid from the $5000 cash surplus he will have after selling his car for $15 000 andpaying off the $10 000 mortgage. This leaves him $4200 to put toward his credit card debt.c.Purchase the condo.Purchasing the condo would lower Brad’s overall housing costs by approximately $223 per month.Using RBC Royal Bank to calculate mortgage payments (https://www.rbcroyalbank.com/cgi- bin/mortgage/mortcalc.pl),we find that Brad’s mortgage payment would be approximately $712.22assuming the 6% is compounded semi-annually (as per the bank act) and paid per month (assuminga mortgage of $126 000 at 6 percent for 30 years). Adding to this the $150 per month in taxes($1800/12), the $70 per month condo fee, a $20 per month ($240/12) increase in householdinsurance, and $125 per month in heating costs, you will come up with a total of $1077.22. This is$222.78 less than Brad’s current rent of $1300. The problem would be for Brad to secure the$19 620 needed for the down payment of $14 000, closing costs of $3100, and CMHC feesof $2520 (126 000 * 2%). Unless he could secure this from family members, the increased debtpayment would more than offset the $222.78 per month savings from the purchase of the condo.Brad MacDonald Worksheet: Part 24

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NAMEDATEd.Purchase the car and the condo.In reviewing the calculations in (a) and (c) above, Brad cannot afford to purchase both the SUV andthe condo without significantly reducing his monthly cash surplus which is needed to reach othergoals. The only way for Brad to afford both the SUV and the condo is to increase his debt level. GivenBrad’s goal to reduce his credit card debt, this is currently not the best course of action.e.Lease the car and purchase the condo.Again referring to the computations above in (b) and (c), it is apparent that Brad’s cash flow will notallow him to both lease the car and purchase the condo without significantly reducing his monthlycash surplus needed to reach other goals.5.Based on the information you provided, Brad decides not to buy the condo at this time. How can he savethe necessary funds to purchase a condo or house in the future? Be specific in your recommendations.By selling his stock and making changes to his financial situation, he can earmark a significantportion of the resulting $350 cash surplus for down payment accumulation. Investing the fundsin an aggressive investment that could potentially yield 10 percent, Brad could accumulate thenecessary funding for a down payment in a relatively short period of time. For example, assumingBrad saves $250 per month at an annual interest rate of 10 percent compounded monthly, he couldaccumulate $19 359 in just five years. This amount would be sufficient to cover the down paymentand closing costs required on his targeted home. If Brad feels like investments earning 10% are toorisky, he can instead choose to invest in a less aggressive investment and take more time to savethe same amount. If Brad can one day pay for the down payment and closing costs, owning thehome will save Brad money on a monthly basis, since he will not have to pay the rent of $1300 permonth anymore.6.In talking to Brad, you mention the increasing threat of identity theft. Brad seems concerned, and afterasking him several questions, you determine the following:a.Brad has several credit cards in his wallet but uses only one regularly. He also carries his social insurancecard, as he can never remember the number.b.Brad recycles, including old invoices, credit card statements, and bank statements after retaining themfor the appropriate legal time period.Brad MacDonald Worksheet: Part 25

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NAMEDATEc.Brad uses his smartphone for virtually all his telephone calls, including ordering merchandise and payingby credit card.Comment on each of these points in terms of the risk of identity theft, and make recommendations toBrad for appropriate changes that will reduce his risk of exposure to identity theft.a.Brad has several credit cards in his wallet but uses only one regularly. He also carries his social insurancecard, as he can never remember the number.Brad should keep the amount of identification in his wallet, including credit cards, to a minimum. Inaddition, Brad does not need to regularly carry his social insurance card in his wallet. If needed, heshould use other forms of identification when possible.b.Brad recycles, including old invoices, credit card statements, and bank statements after retaining themfor the appropriate legal time period.Brad should protect his personal information by ensuring that the items he is recycling, including oldinvoices, credit card statements, and bank statements, are shredded.c.Brad uses his smartphone for virtually all his phone calls, including ordering merchandise and paying bycredit card.Brad should avoid ordering merchandise and paying by credit card unless he has initiated the contactor knows with whom he is dealing with.Brad MacDonald Worksheet: Part 26
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