Case studies in finance

¶ … Value of Money

Marty and Laura Hall are in a fairly typical situation for many couples in their 30's. Starting up in the workforce after graduating college and not yet having any family responsibilities, their spending and debt accumulation was a little out of control, but not as much as others. Currently their annual combined wages are $75,000 and being in the 28% income tax bracket their approximate net pay per year is $54,000, this of course does not include any other costs such as benefits and state and local taxes, etc. But for the purposes of this case study we will say that they make approximately $4,500 per month net.

The expenses they list for one month are as follows:

Leaving them with approximately $2,600 for all other expenses.

If they wished to start a savings plan to send their daughter to college for 4 years 18 years from now they would need to save between $380 and $400 per month in order to accumulate the $172,000 (assuming 8% compound interest) for a four-year education by her 18th birthday. With college increase costs at 4% per year the current $20,000 would become respectively for each of the four years that she would be going to school: $40,516, $42,137, $43,822, $45,575 approximately. This also does not take into account the fact she may wish to pursue a graduate degree.

Concerning the purchase of a home and using the following parameters:

In order to save the necessary money for this purchase for down payment and closing costs they would have to save approximately $1,377 per month for twelve months.

The following is the breakdown of their mortgage should they purchase a home:

Principal borrowed: $126,000.00 ($140,000 - $14,000 DP)

Annual Payments

Total Payments: 360 (30.00 years)

Annual interest rate: 5.00%

Periodic interest rate: 0.4167%

Regular Payment amount: $676.40

Total Repaid: $243,504.00

Total Interest Paid: $117,504.00

Interest as percentage of Principal: 93.257%

The complete amortization table can be found in Appendix I

This would effectively cut their expense for rent almost in half, of course this does not include taxes and insurance.

Their credit card balance of $10,000 has a minimum payment of 3% of the balance, currently $300 per month. Provided they do not add to the card balance and only make the required minimum payments to the card it would take them almost 20 years to pay off the card and they would have incurred almost $8,000 in interest paid. A payment schedule is included in Appendix II reflecting the minimum payment arrangement. As you can see by month 204 minimum payments become a constant $10.00 and even so it still takes another 43 months to pay off the entire amount. This is of course an unacceptable payment plan for many reasons, mostly the interest involved is excessive and would obviously not be the best choice in paying off such a high interest card. Since this is the most substantial of the debt considered effort should be given to paying this off first.

As regards retirement and preparing to maintain a pretax income of $54,000 for 15 yrs (age 65-80). Based on their current salaries tied to 3% increases over time the couple would receive an annual income of $33,000 from social security benefits leaving a shortfall of $21,000 income per year. Over 15 years this amount to $315,000. But taking into account a constant rate of inflation at 4% the actual dollars needed would be $1,344,448. Over 35 years they would need to save at least 10% of their monthly income or $450 per month until age 65 with a guaranteed interest rate of 8%. These figures assume that they are investing into a qualified non-taxable IRA or 401K plan and do not include any employer contributions.