Preparing for the Final Exam Review

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Preparing for the Final Exam Review 1

• Personal Finance
• Another Perspective

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Preparing for the Final Exam

• How to do well on my exams (by order of what I
  think is most important)
• 1. Review the previous quizzes
• Check your answers on Blackboard
• 2. Review the PowerPoints and case studies from
  each class
• These are the things I consider important
• Especially look for application problems
• 3. Review your 7 3x5 note cards (you can
  write on both sides) or write up a good one-sided
  reference sheet (8.5 x 11)
• 4. Review the syllabus (4 objectives)
• Think through the purpose for each case study

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Review Problems

• 1. Financial Statements
• 2. Consumer Loans
• 3. Housing Loans
• 4. Income Taxes

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1. Financial Statements

• Data
• Mickey and Minnie, both recent BYU graduates of 5
  years, together get paid 4,500 every month.
  Monthly expenses include 750 on taxes, 550 on
  charitable contributions, 1,000 on housing and
  utilities, 600 on transportation, 400 on food,
  and an average of 750 on clothing and other
  expenses. Assume the remainder goes into
  savings.
• Calculations
• Prepare an income statement using the better
  method and then calculate and interpret their
  net and gross savings ratio.
• Application How are they doing?

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Both get 4,500 every month. Monthly expenses
include 750 on taxes, 550 on charity,1,000 on
housing and utilities, 600 on transportation,
400 on food, and an average of 750 on clothing
and other expenses. Calculate and interpret their
net and gross savings ratio. How are they
doing?
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Both get 4,500 every month. Monthly expenses
include 750 on taxes, 550 on charity,1,000 on
housing and utilities, 600 on transportation,
400 on food, and an average of 750 on clothing
and other expenses. Calculate and interpret their
net and gross savings ratio. How are they
doing?

• Income Statement
• Income before Tax 4,500
• Taxes 750
• Pay the Lord Charity 550
• Pay themselves - savings 450
• Expenses
• Utilities/Housing 1,000
• Transportation 600
• Food 400
• Clothing/other 750
• Remainder 0
• Note what they have left over they pay
  themselves as savings

Net Savings Ratio (2) Income for Savings 450
12 Income for Living 3,750
They save 12 of their net living expenses and
10 of their gross. While this is likely low,
given they are only 5 years beyond college, it is
the minimum for most people. I would hope it is
closer to 20 for those in this class!
Gross savings ratio Income for savings / Total
Income 450 / 4,500 10
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2. Consumer Loans

• Data
• Jonathan needs approximately 2,500 to buy a new
  computer. A 2-year unsecured loan is available
  with in-store financing for 10. The current
  rate on his revolving home equity line of credit
  is 5.75, although he is reluctant to use it.
  Jon is in the 28 federal tax bracket and the
  5.75 state tax bracket.
• Calculations and Application
• a. What are the advantages and disadvantages of
  each loan? b. Regardless of the loan chosen,
  Rich wants to pay off the loan in 24 months.
  Calculate the monthly payments for him, assuming
  both loans use the simple interest calculation
  method. c. Which loan should he choose?

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Jonathan needs 2,500. A 2-year in-store
unsecured loan is 10 percent. The revolving home
equity line of credit is 5.75. Jon is in the
28 federal and the 5.75 state tax bracket. a.
What are the advantages and disadvantages of each
loan? b. Rich wants to pay off the loan in 24
months. Calculate the monthly payments.
9
Jonathan needs 2,500. A 2-year in-store
unsecured loan is 10. The revolving home equity
line of credit is 5.75. Jon is in the 28
federal and the 5.75 state tax bracket. a.
What are the advantages and disadvantages of each
loan? b. Rich wants to pay off the loan in 24
months. Calculate the monthly payments. c.
Which loan should he take?

• A. Advantages and Disadvantages
• Unsecured line of credit
• No collateral needed
• Cheaper than a credit card
• Does not put the house at risk
• - Expensive
• Home equity loan
• interest may be tax deductible
• secured loan so lower rate
• - Fail to repay loan--may lose the house

10
Jonathan needs 2,500. A 2-year in-store
unsecured loan is 10. The revolving home equity
line of credit is 5.75. Jon is in the 28
federal and the 5.75 state tax bracket. a.
What are the advantages and disadvantages of each
loan? b. Rich wants to pay off the loan in 24
months. Calculate the monthly payments. c.
Which loan should he take?

• B. The unsecured loan monthly payment would be
• PV -2,500, I 10/12, N 24, PMT ?
• 115.36
• The home equity loan monthly payment would be
• PV -2,500, I 5.75/12, N 24, PMT ?
• 110.52
• The home equity loan would save 116.16. In
  addition, the loan would save 51.46 in taxes
  based on the deductibility of the interest
  Total Cost (110.5224) less amount received
  -2500 tax rate of 33.75 (28 Federal 5.75
  state).
• What Jonathan has to decide is whether or not the
  167.62 in total savings is worth the risk of
  losing the house if he cannot repay the loan. I
  would be very careful with this decision!

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Jonathan needs 2,500. A 2-year in-store
unsecured loan is 10. The revolving home equity
line of credit is 5.75. Jon is in the 28
federal and the 5.75 state tax bracket. a.
What are the advantages and disadvantages of each
loan? b. Rich wants to pay off the loan in 24
months. Calculate the monthly payments. c.
Which loan should he take?

• C. Either answer is ok, depending on the why.
  The home equity loan is cheaper, with tax
  savings. The unsecured debt does not risk losing
  the house. It would be helpful to know whether
  he is living on a budget and if he has the
  discipline to pay back the loan quickly.
• The after-tax cost of the 5.75 home equity loan
  would be 3.81 using the following calculation
  that considers the tax savings on both federal
  and state taxes
• 3.81 5.75 1 -(.28 .0575)

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3. Housing Loans

• Data
• You have made the decision to purchase a house,
  and you found the house you want for 200,000
  (assume no down-payment for the sake of this
  problem). You and your wife have agreed to a
  30-year loan, but expect to pay it off in 7 years
  as your work looks extremely promising (assume
  annual payments). Your wife looked on the web,
  and found a 200,000 loan with no points and no
  fees at 6.5, which she is sure, she can lock in.
  You talked with your friend who is a mortgage
  broker, and he knows he can get you a 6.0 loan
  for the 200,000, but it has 2 points and a loan
  origination fee of 1,500. Assume you can get
  either of these loans.
• Calculations and Application
• Calculate the (a) total costs for each loan
  assuming you pay them both off in 7 years (assume
  you make the final balloon payment at the end of
  year 7). (b) What is the effective interest rate
  of each loan? (c) Which is the cheaper
  alternative? (d) Your broker comes back and says
  she can offer you 5.75 but with 3 points and the
  same 1,500 fees. What is effective cost to you
  (i.e. the impact on your effective interest rate)
  of that third point (i.e. calculate it with the
  three points and fees, then compare that to your
  calculation with 2 points and fees, and subtract
  the difference)?

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Quick Review of EIR Process
3. Calculate the balloon payment due at the end
of the prepayment period
1. Calculate the payments on the total amount of
the loan
4. Set PMT to payment, -PV to amount received,
FV to balloon payment, N to years before
prepayment, and solve for I or your EIR
2. Calculate the amount received after
subtracting all your costs
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Loan A 200,000, 30-year, no points and no fees,
6.5, Loan B 200,000, 6, 2 points, 1,500 fees,
all pay it off in 7. Calculate total costs for
each loan, effective rate, cost of 2nd point.
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Loan A 200,000, 30-year, no points and no fees,
6.5, Loan B 200,000, 6, 2 points, 1,500 fees,
all pay it off in 7. Calculate total costs each
loan, effective rate, and Loan C of 5.75, 3
points, 1,500 fees, all pay it off in 7.

• Loan A since no points and fees, the EIR APR
• Loan B
• 1. Calculate the Payment
• I 6.0 N 30 PV -200,000, PMT 14,529.78
• 2. Calculate the amount received
• Points 2 for 4,000 plus 1,500 fees 200,000 -
  5,500
• Loan receipt less points of 194, 500
• 3. Calculate balloon at the end of year 7
• N23 (30 - 7 years), I 6, PMT 14,529.78, PV
  ?
• PV Remaining 178,765.42
• 4. Calculate the effective interest rate
• PMT 14,529.78, FV 178,765.42, PV -194,
  500, N 7 I?
• EIR 6.52

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Loan A 200,000, 30-year, no points and no fees,
6.5, Loan B 200,000, 6, 2 points, 1,500 fees,
all pay it off in 7. Calculate total costs each
loan, effective rate, and Loan C of 5.75, 3
points, 1,500 fees, all pay it off in 7.

• Total Costs
• Loan A 7 x 15,315.49 180,265.39 287,474
• EIR 6.5
• Loan B 7 x 14,529.78178,765.42 5,500
  285,974
• EIR 6.52
• Cost of the Loan C and third point
  
• Loan C 7 x 14,143.25 177,981 7,500
  284,484
• PMT 14,143.25, FV 177,981, PV -192, 500, N
  7, I ?
• EIR 6.46
• Cost of the third point 6.52 6.46 .06
• Loan C is the cheapest loan both in rate terms
  and in dollar terms

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4. Income Taxes

• Data
• Using the married filing jointly status and their
  income and expense statement below, calculate the
  2009 tax liability for Mork and Mindy Williams
  (they have five children, ages 4, 8, 12, 16, and
  18). Mindy is the Young Womens President of her
  ward and has calculated that she drove her car
  300 miles last year to girls camp, which was not
  reimbursed. Exemptions are 3,650 per person,
  the standard deduction for married filing jointly
  is 11,400, medical expenses over 7.5 of AGI and
  job-related expenditures over 2 of AGI are
  deductible, charitable deductions for mileage are
  .14 per mile, and the child-tax credit is 1,000
  per child under 17. a. Calculate their tax
  liability first using the standard deduction and
  then using itemized deductions. b. Write a
  paragraph explaining to the Williams which method
  they should use and why? In that paragraph,
  comment on their marginal and average tax rates
  on taxable income.
• Income Expenses
• Earned Income 74,000 Home Mortgage
  interest 6,200
• Interest Income 2,100 Un-reimbursed
  Medical Bills 4,900
• Retirement Plan Contributions DI and other
  donations 250
• Morks IRA 3,000 Job-related
  expenditures 1,800
• Mindys Roth IRA 2,000 Tithing and other
  offerings 7,000
• Tax Table for Married Filing Jointly for 2009
• Amount Tax
• 0 to 16,700 10
• 16,700 to 67,900 1,670 plus
  15 of the amount over 16,700
• 67,900 to 137,050 9,350 plus 25 of the
  amount over 67,900

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Quick Review of Tax Process
1. Start with income from all sources less
exclusions Total Income
3. Minus Standard Deduction or Itemized
deductions
6. Minus credits Total Tax Owed
4. Minus exemptions Taxable Income
2. Subtract adjustments to Total Income
Adjusted Gross Income (AGI)
7. Minus taxes already paid Balance Due or
Amount of Refund
5. Look up tax on tax table Tentative Tax
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Tax Liability (standard deduction)

• 1.2. AGI 740002100-3000 (IRA) 73,100
• Only the IRA is subtracted to get your AGI
• 3. Less standard deduction 11,400
• 4. Less personal exemptions (7 3,650)
  25,550
• Taxable income
  36,150
• Tax liability
• 16,70010
  1,670
• (36,150 -16,700)15 19,450.15 2,918
• 5. Total tax liability
  4,588
• 6. Child tax credit
  -4,000
• 7. Total
  588
• Average tax rate Total taxes due / Taxable
  income
• Average tax rate 588 / 36,150 1.6
• Marginal tax rate 15 for both
  

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Tax Liability (Itemized deductions)

• 1. 2. AGI 73,100
• 3. Less itemized deductions
• Home mortgage Interest 6,200 Un-reimbursed
  Medical 0
• Job related expenditures 338 Tithes
  other offerings 7,000
• DI other donations 250 Mileage
  42
• Total itemized
  (13,830)
• 4. Less personal exemptions (same as before)
  (25,550)
• Taxable Income
  33,720
• Tax liability
• 16,70010 1,700
• (33,720 - 16,700) 17,020 15
  2,553
• 5. Total tax liability
  4,223
• 6. Child tax credit less
  -4,000
• 7. Tax
  223
• Average tax rate 223 / 33,720 .7
• Paragraph should include the savings (365),
  recommendation, and average and marginal tax
  rates on taxable income, not gross income.