International Research Journal of Applied Finance ISSN 2229 6891

Vol. VI Issue 10 October, 2015 Case Study Series

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Growing Up is Hard to Do or Sophias Choices

Allen B. Atkins* Roxanne Stell Larry Watkins

Sophia sat at her parents kitchen table mulling over many thoughts. One thought was that sitting

at this table would soon become a thing of the past. Another was growing up included a lot of

tedium and decision making that wasnt as much fun as she had assumed it would be. Sophias

mind hurt. She was trying to make some important decisions and the process was difficult and

exhausting.

Sophia had recently completed graduate school and would soon be starting her career as a

physical therapist. Her six year old Honda Civic (valued at $12,000) and her meager belongings

(she had given away much of her college stuff to a local charity) were waiting in her parents

garage for her upcoming move. She was moving to a community approximately two hours away.

Sophia was fortunate to find employment at a regional hospital and was getting excited to be on

her own. She feels the annual salary of $60,000 will provide her with a comfortable lifestyle but

not quite as comfortable as she imagined this time last year. Sophia is learning that living on

ones own will be costly. Even though she has a roommate, her rent will be $1,000 per month

which was the best deal she could find. Although utilities and Wi-Fi are included she still

thought this was very expensive. She was shocked when she had to pay $2,300 for first and last

months rent and a $300 security deposit. Sophia has always been frugal and managed to save

some of the proceeds from her last student loan and graduation gifts; but now all but $4,500 has

been spent on necessities.

Sophias parents are not wealthy by any measure and to complete graduate studies Sophia had

incurred student loans totaling $40,000. She will be required to start paying $460 per month, for

ten long years, as soon as she begins working. She knows that she wont actually take home

$2,307 ($60,000/26) biweekly due to taxes that will be withheld; but she doesnt know how

much her net pay will actually be. Sophias uncle, a small business owner, explained that in

addition to federal taxes there is also a state income tax with an effective rate of 4%. That

doesnt seem like much but she realizes it all adds up.

Sophia has estimated what she hopes are all of her expenditures in anticipation of creating a

budget. She has met with a human resources representative from the hospital where she will

work and has received some interesting information. For one, the hospital offers its professional

employees a pre-paid health plan that provides for all medical care at its facilities for $100 per

month. This seems like a very cost effective option even compared to commercial insurance

coverage with the Affordable Care Act. Also the hospital has a 401K plan in which they will

match 15% of the employees contribution up to $10,000 per year. The 401K is administered

through a national financial services firm. Although the investment offerings are somewhat

limited, they appear to be adequate especially given Sophias limited needs at present. The

firms investment offerings are:

Money Market Fund

S & P 500 Equity Index Fund

International Equity Fund

Bond Fund

International Research Journal of Applied Finance ISSN 2229 6891

Vol. VI Issue 10 October, 2015 Case Study Series

Page2

Sophia anticipates spending $400 per month for food and another $500 for car expenses. She

believes that $3,000 annually for clothes, $2,400 for entertainment, $1,800 for home health and

beauty aids, and $600 for her cell phone plan should all be budgeted. Knowing that you cannot

anticipate everything she believes $50 per month for miscellaneous expenses should also be in

her plan.

Sophias uncle never married and has always been very generous to her. At her graduation he

presented her with a statement from an investment firm showing a balance of $25,000 with

Sophia listed as the owner of the account. He explained that since he had never had children he

had saved over the years so he could give her a meaningful start upon graduation. Sophia was

ecstatic to receive the gift as she had no idea she would get more than a card and perhaps a $100

bill. Her uncles only stipulation was that the money could not be spent on existing debts or a

car. He explained that it was his hope that she would invest it wisely for the future. Sophia

intended to do just that, by adding to that amount monthly so she could finally begin to

accumulate wealth instead of debt.

Sophia, after conferring with her uncle, has determined she needs to do the following and has

asked you, her good friend, to assist her. Her uncle was especially interested in seeing what

Sophie might have in her savings in 10 years time.

QUESTIONS:

Sophias Choices:

Please answer these questions related to the case, which is due September 15th. Please upload to Canvas the excel spreadsheet showing your work. Be sure to use formulas and cell references as much as possible in your spreadsheet. Note that there is not necessarily one right answer, so it is important to provide your logic. Please turn in one case per group, with the names of the members of the group on the case.

1. Determine Sophias approximate biweekly take-home pay assuming her effective state income tax rate is 4%.

Hints:

Assume 1 allowance in the take-home pay calculation. Also, initially assume no other additional monthly deductions. Take-home pay can be determined using IRS Circular E information. However an easier approach for estimation is to use of one of several websites such as

www.calculator.net/take-home-pay-calculator.html

2. Prepare a monthly budget for Sophia using Excel.

3. Calculate how much Sophia will have for discretionary spending each month considering her estimated budget presented above.

4. Determine how much Sophia should have in an emergency cash fund for unexpected expenditures. Please be sure to provide your logic.

5. How should the discretionary amount calculated above be spent? Assume she wants to be an aggressive saver. How much is added to her 401K annually when matched by her employer?

(Hint: Assume she wants to max out her 401 contributions. Why? Two big benefits are that these contributions are not taxed until withdrawn after retirement, and the employer will match the contribution. So, it makes a lot of sense to take advantage of this. Start with the excess of monthly net pay over budgeted expenditures (calculated in #3) for 401K contributions and enter this as the monthly deduction in the take-home pay calculator above.)

6. How should Sophia allocate her investment assets (e.g., the $25,000 from her uncle) given the four fund options presented? Justify your answers.

Hint: You can use the AAII web site asset allocations for someone her age.

http://www.aaii.com/asset-allocation#aggressive?adv=yes

7. If she invests aggressively with her $25,000, her contributions to her 401K, and the hospitals 15% match, estimate how much will be in her investment account and her 401K in ten years. (Hint: Use the AAII 10 year average return to compute her 401K balance in 10 years.)

8. If Sophia keeps allocating her investments in the same manner and gets the same anticipated returns for her entire career, what will be the balance of her investment account and 401K when she retires after working forty years? Disregard any tax implications on the investment account earnings.