Personal Financial Planning Mini-Case

Jeff and Mary Douglas, a couple in their mid-30s, have two children - Paul age 6 and Marcy age 7. The Douglas' do not have substantial assets and have not yet reached their peak earning years. Jeff is a general manager of a jewelry manufacturer in Providence, RI while Mary teaches at the local elementary school in the town of Tiverton, RI. The family needs both incomes to meet their normal living expenses and to meet unforeseen emergency purchases. Their cash flow situation is tight and they have had difficulty growing a "nest egg" through savings and investing.

Jeff and Mary have discussed the needs of their two children who are typical, healthy, and active kids. They have discussed trying to have Mary stay at home, be with the kids more and run the household but her income is very much needed and she also wants a career and doesn't want to put her teaching job on hold to be a stay-at-home mother. Jeff also wants (and needs) to work and his job often requires long days - beyond the 9-5 grind.

Now that both children are in school there is no day care need and Mary's job schedule actually matches nicely with the children's schedule so she not only wants to continue to work but is thinking about completing a graduate degree. Currently, Mary is able to take most of the summer off from teaching (when the children are home on vacation) and so she enjoys a great deal of flexibility in the summer and spends quite a bit of time with the children in the summer.

Jeff is the breadwinner of the family but Mary's contribution is also very significant. Jeff earns about 65% of the total household income with Mary earning the remainder. By completing a graduate degree, Mary could increase her salary by at least 20% but she would need to commit to a continuing education program at either Providence College or URI.

Although their net worth is not substantial, they have big dreams and aspirations. Their personal financial objectives include goals that if achieved would provide a better life for their children than both Jeff and Mary had growing up in working class families in the Fall River and New Bedford areas. They want to help their children go to good colleges and Jeff and Mary want to have assets that allow them (Jeff and Mary) live a comfortable retirement. Both are in excellent health and have family histories of long life expectancies. Their retirements (at age 65 or so) could be a period of 20 or more years.

They own their home which has an assessed value of $200,000 and a market value of about $300,000 (as determined by a real estate appraiser based on recent sales of comparable homes in similar neighborhoods.) The mortgage on the home has a balance of $140,000. A review of the Douglas' financial information, bank statements, and other documents shows the following as of 11/30/16:

2011 Camry worth about $11,000, with a bank loan balance of $3,000

2012 Volvo S60 worth about $15,000, with a bank loan balance of $10,000

An insurance policy on Jeff's life with a face value of $100,000 and no cash surrender value. Mary is the beneficiary listed on Jeff's policy.

An insurance policy on Mary's life with a face value of $10,000 and no cash surrender value. Jeff is the beneficiary listed on Mary's policy.

Credit card balances that total $3,500.

A savings account with a $1,000 balance.

Two mutual funds earmarked for the children's college education. The account for Paul has a balance of $10,000 and Marcy's has $11,000 as a current balance. The fund has averaged an 8% annual rate of return over its life.

100 shares of Apple Inc. (NASDAQ: stock symbol = AAPL), formerly Apple Computer, Inc. You need to value this stock based on the 11/30/16 price per share. You will need to find that on the Internet.

200 Shares of AT&T (value as of 11/30/16)

150 shares of Twitter. (value as of 11/30/16)

A checking account with a balance of $3,000.

Jeff estimates that their furniture, fixtures etc. in the home are worth about $7,000.

Jeff and Mary have retirement accounts that have a current market value of approximately $200,000.

Mary still has an education loan with an outstanding balance of $15,000. It still have seven years left on it.

A vacation loan of $750 due in 6 months and a home improvement loan of $2,000 due in 2 years (unsecured - not a home equity loan.)

Jeff wants to finish the basement and he has discussed this at length with Mary. He is getting estimates from contractors based on ideas that both he and Mary have to create a play area for the children and a TV/den for the family. Jeff and Mary love to play ping pong and pool and would love to introduce the children to both "sports." He believes that the project will cost about $30,000 and he is interested in tapping into the home equity.

Jeff is also an avid baseball fan and is looking at buying a membership to a local baseball/softball facility for both Paul and Marcy. He figures that since he doesn't have any expensive hobbies, it would be fun to get Paul started as a baseball player and Marcy as a softball player. The membership costs and related costs are as follows: $1,500 per year (covers both kids), equipment $500 per year, and team registration and travel costs will be about another $1,000 to $2,000 a year depending on how serious the kids become. Mary is not sure that this is a priority at this point and wants to explore this possibility in more detail.

1. What is the family's net worth? Please attach support for this with either an Excel or MS Word document to the Personal Finance Case assignment tab in myCourses. Your Excel or MS Word file should clearly reveal the Balance Sheet for the Douglas Family. Please produce it in good form - emulating what you see for examples in the book. The balance sheet "as of date" should be 11/30/16.

2. What is the current ratio? (Use the formula from the book)

3. What is the debt ratio?

4. Any comments about the familys investment portfolio? Strengths or weaknesses?

5. If the family's monthly living expenses are about $6,000, what is their liquidity ratio?

6. Jeff Douglas believes strongly that they should help fully fund the equivalent of a state university education (4 years) for Paul and Marcy. Both sets of grandparents have volunteered to make a lump sum donation (50/50 spilt) to the mutual funds today. In other words, these generous grandparents have stated that they are willing to pool their funds and make a substantial deposit to support an education fund.

Assuming that today's cost of that type of college education is $25,000 per year and that it will inflate by 4% per year, how much must the grandparents donate to the mutual funds to fully fund these investments (to meet Jeff's goal)? (Assume that Paul and Marcy will start college in 12 and 11 years respectively. You will need to determine the present value of the future college costs. I have put a worksheet at the end of this document that you might find helpful. If you are an Excel user, you can set this up within an Excel worksheet. Here are some steps to follow:

A. First by growing the cost of education by 4% per year (12 years into the future for Paul and 11 years for Marcy) and then calculating the present value of those future cash flows. Keep in mind that Paul will be going to school for 4 years and so too will Marcy. So you will need to figure the future value of the cost of education for the first year, second year, third year, and fourth year - each year 4% more costly than the year before!

B. Calculate the present value of the future costs of education using the investment yield prediction (8% - see below and notice in the data above that the investment fund has averaged 8% per year).

C. Once you have the present value of the future costs - you can subtract the current balance in these accounts to derive the "donation" that the grandparents will need to make.) Assume that the investment will grow at 8% per year as a result of investment yields. How much (in total) must the grandparents invest today to establish the education fund for Paul and Marcy?

NOTE: There is more on how to approach solving requirement 6 at the end of this document.

7. Calculate the percentage of net worth represented by the home and the next two largest assets. Take into account any loans attributed to those assets so that you show the following - the assets net value/Total family net worth. Count both cars as one asset (Automobiles).

This is called the dominant asset other words, if a family is car rich then that would mean a significant percentage of their wealth (as defined by net worth) would be from the value of its cars. The cars would be the dominant asset. If the familys net worth is mostly from their retirement accounts, then we could say that a significant amount of their wealth is from pensions.

8. Jeff is considering applying for a home equity loan to finance the basement project. What is the maximum home equity loan the Douglas' could possibly get based only on equity (and ignoring cash flow considerations)? Assume that a bank is willing to loan up to 80% of the value of the home (between the mortgage and the home equity loan).

9. Home equity loans have many advantages. For example, the home equity loan may be the source of funds to help Jeff and Mary finish their basement. The interest on the loan will be tax deductible. The arrangement that Jeff and Mary are looking at will involve a 15 year payback period and would allow for them to draw down on any unused funds in a credit line arrangement.

Please describe two disadvantages of a home equity loan and recommend an amount that Jeff and Mary should request for their line of credit.

10. In your textbook chapter on Life Insurance, read about "Determining Your Life Insurance Needs." Please use the following methods: Easy Method (assume Jeff makes $70,000 per year and Mary makes about $40,000), DINK method (even though they do have two kids still use DINK to come up with an estimated amount and assume that funeral expenses will be $10,000 for Jeff and $10,000 for Mary.) and the "Family Need" method. Also, when using the DINK method, assume that "other debts" are 100% of the balances for the vacation, home improvement, and education loans.

For the Family Need method, use the same calculations as shown the book example. Assume that living expenses are 70% of their income (you need this to estimate an emergency fund). Be conservative and estimate an emergency fund of 6 months of living expenses. Keep in mind that when using the "Family Need" method, you have to run the analysis twice (see the book example) - once based on the what-if assumption that Jeff dies now and once based on the what-if assumption that Mary dies now. Assume that the retirement account on the balance sheet is 90% Jeff's funds and 10% Mary's. Ignore social security death benefits. Also, the assumption should be that the Mutual Fund investment should not be considered as a liquid asset because it is earmarked for the children's education.

What do you recommend for death benefit amounts for each person (Jeff and Mary)? Please write a paragraph or two mentioning the amount of life insurance each needs and why you chose the amount you did.

11. Pretend you are a personal financial planning professional attempting to devise a comprehensive personal financial plan for Jeff and Mary. What other areas of Jeff and Mary's personal financial situation should be examined? Please mention at least 2 other concepts that they should take a careful look at. Please write a few paragraphs that answer this question. Feel free to pose additional questions that you would like to ask Jeff and Mary as a way of making sure you, as a financial planner, understand their situation.

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Requirement 6 of the Douglas Personal Financial Planning Case

These steps and the worksheet below might help you solve requirement 6. I find it easier to set this type of thing up within an Excel worksheet and I like to utilize the FV and PV functions of Excel. However, you can also do this with the time value of money tables within the text or with a financial calculator. Its up to you. In any event, please show your work - how you derived your final answer.

1. First step involves growing the cost of education by 4% per year (12 years into the future for Paul and 11 years for Marcy) and then finding the present value of those future costs by assuming an 8% annual return. So here's what you need to do. Set up a table like these for both kids:

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Paul's projections

Years (end of year)	Future Value of Education Cost (4%)	Present value of Education Costs (using 8% as the discount rate)
12	$40,026	$15,894.80
13	$41,627	$$15,306.10
14	$43,292	$14,739.21
15	$45,024	$14,193.31
	Total	$60,133.42

Marcy's projections

Years (end of year)	Future Value of Education Cost (4%)	Present value of Education Costs (using 8% as the discount rate)
11
12
13
14
	Total	$

Once you have the present value of the future costs - you can subtract the current balance in the current education accounts to derive the "donation" that the grandparents will need to make.) How much (in total) must the grandparents invest today to establish the education fund for Paul and Marcy? Use the following formula:

Total present value of the education costs less the $21,000 in the current education accounts = the donation that the grandparents will make.