this is a case study and need to state how is the gates current financial state, future, what are some reccomended changes, and what are they doing correct

CASE 9 TREVOR AND LINDA GATES CASE Today is January 1, 2017 INTRODUCTORY DATA Trevor and Linda Gates have come to you, a financial planner, for help in developing a plan to accomplish their financial goals. From your initial meeting together, you have gathered the following information. THE FAMILY Mn. Gates Debora (70) Mt. Gates (deceased Sredde Krisy (Mother of William) Trevor (32) Linda (23) Living with Trevor & Linda Trevor Gates (Age 32) Trevor grew up with video games and computers. After graduating from college with a degree in computer science, Trevor joined a small internet service company, Web Ideas, Inc. (Web). Trevor has been employed with Web for the last seven years. His salary is $75,000 and he regularly receives Web stock options. In addition, Trevor generates approximately $40,000 in self-employment income from consulting work outside of Web. Trevor is also interested in starting his own internet service business three years from now. Linda Gates (Age 23) Linda is an assistant manager and the benefits officer for Clothes Are Us, Inc. a medium sized retail store in local hopping malls (they have several locations within the city). Clothes Are Us, Inc. operates as a C corporation. Linda INTRODUCTORY DATA 321 began working there in high school and continued to work there throughout college and after. She currently earns $40,000, but is able to buy clothes at a substantial discount. The Children Trevor and Linda have been married for approximately one year and have no children together. Trevor has a son, William, from a former marriage who lives with them. William is three years old and has already begun playing on the computer, the internet, and with his dad's iPad. William usually spends most weekdays with Linda's mother, Debora. Sometimes, she comes to the Gates' house and other times, Linda drops off William at Debora's house. The Gates Trevor and Linda have really enjoyed their first year of marriage and anticipate having additional children. The only sore spot in the marriage is that Trevor is required to pay $500 in alimony each month to his former wife Krissy until her death or remarriage. As per the divorce agreement, Krissy does not have to pay child support to Trevor. All of the support she provides for William is discretionary and in the form of clothes, toys, and other items she pays for out of her current budget. Krissy does not have custody of William, but is allowed visitation on a regular basis. Krissy is a self-employed interior decorator. During 2016, she had several large jobs that lost money and for the year she ended up with expenses equaling her revenues. Fortunately, Krissy has investment portfolio income of $5.000 annually, in addition to the alimony she receives from Trevor. Debore Trebore Debora, who will be seventy-one years old in December of this year, is the mother of five children, including her baby, Linda. Linda was a big surprise to Debora and Fred. Fred, her late husband, died five years ago in an earthquake in Los Angeles. Fred's will created a testamentary charitable remainder unitrust (CRUT) that initially provided income to Debora of approximately $30,000 per year. The trust calls for a required unitrust payment of 8 percent to be paid each year during her life. The assets remaining in the CRUT are to be distributed to the Wounded Warriors Project after death. With the economic downturn, the value of the CRUT assets was devastated. Unfortunately, the assets were in no way insured and there is no possibility of recovering the losses. Today, the value of the CRUT assets is only $85,000. As a result of the enormous loss in the value of the CRUT assets, the trustee has selected new asset managers and the funds have been invested in a balanced fund expected to carn a consistent 5 percent annual rate of return. Debora has the following other assets: Value as of January 1, 2017 $250,000 $80,000 $134.000 $100,000 $54,000 Notes Held at her local bank Held in her brokerage account Cash Investments Fred's IRA Debora's IRA Debora's Qualified Plan Home and Furnishings Includes a life insurance policy The home is worth $150,000 (net of any commission) $215.000 Debora needs approximately $60,000 to live on each year and she receives $10,000 of that from Social Security. However, her needs have been increasing at about five percent per year. Therefore, she has been withdrawing from her asset accounts listed above to provide for her remaining financial needs. The average rate of return on her assets has been and is expected to continue to be 4 percent, excluding furnishings. 322 TREVOR AND LINDA GATES CASE 9 Based on her parents' ages at their death, Deborah expects to live until age 95. She is open to selling her home and moving in with one of her children to save money. "Debora has named William as the beneficiary of her IRA. at the recommendation of her late husband Fred. Linda and her four siblings are named contingent beneficiaries of the IRA to share equally in the event that something should happen to William Mr. Mrs. Gates Unfortunately, Mr. & Mrs. Gates died in a plane crash while traveling outside the United States. While they had assets, they also had a significant amount of debt and what was left for Trevor was very minimal. Trevor is most upset that William and any other children they may have will grow up without knowing their grandparents. FINANCIAL GOALS & CONCERNS 1. Provide for retirement. They would like to retire when Trevor is age 62. Because of his age, he wants to plan on $155,000 in today's dollars, which is a wage replacement ratio of approximately 100%. He does not want to plan for Social Security benefits. They would like to plan on funding potential retirement expenditures until Linda turns age 95 and would like to maintain the same level of spending, even if Trevor is deceased. 2. Provide for the cost of William's college education, as well as any additional children the Gates have. 3. Provide the necessary support for Linda's mother. However, at this point, they have not needed to provide her with any financial support. When she runs out of money, they will have to support her and her expen- ditures will continue to increase at 5%. Deborah has a life expectancy of age 95. 4. Save enough to start an Internet company in three years. Trevor expects that he will need $425.000 ar that time in today's dollars. EXTERNAL INFORMATION ECONOMIC INFORMATION Inflation is expected to be 3.0% annually. Salaries should increase 4.0% for the next 5 to 10 years. There is no state income tax. The yield curve is slightly upward sloping, but relatively flat. The historic and expected correlation between the equity markets in the modernized countries is relatively high. The correlation between these markets increase especially during economic crisis. They have a required rate of return of 10%. The economy is in a steady slow growth expansion phase with moderate unemployment. BANK LENDING RATES 15 year mortgages: 5% 30 year mortgages: 6%. Secured personal loans: 10.0%. Credit cards: 18% Prime rate: 3% EXTERNAL INFORMATION 323 INVESTMENT RETURN EXPECTATIONS Return 2.59 4.0% 6.09 Cash and Money Market Fund Treasury Bonds/ Bond Funds Corporate Bonds/ Bond Funds International Bond Funds Index Fund Large Cap Funds/Stocks Mid/Small Funds/Stocks International Stock Funds Real Estate Funds 7.0% 9.09 10.0% 12.09 13.0% 8.00 Standard Deviation 2.0% 4.0% 5.0% 6.09% 14.0% 16.04 IR.0% 22.0% 12.0% 324 TREVOR AND LINDA GATES CASE Case 9 INTERNAL INFORMATION FINANCIAL STATEMENTS Statement of Financial Position (Beginning of Year) Statement of Financial Position Trevor and Linda Gates Balance Sheet as of 1/1/2017 ASSETS LIABILITIES AND NET WORTH Current Assets Current Liabilities? JT Cash & Checking $7.194 H Brokerage Loan $20.000 JT Money Market $25.500 JT Credit Card 1 $3,000 Total Current Assets 532,694 H Credit Card 2 $2,000 JT Principal Residence Mongage $2,351 Investment Assets JT Mortgage on Vacant Lot $7.172 H Cash Value of Life Insurance $2,000 H Student Loan $1.600 H Brokerage Account $70,000 H Auto Loan $8.353 H Municipal Bonds $45.000 Total Current Liabilities $44.476 H Web Options $475,000 HIBM Stock $40,000 Long-Term Liabilities HEducation Account $10,000 JT Credit Card 1 $27,000 H 401(k) Plan $96,000 H Credit Card 2 $18.000 W 401(k) Plan $20,000 IT Principal Residence Mortgage $151.383 W Traditional IRA $20.000 JT Mortgage on Vacant Lot $129,711 WESOP $20.000 H Student Loan $29,309 Total Investment Assets $798,000 H Auto Loan $28.859 Total Long-Term Liabilities $384.262 Personal Use Assets JT Principal Residence Cland $50.000) $200,000 Total Liabilities $428.738 H Residential lor $225.000 JT Furniture, Clothing $80,000 Total Net Worth $980,956 H Audi $18,000 H Porsche Boxster $55.000 H Kayak $1,000 Total Personal Uwe Assets 5579,000 Total Assets $1,409,694 Total Liabilities & Net Worth $1,409,694 1. Assets are stated at fair market value. 2. Liabilities are stated at principal only as of January 1, 2017 before January payments, 3. Trevor has an outstanding margin loan - interest is 1.5% above prime. 4. The municipal bond portfolio has a modified duration of 5 and a current YTM of 7%. 5. Trevor's 401(k) plan has borrowing provision at 3% per year and a march of 3%. 6. Trevor had to take out student loans to pay for part of his college tuition. Title Designations: H-Husband (Sole Owner)/w . Wife (Sole Owner/JT - Joint Tenancy with Survivorship Rights INTERNAL INFORMATION 325 Statement of Income and Expenses Statement of Income and Expenses Trevor and Linda Gates Statement of Income and Expenses for 2016 and Expected for 2017 Cash Inflows Totals Trevor's Salary $75,000 Linda's Salary S40,000 Trevor's Consulting S40,000 Total Cash Inflows $155.000 Cash Outflows Savings Money Market $1,000 401(k) Plan - Trevor $10,000 401(k) Plan - Linda $4.000 Education (529 Savings Plan) S500 Total Savings $15.500 Taxes Federal Income Taxes Withheld $30.000 Trevor's Social Security Texts $5.738 Linda's Social Security Taxes $3.060 Property Tax Principal Residence $4.000 Property Tax Vacant Lot $4,000 Total Tanes $46,798 Debt Payments (Principal & Interest) Mortgage Principal Residence $11,511 Mortgage - Vacant Lot $15.189 Student Loans $4,015 Auto Loans $10,693 Credit Cards $5,000 Total Debt Payments $46,408 Living Expenses Utilities Principal Residence $3.900 Lawn Service Principal Residence $1.400 Gasoline for Autos $4,500 Lawn Service for Vacant Lot $900 Entertainment $2.000 Vacations $2.000 Church Donations $500 Clothing $3.000 Auto Maintenance $2.000 Satellite TV $2.000 Food $6.000 Alimony $6,000 Miscellaneous $1.500 Total Living Expenses $35.700 Insurance Payments HO Insurance Principal Residence $3.000 Auto Insurance Premium $3.300 Life Insurance policy A Premium $2.100 Total Insurance Payments $8.400 Total Cash Outflows $152.806 Net Discretionary Cash Flows Now Frideral Iwwe Tawad wwwrity are promend touryod vandreture zone die gewerk av hemorragend and one opres are not ind i en of je le 326 TREVOR AND LINDA GATES CASE 9 Face Amount $0 $0 EDUCATION INFORMATION Trevor and Linda strongly believe in education. They want William to attend an Ivy League school for undergraduate studies and attend a very good law school. They also would like to pay for his entire seven years of school so that William can focus on his studies and not be burdened by a part-time job. The current cost of college is $55,000 per year for undergraduate and approximately $70,000 per year for a high quality law school. Tuition has been increasing annually at seven percent, which is expected to continue indefinitely. The Gates' would like to establish an investment portfolio to be exclusively used for funding William's college tuition. Based on discussions with his broker, Trevor expects to earn an average return on investments of ten percent per year. The Gates have $10,000 set aside for education and anticipate contributing to the fund each year until William goes to college. The funds are currently invested in a large cap mutual fund and are held at the broker's firm. INSURANCE INFORMATION Life Insurance Policy A Policy B Policy C Insured Trevor Trevor Linda $250,000 $150,000 $40,000 Type Whole Life Group Term Group Term Cash Value $2,000 Annual Premium $156 $50 Who pays premium Trevor Employer Employer Beneficiary Trevor's Estate Krissy Trevor Policy Owner Trevor Trevor Linda Settlement options clause selected None None Health Insurance Trevor and Linda are covered under Trevor's employer plan which is an indemnity plan with a $200 deductible per person per year and an 80/20 major medical co-insurance clause with a family annual stop loss of $1,500. The major medical policy has no lifetime limit. Long-Term Disability Insurance Trevor is covered by an "own occupation" policy with premiums paid by his employer. The benefits equal 60% of his gross pay after a 90-day climination period. The policy covers both sickness and accidents and is guaranteed renewable Linda is not covered by any disability insurance. Homeowners Insurance The Gates have a HO3 policy with endorsements for replacement value and open perils for personal property. The current dwelling coverage is 100% replacement value with an inflation rider. $2,100 None INTERNAL INFORMATION 327 Automobile Insurance Both cars are insured as follows: Type Bodily Injury Property Damage Medical Payments Physical Damage Uninsured Motorist Bodily Injury Uninsured Motorist Property Damage Comprehensive Deductible Collision Deductible Premium (annual) PAP $100.000/$300,000 $50,000 $5,000 per person Actual Cash Value $100,000/$300,000 $50,000 $1,000 $1,000 $3,300 The Gates do not have a personal liability policy. INVESTMENT INFORMATION The Gates think that they need six months of cash flow, net of all taxes, savings, vacation, and discretionary cash flow, in an emergency fund. They are willing to include in the emergency fund the savings account and Trevor's 401(k) plan balance because it has borrowing provisions (3% per year). The Gates are not well educated in the area of investments, but like to dabble with stocks and mutual funds. They are willing to accept enough risk to accomplish their goals, but not excessive risk. As part of a financial planning engagement, you go through the process of assessing the Gates' risk tolerance. Trevor and Linda answered the following six questions as follows. The answers below are given at the beginning of the engagement 328 TREVOR AND LINDA GATES CASE 9 Disagree Strongly Disagree Risle Tolerance Questionnaire Global Portfolio Allocation Scoring System (PASS) for Individual Investors! Questions Strongly Agree Neutral Agree 1. Earning a high long-term total return that will allow my capital to grow faster than the inflation rate is one of my most TL important investment objectives 2. I would like an investment that provides me with an opportunity to defer taxa T.L tion of capital gains to future years. 3. I do not require a high level of current T.L income from my investments 4. I am willing to tolerate some sharp down swings in the return on my invest- ments in order to seek a potentially T.L higher return than would normally be expected from more stable investments 5. I am willing to risk a short-term loss in return for a potentially higher long-run T L rate of return 6. I am financially able to accept a low level of liquidity in my investment port TL folio. TTL - Linde 1. Global Portfolio Allocation Scoring System (PASS) for Individual Investors - developed by Dr William Droms (Georgetown University) and Steven N. Sr. (DomStream Advisors Inc.) - model used with permission INTERNAL INFORMATION 329 Portfolio Information Gates Portfolio Information 12/31/16 Account Cash Bonds US guide Foreign Equities Total Portfolio Cash and Gail quivales Plus Dulles Total SAN S. S65.000 9.000 S. Municipal de 545,000 $113.000 S. TEMS US Foreign 50.000 S000 Mes Thiti IRA ESOP $30,000 SO w 90 Total Porfolie Account Types Act Taul Fancation Tax Deferred SN T Educa Tas formed Being Municipal de Capaa 5.000 5.000 Sto $156.000 IN 19 . Toul SON 1001 401 50.000 330.000 530.000 20.000 Tradition ISOP 30 S. Sin SI56.000 Trevor's Internet Company Trevor is in the information-gathering phase of owning his own web-based company. He expects the company to have losses for the first several years due to the cost of capital that will be required and the necessary marketing and advertising expenses to establish brand recognition. In addition, he believes that he may need the assistance of a venture capital firm to provide some of the funding necessary for the company after it is up and running. However, he is unsure about this at this stage. 330 TREVOR AND LINDA GATES CASE Case 9 IBM Stock Trevor believes that IBM is strategically positioned to prosper. IBM currently retains 80 percent of their profits for the purpose of growing the business. This policy has allowed them to grow their dividend every year at about seven percent. Trevor thinks that this is one of his best investments. Trevor inherited the 200 shares of IBM stock when his Uncle Steve died. The stock price on the date of death opened at 180, closed at 190, had a high of 196 and a low of 178. Uncle Steve had acquired the stock 4 weeks before his death for $195 per share, including commissions. OTHER INFORMATION REGARDING ASSETS AND LIABILITIES Home and Furnishings They purchased their home 36 months ago for $200,000 and financed 80 percent of the sale price at six percent for 30 years. They considered refinancing, but their FICO score is 530 due to recent late payments on credit cards recently. They plan to sell or lease this property once their dream home is built. Their home furnishings are relatively normal. However, Trevor inherited his great grandfather's grandfather clock, which has great sentimental value to Trevor. Trevor believes the value of the clock to be about $5.000. Automobile Linda's Audi is several years old and is fully paid off. Trevor has just purchased a 2015 Black Porsche Boxster S with a six-speed manual transmission one year ago. He purchased the car for $60,000, made a deposit of $15,000 and financed the remaining balance over five years at seven percent. They both love the Porsche and how they look in it. Residential Lor Trevor and Linda have been dreaming of building a large house and so they decided to purchase a vacant lot for $225,000. Not having sufficient cash to purchase it outright, they made a down payment of $75,000 and financed the remainder over fifteen years at 6 percent with a balloon after five ycars. Their first payment was 24 months ago They have no time table for building at this time. However, under no conditions will they consider selling the lot as it took them years to find it. Student Loans Trevor had to take out loans to pay for college. He borrowed a total of $40,000 to be repaid over 20 years at eight percent. Web Options Trevor has a variety of incentive stock options (ISOs) and non-qualified stock options (NQSOs) that he has received as part of his compensation at Web. The following table below lists each of the option grants including the exercise price and grant date. Year Exercise Grant Options Grant Date Vesting Granted Price 2012 09/01/12 5.000 $35 2013 2 10/15/13 10,000 $25 5 years 2014 3 09/02/14 10.000 $15 5 years 2015 4 09/01/15 15,000 $25 5 years 2016 5 09/01/16 10,000 $28 5 years 5 years INTERNAL INFORMATION 331 The company grants the maximum number of ISOs to Trevor every year and the exercise price is always equal to the FMV of the stock on the date of grant. The current price of Web stock is $34 per share. The options vest over five years with 20 percent vesting each year. Trevor is generally optimistic about the company's future. However, he is concerned about some of Wet's competitors and a new technology that is emerging. Web is responding, but it is unclear how it could impact the company. We has never issued any cash dividends, stock dividends or had any stock splits. Clothes Are Us Linda is the benefits administrator for her company's retirement plans. The company sponsors a 401(k) plan and an ESOP. Following is a list of employees with census information: Name Position Ownership Amy Gomez Founder Jenny Camile? Co-founder & Manager Linda Gates Asst. Manager Russ Ricardo Sales Associate Henrietta Hynes Sales Associate Ingred Iberson Sales Associate Brad Larson Sales Associate Allison Ulysses Sales Associate David Gomez Clerk Nancy Miller Clerk Amy Gomes is not an employee and has not been one for ten years Jenny Camerun the busines, with since from Linda David is the grandion of Amy Gomer 5196 1596 2.6% 2.3% 3.0% 5.0% 1.5% 0.9% 0.2% 0.5% Prior Year Salary SO $65.000 $40,000 $92,000 $88,000 $48.000 $37.000 $50,000 $25,000 $18,000 401) Deferral Percentage 096 10% 10% 7% 896 8% 6% 0% 0% 1. 2. 3. The 401(k) plan permits elective deferral contributions up to 80 percent of an employee's compensation. There is no matching contribution. However, the company does contribute to the ESOP in profitable years, although no contribution was made during 2016 to the ESOP. The remaining ownership of the company is held by the trustee of the ESOP. The ownership in the above table reflects the total stock owned by each person, including stock owned via the ESOP. The business is valued annually for ESOP purposes by an outside appraiser, however, there was no change in value from last year to this year. 332 TREVOR AND LINDA GATES CASE The company grants the maximum number of ISOs to Trevor every year and the exercise price is always equal to the FMV of the stock on the date of grant. The current price of Web stock is $34 per share. The options vest over five years with 20 percent vesting each year. Trevor is generally optimistic about the company's future. However, he is concerned about some of Web's competitors and a new technology that is emerging. Web is responding, but it is unclear how it could impact the company. Web has never issued any cash dividends, stock dividends or had any stock splits. Clothes Are Us Linda is the benefits administrator for her company's retirement plans. The company sponsors a 401(k) plan and an ESOP. Following is a list of employees with census information: Name Position Ownership 401(k) Deferral Percentage 0% 10% 10% 7% 896 Prior Year Salary SO $65.000 $40,000 $92,000 $88,000 $48,000 $37,000 $50,000 $25,000 $18,000 Amy Gomez! Founder Jenny Camile? Co-founder & Manager Linda Gates Asst. Manager Russ Ricardo Sales Associate Henrietta Hynes Sales Associate Ingred Iberson Sales Associate Brad Larson Sales Associate Allison Ulysses Sales Associate David Gomez Clerk Nancy Miller Clerk 1. Amy Gomez is not an employee and has not been one for ten years 2 Jenny Camile runs the business with stance from Linda 3. David is the grandson of Any Goma. 5196 159 2.6% 2.39 3.0% 5.0% 1.5% 0.9% 0.2% 0.5% 896 696 0% 0% The 401(k) plan permits elective deferral contributions up to 80 percent of an employee's compensation. There is no matching contribution. However, the company does contribute to the ESOP in profitable years, although no contribution was made during 2016 to the ESOP. The remaining ownership of the company is held by the trustee of the ESOP. The ownership in the above table reflects the total stock owned by each person, including stock owned via the ESOP. The business is valued annually for ESOP purposes by an outside appraiser, however, there was no change in value from last year to this year. 332 TREVOR AND LINDA GATES CASE CASE 9 TREVOR AND LINDA GATES CASE Today is January 1, 2017 INTRODUCTORY DATA Trevor and Linda Gates have come to you, a financial planner, for help in developing a plan to accomplish their financial goals. From your initial meeting together, you have gathered the following information. THE FAMILY Mn. Gates Debora (70) Mt. Gates (deceased Sredde Krisy (Mother of William) Trevor (32) Linda (23) Living with Trevor & Linda Trevor Gates (Age 32) Trevor grew up with video games and computers. After graduating from college with a degree in computer science, Trevor joined a small internet service company, Web Ideas, Inc. (Web). Trevor has been employed with Web for the last seven years. His salary is $75,000 and he regularly receives Web stock options. In addition, Trevor generates approximately $40,000 in self-employment income from consulting work outside of Web. Trevor is also interested in starting his own internet service business three years from now. Linda Gates (Age 23) Linda is an assistant manager and the benefits officer for Clothes Are Us, Inc. a medium sized retail store in local hopping malls (they have several locations within the city). Clothes Are Us, Inc. operates as a C corporation. Linda INTRODUCTORY DATA 321 began working there in high school and continued to work there throughout college and after. She currently earns $40,000, but is able to buy clothes at a substantial discount. The Children Trevor and Linda have been married for approximately one year and have no children together. Trevor has a son, William, from a former marriage who lives with them. William is three years old and has already begun playing on the computer, the internet, and with his dad's iPad. William usually spends most weekdays with Linda's mother, Debora. Sometimes, she comes to the Gates' house and other times, Linda drops off William at Debora's house. The Gates Trevor and Linda have really enjoyed their first year of marriage and anticipate having additional children. The only sore spot in the marriage is that Trevor is required to pay $500 in alimony each month to his former wife Krissy until her death or remarriage. As per the divorce agreement, Krissy does not have to pay child support to Trevor. All of the support she provides for William is discretionary and in the form of clothes, toys, and other items she pays for out of her current budget. Krissy does not have custody of William, but is allowed visitation on a regular basis. Krissy is a self-employed interior decorator. During 2016, she had several large jobs that lost money and for the year she ended up with expenses equaling her revenues. Fortunately, Krissy has investment portfolio income of $5.000 annually, in addition to the alimony she receives from Trevor. Debore Trebore Debora, who will be seventy-one years old in December of this year, is the mother of five children, including her baby, Linda. Linda was a big surprise to Debora and Fred. Fred, her late husband, died five years ago in an earthquake in Los Angeles. Fred's will created a testamentary charitable remainder unitrust (CRUT) that initially provided income to Debora of approximately $30,000 per year. The trust calls for a required unitrust payment of 8 percent to be paid each year during her life. The assets remaining in the CRUT are to be distributed to the Wounded Warriors Project after death. With the economic downturn, the value of the CRUT assets was devastated. Unfortunately, the assets were in no way insured and there is no possibility of recovering the losses. Today, the value of the CRUT assets is only $85,000. As a result of the enormous loss in the value of the CRUT assets, the trustee has selected new asset managers and the funds have been invested in a balanced fund expected to carn a consistent 5 percent annual rate of return. Debora has the following other assets: Value as of January 1, 2017 $250,000 $80,000 $134.000 $100,000 $54,000 Notes Held at her local bank Held in her brokerage account Cash Investments Fred's IRA Debora's IRA Debora's Qualified Plan Home and Furnishings Includes a life insurance policy The home is worth $150,000 (net of any commission) $215.000 Debora needs approximately $60,000 to live on each year and she receives $10,000 of that from Social Security. However, her needs have been increasing at about five percent per year. Therefore, she has been withdrawing from her asset accounts listed above to provide for her remaining financial needs. The average rate of return on her assets has been and is expected to continue to be 4 percent, excluding furnishings. 322 TREVOR AND LINDA GATES CASE 9 Based on her parents' ages at their death, Deborah expects to live until age 95. She is open to selling her home and moving in with one of her children to save money. "Debora has named William as the beneficiary of her IRA. at the recommendation of her late husband Fred. Linda and her four siblings are named contingent beneficiaries of the IRA to share equally in the event that something should happen to William Mr. Mrs. Gates Unfortunately, Mr. & Mrs. Gates died in a plane crash while traveling outside the United States. While they had assets, they also had a significant amount of debt and what was left for Trevor was very minimal. Trevor is most upset that William and any other children they may have will grow up without knowing their grandparents. FINANCIAL GOALS & CONCERNS 1. Provide for retirement. They would like to retire when Trevor is age 62. Because of his age, he wants to plan on $155,000 in today's dollars, which is a wage replacement ratio of approximately 100%. He does not want to plan for Social Security benefits. They would like to plan on funding potential retirement expenditures until Linda turns age 95 and would like to maintain the same level of spending, even if Trevor is deceased. 2. Provide for the cost of William's college education, as well as any additional children the Gates have. 3. Provide the necessary support for Linda's mother. However, at this point, they have not needed to provide her with any financial support. When she runs out of money, they will have to support her and her expen- ditures will continue to increase at 5%. Deborah has a life expectancy of age 95. 4. Save enough to start an Internet company in three years. Trevor expects that he will need $425.000 ar that time in today's dollars. EXTERNAL INFORMATION ECONOMIC INFORMATION Inflation is expected to be 3.0% annually. Salaries should increase 4.0% for the next 5 to 10 years. There is no state income tax. The yield curve is slightly upward sloping, but relatively flat. The historic and expected correlation between the equity markets in the modernized countries is relatively high. The correlation between these markets increase especially during economic crisis. They have a required rate of return of 10%. The economy is in a steady slow growth expansion phase with moderate unemployment. BANK LENDING RATES 15 year mortgages: 5% 30 year mortgages: 6%. Secured personal loans: 10.0%. Credit cards: 18% Prime rate: 3% EXTERNAL INFORMATION 323 INVESTMENT RETURN EXPECTATIONS Return 2.59 4.0% 6.09 Cash and Money Market Fund Treasury Bonds/ Bond Funds Corporate Bonds/ Bond Funds International Bond Funds Index Fund Large Cap Funds/Stocks Mid/Small Funds/Stocks International Stock Funds Real Estate Funds 7.0% 9.09 10.0% 12.09 13.0% 8.00 Standard Deviation 2.0% 4.0% 5.0% 6.09% 14.0% 16.04 IR.0% 22.0% 12.0% 324 TREVOR AND LINDA GATES CASE Case 9 INTERNAL INFORMATION FINANCIAL STATEMENTS Statement of Financial Position (Beginning of Year) Statement of Financial Position Trevor and Linda Gates Balance Sheet as of 1/1/2017 ASSETS LIABILITIES AND NET WORTH Current Assets Current Liabilities? JT Cash & Checking $7.194 H Brokerage Loan $20.000 JT Money Market $25.500 JT Credit Card 1 $3,000 Total Current Assets 532,694 H Credit Card 2 $2,000 JT Principal Residence Mongage $2,351 Investment Assets JT Mortgage on Vacant Lot $7.172 H Cash Value of Life Insurance $2,000 H Student Loan $1.600 H Brokerage Account $70,000 H Auto Loan $8.353 H Municipal Bonds $45.000 Total Current Liabilities $44.476 H Web Options $475,000 HIBM Stock $40,000 Long-Term Liabilities HEducation Account $10,000 JT Credit Card 1 $27,000 H 401(k) Plan $96,000 H Credit Card 2 $18.000 W 401(k) Plan $20,000 IT Principal Residence Mortgage $151.383 W Traditional IRA $20.000 JT Mortgage on Vacant Lot $129,711 WESOP $20.000 H Student Loan $29,309 Total Investment Assets $798,000 H Auto Loan $28.859 Total Long-Term Liabilities $384.262 Personal Use Assets JT Principal Residence Cland $50.000) $200,000 Total Liabilities $428.738 H Residential lor $225.000 JT Furniture, Clothing $80,000 Total Net Worth $980,956 H Audi $18,000 H Porsche Boxster $55.000 H Kayak $1,000 Total Personal Uwe Assets 5579,000 Total Assets $1,409,694 Total Liabilities & Net Worth $1,409,694 1. Assets are stated at fair market value. 2. Liabilities are stated at principal only as of January 1, 2017 before January payments, 3. Trevor has an outstanding margin loan - interest is 1.5% above prime. 4. The municipal bond portfolio has a modified duration of 5 and a current YTM of 7%. 5. Trevor's 401(k) plan has borrowing provision at 3% per year and a march of 3%. 6. Trevor had to take out student loans to pay for part of his college tuition. Title Designations: H-Husband (Sole Owner)/w . Wife (Sole Owner/JT - Joint Tenancy with Survivorship Rights INTERNAL INFORMATION 325 Statement of Income and Expenses Statement of Income and Expenses Trevor and Linda Gates Statement of Income and Expenses for 2016 and Expected for 2017 Cash Inflows Totals Trevor's Salary $75,000 Linda's Salary S40,000 Trevor's Consulting S40,000 Total Cash Inflows $155.000 Cash Outflows Savings Money Market $1,000 401(k) Plan - Trevor $10,000 401(k) Plan - Linda $4.000 Education (529 Savings Plan) S500 Total Savings $15.500 Taxes Federal Income Taxes Withheld $30.000 Trevor's Social Security Texts $5.738 Linda's Social Security Taxes $3.060 Property Tax Principal Residence $4.000 Property Tax Vacant Lot $4,000 Total Tanes $46,798 Debt Payments (Principal & Interest) Mortgage Principal Residence $11,511 Mortgage - Vacant Lot $15.189 Student Loans $4,015 Auto Loans $10,693 Credit Cards $5,000 Total Debt Payments $46,408 Living Expenses Utilities Principal Residence $3.900 Lawn Service Principal Residence $1.400 Gasoline for Autos $4,500 Lawn Service for Vacant Lot $900 Entertainment $2.000 Vacations $2.000 Church Donations $500 Clothing $3.000 Auto Maintenance $2.000 Satellite TV $2.000 Food $6.000 Alimony $6,000 Miscellaneous $1.500 Total Living Expenses $35.700 Insurance Payments HO Insurance Principal Residence $3.000 Auto Insurance Premium $3.300 Life Insurance policy A Premium $2.100 Total Insurance Payments $8.400 Total Cash Outflows $152.806 Net Discretionary Cash Flows Now Frideral Iwwe Tawad wwwrity are promend touryod vandreture zone die gewerk av hemorragend and one opres are not ind i en of je le 326 TREVOR AND LINDA GATES CASE 9 Face Amount $0 $0 EDUCATION INFORMATION Trevor and Linda strongly believe in education. They want William to attend an Ivy League school for undergraduate studies and attend a very good law school. They also would like to pay for his entire seven years of school so that William can focus on his studies and not be burdened by a part-time job. The current cost of college is $55,000 per year for undergraduate and approximately $70,000 per year for a high quality law school. Tuition has been increasing annually at seven percent, which is expected to continue indefinitely. The Gates' would like to establish an investment portfolio to be exclusively used for funding William's college tuition. Based on discussions with his broker, Trevor expects to earn an average return on investments of ten percent per year. The Gates have $10,000 set aside for education and anticipate contributing to the fund each year until William goes to college. The funds are currently invested in a large cap mutual fund and are held at the broker's firm. INSURANCE INFORMATION Life Insurance Policy A Policy B Policy C Insured Trevor Trevor Linda $250,000 $150,000 $40,000 Type Whole Life Group Term Group Term Cash Value $2,000 Annual Premium $156 $50 Who pays premium Trevor Employer Employer Beneficiary Trevor's Estate Krissy Trevor Policy Owner Trevor Trevor Linda Settlement options clause selected None None Health Insurance Trevor and Linda are covered under Trevor's employer plan which is an indemnity plan with a $200 deductible per person per year and an 80/20 major medical co-insurance clause with a family annual stop loss of $1,500. The major medical policy has no lifetime limit. Long-Term Disability Insurance Trevor is covered by an "own occupation" policy with premiums paid by his employer. The benefits equal 60% of his gross pay after a 90-day climination period. The policy covers both sickness and accidents and is guaranteed renewable Linda is not covered by any disability insurance. Homeowners Insurance The Gates have a HO3 policy with endorsements for replacement value and open perils for personal property. The current dwelling coverage is 100% replacement value with an inflation rider. $2,100 None INTERNAL INFORMATION 327 Automobile Insurance Both cars are insured as follows: Type Bodily Injury Property Damage Medical Payments Physical Damage Uninsured Motorist Bodily Injury Uninsured Motorist Property Damage Comprehensive Deductible Collision Deductible Premium (annual) PAP $100.000/$300,000 $50,000 $5,000 per person Actual Cash Value $100,000/$300,000 $50,000 $1,000 $1,000 $3,300 The Gates do not have a personal liability policy. INVESTMENT INFORMATION The Gates think that they need six months of cash flow, net of all taxes, savings, vacation, and discretionary cash flow, in an emergency fund. They are willing to include in the emergency fund the savings account and Trevor's 401(k) plan balance because it has borrowing provisions (3% per year). The Gates are not well educated in the area of investments, but like to dabble with stocks and mutual funds. They are willing to accept enough risk to accomplish their goals, but not excessive risk. As part of a financial planning engagement, you go through the process of assessing the Gates' risk tolerance. Trevor and Linda answered the following six questions as follows. The answers below are given at the beginning of the engagement 328 TREVOR AND LINDA GATES CASE 9 Disagree Strongly Disagree Risle Tolerance Questionnaire Global Portfolio Allocation Scoring System (PASS) for Individual Investors! Questions Strongly Agree Neutral Agree 1. Earning a high long-term total return that will allow my capital to grow faster than the inflation rate is one of my most TL important investment objectives 2. I would like an investment that provides me with an opportunity to defer taxa T.L tion of capital gains to future years. 3. I do not require a high level of current T.L income from my investments 4. I am willing to tolerate some sharp down swings in the return on my invest- ments in order to seek a potentially T.L higher return than would normally be expected from more stable investments 5. I am willing to risk a short-term loss in return for a potentially higher long-run T L rate of return 6. I am financially able to accept a low level of liquidity in my investment port TL folio. TTL - Linde 1. Global Portfolio Allocation Scoring System (PASS) for Individual Investors - developed by Dr William Droms (Georgetown University) and Steven N. Sr. (DomStream Advisors Inc.) - model used with permission INTERNAL INFORMATION 329 Portfolio Information Gates Portfolio Information 12/31/16 Account Cash Bonds US guide Foreign Equities Total Portfolio Cash and Gail quivales Plus Dulles Total SAN S. S65.000 9.000 S. Municipal de 545,000 $113.000 S. TEMS US Foreign 50.000 S000 Mes Thiti IRA ESOP $30,000 SO w 90 Total Porfolie Account Types Act Taul Fancation Tax Deferred SN T Educa Tas formed Being Municipal de Capaa 5.000 5.000 Sto $156.000 IN 19 . Toul SON 1001 401 50.000 330.000 530.000 20.000 Tradition ISOP 30 S. Sin SI56.000 Trevor's Internet Company Trevor is in the information-gathering phase of owning his own web-based company. He expects the company to have losses for the first several years due to the cost of capital that will be required and the necessary marketing and advertising expenses to establish brand recognition. In addition, he believes that he may need the assistance of a venture capital firm to provide some of the funding necessary for the company after it is up and running. However, he is unsure about this at this stage. 330 TREVOR AND LINDA GATES CASE Case 9 IBM Stock Trevor believes that IBM is strategically positioned to prosper. IBM currently retains 80 percent of their profits for the purpose of growing the business. This policy has allowed them to grow their dividend every year at about seven percent. Trevor thinks that this is one of his best investments. Trevor inherited the 200 shares of IBM stock when his Uncle Steve died. The stock price on the date of death opened at 180, closed at 190, had a high of 196 and a low of 178. Uncle Steve had acquired the stock 4 weeks before his death for $195 per share, including commissions. OTHER INFORMATION REGARDING ASSETS AND LIABILITIES Home and Furnishings They purchased their home 36 months ago for $200,000 and financed 80 percent of the sale price at six percent for 30 years. They considered refinancing, but their FICO score is 530 due to recent late payments on credit cards recently. They plan to sell or lease this property once their dream home is built. Their home furnishings are relatively normal. However, Trevor inherited his great grandfather's grandfather clock, which has great sentimental value to Trevor. Trevor believes the value of the clock to be about $5.000. Automobile Linda's Audi is several years old and is fully paid off. Trevor has just purchased a 2015 Black Porsche Boxster S with a six-speed manual transmission one year ago. He purchased the car for $60,000, made a deposit of $15,000 and financed the remaining balance over five years at seven percent. They both love the Porsche and how they look in it. Residential Lor Trevor and Linda have been dreaming of building a large house and so they decided to purchase a vacant lot for $225,000. Not having sufficient cash to purchase it outright, they made a down payment of $75,000 and financed the remainder over fifteen years at 6 percent with a balloon after five ycars. Their first payment was 24 months ago They have no time table for building at this time. However, under no conditions will they consider selling the lot as it took them years to find it. Student Loans Trevor had to take out loans to pay for college. He borrowed a total of $40,000 to be repaid over 20 years at eight percent. Web Options Trevor has a variety of incentive stock options (ISOs) and non-qualified stock options (NQSOs) that he has received as part of his compensation at Web. The following table below lists each of the option grants including the exercise price and grant date. Year Exercise Grant Options Grant Date Vesting Granted Price 2012 09/01/12 5.000 $35 2013 2 10/15/13 10,000 $25 5 years 2014 3 09/02/14 10.000 $15 5 years 2015 4 09/01/15 15,000 $25 5 years 2016 5 09/01/16 10,000 $28 5 years 5 years INTERNAL INFORMATION 331 The company grants the maximum number of ISOs to Trevor every year and the exercise price is always equal to the FMV of the stock on the date of grant. The current price of Web stock is $34 per share. The options vest over five years with 20 percent vesting each year. Trevor is generally optimistic about the company's future. However, he is concerned about some of Wet's competitors and a new technology that is emerging. Web is responding, but it is unclear how it could impact the company. We has never issued any cash dividends, stock dividends or had any stock splits. Clothes Are Us Linda is the benefits administrator for her company's retirement plans. The company sponsors a 401(k) plan and an ESOP. Following is a list of employees with census information: Name Position Ownership Amy Gomez Founder Jenny Camile? Co-founder & Manager Linda Gates Asst. Manager Russ Ricardo Sales Associate Henrietta Hynes Sales Associate Ingred Iberson Sales Associate Brad Larson Sales Associate Allison Ulysses Sales Associate David Gomez Clerk Nancy Miller Clerk Amy Gomes is not an employee and has not been one for ten years Jenny Camerun the busines, with since from Linda David is the grandion of Amy Gomer 5196 1596 2.6% 2.3% 3.0% 5.0% 1.5% 0.9% 0.2% 0.5% Prior Year Salary SO $65.000 $40,000 $92,000 $88,000 $48.000 $37.000 $50,000 $25,000 $18,000 401) Deferral Percentage 096 10% 10% 7% 896 8% 6% 0% 0% 1. 2. 3. The 401(k) plan permits elective deferral contributions up to 80 percent of an employee's compensation. There is no matching contribution. However, the company does contribute to the ESOP in profitable years, although no contribution was made during 2016 to the ESOP. The remaining ownership of the company is held by the trustee of the ESOP. The ownership in the above table reflects the total stock owned by each person, including stock owned via the ESOP. The business is valued annually for ESOP purposes by an outside appraiser, however, there was no change in value from last year to this year. 332 TREVOR AND LINDA GATES CASE The company grants the maximum number of ISOs to Trevor every year and the exercise price is always equal to the FMV of the stock on the date of grant. The current price of Web stock is $34 per share. The options vest over five years with 20 percent vesting each year. Trevor is generally optimistic about the company's future. However, he is concerned about some of Web's competitors and a new technology that is emerging. Web is responding, but it is unclear how it could impact the company. Web has never issued any cash dividends, stock dividends or had any stock splits. Clothes Are Us Linda is the benefits administrator for her company's retirement plans. The company sponsors a 401(k) plan and an ESOP. Following is a list of employees with census information: Name Position Ownership 401(k) Deferral Percentage 0% 10% 10% 7% 896 Prior Year Salary SO $65.000 $40,000 $92,000 $88,000 $48,000 $37,000 $50,000 $25,000 $18,000 Amy Gomez! Founder Jenny Camile? Co-founder & Manager Linda Gates Asst. Manager Russ Ricardo Sales Associate Henrietta Hynes Sales Associate Ingred Iberson Sales Associate Brad Larson Sales Associate Allison Ulysses Sales Associate David Gomez Clerk Nancy Miller Clerk 1. Amy Gomez is not an employee and has not been one for ten years 2 Jenny Camile runs the business with stance from Linda 3. David is the grandson of Any Goma. 5196 159 2.6% 2.39 3.0% 5.0% 1.5% 0.9% 0.2% 0.5% 896 696 0% 0% The 401(k) plan permits elective deferral contributions up to 80 percent of an employee's compensation. There is no matching contribution. However, the company does contribute to the ESOP in profitable years, although no contribution was made during 2016 to the ESOP. The remaining ownership of the company is held by the trustee of the ESOP. The ownership in the above table reflects the total stock owned by each person, including stock owned via the ESOP. The business is valued annually for ESOP purposes by an outside appraiser, however, there was no change in value from last year to this year. 332 TREVOR AND LINDA GATES CASE