• Wake Up and Smell the Coffee! (The case is adopted from Cases in Finance 2nd Ed. By Jim DeMello) "Wake up and Smell the coffee!" was the latest slogan that Dan Roth had used in his advertising campaign to make people aware of Their need for financial planning, budgeting, and saving for retirement. Dan's financial consulting business had blossomed over the past few years because of such slogans and because Dan strongly believed in and preached the benefits of financial freedom. "A debtor is a slave to the lender," he always said when asked whether it made sense to borrow at low rates of interest. "The only way to financial independence is to be debt-free," he advised. Marty & Laura Hall, who lived in the same town where Dan ran his consulting business, came across the advertisement in a local newspaper and it certainly caught their attention. The Halls had. tied the knot" about three years ago and were enjoying a fairly comforlable lifestyle. Marty was a middle-level manager at an industrial chemical company, while Laura worked as an elementary school teacher in the public school system. Both of them had racked up quite a bit of credit card debt and college loans over the years, but were making all the required minimum payments on time. They loved to take annual vacation trips and host parties so as to keep up with their social circle. And then the other day, Laura announced that she was pregnant with their first child. Their thoughts immediately turned to the future and it was only then that it hit them. With very little money saved up and no financial plan, they knew that they had better get some advice. So they took an appointment to see Dan and at the first meeting they were asked to present information about their ages, current earnings savings, debts, expenses, and desired goals. Table 1 presents a summary of the information that the Halls reported. Financial Information reported by Laura and Marty Hall Marty's Salary $80,000 Laura's Salary $65,000 Savings Account Balance $0 Marty's age 32 Laura's age 30 Credit Card Balance owed $15,000 @19.98% per annum minimum monthly payment required on credit card debt is 3% of balance owed College Loans owed $23,000 @4.5% per annum (24 months remaining) Two cars Loans owed $17,000 (24 payments remaining) Monthly rent $1250 When asked about their goals and objectives, Laura told Dan that they were expecting their first child by the end of the year and were interested in starting a savings plan for their child's college education. "Excellent idea", said Dan "With college costs increasing by about 4% per year and current annual costs of a college education averaging $20,000, it's never too early to start saving for your child's education. What about a retirement nest egg? Have either of you put any money aside in some kind of pension Plan? Marty and Laura looked sheepishly at each other “Unfortunately, we have been living it up and living off borrowed money," they said. "And thanks to your advertisement, we realized that we had better wake up and start planning for the future” “Once again, it's never too late,” said Dan "We’ll come up with some suggestion. Tell me, how long do you guys plan on working? “Until we turn to 65, not a day beyond 65,” they both said without hesitation. "We want to be able to tour the world while we still can!" "My thoughts exactly," said Dan. "Do you guys own your own home?" No, they said, "we are renting a two-bedroom apartment but would like to move into an affordable house as soon as possible. Do you think that's a good idea?" Well, it depends," said Dan. "You will need to come up with a down payment and closing costs. What kind of house did you guys have in mind?" he queried. "A two-story, 3 bedroom house that is currently listed at $320, 000" they responded. "All right, let's get to work,” said Dan. "It's time to smell the coffee!" 1. Assume they live in Ontario estimate their personal marginal tax rate, income tax amount, and average tax rate. Assume total amount qualified for non-refundable tax credits is $21,000 2. Using the template provided estimated their monthly and yearly budget. 3. How much money will Laura and Marty have to deposit each month in RESP (beginning one month after the child is born and ending on his or her 18th birthday) in order to have enough saved up for their child's college education. Canadian Education Saving Grant is 20% of annual contributions to a maximum $400 per year. Assume that the yield on investments is 8% per year, college expenses increase at the rate of 4% per year, and that their child will enter college when he or she turns 18 and will complete the degree in 4 years. 4. How much money will the Halls have to set aside each month so as to have enough saved up for a down payment on the $320,000 house within 24 months? Assume that the closing costs amount to 4% of the loan and that the down payment is 20% of the price. 5. If the interest rate on a 30-year mortgage is at 3.2% per year when the Halls purchase their $320,000 house, how much will their mortgage payment be? Assume insurance $60 per month and property tax 1.15% of value of property. 6. Construct an amortization schedule for the 3.2%, 30 year mortgage. 7. If the Halls want to have as much of an after-tax income when they retire as they currently have, and assuming they live until they are 85 years old, how much money should they set aside each month into RRSP and Tax Free Saving Account so as to have enough money accumulated in their retirement nest egg? Assume that annual inflation rate is 2.5% per year for the whole term, the investment return is 8% per year before and after retirement. Assume maximum $9,000 each they can save in RRSP and maximum $5000 each in Tax Free Saving Account. 8. If the Halls continue paying the minimum 3% on their credit card debt each month, how long will it take them to pay it off and how much total interest will they have paid? If you were Dan, what would you advise them to do? 9. Prepare the Halls’ cash flow table for 10 years, assume their salaries increase by 3% per year and average inflation during the same period 2.5%.