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Chapter 6 Financial Planning Problems (p. xxx)
- Calculating the Amount for a Home Equity Loan. A few years ago, Michael Tucker purchased a home for $100,000. Today, the home is worth $150,000. His remaining mortgage balance is $50,000. Assuming Michael can borrow up to 80 percent of the market value of his home, what is the maximum amount he can borrow?
Solution: Present market value of Michael’s home = $150,000. Michael can borrow up to 80 percent of the market value, or $120,000. Michael still owes $50,000 mortgage on his home. Therefore, he can borrow a maximum of $70,000 ($120,000 – $50,000). LO: 6-2Topic: Credit capacity and ratio analysisLOD: IntermediateBlooms tag: Apply
- Determining the Debt Payments-to-Income Ratio. Louise McIntyre’s monthly gross income is
$2,000. Her employer withholds $400 in federal, state, and local income taxes and $160 in Social Security taxes per month. Louise contributes $80 per month for her IRA. Her monthly credit payments for Visa, MasterCard, and Discover card are $35, $30, and $20, respectively. Her monthly payment on an automobile loan is $285. What is Louise’s debt payments-to-income ratio? Is Louise living within her means? Solution: Louise’s Gross Income = $2,000
|Less: Income taxes||=||-400|
|Less: Social Security Tax||=||-160|
|Less: IRA contribution||=||-80|
|Net take-home pay||=||$1,360|
Her monthly payments on VISA, MasterCard, Discover Card, and a car loan add up to $370 per month. Louise’s debt payments to income ratio is 370 to 1,360, or 27.2 percent. This ratio exceeds the recommended 20 percent figure. Therefore, Louise is overextended. Her maximum monthly loan and credit card payments should not be over $272 (20 percent of $1,360). LO: 6-3Topic: Credit capacity and ratio analysisLOD: AdvancedBlooms tag: Apply
- Calculating the Debt-to-Equity Ratio. Robert Thumme owns a $140,000 townhouse and still has an
unpaid mortgage of $110,000. In addition to his mortgage, he has the following liabilities:
|Personal bank loan||800|
Robert’s net worth (not including his home) is about $21,000. This equity is in mutual funds, an automobile, a coin collection, furniture, and other personal property. What is Robert’s debt-to-equity ratio? Has he reached the upper limit of debt obligations? Explain. Solution: Robert’s total debt (not including mortgage) is $7,410. His net worth (not including his home) is $21,000. Therefore, his debt-to-equity ratio is $7,410 divided by $21,000, or 0.35. Since this ratio is less than 1, Robert has not reached the upper limit of debt obligations. LO: 6-3Topic: Credit capacity and ratio analysisLOD: IntermediateBlooms tag: Apply
- Calculating the Debt Payments-to-Income Ratio. Kim Lee is trying to decide whether she can afford a loan she needs in order to go to chiropractic school. Right now Kim is living at home and works in
a shoe store, earning a gross income of $820 per month. Her employer deducts $145 for taxes from her monthly pay. Kim also pays $95 on several credit card debts each month. The loan she needs for chiropractic school will cost an additional $120 per month. Help Kim make her decision by calculating her debt payments-to-income ratio with and without the college loan. (Remember the 20 percent rule.)Solution: Kim’s debt payments-to-income ratio with the college loan is 31.85 percent; without the college loan it is 14.07 percent. According to the 20 percent rule, she cannot afford the college loan. However, after Kim pays off her credit card debts, her debt payments-to-income ratio with the college loan will be 17.5 percent. Therefore, once she pays off her credit cards, she will be able to afford the loan. [ANSWER: $820 — $145 = $675; $95 + $120 = $215; $215 ÷ $675 = 31.39%; $120 ÷ $675 = 17.8%] LO: 6-3Topic: Credit capacity and ratio analysisLOD: AdvancedBlooms tag: Analyze; Apply
- Calculating Debt Payments–to–Income Ratio. Suppose that your monthly net income is $2,400.
Your monthly debt payments include your student loan payment and a gas credit card. They total$360. What is your debt payments–to–income ratio? Solution:Monthly net income = $2,400Total monthly debt payments = $360Debt-payments-to-income ratio = $360 ÷ $2,400 = 0.15 or 15% LO: 6-3Topic: Credit capacity and ratio analysisLOD: IntermediateBlooms tag: Apply
- Calculating Debt Payments–to–Income Ratio. What is your debt payments–to–income ratio if your debt payments total $684 and your net income is $2,000 per month?
Solution:Total monthly debt payments = $684Monthly net income = $2,000Debt payments-to-income ratio = $684 ÷ $2,000 = 0.342 or 34.2% LO: 6-3Topic: Credit capacity and ratio analysisLOD: BasicBlooms tag: Apply
- Calculating a Safe Credit Limit. Drew’s monthly net income is $1,600. What is the maximum he
should use on debt payments? Solution:Drew’s monthly net income = $1,600Maximum should be 20% of net income, or $320 ($1,600 × .20) LO: 6-3Topic: Credit capacity and ratio analysisLOD: IntermediateBlooms tag: Apply
- Credit Reduces Future Income. The disposable income from your part-time job in 2017 was
$12,000. In 2016, you borrowed $500 at 18 percent interest. You repaid your loan with interest in
- How much would you have available for spending in 2017?
Solution:Amount borrowed in 2016 = $500Interest rate = 18%Interest for one year = $500 × .18 × 1 = $90Loan repaid with interest in 2017 = $500 + $90 = $590Spending amount available in 2017 = $12,000 – $590 = $11,410 LO: 6-3Topic: Credit capacity and ratio anlaysisLOD: BasicBlooms tag: Apply
- Analyzing Feasibility of a Loan. Fred Reinero has had a student loan, two auto loans, and three credit cards. He has always made timely payments on all obligations. He has a savings account of $2,400 and an annual income of $25,000. His current payments for rent, insurance, and utilities are about
$1,100 per month. Fred has accumulated $12,800 in an individual retirement account. Fred’s loan application asks for $10,000 to start up a small restaurant with some friends. Fred will not be an active manager; his partner will run the restaurant. Will he get the loan? Explain your answer. Solution:Even though Fred has always made timely payments on all obligations, he is not likely to get a$10,000 loan to start up a small restaurant with some friends. The lender knows that Fred will not be an active manager, and his partner may not have any experience in running a restaurant. Moreover, restaurants have one of the highest failure rates in the business world. His current yearly income of $25,000 minus expenses for rent, insurance and utilities will leave just enough money to live. His savings of $2,400 are not sufficient to pay off a loan, and he can not access a $12,800 IRA account until he is 59 ½ years old. LO: 6-4Topic: Credit capacity and ratio analysisLOD: IntermediateBlooms tag: Analyze; Apply
- 1 Analyzing a Spending Plan. Carl’s house payment is $1,050 per month and his car payment is $385 per month. If Carl’s take-home pay is $2,800 per month, what percentage does Carl spend on his home and car?
Solution:House Payment = $1,050/month Car Payment = $ 385/month Total Payment = $1,435/month Take-home Pay = $2,800/monthPercentage spent on house and car = $1,435 ÷ $2,800 = .5125 or 51.25%. LO: 6-4Topic: Credit capacity and ratio analysisLOD: IntermediateBlooms tag: Apply