CLASSWORK QUESTIONS ON FINANCIAL PLANNING - II

Case 2.1 – Retirement planning for Couple

Current household expenses of a couple 50,000 Rs. p.m.

Current age of Earning member 35 Years
Current age of dependent spouse 32 Years
Retirement age of Earning member 58 Years
Life expectancy of Earning member 75 Years
Life Expectany of dependent spouse 80 Years
Accumulation from existing investments (at retirement ) 12,000,000 Rs.

Goal:
They would require regular monthly inflation-linked stream of income equivalent to their current household
expenses till the life of Earning member and thereafter 60% of that income till the spouse survives. The corpus
is supposed to be invested at 7% p.a. What additional monthly amount to be invested with immediate effect in
an investment yielding 11% p.a. to attain the desired corpus? (given inflation throughout is 5.5% p.a.) Assume
Annuity due

Case 2.2 – Education planning for Children

Today's date is 1st April, 2020:

Current age of First Child 4 years
Current age of Second Child 1 year

Goal:
Education expenses are required for each child at their respective age of 18 (Rs. 4 lakh at current cost) and for
four subsequent years (Rs. 3 lakh p.a. at current cost). Expenses escalate at 5.5% p.a. All withdrawals are made
in the beginning of the financial year. What monthly amount is to be invested at 11% p.a. with immediate
effect up to one year prior to the required expenses for the First Child to achive this goal?

Case 2.3 – Effective ROI

A personal loan of Rs. 3 lakh is availed on credit card at 14% p.a. interest for tenure of 2 years. The credit card
company charged processing fees of 1% of the loan amount. The interest on monthly reducing balance basis
was charged in the credit card. What is the annual effective rate of interest paid in this transaction?

Case 2.4 – Insurance Planning

Employee's Gross salary per annum 1,000,000 Rs.

Estimated tax during the year 210,000 Rs.
Family's monthly expenses 25,000 Rs.
(including expenses incurred on household from official account)
Insurance premium (annual) 20,000 Rs.
Existing insurance cover 6,000,000 Rs.
Investment yield available on investing funds till retirement 10% p.a.
Number of remaining years to retirement 28 Years
Goal:
The anticipated increase in the Employee's post-tax salary is 5% year on year. The employee consumes 25% of
regular household expenses on self. What should be the amount of additional insurance required to replace the
Employee's income contribution to his family for his remaining years employment?

Case 2.5 – Commuted Value of Pension

Retirement age of the individual 60 yrs

Life expectancy of the individual 80 yrs

A deferred annuity pension plan offers optional one-third commutation on the date of vesting and life certain
level annuity. The level annuity from uncommuted amount is Rs. 60,000 per month. The vesting sum of Rs.
1.5 crore is estimated on retirement of the individual.
Goal:
If the individual opts to commute one-third of the expected vested amount and settles for life annuity from the
remaining amount, at what rate of return the commuted amount shall be invested to yield a total income of Rs.
90,000 per month till he survives?

Case 2.6 – Retirement & Estate Planning

Current age of Mr. A 28 Years

Current age of the spouse of Mr. A 26 Years
Retirement age of Mr. A 60 Years
Current house hold expenses 25,000 Rs. Per month
Life expectancy of each of Mr. A and spouse 80 Years
Post-retire expenses needed till Spouse's survival as % of pre-retire. exp. 75%
Current investment available to be utilized towards retirement corpus 300,000 Rs.

Mr. A desires to have additional cushion of Rs. 1 crore as terminal value from the date of last survivor towards
bequest. The retirement solution can be managed at yield of 12% p.a. in the initial 10 years, moderated to
return 9% p.a. in the next 10 years. In the remaining years to retirement and continuing into retirement the
funds could be managed to yield 7% p.a. Inflation is considered 5.5% p.a. in the pre-retirement period and is
expected to moderate at 4% p.a. in the post-retirement period. Assume annuity due.

Case 2.7 - Situation: Bond valuation and return

Face value of the Bond 1,000 Rs.

Coupon Rate (coupon payable at the end of every year on 31-December) 9% p.a.
Date of maturity 31-Dec-24
Current market price (as on 1-Apr-2020) 1,078 Rs.

What would be the effective return if an investment is made in the bond today and held till maturity?
Case 2.8 – Vacation Planning

Client's current age 28 years

Age from which annual holidays to begin (continuing lifelong) 45 years
Funds required at current costs 50,000 Rs. P.a.
Cost escalation for holiday expenses 7% p.a.
Age of retirement 58 years
Life expectancy 75 years
Holiday expenses to be contained post-retirement (at current costs) to 30,000 Rs. P.a.

Goal:
The client would start investing immediately a certain amount on a quarterly basis in investments yielding 11%
p.a. up to the period of drawing expenses for holiday for the first time. Once the corpus is built-up, the funds
for holidays for 5-year block periods would be switched to safe investments yielding 8% p.a. from which
yearly expenses would be drawn. What is the amount of quarterly investment?

Case 2.9 - Retirement planning for Couple

Current household expenses of a couple 50,000 Rs. p.m.

Current age of the client 33 years
Current age of dependent spouse 30 years
Retirement age of the client 58 years
Life expectancy of the client 78 years
Life Expectancy of dependent spouse 80 years

The client wants to know the corpus required at his retirement which would be sufficient to sustain inflation-
linked monthly expenses equivalent to their pre-retirement household expenses till the expected life of his
spouse. The retirement corpus so accumulated shall be invested at 7% p.a. return while the ruling inflation
would be 5.5% p.a. You estimate the corpus to be .

Case 2.10 – Retirement planning for Couple

Current household expenses of a couple 50,000 Rs. p.m.

Current age of the client 33 years
Current age of dependent spouse 30 years
Retirement age of the client 58 years
Life expectancy of the client 78 years
Life Expectany of dependent spouse 80 years
Estimated retirement corpus the couple is confident to accumulate 30,000,000 Rs.

Goal:
The client wants to now the rate of return which would see the accumulated corpus last till the spouse's
lifetime, if inflation-linked monthly expenses are drawn at 20% curtailment at the time of retirement. The
inflation is considered at 5.5% p.a.
Case 2.11 – Planning for own Education
John is 30 years old at the beginning of the new millennium and is thinking about getting an MBA. John is
currently making $40,000 per year and expects the same for the remainder of his working years (until age 65).
I f he goes to a business school, he gives up his income for two years and, in addition, pays $20,000 per year
for tuition. In return, John expects an increase in his salary after his MBA is completed. Suppose that the post-
graduation salary increases at a 5% per year and that the discount rate is 8%. What is minimum expected
starting salary after graduation that makes going to a business school a positive-NPV investment for John? For
simplicity, assume that all cash flows occur at the end of each year.

Case 2.12 – Human Life Value

After doing well in your finance classes, you landed a job at the IMF. Your salary is $100,000, and your
contract is for 5 years. Your salary will stay the same during the 5 years and, since you are at the IMF, you are
not subject to taxes. If you do well (which we assume will happen with certainty), you will get a permanent
contract. Under this contract, your salary will grow at the rate of 3% per year, until retirement. Retirement will
occur in 30 years after your contract becomes permanent. For simplicity, assume that your salary is paid at the
end of each year.
We assume that the interest rate is 4% (and will stay at 4% forever).

(a)What is the value of your human capital? That is, what is the PV (as of today) of all your future earnings?
(b) Assume that you spend 70% of your salary, and deposit the remainder in a savings account, which pays the
rate 4%. How much money will you have in the savings account just after you received your fifth salary (end
of year 5)? (You deposit only 30% of that salary in the savings account.)

Case 2.13 – Insurance Planning

You observe that your client has a life insurance cover of only Rs. 20 lakh. He tells you that living expenses
for the future 30 years for his family must be insured along with his essential goal of medical/higher of his son
and daughter. The details are given below:

The rate of return which is expected for the funds to be invested 7% p.a.
Inflation for living expenses 5.50% p.a.
Current household expenses 6,00,000 p.a.
Age of son 17 years
Medical education of son to begin after a year and required for 5 years
Current Cost of medical education 5,00,000 Rs. p.a.
cost escalation of medical education 8% p.a.
Age of daughter 15 years
HIgher education of daughter to begin after three years and required for 3 years
Cost of higher education for daughter 3,00,000 Rs. p.a.
cost escalation of higher education for daughter 10% p.a.

Strategy to achieve Goal:

You suggest the client that the aggregate insurance cover should suffice to meet higher education expenses
when due, along with inflation-adjusted living (household) expenses to the extent of 80% of their current
expenses for immediate next 10 years and 50% for the succeeding 20 years. You compute the amount of
insurance cover needed, which comes to _____.