SUBJECT: PRINCIPLES OF FINANCE

CASES FOR ANALYSIS

Case Study 1: Lucy Wants to Buy a House but Doesn’t Want a Roommate Now

Lucy Allen has save $10,000 toward a $20,000 down payment on buying a home. She puts aside
$300 a month in her house fund and is currently renting a one-bedroom apartment on her own
for $1,300 a month. If she rented a two-bedroom apartment with a roommate, she could
reduce her rent to $900 a month. While having a roommate is not Lucy’s favourite solution,
she’d be able to build up her down payment for buying a house a lot faster if she were able to
save an extra $400 a month. If Lucy stays on her own and her finances remain the same, it will
take her about 2 ¾ years to put aside the needed additional $10,000. In contrast, if she set
aside the rent saved by getting a roommate, she would have the needed $10,000 in about only
14 months. Doing without a roommate at this stage in Lucy’s life is costly.

Questions:

1. If you are in the situation of Lucy would you continue renting for a one-bedroom
apartment or settle for a two-bedroom apartment with a roommate?
Answer: If I were Lucy, I will continue renting for a one-bedroom. Even if it maybe costly,
but security and benefits are also considered.

2. On the given situation, what’s the best thing Lucy should do?
Answer: Lucy should continue renting for one-bedroom.

Case Study 2: Ryan Has Had It and Files for Bankruptcy

Ryan Booth is overwhelmed by his bills. While making $60,000 a year, he has amassed credit
card debt of $24,000, has an over $80,000 college loan, holds a $150,000 mortgage, and pays
monthly on his leased Jetta. He’s having trouble paying the mortgage monthly and can never
seem to pay more than the minimum on his credit card debt. Ryan’s wife, Helen, is currently
unemployed. Ryan has heard that declaring bankruptcy can eliminate some of his debt
commitments and give him extra time to deal with others. He’s had it and just filed for
bankruptcy. What can Ryan look forward to as a result of his decision?

Ryan can expect some cash flow relief in the short-term, and filing for bankruptcy will likely
prevent or at least delay foreclosure on his home. However, the bankruptcy filing will adversely
affect his credit report for up to the next 10 years. Ryan will probably have trouble getting a
loan or a new credit card. And if he can borrow money or get a new credit card, he’ll probably
have to pay the highest allowable interest rate. By not having managing his family’s
indebtedness, Ryan has exercised the bankruptcy “nuclear option.” This provides short-term
relief at the expense of longer-term access to credit on reasonable terms.

Questions:

1. Do you think filing bankruptcy will be the best solution for Ryan’s financial crisis?
Support your answer.
Answer: I don’t think it would be the best solution without consulting a professional
for this problem. First and foremost, he has a secured loan which is the mortgage
and auto loan for the Jetta, that once he couldn’t pay, it will be taken away from
him. In that case, he may have ample time to pay for his other debts.

2. Discuss all the advantages and disadvantages of filing personal bankruptcy.

Answer: The advantages of filing a personal bankruptcy is that he can sell some of
his assets to pay for his debts and he can have allotted time to pay for the other
debts. The disadvantages are that it will affect his credit report and low chances of
being granted of a loan or credit card. If ever granted, he may have the highest
interest rate.

Case Study 3: Jake and Agnes Calculate their Auto Loan Backward

Jake and Agnes Barnett budget and spend their money carefully. Their Honda CRV has over
150,000 miles and needs to be replaced. Because they drive their cars so long, Jake and Agnes
have decided to buy a new car and have saved a $5,000 down payment. They are willing to
make a monthly car payment of about $350 while 48 month loans are at 3 percent. Before they
choose a new car, they want to determine how much they can afford to spend on it given their
budget constraints.

Jake and Agnes do their auto loan calculations backwards to figure out the size of the auto loan
implied by a 48 month maturity and 3 percent interest rate. Using a calculator and the
approach explained, that loan amount is about $15,813. Thus, given their down payment of
$5,000, Jake and Agnes can afford a car selling for about $20,813 net of tax, title and licensing
fees. They are indeed careful, if not “backward”, car shoppers who explore the angles.
Questions:

1. On the given data, should Jake and Agnes push through of getting an auto loan?
Support your answer.
Answer: I don’t think they should push through on getting a loan yet because of
some uncertainties. They couldn’t be so sure of their calculations when they get to
apply for loans. It would be better also if they also calculate it in other way.

2. Discuss all the advantages and disadvantages of availing auto loan.

Answer: The advantages of the auto loan are: it is convenient. It is accessible since
there lots of legitimate lenders you can talk to for auto loan application. The
disadvantages are: auto loans usually have high interest rates. Once you failed to
pay on time, it will be costly. If you cannot pay on time – until the maturity date of
your loan, then they will take over your car, since auto loan is a secured type of loan.

Case 4: Quinn and Celia Consider “Buying Term and Investing the Rest”

Quinn and Celia Hansen have two young children and believe it’s time to buy a life insurance
policy to protect their family. They’ve both heard the life insurance advice to “buy term and
invest the rest.” In order to evaluate this advice they’ve collected quotes for 20-year term and
whole life policies on Quinn, both with a payoff of $250,000. The whole life policy premium is
$347 a month, while the term policy premium is only $23 a month. In 20 years, the whole life
policy will have a guaranteed cash value of $70,018 but at current rates would be worth
$105,721. The death benefit will have grown to $326,352. If the Hansens buy the term policy
and invest the $324 difference in monthly premiums at 8 percent for 20 years, they could have
a portfolio worth about $190,843!

The Hansens wonder about the financial consequences of their decision. It looks like buying
term and investing the difference leaves them off. Yet the financial consequences can only be
fully evaluated in light of the Hansens’ objectives and attitudes towards risk. The whole life
insurance policy provides a guaranteed cash value in 20 years, while the invested difference
produces a higher expected but risky, nonguaranteed payoff. And the Hansens must consider
whether they will have the discipline to keep “investing the difference” over the next 20 years.
Once the whole life policy’s cash value builds up, they could stop paying the premium by
accepting some trade-offs in the value of the policy. In 20 years, the term life insurance
coverage will go away, which might be fine if kids are gone and the mortgage is paid off. In
contrast, the Hansens could stop paying the whole life policy premiums then and accept a
reduced paid-up amount of coverage.
The personal financial consequences of “buy term and invest the rest” suggest the advice may
well work for the Hansens. The best decision depends on their objectives, discipline, and
attitudes towards the risk of “investing the rest.”

Questions:

1. Explain the ‘buy term and invest the rest’.

Answer: What I understand is that you have a term insurance and pay for it, then
you continue investing even if your terms are done. It is like taking a term insurance
and whole term insurance together.

2. Discuss all the advantages and disadvantages on the above situation.

Answer: The advantage I saw in this situation is that if he takes the “buy term and
invest the rest” method of insurance, he maybe able to earn high insurance savings
for his beneficiaries. The downside of this is that, the money invested after the term
is the riskier part. It is nonguaranteed payoff. From what I understand of the term
‘’nonguaranteed payoff”, it won’t be an assurance that how much you have invested
is the exact amount you receive.

Case 5: Trevor Expands His Health Insurance Coverage

Trevor Wilson is 27 years old. He works for a company with a good health insurance plan.
Indeed, Trevor has heard it’s priced better than most plans and has consequently taken out the
optional expanded dental and vision plans. While he doesn’t currently wear glasses or contact
lenses, he does go for an annual eye exam and wants the extra vision plan in case he ends up
needing corrective lens or has any eye problems. His plan has a $40 co-payment for an annual
eye exam and pays $100 toward eyeglass frames, plus 20 percent of the rest of the cost.
Contacts lenses have similar coverage. Trevor pays just an additional $15 monthly premium for
the vision plan. He feels more comfortable having expanded health insurance coverage.

While Trevor feels better having expanded health insurance coverage in general and vision
coverage in particular, it isn’t currently a cost-effective decision. He makes a $40 co-payment
for an annual eye exam, which is probably cheaper than the full cost of an eye exam. But Trevor
doesn’t wear glasses or contacts. His $15 monthly premium costs him $180 per year. It’s
extremely unlikely that he saves anywhere near that much on the cost of his exam under the
vision plans. And if Trevor has a significant medical problem with his eyes, his major medical
insurance plan should over the cost well. It could make sense for him to have expanded vision
coverage in the future, if corrective lenses are needed, but for now it appears that Trevor’s
comfort in having expanded vision coverage is costly.
Questions:

1. Discuss the term ‘co-payment.’

Answer: Copayment is part of the health insurance plan wherein the insured should
pay for the covered coverages. The amount is paid to the service provider.

2. Discuss all the advantages and disadvantages of ‘co-payment’.

Answer: The advantage the copayment is that it helps for the convenience of the
check ups or medical needs that covers the coverage. You will also have lesser
amount of premium to pay. Its disadvantage is that it is commonly suitable for
insured at a young age, because if people with illnesses that may result to high
payments, copayment can’t cater it all resulting to high payments instead of
lowering it.

Case 6: Rob Saves on His Car Insurance

Rob McDowell is a frugal and careful financial planner. One of his money-saving decisions is to
continue driving his nine-year old car, which is now worth about $7,500. In order to save money
on his car insurance, Rob increased his deductible from $500 to $1,000, which reduced his
annual premium by $200. He has just decided that he no longer needs the collision coverage on
his policy, which pays for the repair and replacement of his low-value car rather than to
continue taking the certain loss of the higher-priced insurance coverage. This decision will save
him hundred dollars a year.

Questions:

1. Does Rob’s decision that he no longer needs the collision coverage help him save
more insurance money? Support your answer.
Answer: I think it would be more costly in his part if he will take out the collision
coverage since it’s purpose is to pay for the repairs or replacement of the car in case
any accidents happen. Even if the car is 9 years old and it is under insurance, it is still
covered by the car insurance. If any accident happens to the car, then he may be
able to save money for repairs and replacements of it.

2. Discuss the importance of car insurance.

Answer: Car insurance is important because if any accidents happen to your car, you
can use your insurance to have it repaired or you will get paid by the insurer. You
will be secured through car insurance. If you don’t have one, if you have damages or
anything bad that happens to your vehicle – yet you are not at fault, then you will
get paid by the insurer you applied for car insurance.