© Winger & Frasca, Personal Finance: An Integrated Planning Approach, 5th Ed., Prentice Hall Inc. Fifth Edition Personal Finance An Integrated Planning

© Winger & Frasca, Personal Finance: An Integrated Planning Approach, 5th Ed., Prentice Hall Inc.

Fifth EditionFifth Edition

Personal FinancePersonal Finance

An Integrated Planning ApproachAn Integrated Planning ApproachBernard J. WingerBernard J. WingerRalph R. FrascaRalph R. Frasca


Chapter 1: Financial Planning--Chapter 1: Financial Planning--Why It’s ImportantWhy It’s Important

Increased Emphasis on Self Reliance– Less From Government; e.g. Social Security– Less From Employer; e.g. Reduced Role of

Traditional Retirement Plans Achieving Financial Independence Coping with Economic Uncertainties and

Shocks


Financial Success and Financial Financial Success and Financial IndependenceIndependence

Financial Success: Obtaining Maximum Benefits from Limited Financial Resources

Financial Independence: Having Sufficient Income or Financial Resources To Be Self Reliant


What Are Your Goals in Life?What Are Your Goals in Life?

Nonfinancial Goals Financial Goals

– Current Consumption– Future Consumption – Savings


The Principle of Diminishing The Principle of Diminishing Marginal SatisfactionMarginal Satisfaction

Current consumption is limited by diminishing marginal satisfaction.

Example: Would you rather drink 7 soft drinks right now, or have 1 a day for the next 7 days? Most people prefer the latter choice because each additional bottle after the first one (or two) provides much less satisfaction. Indeed, the 7th bottle right now might make you sick!


Important Economic TrendsImportant Economic Trends

Continuing Inflation--How High? 3-4%? Persistent Business Cycles

– Is Your Job Safe?– Do You Have Cash Reserves to Weather a

Storm? A Perplexing Tax System

– High Tax Rates– Selectively Rewarding


A Planning ApproachA Planning Approach

Define a Broad Goal Break it Down To Manageable Sub-goals Create an Action Plan to Achieve Sub-goals Periodically Evaluate the Action Plan

– If Successful, Keep Up Good Work– If Not, Find New Action Plan or New Goal


Planning AreasPlanning Areas

Consumption and savings planning Debt Planning Insurance Planning Investment Planning Retirement Planning Estate Planning Income Tax Planning


Marginal AnalysisMarginal Analysis

Looks at changes in important variables Considers whether a decision’s added

benefits are worth its added costs Example: you choose not be buy whole life

insurance because the cash build-up in the policy is less than what you could earn by buying term insurance and investing the saved premiums.


Opportunity CostsOpportunity Costs

Opportunity costs are benefits that you give up when you choose one alternative over another

Example: the opportunity cost of taking a course in personal finance is the knowledge you could have gained by taking another course in its place


What Is Meant by the “Time What Is Meant by the “Time Value of Money?”Value of Money?”

Having a dollar today is worth more than receiving a dollar sometime in the future.

Conversely, paying a dollar at a later date is more desirable than paying it now.

The above statements make sense because any sum of money today can be invested to earn interest and thereby grow to a larger amount.


Time Value of Money: Time Value of Money: CompoundingCompounding

Must Know:– Interest Rate – Number of Periods Investment is Held

Assumes Interest Earned Is Reinvested Can Find the Future Value of:

– A Single Payment– An Ordinary Annuity– An Annuity Due


Coumpounding IllustratedCoumpounding Illustrated

You invest $1,000 today, hold the investment for 3 years, and earn 10% each year. How much will you accumulate at the end of 3 years?

__________________________________________

Year Beginning-of- Interest End-of-Year

Year Amount Earned Amount

1 $1,000 $100 $1,100

2 1,100 110 1,210

3 1,210 121 1,331 Answer


Portion of a Future-Value-of- $1- Portion of a Future-Value-of- $1- TableTable

Number of Interest Rate ( i )

Periods (n) 6% 8% 10%

1 1.0600 1.0800 1.1000

3 1.1910 1.2597 1.3310

10 1.7908 2.1589 2.5937

20 3.2071 4.6610 6.7275

30 5.7435 10.0620 17.4490

40 10.2850 21.7240 45.2590


Easy Way to Find An FVEasy Way to Find An FV

Use FV of $1 Table to find the FV value for your problem

Multiply by the number of $s invested Example: How much will you accumulate

over 10 years by investing $4,000 today and earning 8% a year?

Answer: Find FVof $1 for n = 10, i = 8: it is 2.1589. Then 2.1589 x $4,000 = $8,635.60


What Is an Annuity?What Is an Annuity?

An annuity is a series of equal payments An ordinary annuity (OA) assumes the payments

occur at the end of periods. Most future-value-of-$1-annuity tables show ordinary annuities

An annuity due assumes the payments occur at the beginning of periods

Annuities are found in many investments, such as bonds


FV of an Ordinary AnnuityFV of an Ordinary Annuity

An investment of $1,000 is made at the end of each of the next 3 years and earns 10%. How much is accumulated at the end of 3 years?

– First payment earns interest for 2 years; so,

$1,000 x 1.1 x 1.1 = $1,210– Second payment earns interest for one year; so,

$1,000 x 1.1 = $1,100– Third payment earns no interest; so,

$1,000 X 1.0 = $1,000– Add: $1,210 + $1,100 + $1,000 = $3,310


Portion of a Future-Value-of-Portion of a Future-Value-of-$1- Annuity Table$1- Annuity Table


Periods (n) 6% 8% 10%

1 1.0000 1.0000 1.0000

3 3.1836 3.2464 3.3100

10 13.1800 14.4860 15.9370

20 36.7850 45.7620 57.2750

30 79.0580 113.2800 164.4900

40 154.7600 259.0500 442.5900


Converting an Ordinary Annuity Converting an Ordinary Annuity (OA) Into An Annuity Due (AD)(OA) Into An Annuity Due (AD)

The conversion formula is:

FVAD = (1 + i ) x FVOA

where i = the interest rate earned Previous example calculated an OA of

$73,570. If payments were made at the beginning of periods, then

FVAD = (1.06) x $73,570

= $77,984


Time Value of Money: Time Value of Money: DiscountingDiscounting

Must Know:– Interest Rate– When Money is Received in the Future

Assumes Interest Earned Is Reinvested Can Find the Present Value of:

– A Single Payment– An Ordinary Annuity– An Annuity Due


Portion of a Present -Value-of-Portion of a Present -Value-of-$1-Table$1-Table


Periods (n) 6% 8% 10%

1 0.9434 0.9259 0.9091

3 0.8396 0.7938 0.7513

10 0.5584 0.4632 0.3855

20 0.3118 0.2145 0.1486

30 0.1741 0.0994 0.0573

40 0.0972 0.0460 0.0221


Portion of a Present -Value-of-a-Portion of a Present -Value-of-a-$1 Annuity-Table$1 Annuity-Table


Periods (n) 6% 8% 10%

1 0.9434 0.9259 0.9091

3 2.6730 2.5571 2.4869

10 7.3601 6.7101 6.1446

20 11.4699 9.8181 8.5136

30 13.7648 11.2578 9.4268

40 15.0463 11.9246 9.7791


Finding Present ValuesFinding Present Values

Easiest method is to use the tables Problem 1: What is the present value of

$1,331 to be received at the end of 3 years, assuming a 10% discount rate?

(1) Find the PV of $1 for n = 3 and i = 10%; it is 0.7513

(2) Multiply by $1,331 to find answer: 0.7513 x $1,331 = $1,000


Finding Present ValuesFinding Present Values

Problem 2: What is the present value of $800 to be received at the end of each of the next 20 years, assuming a 6% interest rate?

(1) Find the PV of $1 annuity for n = 20 and i = 6%; it is 11.4699

(2) Multiply $800 by 11.4699 = $9,175.92 If payments were at beginning of periods:

PVAD = (1 + i) x PVOA = 1.06 x $9,175.92 = $9,726.48


Meet the Steele FamilyMeet the Steele Family

Typical suburban family consisting of Arnold (h) and Sharon (w) and two kids--Nancy and John

Enjoying the “good life” associated with an above-average income

Doing virtually no financial planning– to educate the children– to enjoy retirement


Building Blocks of Success--The Building Blocks of Success--The FoundationFoundation

Developing Your Career Acquiring Adequate Insurance Finding Suitable Housing Saving to Build Adequate Cash Reserves


Building Blocks of Success--Building Blocks of Success--Going Up the LadderGoing Up the Ladder

First Floor: Invest in Very Secure Instruments; e.g. Bank CDs

Second Floor: Gradually Increase Risks to Earn Higher Returns; e.g. High Quality Stocks

Top Floor: Invest in All Types of Assets to Maximize Wealth; e.g. Risky Growth Stocks


Next Chapter 2Next Chapter 2Financial Statements and Financial Statements and

BudgetsBudgets

Documents

© Winger & Frasca, Personal Finance: An Integrated Planning Approach, 5th Ed., Prentice Hall Inc. Fifth Edition Personal Finance An Integrated Planning