Personal Finance:
Another Perspective
Preparing for the
Final Exam –
Review #1
Preparing for the
Final Exam

How to do well on my exams (by order of what I think
is most important):
• 1. Review the PowerPoints for each class
• These are the things I consider important
• Especially look for application problems
and know how to do them
• 2. Review the previous quizzes and exams
• Check your quiz answers from Blackboard
• 3. Review the homework problems and readings
• Think through the purpose for each problem
• 4. Write up a good reference card (8.5” x 11”)
• It is an open reference card but closed
everything else test
Financial Statements
Data:
 Mickey and Minnie, both recent BYU graduates in
2004, together get paid $4,500 every month. Monthly
expenses include $750 on taxes, $1,200 on housing and
utilities, $750 on transportation, $350 on food, and an
average of $1,000 on clothing and other expenses.
Calculations:
 Prepare an income statement and then calculate and
interpret their net and gross savings ratio.
Application:
 How are they doing?
Both get $4,500 every month. Monthly expenses include $750 on taxes, $1,200 on
housing and utilities, $750 on transportation, $350 on food, and an average of $1,000
on clothing and other expenses. Calculate and interpret their net and gross savings
ratio. How are they doing?
Both get $4,500 every month. Monthly expenses include $750 on taxes, $1,200 on
housing and utilities, $750 on transportation, $350 on food, and an average of $1,000
on clothing and other expenses. Calculate and interpret their net and gross savings
ratio. How are they doing?
Income Statement
Income before Tax
Expenses
Taxes
Utilities/Housing
Transportation
Food
Clothing/other
Income for Savings
4,500
750
1,200
750
350
1,000
$450
Net Savings Ratio (2)
Income for Savings 450 = 12%
Income for Living 3,750
They save 12% of their net living
expenses and 10% of their gross. While
this can be high or low, depending on
the age and situation of the family, it is
the minimum for us. I would hope it is
closer to 20% for those in this class!
Gross savings ratio: Income for savings / Total Income: 450 / 4,500 = 10%
Consumer Loans
Data:
 Jonathan needs approximately $2,500 to buy a new
computer. A 2-year unsecured loan is available with instore financing for 10%. The current rate on his
revolving home equity line of credit is 5.75%, although
he is reluctant to use it. Jon is in the 28% federal tax
bracket and the 5.75% state tax bracket.
Calculations and Application
• a. What are the advantages and disadvantages of
each loan? b. Regardless of the loan chosen, Rich
wants to pay off the loan in 24 months. Calculate the
monthly payments for him, assuming both loans use
the simple interest calculation method. c. Which
loan should he choose?
Jonathan needs $2,500. A 2-year in-store unsecured loan is 10 percent. The revolving
home equity line of credit is 5.75%. Jon is in the 28% federal and the 5.75% state tax
bracket. a. What are the advantages and disadvantages of each loan? b. Rich wants to pay
off the loan in 24 months. Calculate the monthly payments.
Jonathan needs $2,500. A 2-year in-store unsecured loan is 10%. The revolving home
equity line of credit is 5.75%. Jon is in the 28% federal and the 5.75% state tax bracket. a.
What are the advantages and disadvantages of each loan? b. Rich wants to pay off the loan
in 24 months. Calculate the monthly payments. c. Which loan should he take?

A. Advantages and Disadvantages
• Unsecured line of credit
• + No collateral needed
• + Cheaper than a credit card
• + Does not put the house at risk
• - Expensive
• Home equity loan
• + interest may be tax deductible
• + secured loan so lower rate
• - Fail to repay loan--may lose the house
Jonathan needs $2,500. A 2-year in-store unsecured loan is 10%. The revolving home
equity line of credit is 5.75%. Jon is in the 28% federal and the 5.75% state tax bracket. a.
What are the advantages and disadvantages of each loan? b. Rich wants to pay off the loan
in 24 months. Calculate the monthly payments. c. Which loan should he take?

B. The unsecured loan monthly payment would be: PV
= -2,500, I = 10/12, N = 24, PMT = ?
• $115.36
 The home equity loan monthly payment would be: PV
= -2,500, I = 5.75/12, N = 24, PMT = ?
• $110.52
 The home equity loan would save $116.16. In addition,
the loan would save $51.46 in taxes based on the
deductibility of the interest: [($110.52*24)] -$2500] *
.3375 (28%+5.75%).
• What Jonathan has to decide is whether or not the
$167.62 in total savings is worth the risk of losing
the house if he cannot repay the loan. I would be
very very very careful
Jonathan needs $2,500. A 2-year in-store unsecured loan is 10%. The revolving home
equity line of credit is 5.75%. Jon is in the 28% federal and the 5.75% state tax bracket. a.
What are the advantages and disadvantages of each loan? b. Rich wants to pay off the loan
in 24 months. Calculate the monthly payments. c. Which loan should he take?

C. Either answer is ok, depending on the why. The
home equity loan is cheaper, with tax savings. The
unsecured debt does not risk losing the house. Helpful
would be to know whether his is living on a budget
and if he has the discipline to pay back the loan
quickly.
• The after-tax cost of the 5.75% home equity loan
would be 3.81% using the following calculation
that considers the tax savings on both federal and
state taxes
• 3.81% = 5.75% [ 1 -(.28 + .0575)]
The Housing Decision
Data:
 You have made the decision to purchase a house, and you found the house
you want for $200,000 (assume no down-payment for the sake of this
problem). You and your wife have agreed to a 30-year loan, but expect to
pay it off in 7 years as your work looks extremely promising (assume annual
payments). Your wife looked on the web, and found a $200,000 loan with no
points and no fees at 6.5%, which she is sure, she can lock in. You talked
with you friend who is a mortgage broker, and he knows he can get you a
6.0% loan for the $200,000, but it has 2 points and a loan origination fee of
$1,500. Assume you can get either of these loans.
Calculations and Application
 Calculate the (a) total costs for each loan assuming you pay them both off in
7 years (assume you make the final balloon payment at the end of year 7).
(b) What is the effective interest rate of each loan? (c) Which is the cheaper
alternative? (d) Your broker comes back and says she can offer you 5.75%
but with 3 points and the same $1,500 fees. What is effective cost to you (i.e.
the impact on your effective interest rate) of that third point (i.e. calculate it
with the three points and fees, then compare that to your calculation with 2
points and fees, and subtract the difference)?
Quick Review of EIR Process
1. Calculate the
Payments of the
total on the
total amount of
the loan
2. Calculate
the amount
received after
subtracting all
your costs
3. Calculate the balloon
payment due at the end of
the prepayment period
4. Set PMT to
payment, -PV to
amount received, FV to
balloon payment, N to
years before
prepayment, and solve
for I or your EIR
Loan A: $200,000, 30-year, no points and no fees, 6.5%, Loan B $200,000,
6%, 2 points, 1,500 fees, all pay it off in 7. Calculate total costs each loan,
effective rate, cost of 2nd point.
Loan A: $200,000, 30-year, no points and no fees, 6.5%, Loan B $200,000,
6%, 2 points, 1,500 fees, all pay it off in 7. Calculate total costs each loan,
effective rate, and Loan C of 5.75%, 3 points, 1,500 fees, all pay it off in 7.


Loan A: since no points and fees, the EIR = APR
Loan B

1. Calculate the Payment
• I = 6.0% N = 30 PV = -200,000, PMT = 14,529.78

2. Calculate the amount received
• Points = 2 for $4,000 plus 1,500 fees = 200,000 - 5,500
• Loan receipt less points of = 194, 500

3. Calculate balloon at the end of year 7
• N=23 (30 - 7 years), I= 6%, PMT = 14,529.78, PV = ?
• PV Remaining = $178,765.42

4. Calculate the effective interest rate
• PMT = $14,529.78, FV = $178,765.42, PV = $-194, 500,
N = 7 I=?
• EIR = 6.52%
Loan A: $200,000, 30-year, no points and no fees, 6.5%, Loan B $200,000,
6%, 2 points, 1,500 fees, all pay it off in 7. Calculate total costs each loan,
effective rate, and Loan C of 5.75%, 3 points, 1,500 fees, all pay it off in 7.
Total Costs:
 Loan A: 7 x 15,315.49 + 180,265.39 = $287,474
• EIR = 6.5%
 Loan B: 7 x 14,529.78+178,765.42 + 5,500 = 285,974
• EIR = 6.52
Cost of the Loan C and third point
 Loan C: 7 x 14,143.25 + 177,981 + 7,500 = 284,484
 PMT = 14,143.25, FV = 177,981, PV = -192, 500, N =
7, I = ?
 EIR = 6.46%
Cost of the third point = 6.52 – 6.46 = .06%
 Loan C is the cheapest loan both in rate terms and in
dollar terms
Tax Strategy
Data:
 Using the married filing jointly status and their income and expense statement
below, calculate the 2006 tax liability for Mork and Mindy Williams (they have five
children, ages 4, 8, 12, 16, and 18). Mindy is the Young Women’s President of her
ward and has calculated that she drove her car 300 miles last year to girls’ camp,
which was not reimbursed. Exemptions are $3,300 per person, the standard
deduction for married filing jointly is $10.300, medical expenses over 7.5% of AGI
and job-related expenditures over 2% of AGI are deductible, charitable deductions
for mileage are .12 per mile, and the child-tax credit is $1,000 per child under 17. a.
Calculate their tax liability first using the standard deduction and then using
itemized deductions. b. Write a paragraph explaining to the Williams which method
they should use and why? In that paragraph, comment on their marginal and average
tax rates on taxable income.
Income
Expenses
Earned Income
$74,000 Home Mortgage interest
Interest Income
2,100 Un-reimbursed Medical Bills
Retirement Plan Contributions
DI and other donations
Mork’s IRA
3,000 Job-related expenditures
Mindy’s Roth IRA
2,000 Tithing and other offerings
Tax Table for Married Filing Jointly for 2006:
Amount
Tax
•
•
•
0 to $15,100
$15,100 to $61,300
$61,300 to $123,700
6,200
4,900
250
1,800
7,000
10%
$1,510 plus 15% of the amount over $15,100
$8,440 plus 25% of the amount over $61,300
Quick Review of Tax Process
1. Start with
income from all
sources less
exclusions =
Total Income
2. Subtract
adjustments to
Total Income =
Adjusted Gross
Income (AGI)
3. Minus
Standard
Deduction or
Itemized
deductions
4. Minus
exemptions
= Taxable
Income
5. Look up tax
on tax table =
Tentative Tax
6. Minus credits
= Total Tax Owed
7. Minus taxes
already paid =
Balance Due or
Amount of
Refund
Tax Liability (standard deduction)
1.+2. AGI =74000+2100-3000 (IRA) =
$73,100
Only the IRA is subtracted to get your AGI
3. Less standard deduction
10,300
4. Less personal exemptions (7 * 3,300) 23,100
Taxable income
$39,700
Tax liability
$15,100*10%=
1,510
(39,700 -15,100)*15%= 24,600*.15
3,690
5. Total tax liability
$5.200
6. Child tax credit
-4,000
7. Total
$1,200
Average tax rate = Total taxes due / Taxable income
Average tax rate = $1,200 / 39,700 = 3.0%
Marginal tax rate = 15% for both
Tax Liability (Itemized deductions)





1. + 2. AGI
73,100
3. Less itemized deductions:
Home mortgage Interest 6,200 Un-reimbursed Medical
0
Job related expenditures
338 Tithes & other offerings
7,000
DI & other donations
250 Mileage
36
• Total itemized
(13,824)
4. Less personal exemptions (same as before)
(23,100)
Taxable Income
$36,176
Tax liability
• 14,100*10%= 1,510 + [(36,176-15,100)*15%] =
3,161
• 5. Total tax liability
$4,671
• 6. Child tax credit less
-4,000
• 7. Tax
671
• Average tax rate = $671 / 36,176 = 1.9%
Paragraph should include the savings ($529), recommendation, and
average and marginal tax rates on taxable income, not gross income.