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Transcript of © Winger & Frasca, Personal Finance: An Integrated Planning Approach, 5th Ed., Prentice Hall Inc....
© 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
© Winger & Frasca, Personal Finance: An Integrated Planning Approach, 5th Ed., Prentice Hall Inc.
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
© Winger & Frasca, Personal Finance: An Integrated Planning Approach, 5th Ed., Prentice Hall Inc.
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
© Winger & Frasca, Personal Finance: An Integrated Planning Approach, 5th Ed., Prentice Hall Inc.
What Are Your Goals in Life?What Are Your Goals in Life?
Nonfinancial Goals Financial Goals
– Current Consumption– Future Consumption – Savings
© Winger & Frasca, Personal Finance: An Integrated Planning Approach, 5th Ed., Prentice Hall Inc.
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!
© Winger & Frasca, Personal Finance: An Integrated Planning Approach, 5th Ed., Prentice Hall Inc.
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
© Winger & Frasca, Personal Finance: An Integrated Planning Approach, 5th Ed., Prentice Hall Inc.
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
© Winger & Frasca, Personal Finance: An Integrated Planning Approach, 5th Ed., Prentice Hall Inc.
Planning AreasPlanning Areas
Consumption and savings planning Debt Planning Insurance Planning Investment Planning Retirement Planning Estate Planning Income Tax Planning
© Winger & Frasca, Personal Finance: An Integrated Planning Approach, 5th Ed., Prentice Hall Inc.
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.
© Winger & Frasca, Personal Finance: An Integrated Planning Approach, 5th Ed., Prentice Hall Inc.
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
© Winger & Frasca, Personal Finance: An Integrated Planning Approach, 5th Ed., Prentice Hall Inc.
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.
© Winger & Frasca, Personal Finance: An Integrated Planning Approach, 5th Ed., Prentice Hall Inc.
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
© Winger & Frasca, Personal Finance: An Integrated Planning Approach, 5th Ed., Prentice Hall Inc.
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
© Winger & Frasca, Personal Finance: An Integrated Planning Approach, 5th Ed., Prentice Hall Inc.
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
© Winger & Frasca, Personal Finance: An Integrated Planning Approach, 5th Ed., Prentice Hall Inc.
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
© Winger & Frasca, Personal Finance: An Integrated Planning Approach, 5th Ed., Prentice Hall Inc.
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
© Winger & Frasca, Personal Finance: An Integrated Planning Approach, 5th Ed., Prentice Hall Inc.
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
© Winger & Frasca, Personal Finance: An Integrated Planning Approach, 5th Ed., Prentice Hall Inc.
Portion of a Future-Value-of-Portion of a Future-Value-of-$1- Annuity Table$1- Annuity Table
Number of Interest Rate ( i )
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
© Winger & Frasca, Personal Finance: An Integrated Planning Approach, 5th Ed., Prentice Hall Inc.
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
© Winger & Frasca, Personal Finance: An Integrated Planning Approach, 5th Ed., Prentice Hall Inc.
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
© Winger & Frasca, Personal Finance: An Integrated Planning Approach, 5th Ed., Prentice Hall Inc.
Portion of a Present -Value-of-Portion of a Present -Value-of-$1-Table$1-Table
Number of Interest Rate ( i )
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
© Winger & Frasca, Personal Finance: An Integrated Planning Approach, 5th Ed., Prentice Hall Inc.
Portion of a Present -Value-of-a-Portion of a Present -Value-of-a-$1 Annuity-Table$1 Annuity-Table
Number of Interest Rate ( i )
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
© Winger & Frasca, Personal Finance: An Integrated Planning Approach, 5th Ed., Prentice Hall Inc.
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
© Winger & Frasca, Personal Finance: An Integrated Planning Approach, 5th Ed., Prentice Hall Inc.
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
© Winger & Frasca, Personal Finance: An Integrated Planning Approach, 5th Ed., Prentice Hall Inc.
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
© Winger & Frasca, Personal Finance: An Integrated Planning Approach, 5th Ed., Prentice Hall Inc.
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
© Winger & Frasca, Personal Finance: An Integrated Planning Approach, 5th Ed., Prentice Hall Inc.
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
© Winger & Frasca, Personal Finance: An Integrated Planning Approach, 5th Ed., Prentice Hall Inc.
Next Chapter 2Next Chapter 2Financial Statements and Financial Statements and
BudgetsBudgets