CASE STUDY ANSWER OUTLINE
THINGS THEY SHOULD DO
• It is very important they find out how much debt they are in because they seem to owe or liable to pay a lot of dues to different investments.
o This is concurrent with how many such groups they are going into. They should go slow in such endeavors and concentrate on in income generating activities.
o This is very important as one should not spend if they have due debts.
o Failure to pay debts can land them in a lot of trouble.
o They need to keep a close eye on their mortgage which in itself is a type of debt.
o They should also reduce on savings and car loans.
o At the moment, the family is in a financial dilemma. The time to pay children’s school fees is due. School fees totals to $65,000 p.a. payable in three installments, each per term. Therefore, Kevin and Alex have to raise at least $22,000 to cater for the current term’s fees. However, they do not have the kind of money needed.
o The payment cannot be post pone to a future date as the children need to go to school.
o Although it is something that they have been expecting, they have obviously not planned for it, therefore, be treated as an emergency.
o The couple has a joint savings account for emergency and some outstanding balance in the credit card. Since the school fees is a must do, they should withdraw $10,000 from the emergency savings account and $12,000 from the credit card to raise the fees. This will see the credit card balance drop to a little over $5,000 and the savings account to $10,000.
o Although this compromises their financial position, it is indispensable as they have to pay for the school fees.
• The other thing that they need to do is set some objectives of what they would want to achieve.
o As a couple, Kevin and Alex have a lot of resources. However, the resources are scattered and poorly appropriated.
o Despite all the resources being committed, there is no major investment which the two seems to be focusing on.
o Neither of the two seems to have clear goals of what he or she wants to achieve.
For instance, no one has an investment savings plan or an outstanding investment.
o All their earnings seem to be committed to current consumption and retirement savings, no investment agendas. This is indicative of a couple without a good financial plan. It is therefore important that the couple should come up with a coherent investment plan, setting goals of what they want to achieve both as a couple and individually.
o Their only concern seems to be saving for retirement. Although it is a good thing, it is not an exceptionally good source of funding upon retirement, since it is limited to the amount saved only.
o The couple should come up with a long term project that will help them invest for their future. In addition, they should also come up with investment projects which will help them increase their current earnings. This will help them appropriate what they own better than they have at the moment.
CURRENT FINANCIAL SITUATION
• To know this with certainty, it is important first calculate the after tax income for the couple.
o At the moment, Kevin is earning a gross of $85,000 p.a. from his IT business. This places him in the 21.9-31.3% income tax bracket (Australia Income Tax Department 2011). After the deductions, his earnings nets to $65,600.
o Alex on the other hand, is a higher earner with a gross of $190,000 which nets to $130,950 after tax.
o The couple earns a total of $196,550 after tax.
o Alex has debenture. She has a listed debenture with a FV of $25,000 and a coupon of 8.5% paid quarterly and with 27months to maturity. It is currently trading at a yield of 7.75%. Although Alex holds some shares in the stock market, their earnings have effectively been neglected as it is negligible. Their total annual earnings thereby totals to $198,765.
o It was assumed that they are paying income tax individually as married persons while calculating their income after tax.
THEIR FINANCES
• The couple has a number of obligations.
o They have to make monthly payment towards the house mortgage of $6,978 totaling to $83,736 p.a.
o They also have to pay $65,000 p.a. for their children’s education.
o They also have personal loans on their cars, where Alex parts with $1557 per month which totals to $18,684 p.a. and David $1,244 per month totaling to $14,928 p.a.
o David contributes $13,000 p.a. towards his Self managed super fund while Jenifer contributes $10,000 p.a. towards her superfund.
o As a couple, their major annual expenses total to $205, 348.
OVERALL SITUATION
• How much they make should determine how much they spend. But it beats logic since the annual income is less than the annual expenses. This indicates that the couple is living beyond its means. They have more commitments that they can fund.
• If the current situation continues, the couple is most likely going to be unable to fund its outstanding loans to which the biggest proportion of their net income is committed. They need to improve on their cash flow.
• The couple owns assets which seem not to be giving them any significant financial gain.
ACTIONS THAT CAN BE TAKEN
WHAT, WHY AND EFFECT
• A very big percentage of the couple’s income goes towards funding the repayment of the mortgage. Since it is a standard principal and interest loan, they cannot make any advance payments or default from paying not even for a month without risking a penalty. Therefore, they have to go on paying the loan on a regular monthly basis. There is nothing much that can be done to ease the pressure it has on them. However, they should establish an offset account which will ensure that they earn interest on the outstanding bank balances pending the repayment of the mortgage.
• All the children attend private school which sees the parents pay a total of $65,000 per year. This is approximately 34% of the couple’s total annual earnings after tax. This is more than reasonable being allocated for the children’s education. Considering that they also have a mortgage to fund, this is most likely to cause financial strains if not financial problems. Already the couple is finding it difficult to raise enough cash to pay school fees for the children. To ease this pressure, they should consider transferring the children to relatively cheaper schools. For instance, they could opt to taking the children to public schools where they will pay at most, half of what they currently pay. They could use the excess money saved from the transfer to fund their daily expenses. This will see the credit card status improve availing money for emergencies and small investment opportunities.
• There is no excuse for Kevin’s brother not to contribute towards housed expenses. They should ensure that he starts contributing towards household expenses, which will ease their budget and help him become accountable of his finances. They should also encourage him to open a first home owner account which will ensure that he accumulates enough to purchase his own property within the shortest time possible.
• It is uneconomical for Alex to continue holding onto the share portfolio which earns her close to nothing while she is financing a loan. The most logical and economical thing she should do is consolidate her shares and use this money to repay her loan. By so doing, Alex will escape the expenses that would have otherwise been charged had she continued holding the loan. This will also see her economically utilize the resources she owns rather than leavening them lay idle while she continues incurring a lot in repaying her loans.
• Since the money from the shares cannot fully repay the loan, she should also consider selling her debentures at the current market yield rate of 7.75%. The debentures are earning her only 8.5% before tax which after being taxed becomes less than the prevailing yield rate and the interest charged on the loan. It is thereby uneconomical to hold onto the debentures. Only a small portion of the debentures money will be committed towards the repayment of her personal loan. After fully repaying the loan, she will be left with an excess of $20,000.
• It is highly uneconomical to redeem the debentures earning Alex should consider other more viable options. She should consider investing the remainder to an optional business where she is likely to get better returns. However, if the couple could come to an amicable agreement, Alex should loan the money to Kevin so that he can repay his personal loan. However, this is only viable in the event that the couple comes to a clear agreement.
• Kevins’s car is used for his business. Some of the loan should thereby be funded by the business. Since his business is in no financial problems at the moment, he should use the business fund to repay the car loan.
• Once all the loans are repaid, they should then establish an investment savings account and contribute the money they would have otherwise used in repaying the loans to build a joint reserve from which they can make future investments.
• Both should continue making their regular concessional contributions. However:
o Kevin should move out of the SMFS since it is time consuming and too expensive for him. He should consider a superfund which will allow him to reinvest his savings in a business with better returns.
o Alex should save all her bonus as she plans to.
o Alex considers taking a life insurance cover against her superfund to cover the family against major health issues since she is the major earner.
o She should also use the savings in her super to fund other investment projects which will help her boost her annual income. This move will put the money in the super to more economic uses. To avoid any risks in losing the super fund, the couple should engage a professional economist while choosing their investment projects.
• Kevin needs to plan for a suitable investment project where he can invest the money he is probable to receive from his father’s inheritance. Although it is not guaranteed that he will receive any money, he should be able to tell his stakes in his father’s holdings as the executor. It is important that he plans beforehand.
ASSUMPTIONS
• For the purpose of this argument, it has been assumed that the couple takes all their income and puts it together to spend it collectively. Only personal loans and assets privately held have been assumed to be personal. However, the income is assumed to be free for use by any of the spouses.
SITUATION AFTER SUGGESTED ACTIONS
• Basically, the couple should have reduced they debts they are incurring an investing more.
• Changes on the current income level will be minimual. It willingly reduce by $2125p.a. for gone after selling the debentures
• Expense reduction will be by:
o $33,000 p.a. from school fees.
o $18,684 p.a. from the repayment of Jenifer’s loan.
o David will also stop incurring expenses in repaying the loan within a short period.
• f they make good investment using their supers, it is expected they will improve their annual earning. The family will also be secured against health risks by the cover that Alex will take.
• They will be in a position to build financial reserves and save enough for future investments.
• Finally, if they learn to make wiser financial decisions, they will find the with a lot more money in their hands and less debt.
