Chapter 3, Problem 1DTM

a

Summary Introduction

To determine: The interpretation of investment assets to total assets ratio. The H family have too few monetary assets when compared with tangible and investment assets, the remedy for the situation in next few years is to be suggested.

Introduction:

Financial statements:It shows value of assets and liabilities of an individual or family as well as their income and expenditure. The two most useful statements are balance sheet and the cash-flow statement.

Financial ratios are mathematical calculations intended to simplify the process of assessing your financials and the progress of your financial conditions using financial statements, ratios act as tools to develop saving, spending, and credit use patterns according to your objectives.

Answer to Problem 1DTM

Investment to total assets ratio of 43.2% is within the acceptable limits, H’s have too few monetary assets when compared with investment and tangible assets, which may lead to financial difficulties for living expenses in coming months. They may have to sell some tangible assets or investments in future.

Explanation of Solution

Investment to total assets can be calculating using following formula

  $\text{Investment}\text{assets}\text{to}\text{total}\text{assets}\text{=}\frac{\text{Investment}\text{assets}}{\text{Total}\text{assets}}$

  $=\frac{\$170,000}{\$393,250}=0.43229$ Or 43.2%

As per the standard investments H’s family has sufficient investments required for age group of 30s or older which is 31%. It can be interpreted as they have investments well above the standard limits.

When compared their monetary assets ratio with investment and tangible assets ratio, it appears to be very low. This situation may lead to financial difficulties in terms of living expenses in case of emergency. Their liquidity ratio is also too low at 1.58 or 1 ½ months. The standard liquidity ratio should have been 3 to 6 months, means they should be able to fund their living expenses for about 3 to 6 months in case of any emergency such as job losses health issues, etc.

In the current situation to improve their monetary assets ratio they can sell some investment assets as it is well above the required limit of 31%.

b

Summary Introduction

To determine: the interpretation of H’s liquidity ratio and the way the issue would be addressed.

Introduction:

Financial statements: It is a summary of assets and liabilities as well as income and spending of an individual or family. The two most useful statements are balance sheet and the cash-flow statement.

Financial ratios are numerical calculations designed to simplify the process of evaluating your financial and the progress of your financial conditions using financial statements, ratios serve as tools to develop saving, spending, and credit use patterns consistent with your goals.

Answer to Problem 1DTM

H’s liquidity ratio is very low at 1.58 or 1 ½ months.

It is advised to sell some of the investment assets to address the issue.

Explanation of Solution

Liquidity ratio can be calculating using following formula

  $\text{Liquidity}\text{ratio}\text{=}\frac{\text{Monetary}\text{assets}}{\text{Monthly}\text{Expenses}}$

  $=\frac{\$12,750}{\$7,977}=1.58$ or 1 ½ months

It determines the number of months in which living expenses can be paid should an emergency arise, preferred liquidity ratio is 3 to 6 months

H’s liquidity ratio is very low at 1.58 or 1 ½ months. They may face financial difficulties to maintain monthly expenses

In the current situation to improve their monetary assets ratio they can sell some investment assets as it is well above the required limit of 31%, and some of investment assets are not providing sufficient returns.

c

Summary Introduction

To discuss: The couple’s diversification of investment assets.

Introduction:

Financial statements: It is a summary of assets and liabilities as well as income and spending of an individual or family. The two most useful statements are balance sheet and the cash-flow statement.

Financial ratios are numerical calculations designed to simplify the process of evaluating your financial and the progress of your financial conditions using financial statements, ratios serve as tools to develop saving, spending, and credit use patterns consistent with your goals.

Answer to Problem 1DTM

H’s investment may be classified under unsystematic risk that is associated with owing only one investment of a particular type, which by chance may do poorly.

Explanation of Solution

H’s investment assets

Investment type	Value in $	Percentage
Fidelity mutual funds	4,500	2.65
Scudder mutual funds	5,000	2.94
Ford motor company stocks	2,800	1.65
New York 2038 bonds	4,000	2.35
Life insurance cash value	5,400	3.18
IRA account	34,300	20.20
Real estate investment	114,000	67.00
Total investment	170,000	100

From the above table it is clear that H’s investments are not adequately diversified, large portion of their investment 67 percent depends on real estate. If real estate sector performs poorly their investment will be in heavy losses, they have a considerable investment in IRA but it is largely related to retirement planning, when we see other investments made by H its very less when compared with overall investment like mutual bunds only above 5 percent equity investment less than 2 percent.

Hence it can be concluded as H’s investment is not adequately diversified may fall under unsystematic risk. It says if invested in only one type of investment its fall will affect then investment adversely.

d

Summary Introduction

To discuss: the action to be taken by H, as it seems to receive most of their income from employment rather than investments.

Introduction:

Financial statements: It is a summary of assets and liabilities as well as income and spending of an individual or family. The two most useful statements are balance sheet and the cash-flow statement.

Financial ratios are numerical calculations designed to simplify the process of evaluating your financial and the progress of your financial conditions using financial statements, ratios serve as tools to develop saving, spending, and credit use patterns consistent with your goals.

Answer to Problem 1DTM

Larger portion of their investment is long term such as they invested 67 percent of their total investment in real estate and 20 percent in IRA, which is the main reason their most of the income is from employment not investment.

To improve they have to invest more in short term investments or the investments which has quick returns.

Explanation of Solution

H’s investment assets

Investment type	Value in $	Percentage
Fidelity mutual funds	4,500	2.65
Scudder mutual funds	5,000	2.94
Ford motor company stocks	2,800	1.65
New York 2038 bonds	4,000	2.35
Life insurance cash value	5,400	3.18
IRA account	34,300	20.20
Real estate investment	114,000	67.00
Total investment	170,000	100

As it can be seen from above table that most of their investment that is 87 percent is a long term investment which does not give quick returns, this is the main reason which their income from investment is less compared to employment, to improve their income from investment they need to invest in either short term investments or an investment which gives quick returns such as equity investment which issues regular dividends.

e

Summary Introduction

To determine: the reasonable changes in expenses that might be considered to increase surplus needed $425 per month, to take a vacation.

Introduction:

Financial statements: It is a summary of assets and liabilities as well as income and spending of an individual or family. The two most useful statements are balance sheet and the cash-flow statement.

Financial ratios are numerical calculations designed to simplify the process of evaluating your financial and the progress of your financial conditions using financial statements, ratios serve as tools to develop saving, spending, and credit use patterns consistent with your goals.

Answer to Problem 1DTM

They can consider changes in personal allowances, children allowances, gift and church to make additional $3,400 surplus so that they can plan for holidays.

Explanation of Solution

They can consider changes in personal allowances, children allowances, gift and church to make additional $3,400 surplus. All these mentioned expenses constitute around 10% of expenses for making $3,400 they need to reduce overall expenses by around 4 percent. As these expenses are not fixed, they can be adjusted to make a surplus by reducing in adequate ratio.