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Solution and Answer Guide nm nm nm
GARMAN/FOX, PERSONAL nm n m FINANCE n m 14E, CHAPTER
nm n m 1: THINKING LIKE
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PLANNER
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TABLE OF CONTENTS nm nm
Answers to Chapter Concept Checks .................................................................................................. 2
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What Do You Recommend Now?......................................................................................................... 4
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Let’s Talk About It ................................................................................................................................. 5
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Do the Math .............................................................................................................................................. 6
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Financial Planning Cases ......................................................................................................................... 8
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Extended Learning .................................................................................................................................. 10
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ANSWERS TO CHAPTER CONCEPT CHECKS nm nm nm nm
LO1.1 Recognize the keys to achieving financial success.
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1. Explain the five steps in the financial planning process.
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Answer: There are five fundamental steps to the personal financial planning process: (1)
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evaluate your financial health to your education and career choice; (2) define your financial
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goals; (3) develop a plan of action to achieve your goals; (4) implement spending and saving
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plans to monitor and control progress toward your goals; and (5) review your financial
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progress and make changes as appropriate.
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2. Distinguish among financial success, financial security, and financial happiness.
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Answer: Financial success is the achievement of financial aspirations that are desired, planned,
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or attempted. Success is defined by the individual or family that seeks it. Financial success
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may be defined as being able to live according to one’s standard of living. Financial security
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is that comfortable feeling that your financial resources will be adequate to fulfill any needs
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you have as well as your wants. Financial happiness is the experience you have when you
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are satisfied with money matters. People who are happy about their finances will see a
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spillover into positive feelings about life in general.
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3. Summarize what you will accomplish studying personal finance.
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Answer: Several things can be accomplished by studying personal finance. Recognize how to
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manage unexpected and expected financial events. Pay as little as possible in income taxes.
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Understand how to effectively comparison shop for vehicles and homes. Protect what we own.
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Invest wisely. Accumulate and protect the wealth that we may choose to spend during our non-
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working years (e.g., retirement) or donate.
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4. What are the building blocks to achieving financial success?
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Answer: The building blocks for achieving financial success include a foundation of regular
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income that provides the means to support your lifestyle and save for desired goals in the
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future. The foundation supports a base of various banking accounts, insurance protection, and
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employee benefits. Then we can establish goals, a recordkeeping system, a budget, and an
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emergency savings fund. We will also manage various expenses such as housing,
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transportation, insurance, and the payment of taxes. We will also need to handle credit, savings,
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and educational costs. Finally, we invest in various investment alternatives such as mutual
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funds, stocks, and bonds, often for retirement. As a result of all these building blocks, we
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are more apt to have a financially successful life.
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LO1.2 Understand how the economy affects your personal financial success.
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1. Summarize the phases of the business cycle.
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Answer: The business cycle entails a wavelike pattern of rising and falling economic activity
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as measured by economic indicators like unemployment rates or the gross domestic product.
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The phases of the business cycle include expansion (preferred stage—production is high,
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unemployment low, interest rates low or falling, stock market and consumer demand high),
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peak, contraction, downturn, trough, and recovery.
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2. Describe two statistics that help predict the future direction of the economy.
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Answer: Forecasting the state of the economy involves predicting, estimating, or calculating
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what will happen in advance. We need to be able to forecast the state of the economy,
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inflation, and interest rates so that we have advance warning of the directions and strength of
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, Solution nmand nmAnswer nmGuide: nmGarman/Fox, nmPersonal nmFinance nm14e, nmChapter nm1: nmThinking nmLike nma
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changes in economic trends since they will affect our personal finances. Two statistics we
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could watch are the consumer confidence index (how consumers feel about the economy and
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their personal finances) and the index of leading economic indicators (composite index,
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averages ten components of economic growth).
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3. Give an example of how inflation affects income and consumption.
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Answer: Inflation reduces the purchasing power of the dollar. This means that our income
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will not go as far and, thus, in real terms will be lowered by inflation. Because items cost
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more, we will have to consume less and may cut back on some expenditures to be able to
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afford those with a higher priority.
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LO1.3 Think like an economist when making financial decisions.
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1. Define opportunity cost and give an example of how opportunity costs might affect
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your financial decision making.
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Answer: The opportunity cost of a decision is measured as the value of the next-best
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alternative that must be forgone. If we, for example, put our retirement savings in a regular
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savings account instead of in a tax- sheltered retirement account, we may be forgoing the tax
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benefits associated with investing in retirement accounts such as IRAs or 401(k) plans. In
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another example, if we decide to borrow the maximum student loan amount for which we
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qualify to live a bit more comfortably while in college, we will not be able to live as
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nicely, save as much for the down payment on a home or save for retirement once we
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graduate because of the higher loan payments.
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2. Explain and give an example of how marginal utility and marginal cost make
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some financial decisions easier.
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Answer: Marginal analysis focuses on the next increment of usefulness or cost when making
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financial decisions. Marginal utility is the extra satisfaction derived from having one more
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incremental unit of a product or service. Marginal cost is the additional cost of that unit.
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When marginal utility exceeds marginal cost, and we compare the two, we can make better
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financial decisions. As an example, if you must fly to some destination, is the marginal cost
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of checking a bag using a carry-on worth the marginal utility?
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3. Describe and give an example of how your marginal income tax rate can affect
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financial decision making.
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Answer: As our income rises, we will find ourselves in higher and higher tax brackets. One
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type of decision that is affected by income taxes is how we should invest for retirement. We
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might want to invest through a 401(k) plan instead of keeping our retirement money in a
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savings account, which is taxable.
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Since most types of income are taxable, it is important that we understand the impact of
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income taxes on financial decisions. Of particular importance is the marginal tax rate (the
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tax rate at which our last dollar earned is taxed). If we are in the 25 percent marginal tax
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bracket, we will get to keep 75 percent (100 percent minus 25 percent) of our last taxable
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dollar earned. If the income is tax-free income, on the other hand, we would get to keep
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100 percent of it. Therefore, it is important to know our marginal tax rate as well as
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what types of income are subject to federal income taxes. It is also important to
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remember the impact of state income taxes and Social Security taxes.
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LO1.4 Perform time value of money calculations in personal financial decision making.
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1. What are the two common questions about money?
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Answer: The two common questions about money are its future value and present value.
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Future value is what investment or series of investments will be at a point in the future.
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Present value is how much we would need to invest today and/or in a series of future
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investments to provide some amount in the future.
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2. Explain the difference between simple interest and compound interest, and
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