SOLUTION MANUAL
Personal Finance, 14th Edition
By E. Thomas Garman, Chapter 1 - 17
,TABLE OF CONTENTS
Part I: FINANCIAL PLANNING.
1. Understanding Personal Finance.
2. Career Planning.
3. Financial Statements, Goals, and Budgets.
Part II: MONEY MANAGEMENT.
4. Managing Income Taxes.
5. Managing Checking and Savings Accounts.
6. Building and Maintaining Good Credit.
7. Credit Cards and Consumer Loans.
8. Vehicles and Other Major Purchases.
9. Obtaining Affordable Housing.
Part III: INCOME AND ASSET PROTECTION.
10. Managing Property and Liability Risk.
11. Planning for Health Care Expenses.
12. Life Insurance Planning.
Part IV: INVESTMENTS.
13. Investment Fundamentals.
14. Investing in Stocks and Bonds.
15. Mutual and Exchange-Traded Funds.
16. Real Estate and High-Risk Investments.
17. Retirement and Estate Planning.
,Solution and Answer Guide
GARMAN/FOX, PERSONAL FINANCE 14E, CHAPTER 1: THINKING LIKE A FINANCIAL PLANNER
TABLE OF CONTENTS
Answers to Chapter Concept Checks ..................................................................................................... 2
What Do You Recommend Now? .......................................................................................................... 4
Let’s Talk About It ........................................................................................................................................................... 5
Do the Math ........................................................................................................................................... 6
Financial Planning Cases ....................................................................................................................... 8
Extended Learning ............................................................................................................................... 10
,ANSWERS TO CHAPTER CONCEPT CHECKS
LO1.1 Recognize the keys to achieving financial success.
1. Explain the five steps in the financial planning process.
Answer: There are five fundamental steps to the personal financial planning process: (1) evaluate your
financial health to your education and career choice; (2) define your financial goals; (3) develop a plan of action
to achieve your goals; (4) implement spending and saving plans to monitor and control progress toward your
goals; and (5) review your financial progress and make changes as appropriate.
2. Distinguish among financial success, financial security, and financial happiness.
Answer: Financial success is the achievement of financial aspirations that are desired, planned, or attempted.
Success is defined by the individual or family that seeks it. Financial success may be defined as being able to live
according to one’s standard of living. Financial security is that comfortable feeling that your financial
resources will be adequate to fulfill any needs you have as well as your wants. Financial happiness is the
experience you have when you are satisfied with money matters. People who are happy about their finances
will see a spillover into positive feelings about life in general.
3. Summarize what you will accomplish studying personal finance.
Answer: Several things can be accomplished by studying personal finance. Recognize how to manage unexpected
and expected financial events. Pay as little as possible in income taxes. Understand how to effectively comparison
shop for vehicles and homes. Protect what we own. Invest wisely. Accumulate and protect the wealth that we may
choose to spend during our non-working years (e.g., retirement) or donate.
4. What are the building blocks to achieving financial success?
Answer: The building blocks for achieving financial success include a foundation of regular income that
provides the means to support your lifestyle and save for desired goals in the future. The foundation supports
a base of various banking accounts, insurance protection, and employee benefits. Then we can establish goals,
a recordkeeping system, a budget, and an emergency savings fund. We will also manage various expenses such
as housing, transportation, insurance, and the payment of taxes. We will also need to handle credit, savings, and
educational costs. Finally, we invest in various investment alternatives such as mutual funds, stocks, and bonds,
often for retirement. As a result of all these building blocks, we are more apt to have a financially successful
life.
LO1.2 Understand how the economy affects your personal financial success.
1. Summarize the phases of the business cycle.
Answer: The business cycle entails a wavelike pattern of rising and falling economic activity as measured by
economic indicators like unemployment rates or the gross domestic product. The phases of the business cycle
include expansion (preferred stage—production is high, unemployment low, interest rates low or falling, stock
market and consumer demand high), peak, contraction, downturn, trough, and recovery.
2. Describe two statistics that help predict the future direction of the economy.
Answer: Forecasting the state of the economy involves predicting, estimating, or calculating what will happen
in advance. We need to be able to forecast the state of the economy, inflation, and interest rates so that we
have advance warning of the directions and strength of changes in economic trends since they will affect our
personal finances. Two statistics we could watch are the consumer confidence index (how consumers feel
about the economy and their personal finances) and the index of leading economic indicators (composite
index, averages ten components of economic growth).
, 3. Give an example of how inflation affects income and consumption.
Answer: Inflation reduces the purchasing power of the dollar. This means that our income will not go as far
and, thus, in real terms will be lowered by inflation. Because items cost more, we will have to consume less and
may cut back on some expenditures to be able to afford those with a higher priority.
LO1.3 Think like an economist when making financial decisions.
1. Define opportunity cost and give an example of how opportunity costs might affect your financial
decision making.
Answer: The opportunity cost of a decision is measured as the value of the next-best alternative that must be
forgone. If we, for example, put our retirement savings in a regular savings account instead of in a tax-
sheltered retirement account, we may be forgoing the tax benefits associated with investing in retirement
accounts such as IRAs or 401(k) plans. In another example, if we decide to borrow the maximum student loan
amount for which we qualify to live a bit more comfortably while in college, we will not be able to live as
nicely, save as much for the down payment on a home or save for retirement once we graduate because of the
higher loan payments.
2. Explain and give an example of how marginal utility and marginal cost make some financial
decisions easier.
Answer: Marginal analysis focuses on the next increment of usefulness or cost when making financial
decisions. Marginal utility is the extra satisfaction derived from having one more incremental unit of a
product or service. Marginal cost is the additional cost of that unit. When marginal utility exceeds marginal
cost, and we compare the two, we can make better financial decisions. As an example, if you must fly to some
destination, is the marginal cost of checking a bag using a carry-on worth the marginal utility?
3. Describe and give an example of how your marginal income tax rate can affect financial decision
making.
Answer: As our income rises, we will find ourselves in higher and higher tax brackets. One type of decision
that is affected by income taxes is how we should invest for retirement. We might want to invest through a
401(k) plan instead of keeping our retirement money in a savings account, which is taxable.
Since most types of income are taxable, it is important that we understand the impact of income taxes on
financial decisions. Of particular importance is the marginal tax rate (the tax rate at which our last dollar earned
is taxed). If we are in the 25 percent marginal tax bracket, we will get to keep 75 percent (100 percent minus 25
percent) of our last taxable dollar earned. If the income is tax-free income, on the other hand, we would get to
keep 100 percent of it. Therefore, it is important to know our marginal tax rate as well as what types of income
are subject to federal income taxes. It is also important to remember the impact of state income taxes and
Social Security taxes.
LO1.4 Perform time value of money calculations in personal financial decision making.
1. What are the two common questions about money?
Answer: The two common questions about money are its future value and present value. Future value is what
investment or series of investments will be at a point in the future. Present value is how much we would need
to invest today and/or in a series of future investments to provide some amount in the future.
2. Explain the difference between simple interest and compound interest, and describe why that
difference is critical.
Answer: Simple interest is money paid on a principal amount for a given number of years. The interest is paid
only on the principal (the original amount invested). For example, we might put $1,000 in a bank savings
account at 5 percent interest for one year. We would have accumulated $50 in that year.
, Compound interest is interest paid on interest and principal. For example, if we leave your $1,000 on deposit
and do not withdraw the $50 interest at the end of the year, we will earn interest on both the deposit and the
interest earned during the first year. This difference in the types of interest paid is important as compound
interest is the basic principle of accumulating wealth. If we invest regularly over time, our money will grow due
to the power of compound interest.
3. Use Table 1-1 to calculate the future value of (a) $2,000 at 5 percent for four years, (b) $4,500 at 9
percent for eight years, and (c) $10,000 at 6 percent for ten years.
Answer:
a. $2,000 at 5 percent for four years would equal $2,431 ($2,000 × 1.2155).
b. $4,500 at 9 percent for eight years would equal $8,966.70 ($4,500 × 1.9926).
c. $10,000 at 6 percent for 10 years would equal $17,908 ($10,000 × 1.7908).
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WHAT DO YOU RECOMMEND NOW?
Now that you have read the chapter on the importance of personal finance, what do you recommend to Jing Wáng in
the case at the beginning of the chapter.
1. Participating in her employer’s 401(k) retirement plan?
Answer: Jing should participate in her employer’s plan because her contributions reduce her taxable income
and will grow tax-sheltered until withdrawn at retirement. By doing so, she will qualify for her employer
contributions, thereby receiving additional tax-sheltered income that will go directly into her retirement
account. If Jing contributed 8 percent of her salary, her employer would match it with 4 percent for a total of
12 percent. Her total contribution would be $9,600 based on her salary of $80,000.
2. Understanding the effects of her marginal tax rate on her financial decisions?
Answer: Jing should use her marginal tax rate to assess how changes in her income and the financial decisions
she will make would be affected by taxes. For every extra dollar that she contributes to her retirement plan, for
example, she will save $0.25 in taxes if she is in the 25 percent tax bracket. Also, if she earns an extra dollar, it
will be taxed at her marginal rate.
3. Considering the current state of the economy in her personal financial planning?
Answer: Jing should stay informed about economic trends as indicated in changes in the gross domestic product,
index of leading economic indicators, and consumer price index. She should also keep track of the federal funds
rate as an indicator of interest rates in the economy. She should be able to make her own estimate for economic
growth, inflation, and interest rates over the next couple of years.
4. Using time value of money considerations to project what her Roth-IRA might be worth at age 63?
Answer: Jing could use Appendix A.1 to calculate how much her IRA fund (currently $2,000) would grow in
40 years. She would need to assume a rate of return on the funds. An 8 to 10 percent rate would be
appropriate given the investment opportunities available to her in her IRA. At 8 percent, her account would be
worth about $43,449 (21.7245 × $2,000).
5. Using time value of money considerations to project what her 401(k) plan might be worth at age 63 if
she were to participate fully?
, Answer: Jing could use Appendix A.3 to calculate how much her contributions would grow in 40 years. She
would need to assume a rate of return on the funds. An 8 percent rate would be appropriate given the
investment opportunities available to her in her 401(k). At 8 percent, her account would be worth about
$2,486,942 (259.0565 × $9,600; $6,400 of Jing’s money and $3,200 from her employer).
6. Saving for retirement versus paying off student loans?
Answer: At a minimum Jing should contribute 8 percent of her salary to her retirement savings to take
advantage of her employer’s match. Jing’s retirement savings capitalizes on compounding and the time value of
money. Employer matching for retirement is free money and should not be left on the table. Jing is paying off
$35,000 in student loans and paying off any loan does provide a guaranteed rate of return.
However, it is unlikely that the return from paying off the student loan will exceed the value of the retirement
savings when it is combined with the employer match.
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LET’S TALK ABOUT IT
1. Economic Growth. How do federal government efforts help stimulate economic growth? How do these
efforts affect consumers?
Answer: Answers will vary depending on the student’s own financial situation. Tax cuts may help students in
the lower tax brackets. Efforts to revive the economy will help students keep or obtain jobs. Education- related
credits will help college students. Efforts to help people buy their first home will help students who might be
so interested.
2. The Business Cycle. Where do you think the United States is in the economic cycle now, and where does it
seem to be heading? List some indicators that suggest in which direction it may move.
Answer: At the time this edition was published, the economy was expanding with annual growth of around
2.3 percent. The gross domestic product was edging up, but growth has been an uneven pattern. Consumer
spending is up, despite inflation being at a four-decade high. Interest rates were raised by the Fed, so borrowing is
more expensive. The unemployment rate is declining slightly and is forecast to continue to decline. Many people
are benefiting from rising wages due to tighter labor markets. Along with inflation, supply chain disruptions have
been an issue. There has been an exuberant real estate market throughout the pandemic but that is starting to cool
due to the rise in interest rates and inflation. Federal infrastructure spending programs were about to kick in and
help some of the economic indicators.
3. Personal Finance Mistakes. What are some common mistakes that people make in personal finance?
Name two that might be the worst, and why?
Answer: Eleven mistakes that people make in personal finance are failing to (1) engage in long-term personal
financial planning, (2) engage in long-term budgeting, (3) engage in short-term budgeting, (4) establish a cash
reserve in case of emergencies, (5) save at a rate that is sufficiently high, (6) establish adequate insurance
protection, (7) manage income tax liabilities advantageously, (8) limit credit card debt,
(9) manage expenditures so as to prevent unexpected expenditures on a credit card, (10) engage in investment
planning, and (11) engage in retirement and estate planning. All eleven mistakes are important. The three most
important mistakes are saving at a rate that is too low, and inadequate retirement and estate planning.
Americans save at a rate that is very low. If you save just 1 percent more of your pay, you will reap a high
return at retirement. Also, if you withdraw money from your tax-sheltered retirement plan before retirement,
you will have a substantial shortfall when it comes time to retire.
, 4. Federal Reserve. Describe some economic circumstances that might persuade the Federal Reserve to
lower short-term interest rates.
Answer: This is a potential ―Class Activity exercise related to page 14 in the text.
The Federal Reserve Board might be persuaded to lower interest rates if the economy is in a downturn, a trough,
or even in the early stages of recovery. The goal would be to make borrowing easier and provide a boost to the
economy.
5. Opportunity Costs. People regularly make decisions in personal finance that have opportunity costs. Share
financial decisions you have made recently and identify the opportunity cost for each.
Answer: Students’ examples of decisions in personal finance that have opportunity costs will vary. Each
should focus not on the direct cost of the decision but on the lost opportunity that resulted from making the
decision.
6. Inherited Money. What would you do if you inherited $3,000 from an aunt? Identify three options.
Answer: Students’ options will vary by their financial circumstances. Common options might include paying
off debt, paying future schooling costs, or beginning a retirement savings program.
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DO THE MATH
1. Real Income. Joshua Vermier of Topeka, Kansas, received a raise after his first year on the job to $45,800
from his initial salary of $44,000 (LO2 and LO3). What was Joshua’s raise stated as a percentage? If inflation
averaged 2.8 percent for the year, what was his real income after the raise? What was his real raise stated as a
percentage?
Solution: This is a potential ―Class Activity‖ exercise related to page 12 in the text.
Joshua received a $1,800 raise. As a percentage of his pre-raise income that was a raise of 4.1 percent
($1,800/$44,000 × 100). His real inflation-adjusted income after the raise is $45,553 ($45,800/1.028). As a
percentage, his real raise was 1.3 percent (4.1% − 2.8%).
2. Future Value. As a graduating senior, Chun Kumora of Charleston, West Virginia, is eager to enter the job
market at an anticipated annual salary of $54,000 (LO3 and LO4). Assuming an average inflation rate of 3
percent and an equal cost-of-living raise, what will his salary possibly become in 10 years? In 20 years? (Hint:
Use Appendix A.1.) To make real economic progress, how much of a raise (in dollars) does Chun need to
receive next year and the year after?
Solution: This is a potential ―Class Activity‖ exercise related to page 21 in the text.
Assuming an average inflation rate of 3 percent and an equal cost-of-living raise, Chun’s salary in 10 years will
be $72,571 ($54,000 × 1.3439). In 20 years, he could anticipate earning $97,529 ($54,000 × 1.8061). To make
real economic progress, Chun must receive raises greater than each year’s rate of inflation.
Otherwise, Chun is standing still because his raises will be required to compensate for the inflationary increase
in the cost of living.
3. Present and Future Values. Megan Berry, a freshman horticulture major at the University of Minnesota, has
some financial questions for the next three years of school and beyond (LO4). Answers to these questions
can be obtained by using Appendix A.
a. If Megan’s tuition, fees, and expenditures for books this year total $22,000, what will they be during her
senior year (three years from now), assuming costs rise 4 percent annually?
, b. Megan is applying for a scholarship currently valued at $5,000. If she is awarded it at the end of next
year, how much is the scholarship worth in today’s dollars, assuming inflation of 3 percent?
c. Megan is already looking ahead to graduation and a job, and she wants to buy a new car not long after her
graduation. If after graduation she begins an investment program of $2,400 per year in an investment
yielding 4 percent, what will be the value of the fund after three years?
d. Megan’s Aunt Karroll, from Austin, Texas, told her that she would give Megan $1,000 at the end of
each year for the next three years to help with her college expenses. Assuming an annual interest rate of
2 percent, what is the present value of that stream of payments?
Solution:
a. Assuming a 4 percent increase over the next three years, Megan’s tuition, fees, and books will cost
$24,748 ($22,000 × 1.1249).
b. Assuming an inflation rate of 3 percent, the scholarship is worth $4,855 in today’s dollars ($5,000 ×
0.9709).
c. With an annual contribution of $2,400 and an expected return of 4 percent, in three years Megan’s
savings will total $7,492 ($2,400 × 3.1216).
d. Assuming a 2 percent interest rate, the stream of payments from Megan’s aunt is presently worth
$2,884 ($1,000 × 2.8839).
4. Future Values. Using Table 1-1 calculate the following (LO4):
a. The future value of lump-sum investment of $4,000 in four years that earns 5 percent.
b. The future value of $1,500 saved each year for three years that earns 6 percent.
c. A person who invests $1,200 each year finds one choice that is expected to pay 3 percent per year and
another choice that may pay 4 percent. What is the difference in return if the investment is made for four
years?
d. The amount a person would need to deposit today with a 5 percent interest rate to have $2,000 in three
years.
Solution:
This is a potential ―Class Activity‖ exercise related to page 21 in the text.
a. The future value of $4,000 in four years, assuming a 5 percent rate of return, would be $4,862
($4,000 × 1.2155).
b. Assuming a 6 percent return, $1,500 saved each year for three years would be $4,775 ($1,500 ×
3.1836).
c. The $1,200 would grow to $5,020 ($1,200 × 4.1836) after four years at 3 percent and $5,096
($1,200 × 4.2465) at 4 percent. The difference is $76.
d. One would need to invest $1,728 now to have $2,000 in three years, assuming a 5 percent return
($2,000 × 0.8638).
5. Using the present and future value tables in Appendix A, or an alternate financial calculator, calculate
the following (LO4):
a. The amount a person would need to deposit today to be able to withdraw $6,000 each year for 10
years from an account earning 6 percent.
b. A person is offered a gift of $5,000 now or $8,000 five years from now. If such funds could be
expected to earn 8 percent over the next five years, which is the better choice?
c. A person wants to have $3,000 available to spend on an overseas trip four years from now. If such
funds could be expected to earn 6 percent, how much should be invested in a lump sum to realize the
$3,000 when needed?
d. A person invests $50,000 in an investment that earns 6 percent. If $6,000 is withdrawn each year,
how many years will it take for the fund to run out?
Solution:
, a. One would need to invest $44,160 now to withdraw $6,000 per year for 10 years, assuming a 6
percent return ($6,000 × 7.3601).
b. $8,000 in five years is the better choice because the future value of $5,000 in five years, assuming an 8
percent return, is $7,347 ($5,000 × 1.4693).
c. One would need to invest $2,376 now to have $3,000 in four years, assuming a 7 percent return
($3,000 × 0.7921).
d. The $50,000 investment will last approximately 12 years if it earns 6 percent and $6,000 is
withdrawn annually ($50,000/$6,000 = 8.33—look for the factor 8.33 in the 6 percent column of
the present value of a stream of equal payments table; Appendix A-4).
6. Inflation. Laureen Mauer, from Baton Rouge, Louisiana, earned a salary a year ago of $52,000 (LO2 and
LO3). If inflation during the year was 3.5 percent where she lives, how much of a decline in her purchasing
power occurred? Also, what would be her purchasing power if deflation of 1 percent occurred?
Solution:
This is a potential ―Class Activity‖ exercise related to page 12 in the text.
The 3.5 percent inflation resulted in a $1,820 reduction in purchasing power for Laureen (1.035 × $52,000) minus
$52,000. The 1 percent deflation would result in $420 increase in purchasing power for Lauren (0.01
× $52,000 = $520).
7. Use the Rule of 72. Using the Rule of 72, calculate how quickly $1,000 will double to $2,000 at interest
rates of 2 percent, 4 percent, 6 percent, 8 percent, and 10 percent (LO2).
Solution:
To calculate the years until an investment would double, divide the rate into seventy-two. For 2 percent it
would be 36 years, 4 percent would be 18 years, 6 percent would be 12 years, 8 percent would be 9 years, and
10 percent would be 7.2 years.
8. Use the Rule of 72. Based on the Rule of 72 determine how long it would take to double an investment of
$5,000 if you could invest it at 7 percent. How long would it take to triple the investment (LO4)?
Solution:
This is a potential ―Class Activity‖ exercise related to page 22 in the text.
The investment would double in about 10.3 years (72/7). It would take about 15 years for the investment to
triple. For this tripling time use Appendix, A-1, and in the 7 percent, column look for the year that most closely
approximates a factor of three.
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FINANCIAL PLANNING CASES
CASE 1: Harry and Belinda Johnson Consider Inflation and Children
Throughout this book, we will present a continuing narrative about Harry and Belinda Johnson. The following
is a brief description of the lives of this couple.
Harry is 28 years old and graduated five years ago with a bachelor’s degree in interior design from a large
Midwestern university near his hometown in Indiana. Since graduation Harry has been working in a small
interior design firm in Kansas City earning a salary of about $50,000.
Belinda is 27, has a degree in business administration from a university on the West Coast, and has been
employed in a medium-size manufacturing firm in California for about five years. Harry and Belinda both
worked on their schools’ student newspapers and met at a conference during their junior year in college.
After all these years they met again socially in January in Kansas City, Missouri, where Belinda was visiting
relatives and by chance she and Harry were at the same museum. After getting reacquainted they
