Case 3: Kate Myers

Basic Concepts: The Time Value of Money

After graduating from Ohio State University with a degree in Finance, Kate
Myers took a position as a stock broker with Merrill Lynch in Cleveland.
Although she had several college loans to make payments on, her goal was
to set aside funds for the next eight years in order to make a down payment
on a house. After considering the various suburbs of Cleveland, Kate chose
Lakewood as her desired future residency. Based on median house price
data, she learned that a three-bedroom, two-bath house currently costs
$98,000. To avoid paying Private Mortgage Insurance (PMI), Kate wanted to
make a down payment of 20%.

Because it will be eight years before Kate buys a house, the $98,000 price
will surely not be the same in the future. To estimate the rate at which the
median house price will increase, she considered the historical price
appreciation in Lakewood. In the past, homes appreciated by nearly 4% per
annum. Kate was satisfied with this estimation.

Merrill Lynch provides several opportunities for Kate to invest the funds that
will be devoted to the purchase of her future home. She feels that a
balanced account containing stocks, bonds, and government securities would
realistically achieve an annual rate of return of 8%.

Questions

1. Taking into consideration the fact that the $98,000 home price
will grow at 4% per year, what will be the future median home selling
price in Lakewood in eight years? What amount will Kate Myers have
to accumulate as a down payment if she does decide to buy a house
in Lakewood?
2. Based on your answer from number 1, how much will have to be
deposited into the Merrill Lynch account (which earns 8% per year) at
the end of each month to accumulate the required down payment?
3. If Kate decides to make end-of-the-year deposits into the Merrill
Lynch account, how much would these deposits be? Why is this
amount greater than twelve times the monthly payment amount?
4. If homes in Lakewood appreciate by 6% per annum over the next
eight years instead of the assumed 4%, how much would Kate have
to deposit at the end of each month to make the down payment?
What if the appreciation is only 2% per year?
5. If Kate decided to deposit her down payment funds in less risky
certificates of deposit (CDs) earning only 4%, how much would she
have to deposit at the end of each month to make the down
payment? What if she pursued a more risky investment of growth
stocks that have an expected return of 12%?
 Case 4: Quilici Family
Basic Concepts: The Time Value of Money

Greg and Debra Quilici own a four bedroom home in an affluent

neighborhood just north of San Francisco, California. Greg is a partner in the
family owned commercial painting business. Debra now stays home with
their child, Brady, who is age 5. Until recently, the Quilicis have felt very
comfortable with their financial position.

After visiting Lawrence Krause, a family financial planner, the couple became
concerned that they were spending too much and not putting enough funds
aside for both their child's future education needs and their own retirement.
Greg earns $85,000 per year, but with the rising costs of education, their
past contribution efforts have left them short of their financial goals.

To estimate the amount of money the Quilicis need to begin putting away for
future security some general information was obtained by their financial
planner. The couple felt that the amount of money they currently contribute
to their Koegh plan would be sufficient for their retirement needs. What they
had not accounted for was Brady's education.

Greg is an alumni of Stanford University, a private school with an extremely

high tuition of approximately $20,000 per year. Debra graduated from the
University of North Carolina at Chapel Hill. The tuition expense there is only
$2,500 per year. When Brady turns 18, the couple wishes to send him to
either of these exceptional universities. They have a slight preference for the
much more local Stanford University. The problem, however, is that with the
rate at which tuition is increasing the Quilicis are not sure they can raise
enough money.

To assist in the calculations, assume the tuition at both universities will

increase at an annual rate of 5%. Living expenses are currently estimated at
$6,000 per year at both schools. This expense is expected to grow at only
3% per year. Further assume the Quilicis can deposit their money into a
growth oriented mutual fund at Neuberger & Berman Management, Inc.,
which has historically earned a 12% return per annum (1% per month).

The couple wishes to have a pre-determined monthly amount automatically

drafted from their checking account. When Brady starts college they will
slowly liquidate the account by making an annual payment to Brady to cover
tuition and living expenses at the beginning of each year for the four years
he will be in college.
Questions

1. How much will be the tuition and living expenses per year when
Brady is ready to attend? Give an answer for each university.
2. Once Brady starts college what will his total expenses be in each
of his four years? Again, give an answer for each university.
3. How much money will Greg and Debra have to deposit per month
to allow Brady to attend Stanford University? How much money will
have to be deposited per month to allow Brady to attend the
University of North Carolina? (HINT: To answer this question you need
to consider the costs of ALL four years.)
4. What if the Quilicis feel the Neuberger & Berman mutual fund will
only yield 10%. How much will have to be deposited per month in
order for Brady to attend each college?
5. What is the relationship between the amount that must be
deposited monthly by the parents and the future increases in both
tuition and living expenses?