Solution and Answer Guide: Garman/Fox, Personal Finance 15e, Chapter 1: Thinking Like a Financial Planner
Solution and Answer Guide
GARMAN/FOX, PERSONAL FINANCE 15E, CHAPTER 1: THINKING LIKE A FINANCIAL PLANNER
TABLE OF CONTENTS
Answers to Chapter Concept Checks ................................................................................. 2
What Do You Recommend Now? ........................................................................................ 5
Let’s Talk About It ................................................................................................................ 6
Do the Math .......................................................................................................................... 7
Financial Planning Cases ................................................................................................... 10
Extended Learning .............................................................................................................. 13
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, Solution and Answer Guide: Garman/Fox, Personal Finance 15e, Chapter 1: Thinking Like a Financial Planner
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 financial health relative to education and career choice; (2)
define financial goals; (3) develop a plan of action to achieve goals; (4) implement
spending and saving plans to monitor and control progress toward goals; and (5)
review 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 our financial
resources will be adequate to fulfill our needs as well as our wants. Financial
happiness is the experience we have when we are satisfied with money matters.
People who are happy about their finances will experience a spillover into positive
feelings about life in general.
3. Summarize what is accomplished by studying personal finance.
Answer: Several things can be accomplished by studying personal finance. We
recognize how to manage unexpected and expected financial events. We pay as
little as legally possible in income taxes. We understand how to effectively
comparison shop for vehicles and homes. We protect what we own and invest
wisely. We accumulate and protect the wealth that we may choose to spend during
our nonworking 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 -our lifestyle and save for our
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.
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, Solution and Answer Guide: Garman/Fox, Personal Finance 15e, Chapter 1: Thinking Like a Financial Planner
Answer: The business cycle involves 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 in advance what will happen. 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, because 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, which 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; in real terms, it will be lowered by inflation. Because
items cost more, we will have to consume less and may cut back on some
expenditures in order to be able to afford those with a higher priority.
LO1.3 APPLY ECONOMIC CONCEPTS IN MAKING FINANCIAL DECISIONS.
1. Define opportunity cost and give an example of how opportunity costs might affect
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, later we will not be able to live as well, save as
much for the down payment on a home, or save for retirement once we graduate,
because our student loan payments will be higher.
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 (utility) 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 one unit. When marginal utility exceeds marginal
cost, and we compare the two, we can make better financial decisions. To
maximize utility, we seek options where the added utility per last dollar spent is
maximized. As an example, if one must fly to some destination, is the marginal
cost of checking a bag versus using a carry-on worth the marginal utility? We
continually ask, Is this the best way to spend those last few dollars now?
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, Solution and Answer Guide: Garman/Fox, Personal Finance 15e, Chapter 1: Thinking Like a Financial Planner
3. Describe and give an example of how the 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. Because 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 22
percent marginal tax bracket, we will get to keep 78 percent (100 percent minus 22
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 time value of money questions?
Answer: The two common questions about money are its future value and its
present value. Future value is what lump-sum investments 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 for long-term financial planning.
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 the $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; compound interest is one of
the most basic principles 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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Solution and Answer Guide
GARMAN/FOX, PERSONAL FINANCE 15E, CHAPTER 1: THINKING LIKE A FINANCIAL PLANNER
TABLE OF CONTENTS
Answers to Chapter Concept Checks ................................................................................. 2
What Do You Recommend Now? ........................................................................................ 5
Let’s Talk About It ................................................................................................................ 6
Do the Math .......................................................................................................................... 7
Financial Planning Cases ................................................................................................... 10
Extended Learning .............................................................................................................. 13
© 1
, Solution and Answer Guide: Garman/Fox, Personal Finance 15e, Chapter 1: Thinking Like a Financial Planner
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 financial health relative to education and career choice; (2)
define financial goals; (3) develop a plan of action to achieve goals; (4) implement
spending and saving plans to monitor and control progress toward goals; and (5)
review 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 our financial
resources will be adequate to fulfill our needs as well as our wants. Financial
happiness is the experience we have when we are satisfied with money matters.
People who are happy about their finances will experience a spillover into positive
feelings about life in general.
3. Summarize what is accomplished by studying personal finance.
Answer: Several things can be accomplished by studying personal finance. We
recognize how to manage unexpected and expected financial events. We pay as
little as legally possible in income taxes. We understand how to effectively
comparison shop for vehicles and homes. We protect what we own and invest
wisely. We accumulate and protect the wealth that we may choose to spend during
our nonworking 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 -our lifestyle and save for our
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.
© 2
, Solution and Answer Guide: Garman/Fox, Personal Finance 15e, Chapter 1: Thinking Like a Financial Planner
Answer: The business cycle involves 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 in advance what will happen. 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, because 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, which 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; in real terms, it will be lowered by inflation. Because
items cost more, we will have to consume less and may cut back on some
expenditures in order to be able to afford those with a higher priority.
LO1.3 APPLY ECONOMIC CONCEPTS IN MAKING FINANCIAL DECISIONS.
1. Define opportunity cost and give an example of how opportunity costs might affect
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, later we will not be able to live as well, save as
much for the down payment on a home, or save for retirement once we graduate,
because our student loan payments will be higher.
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 (utility) 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 one unit. When marginal utility exceeds marginal
cost, and we compare the two, we can make better financial decisions. To
maximize utility, we seek options where the added utility per last dollar spent is
maximized. As an example, if one must fly to some destination, is the marginal
cost of checking a bag versus using a carry-on worth the marginal utility? We
continually ask, Is this the best way to spend those last few dollars now?
© 3
, Solution and Answer Guide: Garman/Fox, Personal Finance 15e, Chapter 1: Thinking Like a Financial Planner
3. Describe and give an example of how the 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. Because 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 22
percent marginal tax bracket, we will get to keep 78 percent (100 percent minus 22
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 time value of money questions?
Answer: The two common questions about money are its future value and its
present value. Future value is what lump-sum investments 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 for long-term financial planning.
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 the $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; compound interest is one of
the most basic principles 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).
[return to top]
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