The case refers to the budgeting aspects of a family in which both husband and wife are working to cover their expenses and live comfortably with their salaries. However, they Marty and Laura have been living beyond their means and owe money for their car and credit card purchases. Moreover, they are going to have an addition of another family member by the end of the year, for which they have not done financial planning as yet.
The case indicates several aspects of time value of money that both Marty and Laura should take into account. In order to evaluate their current debt situation, they have to take into account their future expenses as well as current debt charges including credit card and car loan. Other than that, income tax will have to be taken into consideration since both Marty and Laura earn.
Considering the scenario where the new baby will need college funds and Marty and Laura plan to set up a college fund for the baby, following calculation has been done to evaluate what amount would be needed. Two evaluations are done where Marty and Laura may deposit a lump sum today, or make annual payments to the fund:
Years: 18
I = 4% per annum
Future value: $ 20,000
Present value if lump sum deposited at the end of this year (Present value formula has been used): $ 9,872.56
Payments for the next 18 years in case lump sum is not deposited by end of this year (Payment or annuity formula has been used): $ 1,579.87
If both Laura and Marty need to start retirement funds as well, then further calculations would need to be done and evaluation on their life expectancy would have to be done as well.
As disclosed by the couple, they have been living off borrowed money by taking loans on credit cards and taking loans for their car as well. This becomes expensive as the cost of borrowed funds needs to be taken into account as well. The point to note is that apart from the principal amount, a component of interest needs to be returned as well which makes the funds expensive than the money being earned by the couple.
Evaluating the debt profile of the couple, they have three major debts, credit card, college loan and car loan, of which the credit card loan has the highest charges per annum of 15.99%. Therefore, the best choice that both Marty and Laura have right now is to eliminate their debts or in other words, pay them off completely. However, since they do not have any savings and their salary does not allow paying off the hefty loans in one bullet payment, it is best to chalk out aggressive debt elimination and savings plan so that the interest charges are minimized, savings can be deposited and the couple is out of the loans and debts entirely.
Considering the following scenario:
- On a yearly basis, salary total: $ 75000
- House rent for the year: $ 14400
- Remaining Salary: $ 60600
- Total Debt: $ 27000
- If total debt is eliminated this year, the salary remaining for other expenses would be: $ 33600
The couple can still have $ 2800 to spend on a monthly basis. However, this is a very aggressive financial plan for this year, especially as their expenses would increase due to medical bills and preparation for the new baby.