SOLUTION AND ANSWER GUIDE
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r GARMAN/FOX’SPERSONALFINANCE,14THEDITION
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ALLCHAPTERSCOVEREDGRADEDA+ NEWEST
r r r r r
VERSION.
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1
,TABLE OF CONTENTS R R
Answers to Chapter Concept Checks ........................................................................................................... 2
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What Do You Recommend Now? ................................................................................................................. 4
r r r r
Let’s TalkAbout It ........................................................................................................................................ 5
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Do the Math................................................................................................................................................... 6
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FinancialPlanningCases.............................................................................................................................. 8
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ExtendedLearning ..................................................................................................................................... 10
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2
,ANSWERS TO CHAPTER CONCEPT CHECKS R R R R
LO1.1Recognize the keys to achieving financial success.
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1. Explain the five steps in the financial planning process.
r r r r r r r r
Answer: There are five fundamental steps to the personal financial planning process: (1) evaluate your
r r r r r r r r r r r r r r
financialhealth to your education and career choice; (2) define your financialgoals;(3)develop a plan of action to
r r r r r r r r r r r r r r r r r r r r
achieve your goals; (4) implement spending and saving plans to monitor and control progress toward your
r r r r r r r r r r r r r r r r
goals; and (5) review your financial progress and make changes as appropriate.
r r r r r r r r r r r r
2. Distinguish among financial success, financial security, and financial happiness.
r r r r r r r r
Answer: Financial success is the achievement of financial aspirations that are desired, planned, or attempted.
r r r r r r r r r r r r r r
Success is defined bythe individual or familythat seeks it. Financial success maybe defined as being able to live
r r r r r r r r r r r r r r r r r r r r r
according to one’s standard of living. Financial security is that comfortable feeling that your financial
r r r r r r r r r r r r r r r
resources will be adequate to fulfill any needs you have as well as your wants. Financial happiness is the
r r r r r r r r r r r r r r r r r r r
experience you have when you are satisfied with money matters. People who are happy about their finances
r r r r r r r r r r r r r r r r r
will see a spillover into positive feelings about life in general.
r r r r r r r r r r r
3. Summarize what you will accomplish studying personal finance. r r r r r r r
Answer: Several things can be accomplished by studying personal finance. Recognize how to manage
r r r r r r r r r r r r r
unexpected and expected financial events. Pay as little as possible in income taxes. Understand how to
r r r r r r r r r r r r r r r r
effectivelycomparison shop for vehicles andhomes. Protect what weown. Invest wisely. Accumulateand
r r r r r r r r r r r r r r r
protect the wealth that we maychoose to spend during our non-working years (e.g., retirement) or donate.
r r r r r r r r r r r r r r r r r
4. What are the building blocks to achieving financialsuccess?
r r r r r r r r
Answer: The building blocks for achieving financial success include a foundation of regular income that
r r r r r r r r r r r r r r
provides the means to support your lifestyle and save for desired goals in the future. The foundation supports a
r r r r r r r r r r r r r r r r r r r
base of various banking accounts, insurance protection, and employee benefits. Then we can establish goals, a
r r r r r r r r r r r r r r r r
recordkeeping system, a budget, and an emergency savings fund. We will also manage various expenses such as
r r r r r r r r r r r r r r r r r
housing, transportation, insurance, and the payment oftaxes. We will alsoneed to handle credit, savings, and
r r r r r r r r r r r r r r r r r
educational costs. Finally, we invest in various investment alternatives such as mutual funds, stocks, and bonds,
r r r r r r r r r r r r r r r r
often for retirement. As a result of all these building blocks, we are more apt to have a financially successful life.
r r r r r r r r r r r r r r r r r r r r r
LO1.2Understandhowthe economy affects your personal financial success.
r r r r r r r r r
1. Summarize the phases of the business cycle. r r r r r r
Answer: The business cycle entailsa wavelike pattern of rising and falling economic activityas measured by
r r r r r r r r r r r r r r r r
economic indicatorslike unemployment rates or the gross domestic product. The phases of the business cycle
r r r r r r r r r r r r r r r r
include expansion (preferred stage—production is high, unemployment low, interest rates low or falling, stock
r r r r r r r r r r r r r r
market and consumer demand high), peak, contraction, downturn, trough, and recovery.
r r r r r r r r r r r
2. Describetwo statistics that help predict the future direction of the economy.
r r r r r r r r r r r
Answer: Forecasting the state of the economy involves predicting, estimating, or calculating what will happen
r r r r r r r r r r r r r r
in advance. We need to be able to forecast the state of the economy, inflation, and interest rates so that we have
r r r r r r r r r r r r r r r r r r r r r r
advance warning ofthe directionsand strength ofchangesin economic trends since theywill affect our personal
r r r r r r r r r r r r r r r r r r
finances. Two statistics we could watch are the consumer confidence index (how consumers feel about the
r r r r r r r r r r r r r r r r
economy and their personal finances) and the index of leading economic indicators (composite index,
r r r r r r r r r r r r r r
averages ten components of economic growth).
r r r r r r
3
, 3. Givean exampleof how inflation affectsincome andconsumption.
r r r r r r r r r
Answer: Inflation reduces the purchasing power of the dollar. This means that our income will not go as far
r r r r r r r r r r r r r r r r r r
and, thus, inreal terms will be lowered byinflation. Because items cost more, we will have to consume less and
r r r r r r r r r r r r r r r r r r r r r
may cut back on some expenditures to be able to afford those with a higher priority.
r r r r r r r r r r r r r r r r
LO1.3Think like an economist when making financial decisions.
r r r r r r r r
1. Define opportunity cost and give anexample of how opportunity costs might affect your financial
r r r r r r r r r r r r r r
decision making.
r r
Answer: The opportunitycost of a decision is measured as the value of thenext-best alternative that must be
r r r r r r r r r r r r r r r r r r
forgone. If we, for example, put our retirement savings in a regular savings account instead of in a tax- sheltered
r r r r r r r r r r r r r r r r r r r r
retirement account, we may be forgoing the tax benefits associated with investing in retirement accounts such
r r r r r r r r r r r r r r r r
as IRAs or 401(k) plans. In another example, if we decide to borrow the maximum student loan amount for
r r r r r r r r r r r r r r r r r r r
which we qualify to live a bit more comfortably while in college, we will not be able to live as nicely, save as
r r r r r r r r r r r r r r r r r r r r r r r
much for the down payment on a home or save for retirement once we graduate because of the higher loan
r r r r r r r r r r r r r r r r r r r r
payments.
r
2. Explain and give anexample of how marginal utility and marginal cost make some financial
r r r r r r r r r r r r r r
decisions easier.
r r
Answer: Marginal analysis focuses on the next increment of usefulness or cost when making financial
r r r r r r r r r r r r r r
decisions. Marginal utility is the extra satisfaction derived from having one more incremental unit of a product
r r r r r r r r r r r r r r r r r
or service. Marginal cost is the additional cost of that unit. When marginal utility exceeds marginal cost, and we
r r r r r r r r r r r r r r r r r r r
compare thetwo, we can make better financial decisions. As an example, if you must fly to some destination, is the
r r r r r r r r r r r r r r r r r r r r r
marginal cost of checking a bag using a carry-on worth the marginal utility?
r r r r r r r r r r r r r
3. Describe and give an example of how your marginal income tax rate can affect financial decision
r r r r r r r r r r r r r r r
making.
r
Answer: As our income rises, we will find ourselves in higher and higher tax brackets. One type of decision
r r r r r r r r r r r r r r r r r r
that isaffected byincome taxes ishow we should invest for retirement. We might want to invest through a 401(k)
r r r r r r r r r r r r r r r r r r r r r
plan instead of keeping our retirement money in a savings account, which is taxable.
r r r r r r r r r r r r r r
Since most types of income are taxable, it is important that we understand the impact of income taxes on financial
r r r r r r r r r r r r r r r r r r r
decisions. Of particular importance is the marginal tax rate (the tax rate at which our last dollar earned is taxed).
r r r r r r r r r r r r r r r r r r r r
If we are in the 25 percent marginal tax bracket, we will get to keep 75 percent (100 percent minus 25 percent) of
r r r r r r r r r r r r r r r r r r r r r r r
our last taxable dollar earned. Ifthe income istax-free income, on the other hand, we would get to keep 100
r r r r r r r r r r r r r r r r r r r r r
percent of it. Therefore, it isimportant to know our marginal tax rate as well as what types of income are subject
r r r r r r r r r r r r r r r r r r r r r r
to federal income taxes. It is also important to remember the impact of state income taxes and Social Security
r r r r r r r r r r r r r r r r r r r
taxes.
r
LO1.4 Performtime value of money calculations in personal financial decision making.
r r r r r r r r r r r
1. What arethe two commonquestions about money?
r r r r r r r
Answer: Thetwo common questionsabout moneyare its future valueandpresent value. Future value is what
r r r r r r r r r r r r r r r r r
investment or series of investments will be at a point in the future. Present value is how much we would need to
r r r r r r r r r r r r r r r r r r r r r r
invest todayand/or in a series of future investments to provide some amount in the future.
r r r r r r r r r r r r r r r r
2. Explain the difference between simple interest and compound interest, and describe why that
r r r r r r r r r r r r
difference is critical.
r r r
Answer: Simple interest ismoneypaid on a principal amount for a given number of years. The interest is paid
r r r r r r r r r r r r r r r r r r r
only on the principal (the original amount invested). For example, we might put $1,000 in a bank savings
r r r r r r r r r r r r r r r r r r
account at 5 percent interest for one year. We would have accumulated $50 in that year.
r r r r r r r r r r r r r r r r
4
r r r
r GARMAN/FOX’SPERSONALFINANCE,14THEDITION
r r r r
ALLCHAPTERSCOVEREDGRADEDA+ NEWEST
r r r r r
VERSION.
r
1
,TABLE OF CONTENTS R R
Answers to Chapter Concept Checks ........................................................................................................... 2
r r r r
What Do You Recommend Now? ................................................................................................................. 4
r r r r
Let’s TalkAbout It ........................................................................................................................................ 5
r r r
Do the Math................................................................................................................................................... 6
r r
FinancialPlanningCases.............................................................................................................................. 8
r r
ExtendedLearning ..................................................................................................................................... 10
r
2
,ANSWERS TO CHAPTER CONCEPT CHECKS R R R R
LO1.1Recognize the keys to achieving financial success.
r r r r r r r
1. Explain the five steps in the financial planning process.
r r r r r r r r
Answer: There are five fundamental steps to the personal financial planning process: (1) evaluate your
r r r r r r r r r r r r r r
financialhealth to your education and career choice; (2) define your financialgoals;(3)develop a plan of action to
r r r r r r r r r r r r r r r r r r r r
achieve your goals; (4) implement spending and saving plans to monitor and control progress toward your
r r r r r r r r r r r r r r r r
goals; and (5) review your financial progress and make changes as appropriate.
r r r r r r r r r r r r
2. Distinguish among financial success, financial security, and financial happiness.
r r r r r r r r
Answer: Financial success is the achievement of financial aspirations that are desired, planned, or attempted.
r r r r r r r r r r r r r r
Success is defined bythe individual or familythat seeks it. Financial success maybe defined as being able to live
r r r r r r r r r r r r r r r r r r r r r
according to one’s standard of living. Financial security is that comfortable feeling that your financial
r r r r r r r r r r r r r r r
resources will be adequate to fulfill any needs you have as well as your wants. Financial happiness is the
r r r r r r r r r r r r r r r r r r r
experience you have when you are satisfied with money matters. People who are happy about their finances
r r r r r r r r r r r r r r r r r
will see a spillover into positive feelings about life in general.
r r r r r r r r r r r
3. Summarize what you will accomplish studying personal finance. r r r r r r r
Answer: Several things can be accomplished by studying personal finance. Recognize how to manage
r r r r r r r r r r r r r
unexpected and expected financial events. Pay as little as possible in income taxes. Understand how to
r r r r r r r r r r r r r r r r
effectivelycomparison shop for vehicles andhomes. Protect what weown. Invest wisely. Accumulateand
r r r r r r r r r r r r r r r
protect the wealth that we maychoose to spend during our non-working years (e.g., retirement) or donate.
r r r r r r r r r r r r r r r r r
4. What are the building blocks to achieving financialsuccess?
r r r r r r r r
Answer: The building blocks for achieving financial success include a foundation of regular income that
r r r r r r r r r r r r r r
provides the means to support your lifestyle and save for desired goals in the future. The foundation supports a
r r r r r r r r r r r r r r r r r r r
base of various banking accounts, insurance protection, and employee benefits. Then we can establish goals, a
r r r r r r r r r r r r r r r r
recordkeeping system, a budget, and an emergency savings fund. We will also manage various expenses such as
r r r r r r r r r r r r r r r r r
housing, transportation, insurance, and the payment oftaxes. We will alsoneed to handle credit, savings, and
r r r r r r r r r r r r r r r r r
educational costs. Finally, we invest in various investment alternatives such as mutual funds, stocks, and bonds,
r r r r r r r r r r r r r r r r
often for retirement. As a result of all these building blocks, we are more apt to have a financially successful life.
r r r r r r r r r r r r r r r r r r r r r
LO1.2Understandhowthe economy affects your personal financial success.
r r r r r r r r r
1. Summarize the phases of the business cycle. r r r r r r
Answer: The business cycle entailsa wavelike pattern of rising and falling economic activityas measured by
r r r r r r r r r r r r r r r r
economic indicatorslike unemployment rates or the gross domestic product. The phases of the business cycle
r r r r r r r r r r r r r r r r
include expansion (preferred stage—production is high, unemployment low, interest rates low or falling, stock
r r r r r r r r r r r r r r
market and consumer demand high), peak, contraction, downturn, trough, and recovery.
r r r r r r r r r r r
2. Describetwo statistics that help predict the future direction of the economy.
r r r r r r r r r r r
Answer: Forecasting the state of the economy involves predicting, estimating, or calculating what will happen
r r r r r r r r r r r r r r
in advance. We need to be able to forecast the state of the economy, inflation, and interest rates so that we have
r r r r r r r r r r r r r r r r r r r r r r
advance warning ofthe directionsand strength ofchangesin economic trends since theywill affect our personal
r r r r r r r r r r r r r r r r r r
finances. Two statistics we could watch are the consumer confidence index (how consumers feel about the
r r r r r r r r r r r r r r r r
economy and their personal finances) and the index of leading economic indicators (composite index,
r r r r r r r r r r r r r r
averages ten components of economic growth).
r r r r r r
3
, 3. Givean exampleof how inflation affectsincome andconsumption.
r r r r r r r r r
Answer: Inflation reduces the purchasing power of the dollar. This means that our income will not go as far
r r r r r r r r r r r r r r r r r r
and, thus, inreal terms will be lowered byinflation. Because items cost more, we will have to consume less and
r r r r r r r r r r r r r r r r r r r r r
may cut back on some expenditures to be able to afford those with a higher priority.
r r r r r r r r r r r r r r r r
LO1.3Think like an economist when making financial decisions.
r r r r r r r r
1. Define opportunity cost and give anexample of how opportunity costs might affect your financial
r r r r r r r r r r r r r r
decision making.
r r
Answer: The opportunitycost of a decision is measured as the value of thenext-best alternative that must be
r r r r r r r r r r r r r r r r r r
forgone. If we, for example, put our retirement savings in a regular savings account instead of in a tax- sheltered
r r r r r r r r r r r r r r r r r r r r
retirement account, we may be forgoing the tax benefits associated with investing in retirement accounts such
r r r r r r r r r r r r r r r r
as IRAs or 401(k) plans. In another example, if we decide to borrow the maximum student loan amount for
r r r r r r r r r r r r r r r r r r r
which we qualify to live a bit more comfortably while in college, we will not be able to live as nicely, save as
r r r r r r r r r r r r r r r r r r r r r r r
much for the down payment on a home or save for retirement once we graduate because of the higher loan
r r r r r r r r r r r r r r r r r r r r
payments.
r
2. Explain and give anexample of how marginal utility and marginal cost make some financial
r r r r r r r r r r r r r r
decisions easier.
r r
Answer: Marginal analysis focuses on the next increment of usefulness or cost when making financial
r r r r r r r r r r r r r r
decisions. Marginal utility is the extra satisfaction derived from having one more incremental unit of a product
r r r r r r r r r r r r r r r r r
or service. Marginal cost is the additional cost of that unit. When marginal utility exceeds marginal cost, and we
r r r r r r r r r r r r r r r r r r r
compare thetwo, we can make better financial decisions. As an example, if you must fly to some destination, is the
r r r r r r r r r r r r r r r r r r r r r
marginal cost of checking a bag using a carry-on worth the marginal utility?
r r r r r r r r r r r r r
3. Describe and give an example of how your marginal income tax rate can affect financial decision
r r r r r r r r r r r r r r r
making.
r
Answer: As our income rises, we will find ourselves in higher and higher tax brackets. One type of decision
r r r r r r r r r r r r r r r r r r
that isaffected byincome taxes ishow we should invest for retirement. We might want to invest through a 401(k)
r r r r r r r r r r r r r r r r r r r r r
plan instead of keeping our retirement money in a savings account, which is taxable.
r r r r r r r r r r r r r r
Since most types of income are taxable, it is important that we understand the impact of income taxes on financial
r r r r r r r r r r r r r r r r r r r
decisions. Of particular importance is the marginal tax rate (the tax rate at which our last dollar earned is taxed).
r r r r r r r r r r r r r r r r r r r r
If we are in the 25 percent marginal tax bracket, we will get to keep 75 percent (100 percent minus 25 percent) of
r r r r r r r r r r r r r r r r r r r r r r r
our last taxable dollar earned. Ifthe income istax-free income, on the other hand, we would get to keep 100
r r r r r r r r r r r r r r r r r r r r r
percent of it. Therefore, it isimportant to know our marginal tax rate as well as what types of income are subject
r r r r r r r r r r r r r r r r r r r r r r
to federal income taxes. It is also important to remember the impact of state income taxes and Social Security
r r r r r r r r r r r r r r r r r r r
taxes.
r
LO1.4 Performtime value of money calculations in personal financial decision making.
r r r r r r r r r r r
1. What arethe two commonquestions about money?
r r r r r r r
Answer: Thetwo common questionsabout moneyare its future valueandpresent value. Future value is what
r r r r r r r r r r r r r r r r r
investment or series of investments will be at a point in the future. Present value is how much we would need to
r r r r r r r r r r r r r r r r r r r r r r
invest todayand/or in a series of future investments to provide some amount in the future.
r r r r r r r r r r r r r r r r
2. Explain the difference between simple interest and compound interest, and describe why that
r r r r r r r r r r r r
difference is critical.
r r r
Answer: Simple interest ismoneypaid on a principal amount for a given number of years. The interest is paid
r r r r r r r r r r r r r r r r r r r
only on the principal (the original amount invested). For example, we might put $1,000 in a bank savings
r r r r r r r r r r r r r r r r r r
account at 5 percent interest for one year. We would have accumulated $50 in that year.
r r r r r r r r r r r r r r r r
4
