1. Kevin Jones is single and recently graduated from law school. He earns $9000 per month, an awesome salary for someone only 26 years old. He also has $1400 withheld for federal income tax, $540 for state income taxes, $688 for Medicare and Social Security taxes, and $230 for health insurance every month. Kevin has outstanding student loans of almost $80,000 on which he pays about $900 per month and a 0% auto loan payment of $300 on a Ford Fusion Hybrid he purchased new during law school. He is considering taking out a loan to buy a Kawasaki motorcycle.
(a) What is Kevin’s debt payments-to-disposable income ratio?
(b) Based on your answer to (a), how would you advise Kevin about his plan?
2. Carmen and Juan Montoya have just finished putting their three daughters through college. As empty-nesters, they are considering purchasing a vacation home on a nearby lake because prices have dropped in recent years. The house might also serve as a retirement home once they retire in 12 years. The Montoyas’ net worth is $283,000 including their home worth about $265,000 on which they currently owe $143,000 for their first mortgage. Their outstanding debts in addition to their mortgage include $12,500 on one car loan, $13,700 on a second car loan, and a $25,500 second mortgage on their home taken out to help pay for college expenses.
(a) Calculate the Montoyas’ debt-to-equity ratio.
(b) Advise them as to the wisdom of borrowing for a vacation home at this time.
3. Chelsea Menken recently graduated with a degree in food science and now works for a major consumer foods company earning $20K per year with about $36,000 in take-home pay. She rents an apartment for $1040 per month. While in school, she accumulated about $38,000 in student loan debt on which she pays $385 per month. During her last fall semester in school, she had an internship in a city about 100 miles from her campus. She used her credit card for her extra expenses and has a current debt on the account of $8000. She has been making the minimum payment on the account of about $320. She has assets of $14,000.
(a) Calculate Chelsea’s debt payment-to-disposable income and debt-service-to-income ratios.
(b) Calculate Chelsea’s debt-to-equity ratio.
(c) Comment on Chelsea’s debt situation and her use of student loans and credit cards while in college.