F303 INTERMEDIATE FINANCE - SPRING 1997 - HOLDEN, MYSKER, WEDIG

PROJECT 2: LIFETIME FINANCIAL PLAN

 

This is a team project. Each team will develop a lifetime financial plan designed to meet the needs a typical IU business graduate with medium risk aversion. Each team will do one out of three alternative extensions to account for: (1) higher or lower realized returns, (2) higher or lower risk aversion, and (3) the benefit of tax-favored retirement plans.

 

HISTORICAL DATA

 

This project uses historical data on annual returns for two risky assets:

and the annual US riskfree rate and US inflation rate. The F303 Home Page provides a data file for this project in both Lotus and Excel formats. They are also available on the Instruct server for F303 Holden under the menu options EXCEL2 and LOTUS2.

 

BASE CASE

 

Each team should guess/estimate the following for each working year for a typical IU business graduate with medium risk aversion:

 

Then put together an investment plan and consumption plan covering both working years and retirement years. The investment plan should recommend how much to invest in each of the assets. To do this, you need to estimate the following:

 

You will need to account for taxes. Here are the applicable tax rates:

Condition Outcome

If Income < $38,000 ==> Tax = (Income) (18%)

Otherwise If Income < $91,850 ==> Tax = ($38,000) (18%) + (Income - $38,000) (28%)

Otherwise If Income < $140,000 ==> Tax = ($38,000) (18%) + ($91,850 - $38,000) (28%)

+ (Income - $91,850) (31%)

Otherwise ==> Tax = ($38,000) (18%) + ($91,850 - $38,000) (28%)

+ ($140,000 - $91,850) (31%) + (Income - $140,000) (36%)

Nested IF statements in Excel:

=IF(First_Condition,First_Outcome,IF(Second_Condition,Second_Outcome,IF(Third_Condition,

Third_Outcome,Fourth_Outcome)))

 

Nested IF statements in Lotus:

@IF(First_Condition,First_Outcome,@IF(Second_Condition,Second_Outcome,@IF(Third_Condition,

Third_Outcome,Fourth_Outcome)))

 

 

Assume that you have access to a before-tax, tax-deferred retirement account (such as a 401(k), 403(b), or Keogh account) for all of the money you are saving for retirement. For simplicity, ignore the cap on such accounts. Inside this retirement account you can invest in four assets: (1) US stocks, (2) foreign stocks, (3) the US riskfree asset, and (4) a lifetime annuity at the US riskfree rate as described below. You can freely transfer funds between these four assets while still keeping all of the funds inside the retirement account and thus deferring taxes. You only pay taxes when money is withdrawn from the retirement account to use for consumption.

 

When there are two risky assets, the weights of the optimal risky portfolio in asset B and asset S are given by the formula at the bottom of page 145 of the textbook:

 

 

Next put together a consumption plan for both working years and retirement years.

 

 EXTENSIONS

 

Each team will be designated as Type-A, Type-B, or Type-C and should do the corresponding extension described below.

 

(1) FOR TYPE-A TEAMS: BASE CASE VS. ALTERNATIVE REALIZED RETURNS

 

Modify the consumption plan for: (A) low average realized returns from the risky assets and (B) high average realized returns from the risky assets.

 

(2) FOR TYPE-B TEAMS: BASE CASE VS. ALTERNATIVE RISK AVERSION

 

Modify the investment and consumption plan for: (A) a high risk aversion investor and (B) a low risk aversion investor.

 

(3) FOR TYPE-C TEAMS: BENEFIT OF TAX-FAVORED RETIREMENT PLANS

 

Modify the investment and consumption plan by assuming that no tax-favored retirement accounts (such as a 401(k), 403(b), Keogh plan, or IRA) are available. Specifically, compare the difference in consumption plans between using a before-tax, tax-deferred retirement account vs. using an after-tax, non-deferred retirement account.

 

SALES PRESENTATION AND REPORT

 

On Thursday, February 20th, half of the teams will make a brief sales presentation to the class to summarize their findings. Each team will have twelve minutes to present their results, there will two minutes for questions, and one minute for transition between teams. These time limits will be strictly observed in order to be fair to everyone. A computer projector with Lotus FreeLance and Microsoft PowerPoint will be available. All teams are required to use one of these two presentation software packages. With presentation software, it is typical for one team member to operate the computer presentation while other members to talk.

 

Professors Holden, Mysker, or Wedig will evaluate the presentation based on:

 

A written report is also due in class on Thursday, February 20th. The format is one-page executive summary, four-page double-spaced body, and no more than ten pages of appendices, including all graphs, spreadsheets, and presentation print outs. The body of the paper should tell the complete story. It should be written as if we were very busy bosses, who probably would not look at the appendices at all.

GRADING

 

The project is graded as follows:

    • Project 2: Lifetime Financial Plan:
      • Substance of report . . . . . . . . . . . . . . . . . . . .
      • Exposition of the report . . . . . . . . . . . . . . . .
    • Slide Show Presentation of Project 2 or Project 4 . . .

 

20 points

20 points

20 points

 

Confidential peer evaluations of individual contributions to the team project will made. Individuals who have contributed significantly more or significantly less than the group average will be rewarded or penalized accordingly. The purpose of these peer evaluations is to provide direct incentives for individual contributions to the team project.

 

TIPS FOR REPORT EXPOSITION

 

Here are some general suggestions for report exposition that would apply to a broad range of reports:

 

  1. Layering. Provide an executive summary, then the main analysis, then more details of analysis.

 

  1. Summarize. Highlight your key assumptions and your key results ("the bottom line"). Skip the "intermediate calculations." Focus on the key actions to take or key decisions to be made and give your recommendations.
  2.  

  3. Motivate. Justify your key assumptions and general modeling approach.

 

TIPS FOR A QUALITY PRESENTATION

 

Here are some general suggestions for a quality presentation that would apply to a broad range of presentations:

 

  1. Summarize. Highlight your key assumptions and your key results ("the bottom line"). Skip the "intermediate calculations." Focus on the key actions to take or key decisions to be made and give your recommendations.
  2.  

  3. Connect. Reach your audience by:

 

  1. Backup. Always have backup transparency slides in case of computer hardware / software problems.

Appendix: Projecting Cash Flows

 

Here are sample spreadsheet layouts for the two cases: (1) when savings are before-tax and tax-deferred and (2) when savings are after-tax and not tax-deferred.

 

When Savings are Before-Tax and Tax-Deferred

Working Years

 

Retirement Years

 

 

 

Before-tax Income

 

Money withdrawn from 401(k) plan

Less Mortgage Interest Expense

 

Less Taxes

Less 401(k) Savings Amount

 

Money available for consumption

Taxable Income

 

==> pay taxes on the full amount, since you

Less Taxes

 

havenít paid any taxes so far!

After-tax Income

 

 

Less Mortgage Principal Reduction Expense

 

 

Less All Other Consumption Expenses

 

 

Zero

 

 

 

 

 

  • No taxes paid on capital gains in 401(k) plan

 

 

 

When Savings are After Tax and Not Tax Deferred

Working Years

 

Retirement Years

 

 

 

Before-tax Income

 

No taxes paid on when you use your savings

Less Mortgage Interest Expense

 

==> you already paid taxes

Taxable Income

 

==> you donít have to pay twice!

Less Taxes

 

 

After-tax Income

 

 

Less Mortgage Principal Reduction Expense

 

 

Less All Other Consumption Expenses

 

 

Less Savings

 

 

Zero

 

 

 

 

 

Earn Recognized Capital Gain on Savings

 

 

Less Taxes

 

 

Reinvest After-tax Capital Gain

 

 

 

Directions for downloading the Project 2 dataset from the F303 Home Page.

 

  1. Double-click on the Netscape icon.
  2.  

  3. Enter the Web address: www.bus.indiana.edu/finweb/f303home.htm
  4.  

  5. Click on Project 2 dataset in Excel 5.0 or higher or Project 2 dataset in Lotus for Windows 4.0 or higher.
  6.  

  7. When you see the Netscape message "No Viewer Configured," click on "Save to Disk." Alternatively, if you see the Microsoft Internet Explorer message "Confirm File Open," click on "Save As."
  8.  

  9. Open the downloaded file in Excel or Lotus as usual.