Needs to see formulas & calculations Your friend John asks you for advice concer

Question

Needs to see formulas & calculations Your friend John asks you for advice concerning life insurance. John is 28 years old and graduated from law school last year. He currently earns $48,000 per year. John must begin paying back his student loan this month. His monthly payment will be $400 per month for the next fiveyears at an interest rate of5% per year. John is married and has one child, Billy, age 3 John's wife, Mary, is a professor who currently earns $58,000 per year. Mary is 32 years old John and Mary pay $1,200 per month for their home mortgage, which will be paid off in 25 years. The interest rate on their mortgage is 6.5% (Their current equity in the home is $40,000.) The couple owns two cars, both 10 years old, and personal property (such as clothes iture, etc.) valued at $45,000. Their investments include checking, savings, and mutual fund accounts equal to S25,000. John has no life insurance. Mary has $150,000 of life insurance provided by her employer. Mary's pension plus social security are expected to total S25,000 per year, beginning when she is 65 years old. If John should die, Mary would receive approximately $10,000 per year from social security until Billy reaches age 18 John, Mary, and Billy live comfortably on their current family income. As a matter of fact, th family has been saving about $400 per month. However, this amount is expected to now b required to make John's school loan payment. Their investments earn approximately 5% per year. Given that John and Mary both enjoy flexible work schedules, they are able to raise Billy without the help of a babysitter or nanny. John picks up Billy from school on Tuesdays and Thursdays and Mary picks him up on Mondays, Wednesdays and Fridays. John is worried about what may happen to his family is he should die. He is considering the purchase of life insurance and asks your advice. Assuming neither John nor Mary will receive large inheritances, how much lif insurance do you think John needs? Calculate the amount using the needs approach. Show all calculations and explain your answer. Make a. any assumptions u believe are reasonable, and make sure your assumptions are clearly stated. Also indicate the type of insurance you would recommend, whole life or term. If you recommend term, specify the length of the term policy

Explanation / Answer

For John, the amount of debt outstanding is USD400 per month to be paid as EMIs for a period of 60 months @ 5 percent per annum. The present value of this amount would be = 4.329*4800 = USD20,779 Now, we have to think for the income replacement of John solely used for the needs of the family assuming the prevailing rate of return on investment as 5 percent per annum inclusive of inflation premium. Say, John spends 25 percent of salary for his family only apart from the payment of the home mortgage loan. Hence, his wife will require about USD12,000/0.05 = USD240,000 to replace his income. The amount of mortgage loan repaid by John is USD600 (say) per month @ 6.5 percent per annum that is to be repaid by the next 25 years. The present value of this home mortgage loan is 600*12*12.319 = 88693 Hence, the life insurance coverage requirement for John would be = 20779 + 240,000 + 88,693 = USD349,472 or USD350,000.

In this case, term life insurance is recommended as it is cheaper than the whole life insurance policy.

b) As the premium for that policy has been paid for 14 years, it has become a paid up policy. Hence, John may be adviced to stop the payment of premium provided he has accumulated adequate wealth to meet his insurance requirements by his own.

c) If John dies at the age of 55 years, then the age of Mary would be 59 years. She can withdraw the entire sum to invest the same in the market to get a healthy return to meet her expenses during the future days. In addition to that, she may demand for the payment of annuity to meet her expenses for her future life.

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