Debt and Debt Service Ratio Essay

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Nick Klump

2) Tori and Michael’s Solvency ratio indicates they are able to withstand a 21.84% drop in asses before they would become insolvent. Although this is a good start, the textbook indicates a couple times when key measurements fell more than 21.84%. The stock market during the financial crisis fell 37%, which would wipe out the Rivera’s ability to stay solvent. The River’s liquidity ratio is actually pretty solid. They could cover almost 69% of their current liabilities within the year with the current assets they have available. Their liquid assets of $7,600 would only cover about 1.5 months of living expenses. Recommended levels are more like 3-6 months. Their savings ratio is not good, however. They have a negative savings ratio with indicates they are spending more than they are saving. Lastly, their Debt Service ratio is very good, with only 4.57% of their monthly gross income going to loan payments. This indicates they will have plenty of money to put towards loans and could potentially look to increase this percentage. The textbook recommends a Debt Service ratio below 35%. The Rivera’s are doing well with this.

3) Short Term appropriate goals for the Rivera’s should include: Increasing their liquidity ratio, by decreasing their eating out budget of $600/month and reducing their $700/monthly vacation expense. Trimming these two categories in the short term will allow significantly more money to be put towards savings for Michael’s MBA. Longer term, after a sufficient 3-6 month cushion is built up in liquid assets (at least $15,373), the Rivera’s should concentrate fully on eliminating their credit card debt. The interest rates are not given, but credit card debt is one of the worst debts that people can carry. They should increase the minimum payments on their credit cards.

4)

A. First, it is not clear how much Michael’s tuition costs will be. He already has $7,500 in student loan debt, but it is confusing whether this is proposed tuition or debt he already has from his undergraduate studies. I’ll discuss based on the assumption that we don’t know how much the MBA tuition will cost. For Michael to quit work, he will give up $3,000 in gross income per month, but replace that with $400/per month and have his tuition paid for. Therefore, his tuition bill would need to be $2,600 or more per month for it to make sense for Michael to quit work and get his MBA. For example, if Michael quit his work he would lose $36,000 per year. However, if tuition costs are $2,600/month or $31,200/year or more, and Michael gets $4,800 per year working for his assistantship, it would make sense for him to quit work and get his MBA. This calculation would give him a breakeven cost of tuition. Another factor is that he will eventually make more money by getting his MBA, so any deficit, could likely be offset by a higher future income.

B. The two categories that stick out to me that need to be cut are; vacation expenses and eating out. They could easily cut both expense
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