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CISC 121 Lecture 9: 2 - Chapter 2 - Part A 2018

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School
Queen's University
Department
Computing
Course
CISC 121
Professor
Wendy L Powley

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Document Summary

In this chapter the goal is to calculate the actuarial present value (apv) of the benefits of a life insurance policy. The actuarial present value may also be called the net single premium (nsp) and it is an expected present value. The apv or nsp is calculated by finding the expected value of the present- value random variable z, e[z]. You are probably already familiar with the concepts of present values and expected values. To illustrate, take an example of a person currently 115 years old. Say you are an insurance provider who has agreed to pay them. if they die in the current year or in the following year. Let us also suppose that there is a 1/3 chance that they will die this year, a 2/3 chance that they will die next year and that interest rates are steady at 5%. Payments are made at the end of the year of death.

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Related Questions

Joe and Lisa White are a married couple. Joe is 63 and Lisa is 61. Joe is thinking about retiring in a few years, and the Whites have come to you for an insurance evaluation. Lisa plans to continue working even after Joe retires. The following provides a summary of the Whites’ insurance planning situation.

Life Insurance

Joe owns a $500,000 universal life insurance policy. Joe is the insured and their son David, age 37, is the beneficiary. The policy has a cash value of $50,000 and a living benefits provision; all account earnings are used to offset premium expenses. Lisa owns a 20 year $350,000 level term life policy that she purchased five years ago. She pays approximately $1,000 per year in premium costs. Lisa is the insured and Joe is the beneficiary.

Property and casualty insurance

Joe and Lisa own a home as JTWROS. The home has a market and replacement value of $675,000. The house is insured with the standard HO-3 policy for $550,000. The policy requires that the Whites pay a $500 deductible per claim occurrence. Other provisions include the following:

10% coverage on detached structures

Coverage up to $250 for cash

Coverage up to $1,500 for collectibles, artwork, and similar assets

Personal property contents coverage equal to 20% of the insured dwelling

Living expenses coverage for six months

Coverage up to $100,000 for personal liability

A replacement cost coverage endorsement is in place

The Whites’ two cars are insured under a personal automobile policy with split limit coverage of 250,000/500,000/50,000. They also have a $1 million excess liability policy.

Health insurance

The Whites are covered under Lisa’s group health insurance plan. The traditional plan has a lifetime maximum benefit equal to $5 million for the family, a $500 per person deductible, and an 80% coinsurance clause, with the family stop-loss limit of $2,500.

Using this information, please answer the following questions.

3. If Joe were to die today, how would the universal life insurance policy benefits be distributed? Would there by any taxes involved: income tax, estate tax, gift tax? Explain your response completely.

4. What will be the tax consequences if Lisa decides to cancel her term life insurance policy? Justify your answer.

You have a contractor make improvements to a business rental for a fixxed price of $64,000. With this improvement you can obtain additional rent payments of $1,200 per month. You estimate the improvements will cause extra monthly expenses of $50 for property taxes, $45 for insurance, and $100 and $200
per month, respectively, in utility and maintenance costs. The life of this project is 15 years at which point the salvage value to the improvement is exactly $16,000. The improvements are depreciated on straight depreciation schedule (15 years). There is no income tax in Wyoming, so the only tax is Federal. Assume a marginal Federal tax rate of 33%.

(a) Assume that you pay cash of $64,000 for the project. Use
an MARR of 15% and calculate a net present value for this
cash stream after taxes.

(b) Assume that you borrow $50,000 (of the needed $64,000)
for the project at a nominal interest rate of 9%. The inter-
est on this loan is tax deductable. Use an MARR of 15%
and calculate a net present value for this cash stream after
taxes.

(Hint: The interest paid is not the same each year;
so part b) will probably require Excel to make the calcula-
tion easy. You can do it by hand, but it will take a few
calculations. The principal payments on the loan are not
tax deductable.)

Please show work for both problems and I will give a thumbs up!

5. You are considering the purchase of a quadruplex apartment building. Effective gross income during the first year of operations is expected to be $33,600 ($700 per month per unit). First-year operating expenses are expected to be $13,440 (at 40 percent of EGI). Ignore capital expenditures. The purchase price of the quadruplex is $200,000. The acquisition will be financed with $60,000 in equity and a $140,000 standard fixed-rate mortgage. The interest rate on the debt financing is 8 percent and the loan term is 30 years. Assume, for simplicity, that payments will be made annually and that there are no up-front financing costs.
a. What is the overall capitalization rate?
b. What is the effective gross income multiplier?
c. What is the equity dividend rate (the before-tax return on equity)?
d. What is the debt coverage ratio?
e. Assume the lender requires a minimum debt coverage ratio of 1.2. What is the largest loan that you could obtain if you decide that you want to borrow more than $140,000?
12. An office building is purchased with the following projected cash flows:
• NOI is expected to be $130,000 in year 1 with 5 percent annual increases.
• The purchase price of the property is $720,000.
• 100 percent equity financing is used to purchase the property.
• The property is sold at the end of year 4 for $860,000 with selling costs of 4 percent.
• The required unlevered rate of return is 14 percent.
a. Calculate the unlevered internal rate of return (IRR).
b. Calculate the unlevered net present value (NPV).
2. Health Care Event Protection. Christina Haley of San Marcos, Texas, age 57, recently suffered a stroke. She was in intensive care for 3 days and was hospitalized for 10 more days. Her total bill for this care was $125,500. After being discharged from the hospital, she spent 25 days in a nursing home at a cost of $170 per day. Christina, who earns $4,500 per month, missed two months of work. Christina had a health insurance plan through her employer. The policy had a $1000 deductible and an 80/20 coinsurance clause with a $2000 coinsurance cap. She had also accumulated 21 sick days (equivalent to one month) at work. Otherwise she had no long-term care or disability income insurance.
(a) How much of Christina's direct medical expenses was paid by her insurance policy?
(b) What did Christina have to pay for her nursing home care?
(c) How much income did Christina lose?
1. Calculating Life Insurance Need. Review the material in “How Much Life Insurance Do You Need?” on pages 351–354. Then using dollar amounts that fit your personal situation, complete Worksheet 48: Determining My Life Insurance Needs from “My Personal Financial Planner.” If you are currently single and childless, for the purposes of this activity, assume that you are 30 years old, have two children under age 5, are married, and earn $60,000 per year and redo the estimate of need. How would having a family change your need for life insurance?
Determining My Life Insurance Needs (page 353)
NOTE: Results here may differ slightly than when using Appendix A in text due to rounding.
Factors Affecting Need
Sample Only
Insert Your Own Figures
1. Income-replacement needs*
$823,219
2. Final-expense needs
$ 12,000
3. Readjustment-period needs
$ 19,000
4. Debt-repayment needs
$ 10,000
5. College-expense needs
$ 75,000
6. Other special needs
$ -
7. Subtotal (combined effects of items 1–6)
$ 939,219
8. Government benefits**
$390,370
9. Investment Assets Available
$0
10. Current Life Insurance In Place
$ 98,000
11. Life insurance needed
$ 450,848
*Income Replacement Needs Calculator
Current Annual Income
$56,000
Percent of Annual Income To Be Replaced
75%
Annuity Amount (% desired of annual income)
$42,000
i (assumed interest rate
3.00%
n (number of annuity payments)
30
PV (present value) of Income Replacement Needs
$823,219
**Present Value of Social Security Benefits Calculator
Estimated Monthly Benefit (See Appendix B in Text)
$2,725.00
Estimated Annual Benefit
$32,700
i (assumed interest rate
3.00%
n (number of annuity payments)
15
PV (present value) of Government Benefits
$390,370