Question

Pat estimates that $60,000 is seen as sufficient wealth to meet his family's needs after his death. Currently, the family has $800,000 total assets, including bank saving, securities investment, house, cars, etc. The family currently has $220,000 total liability (e.g., mortgage payoff, auto loan, credit card balance), $135,000 cash needs (e.g., emergency fund, educational fund, and final expenses), and $145,000 non-income-producing capital. Ignore any other potential capital resources or needs, e.g., Social Security benefits. Assuming a 5% rate of return, how much life insurance does the Capital Retention Approach suggest? (Supplement reading/example about Capital Retention Approach is provided at Module 4 --> Life Insurance -->Reading). Again, please show all your work and calculations so you can receive partial credit even if you make a mistake. The appearance of your homework is a factor in your grade; therefore, it is suggested it be presented in a professional manner.

Please use the given information to calculate the amount of life insurance Pat should get, using the Capital Retention Approach. Please show all calculations and use your own work, thanks!

Answer 1

Step 1 - Basic Data

1.Total Assets - 800,000

2. Total Liabilities - 220,000

3. Cash Needs - 135,000

4. Non-income-Producing capital - 145,000

Step 2 - Compute Income producing capital

1.Total Assets 800,000

2. Less :

a. Total Liabilities 220,000

b. Cash Needs 135,000

c. Non income producing capital 145,000

3. Total Deductions 500,000

4. Capital available for income 300,000

Step 3 - Amount of Life Insurance

1. Wealth estimates to meet family needs 60,000

2. Income required (60,000*5%) 3,000

3. Capital available (step 2)     300,000

4. Income to get generated (300,000*5%) 15,000

Step 4 - Conclusion

Since income generated from capital available (Step 3.4) is greater than income requirements of the family (Step 3.2), there is no need for life insurance cover.