David and Kate White Jones, aged 37 and 34, have two young children, aged 4 & 7, and live in Hamilton. They own their own coffee-grinding business in which they work together full-time. The business is doing reasonably well. They rent a shop premises and own equipment worth $28,000.
After covering basic living expenses, David and Kate can put aside $1,500 as savings each month. They have managed to save $50,000 so far during their working lives and this money is earning 3.15% annual interest, compounded monthly, in a bank fixed deposit. As self-employed they have no KiwiSaver funds. David and Kate are renting at present but wish to purchase a home. Their goal is to put down a 20% deposit on a $700,000 home in three years’ time. They are finding, however, that average 10% p/a house prices rise, is making it difficult as they are chasing a moving target.
The couple also has a credit card on which they owe $6,200 according to their last bill. They are trying not to use the card anymore but tend to only pay off the minimum amount (2% of the balance) each month. The interest rate on the card is 21.74%, compounded monthly. In addition, the couple also owe $7,000 to their bank from taking a small business loan to fund their purchase of the equipment in their shop, they are paying an interest rate of 6.5% for the loan at the moment.
David and Kate have somewhat different ideas about the best way to manage their money going forward. Kate is happy to keep their present and future savings in the bank earning a moderate rate of interest. However, David has started to take a more active interest in finance and investment and has come to the conclusion that if they are to have any chance of achieving their goal of saving for the house deposit they must take a much more aggressive approach. He has been doing some intensive research on the internet, as well as asking around. His friend has advised him that his BitCoin investments have returned 45% p/a over the last two years. David hopes he will be able to persuade Kate to invest their $50,000 in Bitcoins for a period of two years, while investing any additional future monthly savings in the bank. Kate laughs at his idea, and insists that their money should stay in fixed deposit.
After a lot of heated discussion, David and Kate decide if they want to own a house they need a new approach, and decide to get investment advice. They go and see an ex-school-friend, Jeremy, who commenced work as a commissioned financial adviser two months ago. They ask Jeremy to provide them with more information on investing, and what Jeremy thinks about the merits of their respective approaches. During the course of a one-hour meeting, Jeremy agrees that a more aggressive investment approach is required and is more likely to help them achieve their goals. Jeremy also states that sources of information on the investment process are somewhat limited and that David and Kate have made the right decision in approaching him for advice. Jeremy recommends that they invest in an IT start-up established by a friend of his, a just listed firm called SMARTIT. SMARTIT shares cost $5:15 each and the prospectus promises a dividend of 15c per quarter, as well as forecasting capital growth of 20% per year. Being a start-up, SMARTIT has never made a profit in its 3 years of existence. Its shares have changed in price by 22%, -15%, and 35% over the last three years.
Answer the following seven questions, showing all of your working where appropriate. For the purposes of calculations, you may ignore the impact of taxes.
1. What financial issues do David and Kate have? (4 marks)
2. Calculate the current dividend return on SMARTIT. (1 mark)
3. What has SMARTIT’s average p/a capital growth been? If SMARTIT share price grows over the next three years by that average, then what will the share price be in three year’s time? (2 marks)
4. Assuming the rates of return indicated in the case study could be achieved, and did not change over the next three years, would any of the three alternative investment plans enable them to achieve their goal of saving a deposit for a home? (3 marks)
5. Briefly assess David and Kate’s differing ideas about investing in terms of the risks and returns involved. Which option is best to them, alternatively are there other options? (3 marks)
6. Discuss the ethical issues arising from Jeremy’s advice. (3 marks)
7. What financial planning process should David and Kate follow? (4 mark)