Question

Howard and Millie, 28 and 26 respectively, is a young family without children. Howard works as an engineer for a medium size manufacturing company, earning $70,000 per year. Millie works part-time at a doctor's office, earning $20,000 per year. They expect that their income will keep pace with inflation, which is expected to be 2% per year.

Millie does all the housework, such as cooking meals and cleaning the house. She estimates that it would cost $18,000 to hire somebody to do (all) the housework that she is doing.

They are free spenders; they spend all their income every month, so that they have no savings. Although they want to save, they don't want to change their life style. If one of them dies; the remaining person would still need 90% of their current spending. You can ignore taxes in this question.

Howard has good benefits from his work, including group life insurance that provides a lump sum equal to three times his salary if he dies. They plan to work until age 65.

Assumptions:

- Use real dollars in your answer.

- The nominal rate of interest is 6%.

- Cash flows are at the end of the year.

- Ignore taxes.

Required:

(a) Using the Income Approach, how much life insurance does the family need?

(b) Using the Expense Approach, how much life insurance does the family need?

Answer #1

**Answer :**

**(1). Income Approach**

Particulars |
Howard
($) |
Millie
($) |

Retirement age |
65 |
65 |

Present age |
28 |
26 |

Remaining age |
37 |
39 |

Yearly salary |
70000 |
20000 |

Opportunity salary |
0 |
18000 |

Annualy salary |
70000 |
38000 |

Infliation % per
year |
2% |
2% |

Insurance needed
using |
- |
- |

Income approach |
37,82,398 |
22,13,015 |

**Hence insurance needed to the family using income
approach is $ 59,95,413 (37,82,398 + 22,13,015)**

**(2). Expensea Approach**

Total income of the
family |
90,000 |
(70000 +
20000) |

Total Expenses they
required |
90,000 |
- |

Expenses required if one
dies |
81,000 |
- |

Average age remaining for
retirement |
38 |
(37+39)/2 |

Nominal rate of
interest |
6% |
- |

Insurance needed |
1,10,08,241 |
- |

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