Client Situation
Rosemarie just turned 30 and is considering a job opportunity as a travelling officer. She will receive a taxable travelling allowance of $1,500 monthly and will be able to include two thirds of her vehicle-related expenses in her tax return.
Rosemarie is thinking about an offer from her bank to finance 100 per cent of the purchase price of a new vehicle costing $205,000; the loan will run for six years at an APR of 8.0 per cent. She has to cover the upfront bank fees, legal costs and full-comprehensive insurance for the period.Apart from the financing costs, she has to consider the cost of operating the vehicle.
She estimates:
�2 Monthly: gas: $600, parking: $500, detailing: $100.
�2 Quarterly: service: $1,500.
�2 Annually: insurance: $10,000, GPS tracking: $1,200.
�2 Biannually: tyres $2,000.
Rosemarie was told that the car could lose approximately 10 per cent of its market value as soon as she drives it out of the showroom and every year after that.This got her thinking about the overall financial impact of this purchase and wondered if it can be quantified for the period of the loan.
Nick's assessment & advice
This is an interesting case. It is not common that someone would ask about the impact of owning a new vehicle.Most times they are filled with the euphoria of the new car smell. The benefits are obvious in terms of the convenience, comfort and confidence but the costs are seldom ever considered. When the car bill comes up you just pay it!When evaluating the overall financial impact of this investment the main variables to consider are:
The negative financial impact
�2 The upfront borrowing cost
�2 The interest cost
�2 Depreciation (10 per cent)
�2 The operating costs
�2 Monthly: gas, parking and detailing
�2 Quarterly: routine service
�2 Annually: insurance and GPS
�2 Biannual: tyres
The positive financial impact
�2 The taxable benefit
�2 The reduction in taxes
Once these variables are quantified and combined, we can then ascertain Rosemarie's net financial position at the end of the six-year period; the negative financial variables will offset the positives.
The upfront borrowing cost
Rosemarie has to put out some of her own money from the outset even though she is receiving 100 per cent financing on the car. We can only estimate what some of these costs are:
Credit bureau fees: $100
Bank negotiation/administration Fees: $500
Group creditor's life insurance (optional): $1,000
Legal fees (mortgage bill of sale): $2,400
GPS/anti-theft system:$3,000
Full comprehensive insurance: $10,000
Total estimated upfront cost: $17,000
The interest cost
Using the principal sum of $205,000, an interest rate of 8.0 per cent (APR) and a term of six years, the monthly payment would be: $3,594–multiplied by 72 months would result in a total payback to the bank of $258,768–this amount less the principal of $205,000 translates into a total interest cost of $53,768. Table 3 shows how this will be spread over the six-year period.
Depreciation
Using a "declining balance method" with an annual rate of 10 per cent, (holding all other variables constant), Table 2 illustrates the yearly and then the total loss in value of the car.
The operating costs
Table 1 illustrates a projection of the running and interest costs. The expenses are first converted to an annual figure then to a six-year total to show the trend of the reducing bank interest and insurance premiums (10 per cent reduction to cater for no claim discounts).
The taxable benefit
After accounting for taxes, her travelling allowance of $1,500 becomes $1,125 monthly or $13,500 annually or $81,000 over the six-year period (after tax).
Tax deductible travelling expenses
Assuming that all of her operating expenses are allowed by the Inland Revenue Division, she can use two thirds (2/3) of it to reduce her assessable /chargeable income before computing her tax liability. This also assumes that she is indeed liable to pay taxes based on her income bracket. The tax savings will be 25% of 2/3 of her travelling expenses. In the first year this can be calculated as: $47,998 x 2/3 = $31,999 x 25% = $8,000 tax refund. The total tax benefit over the six-year period will be: $236,247 x 2/3 = $157,498 x 25% = $39,375 tax refund.
End of sixth year financial position
To know where she will stand financially at the end of the period we need to bring all of the cash flows together (negative) and positive:
Cost of car: ($205,000)
Up front borrowing cost: ($17,000)
Depreciation: ($ 96,055)
Operating cost for period
(including interest): $236,247
Total negative impact: ($554,302)
Travelling allowance
(after tax): $81,000
Total tax refund: $39,375
End of period value: $108,945
Total positive impact: $229,320
Net financial position: ($324,982)
(Details were modified to protect client's identity)
Nicholas Dean (Cer-Fa) is a financial coach and mentor who is the managing director of the Financial Coaching Centre. He can be contacted at: nickadvice@gmail.com www.FinancialCoachingCentre.com
