Roberto listed his assets and liabilities on a personal balance sheet.
| | Assets | | Liabilities |
|---|---|---|---|
| cash | $1,800 | credit card | $4,000 |
| investments | $6,200 | personal loan | $1,000 |
| house | $150,000 | mortgage | $100,000 |
| car | $8,000 | car loan | $5,000 |
| Total | | Total |
After creating the balance sheet, Roberto decided to use his investments to pay off his car loan. How will that decision affect the difference between his assets and liabilities?
A. It will make the assets $5,000 less than the liabilities.
B. It will make the assets $5,000 more than the liabilities.
C. The difference between the assets and the liabilities will remain the same.
D. The difference between the assets and the liabilities cannot be compared.
Answer (2)
Calculate initial total assets and liabilities.
Calculate new total assets and liabilities after paying off the car loan.
Find the difference between assets and liabilities before and after the transaction.
Compare the differences to conclude that the difference remains the same: T h e d i ff ere n ce b e tw ee n t h e a sse t s an d t h e l iabi l i t i es w i ll re main t h es am e .
Explanation
Initial Assessment Let's analyze Roberto's balance sheet to understand how paying off his car loan with his investments affects his overall financial position. We'll start by calculating his initial total assets and total liabilities.
Calculating Initial Net Worth Roberto's initial assets include cash, investments, his house, and his car. So, his initial total assets ( A i ) are: A i = $1 , 800 + $6 , 200 + $150 , 000 + $8 , 000 = $166 , 000 His initial liabilities include his credit card balance, personal loan, mortgage, and car loan. So, his initial total liabilities ( L i ) are: L i = $4 , 000 + $1 , 000 + $100 , 000 + $5 , 000 = $110 , 000 Therefore, the initial difference ( D i ) between his assets and liabilities is: D i = A i − L i = $166 , 000 − $110 , 000 = $56 , 000
Changes After Paying Car Loan Now, let's see how Roberto's balance sheet changes after he uses his investments to pay off his car loan. He uses $5,000 from his investments to pay off his $5,000 car loan.
Calculating New Net Worth After paying off the car loan, Roberto's investments decrease by $5,000. His new investment value is: $6 , 200 − $5 , 000 = $1 , 200 His new total assets ( A f ) are: A f = $1 , 800 + $1 , 200 + $150 , 000 + $8 , 000 = $161 , 000 His car loan is now $0, so his new total liabilities ( L f ) are: L f = $4 , 000 + $1 , 000 + $100 , 000 + $0 = $105 , 000 The new difference ( D f ) between his assets and liabilities is: D f = A f − L f = $161 , 000 − $105 , 000 = $56 , 000
Comparing Initial and New Net Worth To determine the effect of Roberto's decision, we compare the initial difference ( D i ) and the new difference ( D f ): D f − D i = $56 , 000 − $56 , 000 = $0 Since the difference is $0, the difference between Roberto's assets and liabilities remains the same.
Conclusion Roberto's decision to use his investments to pay off his car loan does not change the difference between his total assets and total liabilities.
Examples
Imagine you have a certain amount of money (assets) and debts (liabilities). If you use some of your money to pay off a debt, the total amount of money you have decreases, but so does the amount of debt you owe. In the end, your overall financial health (the difference between what you own and what you owe) remains the same. This principle is crucial in personal finance for making informed decisions about managing debts and assets to maintain a stable financial position.
Roberto's decision to pay off his car loan with his investments keeps the difference between his total assets and total liabilities unchanged. Initially, the difference was $56,000 and remains $56,000 after the payment. Therefore, option C is the correct answer.
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